Working capital is the difference bétween the inflow and outflow of funds. in other words, it is the net cash inflow. It is defined as “the excess of current assets over current liabilities and provisions,” In other words, it is “net current assets or net working capital”. Working capital represents the total of all current assets. In gther words, it is “gross working capital’. It is also"known as circulating capital or current capital, for current assets are Totating in their nature, Where current liabilities and provisions exceed assets; the difference is referred to as negative working capital. This is a situation of crisis, The use of the term circulating capital instead of work the flow is circular in nature. At the beginning of a business venture, cash is provided by the owners and lenders, A part of his cash is invested in tools, machinery, furniture, equipment, building and other forms of fixed assets, which are not to be sold during the normal course of the business, The remaining cash is used as working capital to meet the current requirements of a business enterprise such as purchase of services, raw materials or merchandise When a firm's products or finished goods are sold, it has, what is known es ri receivables, Wh sh or receivables are collected, more cash is availabie for planning of services and the purchase of raw materials or merchandise. This flow of cash into production and so on, illustrates the cincular flow of working capital, Types of working capital oiNet Working capital “* Gross working capital ——-—Cash Working Capital Permanent working capital Variable working capital Negative Working Capital Balance Sheet working capital _____ 531 Current Net working Capital: The net working capit the difference be mn assets and current liabilities. The concept of net working capital enables a firm to determine how much amount is left for operational requtireme! Gross Working Capital: Gross working capital is the amount of funds invested in the various components of current assets. Permanent Working Capital: Permanent working capital is the minimum amount of current assets, which is required to conduct a business even during the dullest season of the year. This amount varies from year to year, depending upon the growth of a company and the stage of the business cycle in which it operates, It represents the current assets; which are required on a continuing Dasis over the entire year It is maintained as the medium to carry on operations atanytime. Cemporary or Variable Working Capital: It represenis the additional assets, which ate requized at different times during the operating year- additional inventory, extra cash etc. Seasonal working capital is the additional amount of current assets- primarily cash, receivables and inventory which are required during the more active business seasons of the year Nalance Sheet Working Capital: The balance sheet working capital is one, wiiich is calculated from the items appearing in the balance sheet. Gross working capital, which is represented by the tolal of awrent assets, and net working capital, represented by the excess of current assets over current liabilities, are examples of the balance sheet worki i Sash Working Capital: Cash Working Capital is one, which is calculated from the items appearing in the profit and loss account. It shows the real flow of money or value at a particular time and is considered to be the most realistic approach in working capital management. It is the basis of the operation cycle concept and indicates the adequacy of the cash flow, which is an essential pre- requisite of a business. Negative Working Capital: Negative working capital emerges when current Habilities exceed current assets. Such a situation is not absolutely theoreiical, oceurs when a firm is nearing a crisis of some magnitude. FACTORS DI ‘ERMINING WORKING CAPITA! 1. Nature‘of Industry: The composition of assets is a function of the size of a business and the industry to which it belongs. Small compani: smaller proportions of cash, receivables and inventory tha St have lasgecorporations. A public Utility, for exampl Us operations, while merchandising department depends generally on mwventory and receivables. Needs for working capitals are thus determined by the nature of an enterprise Demand of Industry: Creditors are interested in the security of loans ‘They want their obligations to be sufficiently covered. They want the amount of securities in assets, which are greater than the Kability. Cash requirements: Cash should be adequate and. properly utilized. It would be very expensive to hold excessive cash. A minimum level of cash is always required to keep the operations going. Adequate cash is aiso required to maintain good credit relations. le, mostly employs fixed assets in e Time: The level of working capital depends upon the time required to manufacture good products. If the time is longer, the size of working capital is greater. — . Volume of sales: The volume of sales and size of the working capital are directly related to each other, As the volume of sales increases, there is an increase in the investment of working capital- in the cost of operations, in inventories and in receivables. Terms of purchases and sales; With more favourable credit terms, working capital requirements can be reduced. A firm gets more time for payment to creditors or suppliers, A firm, which enjoys greater credit with banks, needs less working capital Inventory Turnoyer: If the inventory turnover is high, the working capital requirements will be low 8. Receivable Turnover: 4 facilities for settling payal will be low. 9. Production Schedule: The object of continuity in production can be ensured if necessary raw material component etc,, are properly stored and supplied. Availability of working capital can solve the problem of stoppage of prodiction. 