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Project On Working Capital Management
Project On Working Capital Management
Working capital is the life blood and nerve centre of a business. Working part of firms capital which is required to finance short term or current assets. According to account terminology-It is the difference between the inflow and outflow of funds. In other words it is net cash flow. Thus working capital is the amount of funds necessary to cover the cost of operating an enterprise.
e. To provide credit facilities to customers. f. To maintain inventories of raw material, work in progress, stores and spares, finished goods. Sufficient working capital is necessary to sustain sales activity; this is referred to operating or cash cycle. The continuing flow from cash to suppliers, to inventory, to accounts receivables and back in to cash is what is called operating cycle. In other words the term cash cycle refers to the length of time necessary to complete the following cycle of events; 1, conversion of cash to inventory 2. Conversion of inventory in to receivables. 3. Conversion of receivables in to cash. The need or objects of working capital in a business can be understood by studying the business under varying circumstances such as a new concern, as a growing concern, and as one, which has attainted maturity. A new concern needs a lot of liquid funds to meet the various initial expenses. The amount of working capital needed goes on increasing with the growth and expansion of the business till it attains maturity. At maturity the amount of working capital needed is called normal working capital.
5. Business concern with adequate working capital can exploit favorable market conditions like purchasing its
requirements in bulk when the prices are low. And lower by holding its inventories for high prices 6. Only concern with adequate working capital can face business crises in emergencies such as depression because during such periods generally there is much pressure on working capital. 7. Sufficiency of working capital enables a concern to pay quick and regular dividends to its investors as there may not be much pressure to plough back profits. This gains the confidence of its investors and creates favorable market to raise additional fund in the future. 8. It also creates an environment of safety, confidence, and high morale and thus improves over all efficiency of a business.
4. a company may loss its reputation when it is not in a position to pay off its short term obligations. As a result the firm faces tight credit terms. 5. It becomes difficult for the firms to exploit favorable conditions. So a company may not be able to take advantage of profitable business opportunities. An enlightened management should there fore maintain the right amount of working capital on continuous basis. Sound financial and statistical techniques, supported by judgment, should be used to predict the quantum of working capital needed at different times.
justified by a firms equity position. The level of current assets may be measured with the help of two ratios 1. Current assets as a percentage of total assets 2. Current assets of total percentage of total assets While deciding about the composition of current assets, the financial manager may consider the relevant industrial averages 3. PRINCIPLE OF MATURITY OF PAYMENT This principle is concerned with planning the sources of finance for working capital. According to this principle a firm should make every effort to relate maturities of payment to its flow of internally generated funds. Maturity pattern of various current obligations is an important factor in risk assumptions and risk assessments. Generally shorter the maturity schedules of current liabilities in relation to expected cash inflows the greater the inability to meet its obligation in time.
2. Action to stocks
Consider keeping stock in suppliers warehouse, drawing on it as needed and saving warehousing cost. To keep stock levels as low as possible consistent with no running out of stock and not ordering stock in
uneconomically small qualities just in time stock management is fine as long as is just in time and never fails delivery on time.
4. action on creditors
Company shall try not to pay invoices too early so as to take advantage of credit offered by suppliers. A firm should try to pay early if the supplier is offering a discount. A company should maintain a register of creditors to ensure that creditors are paid on a correct date not earlier and not later.
OPERATING CYCLE
There is a difference between current assets and fixed assets in terms of their liquidity. A firm requires many years to recover the initial investments in fixed assets such as plant and machinery or land and building. On the contrary, investment in current assets is turned over many times in a year. Operating cycle is the time duration required to cover the sales, after the conversion of resources in to inventories, in to cash. The operating cycle of a manufacturing company involves three phases; o Acquisition of resources such as raw material, labour, power and fuel etc. o Manufacture of of the product which includes conversion of raw material in to work in progress in to finished goods. o Sales of the product either for cash or on credit. Credit sales create book debt for collection. The length of the operating cycle is determined by the sum of Inventory conversion period (ICP) Book debt conversion period (BDCP) Inventory conversion period is the total time needed for producing and selling the product. It includes the Raw material conversion period Working progress conversion period Finished goods conversion period. The book debt conversion period includes the time required to collect the outstanding amount from customers. The total of inventory conversion period and book debts and conversion period is some times referred to as gross operating cycle.
RATIO ANALYSIS
It is a powerful tool of financial analysis. A ratio is defined as the indicated quotient of two mathematical expressions and as the relationship between two or more things. In financial analysis a ratio is used as a bench mark for evaluating the financial position and performance of a firm. An accounting figure conveys meaning when it is related to some other relevant information. The relationship between two accounting figures expressed mathematically is known as a financial ratio. Ratio helps to summaries the large quantizes of financial data and to make quantitative judgment about the firms financial performance.
