WORKING CAPITAL & METHODS USED FOR FINANCIAL

PLANNING, NEEDS & LIMITATIONS, TYPES OF

FINANCIAL STATEMENT ANALYSIS

INTRODUCTION

Working capital management is concerned with the decisions which are related with
the current assets and the current liabilities. It means, it concerned with day-to-day
management activities. The key factor, which is used to differentiate long term financial
management and short- term financial management, is the timing of cash. Long- term
financial decisions by buying capital equipment or issuing debentures, involve cash which
flows over an extended period of time. But a short time financial decision mainly involves the
cash flow within a year, or within the operating cycle of the firm.

CONCEPTS OF WORKING CAPITAL

The two concepts of working capital are

Gross working capital

It refers to the investment made by the company in current assets. Current assets are
the assets which can be converted into cash with an accounting year or operating cycle. It
also includes cash, short-term securities, debtors, bills receivable and stock.

Net working capital

The difference between current assets and current is called the net working capital.
Current liabilities are the one which is claimed from the outsiders and are expected to be
returned within an accounting year. It includes creditors, bills payable, and out siding
expenses. Net working capital may be positive or negative. A net working capital becomes
positive only when the current assets exceed current liabilities. A negative net working
capital occurs when current liabilities exceed current assets.

1
LIMITATIONS

Danger of inadequate working capital

Inadequate working capital will lead to a condition, in which one cannot pay its
short-term liabilities in time. So there arises a situation where there is a loss of
reputation and tight credit terms.
The organizations requirements cannot be fulfilled in bulk; hence it cannot take
the advantage of cash discounts.
Difficulties will arise in meeting the day-to-day expenses. This will lead to
inefficiency and increase in costs with the minimum profits.
Lack of working capital will lead to less favorable marketing conditions and less
profitable projects.
Due to scarcity of working capital, fixed assets are not properly utilized. Thus this
results in the fall of investments return.

Danger of Excessive Working Capital

Excessive working capital will lead to low investments in fixed assets. Hence
there will be no profits for the business and there can be no proper rote of return
on its investments.
The low rate of return on investment will lead to the fall in the value of shares.
Excessive debtors and defective credit policy are the indication of excessive
working capital. There may be delay in collection and increased incidence of bad
debts.
Excessive working capital will make the management complacent. This will lead
to overall inefficiency in the organization.

NEED FOR WORKING CAPITAL MANAGEMENT

Beyond the limit, both the current assets i.e., inadequate working capital and
excessive working capital are dangerous. Beyond the limitations of both the level,
the common goal of the organization cannot be achieved.
Working capital Management provides effective and efficient decision to allocate
the current assets.

2
METHODS USED FOR FINANCIAL PLANNING

Financial analysts often compare financial ratios (of solvency, profitability, growth,
etc.): Financial performance can be measured in three methods. They are

Past Performance
Future Performance
Comparative Performance

Past Performance

Across historical time periods for the same company (the last 5 years for example),

Future Performance

Using historical figures and certain mathematical and statistical techniques, including
present and future values, this extrapolation method is the main source of errors in financial
analysis as past statistics can be poor predictors of future prospects.

Comparative Performance

Comparison between similar companys is analyzed for measuring comparative

performance. These ratios are calculated by dividing a (group of) account balance(s), taken
from the balance sheet and / or the income statement, by another, for example:

Net income / equity = return on equity (ROE)

Net income / total assets = return on assets (ROA)

Asset Management Ratios gauge how efficiently a company can change assets into
sales.

Stock price / earnings per share = P/E ratio

Comparing financial ratios is merely one way of conducting financial analysis.

Financial ratios face several theoretical challenges:

3
 They say little about the company's prospects in an absolute sense. Their insights
about relative performance require a reference point from other time periods or
similar companys.
One ratio holds little meaning. As indicators, ratios can be logically interpreted in
at least two ways. One can partially overcome this problem by combining several
related ratios to paint a more comprehensive picture of the company's
performance.
Seasonal factors may prevent year-end values from being representative. A ratio's
values may be distorted as account balances change from the beginning to the end
of an accounting period. Use average values for such accounts whenever possible.
Financial ratios are no more objective than the accounting methods employed.
Changes in accounting policies or choices can yield drastically different ratio
values.

TYPES OF FINANCIAL STATEMENT ANALYSIS

FINANCIAL ANALYSIS

Financial analysis or financial statement analysis or accounting analysis or Analysis

of finance refers to an assessment of the viability, stability and profitability of a business,
sub-business or project. It is performed by professionals who prepare reports using ratios that
make use of information taken from financial statements and other reports. These reports are
usually presented to top management as one of their bases in making business decisions.

Continue or discontinue its main operation or part of its business;

Make or purchase certain materials in the manufacture of its product;
Acquire or rent/lease certain machineries and equipment in the production of its
goods;
Issue stocks or negotiate for a company loan to increase its working capital;
Make decisions regarding investing or lending capital;
Other decisions that allow management to make an informed selection on various
alternatives in the conduct of its business.

4
 Financial analysts can also use percentage analysis which involves reducing a series
of figures as a percentage of some base amounts. When proportionate changes in the same
figure over a given time period expressed as a percentage is known as horizontal analysis.
Vertical or common-size analysis reduces all items on a statement to a common size as a
percentage of some base value which assists in comparability with other companies of
different sizes. Financial statement analysis is a valuable tool for gauging the financial
stability and health of a company. Financial statement analysis is a popular tool for investors,
stakeholders and the key decision makers within the organization.

Two very popular methods of financial statement analysis are: horizontal and vertical
analysis and the use of financial ratios. As a result, all Income Statement items are divided by
Sales, and all Balance Sheet items are divided by Total Assets. Another method is
comparative analysis. This provides a better way to determine trends. Comparative analysis
presents the same information for two or more time periods and is presented side-by-side to
allow for easy analysis.

CONCLUSION

Financial Analysis provides analytical services including annual reports and surveys,
university and EVPCFO budget process, consulting services, capital planning and recharge
rate approvals. Horizontal analysis compares financial information over a series of time,
typically from past quarters or years. Horizontal analysis is performed by comparing financial
data from a past statement, such as the income statement. When comparing this past
information one will want to look for variations such as higher/lower earnings. Vertical
analysis is a proportional analysis of financial statements. Each line item listed in the
financial statement is listed as the percentage of another line item. For example, on an income
statement each line item will be listed as a percentage of gross sales.

REFERENCES

https://en.wikipedia.org/wiki/working-capital
http://www.investopedia.com/terms/w/workingcapital.asp
http://www.businessdictionary.com
http://economictimes.indiatimes.com
http://www.accountingcoach.com/blog/what-is-financial-analysis