10. Business Cycle: More working capital is required during periods of prosperity and less during the periods of depression. During marked upswings of activity, there is usually a need for larger amounts of capital to cover the lag between collection and increased sales and to finance purchases of additional materials to support growing business activity Moreover, during the recovery and prosperity phase of the business cycle, prices of raw materials and wages tend to rise and the business will require additional funds to carry even the same physical volume of business & ompt collection of receivables and. ooil <5 result into low working capital re 11, Production Cycle: The time taken to convert raw materials into finished products is referred to as the production or operating: cycle. The longer the production cycle, the greater is the requirement of working capital. 5Svents insolvency/bankruptey sctationship with the bank is not stained od celationship w TOME paymes nagement. st can be availed if payment is made before a eats io-suong credit rating cesulling in pschase of seods on favourable fp Itleads to stiong rea ¢ liste {) Totake advantage of favourable business opportunities ; g) The fisay can meet unexpected cash expenditure with minimum strain Minisizing fwids committed to cash balances minimizing cash balances Wwoutd } payment with all its advantages. Buu it also finplies that lage funds will rema res Ne prompe : , “ l idle, as cash is q nan-erning asset and the firm will have to forego protits a low level cash balance may iy failure to meet the payment schedule. The aim of cash management should be een amount of cash balance. ‘0 have tight roblems iitvolyed in managing cash flows ) Centtolling the*level of cash balance: the level of ca _ following devices ~ a) By preparing cash budget: it is an estimate of the fiem’s ca varigus intervals of time. It helps the mana same tiie to prevent accumulation of large inventory cash balances “)) By prdviding for ‘unpredictable discrepancies: means providing, sufficient cask tatone mest the discreyancies.between eash inflow and cash outflow on accotit of afore: cash utes Strikes floods etc. which are not provided by cash budgets The anmar of cash requitéd (© be*maintained can be Uetexinined on the basis of past expendituce and wy forecast about the Hutiive c Shovt costs imay compro: sh balances can be contilied by ite st receipts and cash payments over sement to rheet ail its obligations in ti nd at the: ration of shortag S istted en account of shurt S€ costs incuried in de Secuting the amounts duc to them. Tigh cos: af bat . feplilation, penally cetes by hanks to mee d) Exes Inge i Opportunitics to iw i short fall in compensating balmices ete large fiundls ave idle, the implication ts dint thie firm lias wissen those finds and has therefore lost interest whieh it Ww ‘oss tf interest is primagily the exces - artangement for funds ftom other sources particularly banks ta times of emergencies therefore a firm can avoid unnacessavily large amounts of cash have earnetl otherwise, Thi By making ) Controlling the inflow of cash: - — The objective is the precaution of defalcation of cash by employers and increasing of ch “through speedy collection of cash from customers. The following are the techniques controlling cash inflows: | a) By increasing cash sales. cash inllows ean be increased. | he reduced 3 Speeding collection of accoutts ~ the averaze collection period ore eee by changes in i. Credit terms it, Credit standards an Sec une + Credit standards determine the criterion for determining t0 wipon cet tol ) Collection policies determine the effort peut terth to collect Se |g) Thorough proper system of intacnal ies peer ao Fe et erem ples , d) Concentration banking: large firms which have large « banks at e 3 for 5 -ollection eanter pecsal Ject some of these, which are strategically located as ona ove collected at? ee 2 See from customers. Cheques for a ecrtain geographical afea 10° 7 1 . stome Se nillires Payee oncentration banking iS a-system ct deventralssed billing f center. Con bt4) Duvestiment of surplus cash: Temporary surplus cash may be invested in marketabl wables [t reduces time nee ed for coll! x Won, te results in saving Une 4 mailing and clearing of custemer payments. 