TYPES OF RATIOS
Several ratios calculated from the accounting data can be grouped in to various classes according to the financial activity or the function to be evaluated. Following are the classifications. Liquidity ratios Leverage ratios Activity ratios Profitability ratios
Liquidity ratios measures the firms ability to meet current obligations; leverage ratios shows the proportions of debt and equity in financing the firms asset; activity ratios shows the firms efficiency in utilizing its assets, and profitability ratio measures over all performance and effectiveness of the firm.
LIQUIDITY RATIO
Liquidity ratio measures the ability of the firm to meet its current obligations. A firm should ensure that it does not suffer from lack of liquidity, and also that it does not have excess liquidity. The failure of a company to meet its obligations due to lack of sufficient liquidity, will result in a poor credit worthiness, loss of creditors confidence, or even in legal tangles resulting in the closure of the company. A very high degree of liquidity is also bad; idle assets earn nothing. The firms funds will be un necessarily tied up in current assets. There for it is necessary to strike a proper balance between high liquidity and lack of liquidity. Following are the most common liquidity ratios; Current ratio Quick ratio Absolute Quick ratio Interval measures
CURRENT RATIO;
Current assets are the assets which can be converted in to cash with in a year. Such as marketable securities, debtors, inventories, etc.current liabilities include creditors, bills payable, and short term bank loan. The ratio measures the firms short term solvency. It indicates the availability of the current assets in rupees for every one rupee of current liability. A ratio is greater than one means that the firm has more current assets than current claims against them.
QUICK RATIO;
This ratio establishes a relationship between quick or liquid assets and current liabilities. An asset is liquid as it can be converted in to cash immediately or reasonably soon with out a loss of value. Cash is a most liquid asset and inventories are considered to be less liquid. an idle quick ratio is 1:1.
INTERVAL MEASURES;
This ratio indicates that a firms ability to meet its regular cash expenses. Interval measures relate liquid assets to average daily cash outflows.
LIVERAGE RATIO
DEBT EQUITY RATIO
The short term creditors, like banks and suppliers of raw material, are more concerned about the firms current debt paying ability. On the other hand the long term creditors like debenture holders; financial institutions etc are more interested in the firms financial strength. In fact the firm should have a strong short as well as long term financial position.
ACTIVITY RATIO
Funds of various owners are invested in various assets to generate sales and profits. The better management of assets, the larger amount of sales. Activity ratios are employed to evaluate the efficiency with which the firm manages and utilizes its assets. These are also called the turn over ratios. Following are the important activity ratios. Inventory turn over ratio Debtors turn over ratio Creditors turn over ratio Current assets turn over ratio Working capital turn over ratio Cash turn over ratio
Inventory turn over ratio; this ratio indicates that the efficiency of firm in selling its product. It shows the conversation of the raw material in to finished goods. Debtors turn over ratio; this shows the number of times debtors turn over in each year. Generally a high value of debtors turn over ratio means the more efficient management of credit. Creditors turn over ratio; it shows efficiency of the firm to pay its debt. And the length of the payment period encourages the suppliers to allow the credit. Current assets turn over ratio; it is the turn over of the current assets. Assets are used to generate sales. This ratio helps to understand the efficiency of the current assets in promoting the sales. Working capital turnover ratio; it shows the efficiency of the working capital management of the firm. Cash turn over ratio; is also shows the involvement of the cash in sales.
PROFITABILITY RATIOS
A company should earn profits to survive and grow over a long period of time. Profits are essential but it would be wrong to assume that every action initiated by management of the firm should be aimed at maximizing the profit. Profits are the difference between the revenue and expenses. They are the ultimate output of the company. And it will have no future there fore the financial manager should continuously evaluate the efficiency of its company in terms of profits.following are the important profitability ratios. Net profit ratio Gross profit ratio Operating expenses ratio Net profit ratio: it is the profit obtained when operating expenses, interest and taxes are subtracted from the gross profit
Gross profit ratio: this ratio reflects the efficiency with which management produces each unit of product. it indicate the average spread between the cost of goods sold and sales revenue. a high G.P ratio is a sign of good management. Operating expenses ratio: it is an important ratio that changes in the profit margin ratio. a high ratio is unfavorable since it will leave a small amount of operating income to meet interest, dividend etc.
Importance of ratio analysis; o The ability of the firm to meet its current obligations o The extent to which the firm has used its long term solvency by borrowing funds. o The efficiency with which the firm is utilizing its assets in generating sales revenue o The over all operating efficiency and performance of the firm Limitations of ratio analysis;
o It is difficult to decide on the proper basis of comparison. o The comparison is reentered difficult because of difference in situations of two companies of one company over years o The price level changes make the interpretations of ratios invalid o The differences in the definitions of items in the balance sheet and profit and loss statement make the interpretations of ratio difficult. o The ratios calculated at a point of time are less informative and defective as they suffer from short term changes o The ratio are generally calculated from past financial statement and thus are no indicates of future.