8) Lock-box systerm there is time lapse beldre a cheyute is deposited by the local collect 3H center in its account. The lock-bow system takes care of this kind of problem apart from affecting economy in mailing and clearance ume. Under this arrangement, a firm hives pe office boxes at important centets. The customers are required to box. The local emit paynients inte the loc! ks of the firm at respective places ate authorized to open its box and pick up its remittances (cheques) received [rom the customer several times a day and deposit them into the account. Controlling outélow of cash: main objective is slowing dawn disbursement of payment. as [ar as possible without damaging the eredit standing. a) Centralized system of disbursement is one of the devices employed by firms ta slow down disbursemonts. All disbursements are made {com a single contvol account. This will result in delay in presentment of cheque for payment that is tar away trom the place of control account, b) A firm can control outtlow of cash by make payment only on due dates. Le. neither before fot after. Thus a firm can also enjoy cash discounts and keep up its profile. ©) Adopt a technique of playing float. which refers to ths amount tied tp in cheques that have been issued. The firms should ensure that the cheques are not dishonoured for want of finds ‘The 2 ways are as (allows: 1 Paying a distant bank: a firm may issue a cheque on a bank away from the customer’ bank. This would involve relatively longer transit time for creditors bank to get payment and thus enable a firm to use its funds longer. E 2. Cash encashment analysis: another way i make usc of float is to analyse on the basis of past experience, the time lag is the issue of cheque and their encashment. Eg. Cheques issned to pay salaries; wages may aot be encashed! immediately. Tt may be spread over 2 few days, 25% in one day, 50% in to days ete. thus the first need not to keep the entire amount of payroll but only a faction represented by the aetual withdrawal each day 3. Cestain times. employees who render services in advance, receive payments later, The larger period after which the payment is made the greatex the smount of free financing and smaller the amount of cash balances vequited ~ 4 Investment of surplus cash: once the optinuim tevel of cash b: fi lance of a fim is determined, its residual liquid assets are invested on m: arketable securities, These securities can be converted into cash in a shovt period af time. However these are 2 b : basic probierus involved in this regard.” Determination of surplus cash: i.e. cash in excess of firms can be determined by taking i account to the no. of days the cash balance'is required to be held and the average amount of ta: |Y cash outflows. . le securities Fo! Hot more than 6 months. Permanent surplus cash may be utlized for repayment of tone term loans or for expansion 5) Efficient inventorv- product management: 5; tnereasing the finished goods tumover through letter fo: ut = i Another strategy is to increase inventory turnover rate, avoiding raw materiats aunover 29 using efficient inventory control technique. li. Decreasing production cycle by providing better production planning schedules and cont 2! techniques feasting of demand and a bait -lanaine af aroducton bE« \ si HW MANAGEMENT & | mek et © different motives of holding cash? tt XE POO! of liquidity that provides cash quich me rafts, THES. tine: deposits. 4 to wi FY Molives (or maint eee Trarsectior z maintaining cash balance c 1 Rianee i this system refers to holding of cash co meet myg@e cash requirements tO nance the tansactions which enters into a vetlly Gr. firm cartier: ‘on within the ordinary course of business. A firm © ransactions, ayments for purchases, wages, op ash from sales, retuens those suce perfectly coincide, Thus atenons whe yy exceed current rey lents of cash, balances ecautionary motives. A fiem may Short notice. The causes could be a) Floods, strikes, failure of important custoniers, bh) Unexpected slowdown for collection ‘of accoune receivables, ©) Sharp increase in the cost of ray materials Cash balances eld in reserve for such unforeseen Hluctuations in ¢ ionacy motives’ (balances). The more iimpredictable the eas F balances. Spectdalive Motives This cefers to the desive wf fi 0 take advantage of o present themselves at unexpected moments on! which are typically ouside business. This motive represents an aggressive and prominent aprroser age ot . : me ee iy t purchase ra materia a sd pees Parent OF isibuediae cash b) A chance to speculate interest cate investnies 25 bei anterest cates xpecterl to decline. ssn prriny purchase of raw materials (0 t which Kave to be paidl for in the form of cash. E.g.: cash erating expenses. etc. Similarly there are fund inflows. ex: ide investments ete. but the inflows and the eutflows do not Sash balances must be maintained to meet the disbursements ‘pts. Such cash balances are known as-transaction balance’ and are known as “transaction matives* have to reserve cash to mect the unexpected cash needs at eat aha aU es I pas flows is called h lows the larger the need for pportunities which the normal course of The SM helps to take are aily of decline in Rae Paine Another ynotive to had a eas balance is to compensate hanks 11 Afative: ove a vacity of sevies sh as clearing of chequen gra Bs Voss an services, BANS DO a vision ee Fereee they seek indivene GO finds, et. For some services banks charge covnnision of te, for Sufficient to earh a reat E unds, anks requis : NSATING ES. Ca s @ >> compensation. ae Se Such balances are a oo. BALANCES. Cush balances is » cast of services. aveen banks and euston FAW equal tothe cove by loan agreements betves E Iso required by loan aere 2 > areal sett Providingissued. The physical verification of ‘the’ materiale are throughout the year, . VED Analysis: It is the mast suitable method i eo io ior automobile industries specially to maintain spare parts. Ail the parts are classified into Vital, Essential and Desirable components. Vital parts for the manufacturing of a product will be closely monitored. Inadequate supply of these parts may substantially damage the productive activities. E type of materials is no doubt that they are essential, but its level of stocks is moderately low. Desirable (D) components may or may not be maintained. Non- availability D types of spares do not damage the normal functioning of the industry. o FSN Analysis: Under this method, materials are grouped according to the movements. Fast moving items,.slow moving and non- moving items. Fast moving items are stored in large quantity. The production department, accordingly moderate quantity, does not frequently need slow moving items. Non-moving items are rarely required by production departments. Hence a smaller number of materials are kept in stock. 7. Periodical Inventory Valuation: Under this system inventory valuation with checking will be carried out at different intervals, generally twice or thrice in a year. During the period of stock checking normal functioning of the organization swill be closed for one or two days and complete stock verification and valuation will be done. pu Ak AGEING SCHEDULE ‘This is a statement prepared to determine the quality of individual debtors. comparative statement of individual for two periods will be prepared. The time period covered may be two years'¢ two periods in the same year. Normally the period is spilt having a frequency of 30 days, ie. 0-30 days, 31-60 days, 61.90 days, 91-120 days etc. and what is the percentage of debt due diring these periods will be known and the percentage will ke compared with the figures of the corresponding period during the previous year. VWihat is the sound management policy for Accounts Receivable? (Credit Evaluation Or Credit Standard) : Two important factors govern the management of account receivables. They are (1) Sales volume, (2) The Average period between sales and collection. Credit policy determines the average collection period. (3) Credit Control: 1. Credit Rating: This refers to the management of the creditworthiness of the customer. The credit rating is done by the established practices by adopting the “S Cs” esWorking capital may be assessed by finding ou the pe: funds, except cash and bank balances would be loc deducting the credit received from the suppliers and the other credits received. Adequacy of Working Capital ~ Sf Working capital should be adequate for the following reasons: () It protects a business from the adverse effects of shrinkage in the values of current assets, Gi) It is possible to pay all the current obligations promptly and to take advantage of cash discounts, Tt ensures to a greater extent the maintenance of a company’s credit standing and provides for such emergencies as strikes, floods, fires etc. Gv) It permits the carrying of inventories at a level that would enable a business to serve satisfactorily the needs of its customers. Tt enables a company to extend favourable credit terms to customers. (vi) It enables a company to operate its business more efficiently because there is no delay in obteining materials etc. because of credit difficulties ‘ It enables a business to withstand periods of depression smoothly. ‘The management may fail to obtain funds from other sources for the purposes of expansion. There may be increasing price necessitating bigger investment inventories and fixed assets. Inadeauacy of Working Capital ~ [tis impossible for the company to utilize production facilities fully for the want of working capital. A company may not be able to lake advantage of profitable business opportunities. (ii) The credit-worthiness of the company is likely to be jeopardized because of the lack of liquidity. (iv) A company may not be able to take advantage of cash discount facilities. (v) The modemization of equipment and even routine repairs and maintenance facilities may be difficult to administ: (vi) A company will not be able to pay its dividends because of non- aveilability o funds. (vii) A company cannot afford to increase its cash sales and have to restrict jts activities to credit sales onty. (vill) A company may have to borrow funds at exorbitant rates of interest, (x) ts low liquidity znay teed to low profitability in the same way as low profitability results in low liquidity. s+12. Credit Cantrot: Credit coniroi includes such factors as the volume 0! credit sales, the terms of credit sales, tle collection policy ete. With & sound credit control policy, it is possible fer a firm to improve its casi inflow. 13, Profit Planning and Control: The management in accordance with its policy of profit planning and cont=c! decides the level of working capital. Adequate profit assists in substantial generation of cash. It makes it possible for the management to plough back a part of its earnings in the business and substantially build up internal financial resources. A firm has to plan for texation payments, «hich are an important part of working capital managements. Often the dividend policy of a corporation may depend upon the amount of cash available to it. 14. Operational and financial efficiency: working capital turn over is ~ improved with a better operational and financial efficiency of a firm, With a greater working capital turn over, it may be able to reduce its working capital requirements. 15. Activities of the firm: A firm's stocking on heavy inventory or selling on easy credit terms calls for a higher level of working capital than for selling services or making cash sales. METHODS OF ESTIMATING WORKING CAPITAL. Conventional method: according to this method, cach inflows and outflows are maiched with each other. Greater emphasis is laid on liquidity Operating cycle method: in order to undeistand what gives rise to differences in the amount of timing cf cash flows, we should first know the iengtii of which is required to convert cash into resources, resources into final products, the final product inte receivables and rectivables back into cach. There are four major components of the operating cycle of the manufacturing company: a. The cycle starts with free capital in form of cash and credit, followed by investment in materials, man power and services b. Production phase c. Storage of finished producis terminating at the time finished product is sold : a. Cash or accounts receivable collection period, which results in, and ends at the point of disinvestments of the free capital originally committed, New free capital then becomes available for productive remvestment, When new liquid capital becomes available for recommitment to productive activity, a new operating cycle begins. This method helps in increasing the Profitability of a business. It enables a company to maintain its liquidity and preserve that liquidity through profitability. To meet the day to day Tequirements of the trade, the need i 56 ‘ -(x) Low liquidity would positively threaten the solvency of eee A company is considered illiquid when it is not able to pay its Gebt on maturity, Dangers of Excessive working capital (i) Acompany may be tempted io overtrade and lose heavily. , | (i) A company may keep very big inventories and He up ils funds amnecessarily. ; (@)_ There may be an imbalance between liquidity and profitability (iv) Accompany may enjoy high liquidity and, at the same time, suffer from Jow profitability. High liquidity may induce a company to undextake greater production, which may not have a matching demand. A company invests heavily in its fixed equipment, which may not be justified by actual sales or production. WORKING CAPITAL MANAGEMENT The effective management of working capital like other areas of management Teguires a clear statement of goals to be pursued and responsibilities to be allocated. Cash management and shori-term loans, along with the level of debiors, are the responsibility of financial executives. Inventory and credit contre] are managed in other departments. This division of responsibilities makes a coordinated approach to werking capital management all the more necessary, although itis a bit difficult particularly when managers from different departments pursue different goals The twin objectives of working capite] management are profitability and liquidity. Investraent in current as well as long term assets have to be undertaken so as to offer the most satisfactory return to the share holders. The goal of liquidity is to ensure that a company satisfies financial obligations and continues asa going concern. Profitability and liquidity conflict with each other. Attempts ‘o produce maximum profitability out of the various elements of working capital do create severe liquidity problems. At the same time, over concentration on liquidity does dilute pzofils. Working capital management establishes the best possible trade-off between the profitabrlity of net current assets employed and the ability to pay the current abilities as they fall due. PRINCIPLES OF WORKING CAPITAL MANAGEMENT ~ Principle of risk variation: risk here refers to the inability of a firm to maintain sufficient current assets to pay for its obligations. There is a definite relationship between the degree of risk and the rate of return. As a firm assumes more risk, BB ‘vunvrwvro””, he oppottunity for gain or sales decreases, the degree of risl the opportunity for gain and | capital goes up, the amount prefers to minimize risks by Hberal managements assume greater visk by reducing this level, The goal of a management should, however, be that level of working capital which would Optimize a firm's rate of return, . the degree of risk increa: es. Thus, if the level of worl Of risk goes down. A 6 also incre: conservative managen: holding a higher level of working capital, while Principle of cost of capital: this principle emphasizes the different sources of finance, for each source has a different cost of capital. It should be rememberad thal the cost of capital moves inversely with risk. Frinciple of equity position: According to this principle, the amount of working capital invested in each component should be adequately justified by a firm's equity position, Every rupee invested in the working capital should contribute to the net worth of the frm. Principle of maturity of payment: A company should make every effort to relate taaturities of payment to its How of internally generated funds. There should be the least disparity between the maturities of a firm’s short-term debt instruments and its flow of internally generated funds. - SOURCES OF WORKING CAPITAL Bources of we + 2 a Permanen' eo ¥ 1. Shares 1, Trade Credit 2. Debentures 2. Advances 3. Public Deposits 3. Commercial Banks 4. Retained Earnings 4 Indigenous Bankers 5. Loans from Financial Institutions 9. Installment Credit 6.Accounts Receivable Credits/Bills Receivable Financing Fixed Working Capital Requirements Shares: With a view to financing additional working capital needs, issue of additional shares could be one way to raise the equity base eyhh .¢ has still to gain Debentures: In the Indian capital market, No: of debentures has & i nvertibl Popularity. In this context, the mode of raising funds by pee cee le debentures/bonds is also considered, which may attract a number of im lic deposits is directly related to the lic deposits. Public deposits: The issue of tapping image of the company seeking te invite p' Retained Earnings: A feasible solution Ves in increasing profitability gira cost control and cost reduction measures managing the cash operating cycle, rationalizing inventory stocks and so on. Loans from ‘Financial Institutions: Financial institutions do nt provide Sinance for working capital requirements. This facility is not is available to all companies. For small companies, this option is not practical. Financing of temporary, working capital Trade cre 18: The trade eredit arzangement of a concern with its suppliers is an important source of finance. Advantages are: convenient mode of finance, flexible and it may be possible to obtain favourable terms. But the major cisadvantage is: charging a higher price, and lose of cash discount. Advances: Some business houses get advances from their customers and an agent against orders and this is a shor! term source of finance for them, Some Erms having long production cycle, especially firms manufacturing industrial products prefer to take advances fcirm their customers, Commercial banks: They provide a wide variety Specific requirements of a concern, The different forms in which the banks normally provide loans and advances are in the following ways: 1. Loans: When a bank makes an advance in lump ‘sum against some Security itis called LOAN. The entire loan amount is paid to borrower in cash or by credit to this Ioan account. Interest on loan is calculated on quarterly and test on reduced balances which repa ment is stipulated in installments, Now a days, term loans exceeding one year are aleo given. 2. Cash credits: It is an arrangement by which a bank allows its customer to borrow money up to a certain limit against some tangible asset or security. A customer, according to his cash credit limit withdraws money and also deposits any surplus amount with him, Interest is calculated on daily balance and not on the entire amount of the unit. to of loans tailored to meet theae » Purchasty Scounting of bills: Bank lends without any security. The present day business is built on credit. The seller draws » BOE on the buyer of goods on credit. Such a bill may either be clean or documentary bill, which is accompanied by documents of title on goods such a lway receipt. When BOE are discounted, customer is paid the ar f the bill less discount. On maturity, bank presents the bill for payment to the acceptor. On dishonor, the customer is held liable. Indigenous bankers: Before the establisiunent Moneylenders and country bankérs, provided interest and exploited the customers to the larg with the development of commercial banks, of commezcial banks, private finance, charging very ‘tate of est extent possible. Now a days they have lost their monopoly. installment Credit: Under this method asset are purchased, possession is taken immediately but payment is made in installments over a pre-determined period of time, Interest is charged on the unpaid price or it may be adjustocbim the Jrice, x INVENTORY MANAGEMENT * — Inventory management is one of the components of working capifir management, It involves the processes of providing continuons flow of raw materials to production department. More than 60% of the working cap noumally be invested in the inventory. The scientific process of implementing inventory management provides inventory at right time, from right source and at right prices. It also involves the steps that are to be undertaken with regard to storage and supervision of these materials. The main objective of inventory management is to reduce the order placing, receiving and inventory carrying cost. This not only enstires continuous flow of raw materials but also educes the cost of production. Excess inventory leads to idle investment, high inventory carrying cost and wastages. Inadequate inventory directly affect the production Processes, Therefore, scientific principles are to be adopted to manage the inventory. To avoid all these problems, in Japan, JIT concept has been introduced (Just Jp Time). It refers to supply of raw materials to the production department directjy by the supplies. The agreement will normally be made with supplier of materials on such terms, so that the supply of zaw materials must be a without any interruption to the normal productive activities, ade élObjects of Taventory The important obje: a i) Management ives of inventory management are: To provide continuous supply of raw materials to carryout uninterrupted production. . To reduce the wastages and to avoid loss of pilferage, breakage and - deterioration. gp pang . ABC Analysis: Under this method, the materials . To exploit the opportunities available and to reduce the cost of purchases To introduce scientific inventory management techniques. To provide right materials at right time, fom right sources and at right prices. Tomeet the demand for goods of ultimate consumers on time. . To avoid excess and inadequate storing of materials. . To protect quality of raw materials. . To reduce the order placing and receiving costs to the minimum. 10. To ensure effective utilization of the floor space. TOOLS OF INVENTORY MANAGEMENT 7 Fixation of level: It is @ tool through which the inventories are maintained by fixing different levels namely,, Maximum level, Re-order Jevel, Minimum level and Danger level. Fixations of levels are made by considering different factors viz, nature of raw materials, cost, availability, lead-time, storage space and cost etc. The different levels set by considering the above factors will act as an ind inventory. catcr for managing the are managed by giving importance to its value. Classifications are being made ‘by grading the materials as A,B, and C. Grade A materials are costly high in value but less in number and are supervised and controller closely. Grade C materials are cheap in value but more in quantity ay and least attention is given in monitoring these times. Grade B materials are moderate in value and moderate number of such items are maintained with moderate control. ‘The main purpose’ of adopting this technique as an inventoy control is to maintain scientific investments. . Economic order Quantity: Economic order Quantity is that quantity of materials to be ordered where it will have least or minimum order placing and carting cost It is also called as the size of the materials to be purchased most economically. . Perpetual Inventory 5 ystem: It is also referred as continuous stock checking Under this system, different Tegisters are maintained for materials, entries are made as and when the materials are received and 6L-“Char refers io the temperament of the customer. Ii i fo be juedged whether the customer is honest and is prompt im paying the dues that ke had undertaken te pay. Credit evaluation has to be made, taking into account iis facto: “Capacity” refers to the ability of the customer to pay back the purchase price. This can by conducting a detailed investigation of kis dealings, his past actions, his possessions, his business methods etc, This investigation reveals tohether the customers are capable of managing his business efficiently. “Capitat” refers to the financial soundness of the customers. This can't be assessed by studying the financial statements of the firm. “Collateral” is a term used to express the additional ability of the custamers. This measures the securities held by the customers, which can be offered for the credit he avails, “Condition” refers to the econontic conditions, which influence the activities of the firm, If the conditions are unfiscourcble the situation, will not be good jor extending credit to such firms: Thus, these five “C's determine the credit rating of the customers. 2 Credit Period: Credit period, as fat as possible, should he a shorier one. Short period credit fecilitates the firm to have regular funds inflow, which can be synchronized with payments, Collection Policy:It is always Letter to have short collection period, However, the collection period depends mn th: ns of credit and types of customers. Same customers would like to have lon credit period, pay on the die dates and enjoy the credit. But same others would like to have short period and enjoy cash discount facility. The firm will have to prepare regularly the debtors’ schedule and classify the debtors. Overdue accounts should ke followed up. Timely action has to be taken to-collect the debts. Ag far as possible the debtors have to be wooed and debts should be collected. Otherwise, there will be a chance of losing the customers. . Discounts: This induces the customers to make Prompt payments. But several suryeys conducted have shown-that discounts are not worth giving. The suppliers have experienced anuch difficulty in checking discount allowances, their calculations, rectifying the wrong deductions etc. Tt is 2 time consuming proposition and a cumbersome process also Ge e e =FACTORING eee FOR CONTRGLEING RECELV What is factoring? “Factoring is 2 debt-collection se where the factor pus ee book-debts of the client at a discount either with or with out resource - He undertakes responsibility of debt collection and maintenance of the client's sales ledger in return for a service fee. Nearly 80% of the assigned debts are advanced to the clients. Factors mainly help the organizations, which are going to use the finance and service to smoothly operate and expand their activities. Definition ms h , Factoring means an arrangement between a factor and his client which includes at Teast two of the following services to be provided by the Factor: > Finance > Maintenance of accounts > Collection of debts > Protection against credit risks Features of Factoring “1, Client can get 80% of the invoice amount from the factor after the factoring agreement 2. Client shifts responsibility of credit collection from the customers. 3, The responsibility of maintaining credit sales ledger vests with the factor 4, The client will have easy access to know the details of credit sale: 5. The financial position of the client can be strengthened supply easy cash. This helps the company to provi factoring funds for wer! capital 6, The remaining balance of 20% of invoice amount will be paid by the factor at the time of realization of assigned invoice. ie The client has to pay service charges in addition to the interest a funded amount to the factor. Factoring allows client to spend more time on planning for his business as the time to be spent on credit collection is looked after by the factor. 9. Factor many a2 times offers the services of consultancy in areas of production, finance and marketing, . TYPES OF FACTORING teal oa Full Setvice Factoring: Under thie system, factor provides maintains sales ledger, undertakes credil finance, vt collection, offers protection se bad debts and offers consultancy services, In the event of bad lebts if the factoring agreement has been made as “Factoring with recourse”, the obligation to repay the dues vests with clients, In case of 65“Factoring with nor-recourse” factors has'to absorb the loss of kari debts, . Factoring with Recourse: Under this method, the client is not given Protection against the bad debts. In the normal factoring arrangements 30m days credit collection period will be allowed to customer to pay his dues. If the customer fails to pay his dues within this allotted time, _ it becomes the responsibility of the client to pay the remaining balance of the amount to the factor. ic . Maturity Factoring: Under this method, factor offers only services relating to maintenance of sales Jedger account, asset management, credit control including collection of debts, debt protection and will Rot Provide finance. ‘Therefore, it is also called as “Collection Factoring”. » Invoice Factoring: The business firm lists the invoices it wishes to sell, Stating the anticipated settlesnent dates. This form is sent with Supporting evidence, e.g., copy invoices, and on acceptance, the factor at one makes a first Payment of an agreed percentage approximately 80% of the face value of the offer. The debts are sold outright for this first Payment and for 4 further payment or payments amounting to the temaining 20%. The business then acts as a trustee to collect payments and, when they are received, pays them into a separate bank account, on which no bank charges are payable. Each offer is self-liquidating, separate entity. Extra cash thus circulates within the compary ar a4 when fresh offers are processed. Bulk Factoring: Under this method, the total agreed bunch of invoices of the clients would be considered for provicing 80% fnanice to clieni However, the arrangement of this will be made known to the debtors, Hence, the responsibility of maintaining sales ledger, callection of debts and the risk of bad debts vests with the client himself. Agency Factoring: The Factor assumes the Tesponsibility of down payment/pre-payment facility to the client and Protects the client against bad debts. It operates on a “With Recourse” basis Undisclosed Factoring: Under this method, instead of making a direct sale to the customer, on arrival of the time for delivery goods are sold to a.factor for cash who then appoints the business ‘as its agent to collect the outstanding debt, A cheque is received on delivery of the goods and the customers collect the debt on behalf of ae eee ihe factor has no recourse to the business in the event of a bad debt arising. 66