43 Analysis the Need of WOrking Capital Management

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A

RESEARCH REPORT

ON

ANALYSIS THE NEED OF WORKING

CAPITAL MANAGEMENT

Submitted In Partial Fulfillment Of Requirements For The Master OfBusiness Administration Degree Of Punjab Technical University, Jalandhar

2007-2009

SUBMITTED TO SUBMITTEDBY

Soumendra Kumar MohapatraPUNJAB TECHNICAL UNIVERSITY MBA-4th Sem

Roll # 720743032

ASIAN BUSINESS SCHOOLFILMCITY, NOIDA


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ACKNOWLEDGEMENT

On completing this project, it is my pleasure to thank all those who havehelped me during the course of the project.

I am thankful to Mr. G.S. Khera, faculty Guide, ABS, Film City, Noida, whoallowed me to carry out the study and use their different officials andimportant documents useful for my project and prepare a report onAnalysis the Need of Working Capital Management.

Lastly I am extremely thankful to all the members of Advance Product

Private Limited for their undue and kind cooperation and valuable guidance.

SOMENDRA KUMAR MOHAPATRA


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Table Of Contents

Chapter No

Chapter-1.0 Executive Summary

Chapter-2.0 Objective of the Study

Chapter-3.0 Scope of the study

Chapter-4.0 Introduction: ADVANCE PRODUCT

PRIVATE LIMITED

Chapter-5.0 Working capital management

Chapter-6.0 Data Collection

Chapter-7.0 Data Interpretation and Analysis

Chapter-8.0 Limitations

Bibliography


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a business expands the more cash it will need for working capital and

investment. The cheapest and best sources of cash exist as working capital

right within business. Good management of working capital will generate

cash will help improve profits and reduce risks. Bear in mind that the cost of

providing credit to customers and holding stocks can represent a substantial

proportion of a firm's total profits.

There are two elements in the business cycle that absorb cash

Inventory (stocks and work-in-progress) and Receivables (debtors owing

you money). The main sources of cash are Payables (your creditors) and

Equity and Loans.

Each component of working capital (namely inventory, receivables and

payables) has two dimensions:- 1)TIME and 2) MONEY.


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When it comes to managing working capital - TIME IS MONEY. If you

can get money to move faster around the cycle (e.g. collect monies due from

debtors more quickly) or reduce the amount of money tied up (e.g. reduce

Inventory levels relative to sales), the business will generate more cash or it

will need to borrow less money to fund working capital. As a consequence,

you could reduce the cost of bank interest or you'll have additional free

money available to support additional sales growth or investment. Similarly,

if you can negotiate improved terms with suppliers e.g. get longer credit or

an increased credit limit; you effectively create free finance to help fund

future sales.


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Objectives of the study

The need for investing in current assets and elaborate the concept of

operating cycle.

To know the necessity of managing current assets and current

liabilities.

To know the principles of current assets investment and financing

To focus on the proper mix of Short term and Long term financing

for current assets.

To find out the profitability of the company.

To find out the degree of flexibility in managing current assets.

To know the firm liquidity position i.e., the ability or capacity of the

firm to meet its short term obligations out of current assets.

To know the overall performance of the business.

To focus on the shareholders wealth maximization principle as

operationally desirable finance decision criterion.


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To focus on the decision making role of accounting system.

To analysis the nature, content, form, and utility of 2 financial

statement viz. Balance sheet and Profit And Loss statement.

To study the need for analyzing the changes in a firms funds and

cash flow position.

To study the utility of financial ratios in credit analysis and

competitive analysis as well as in determining the financial capacity

of the firm.


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Scope of the study

This project will be a learning device for the finance student.

Through this project we would study the various methods of the

working capital management.

The project will be a learning of planning and financing working

capital.

This will show different methods of holding inventory and dealing

with cash and receivables.

This will show us the liquidity position of the company and also how

do they maintain a particular liquidity position.

The company could also benefit from our views and

recommendations. They could get at least some hints and get better

off.


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Research Methodology And Data Collection:

Research is an art of scientific investigation. Research comprises defining

and redefining problems, formulating hypothesis or suggested solution;

collecting, organizing and evaluating data; making deductions and reaching

conclusions; and at least carefully testing the conclusions to determine

whether they fit the formulating hypothesis.


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Research Methodology:

Research Methodology is a way to systematically solve the research

problem. It may be understood as the science of studying how research is

done scientifically. In it we study the various steps that are generally

adopted by a researcher in studying his research problem along with the

logic behind them. It is necessary for the researcher to know not only the

research methods/techniques but also the methodology.

This study will be based on :

1. Secondary Research

2. Primary Research through structured questionnaire administration


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Data Collection

Since research is combination of secondary data collection through desk

research and primary data through the author of this study collected the

information from the personal interviews of the member of financial

department of the firm.

Secondary Data:All relevant information connected with this study was

assembled from following sources:-

Foreign and Indian Books.

Banking and Financial Journals.

Through website.

Primary Research: To evaluate various attributes needed to conduct this

study questionnaire was designed in line with the objectives of study i.e., to

study following Data:

Balance Sheet


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Profit and Loss Account

Cash Flow Statement

Personal Interview

Data Interpretation and Analysis

The data collected from secondary sources was assembled, screened, sorted,

Evaluated in line with the objectives of the study and has been incorporated

in this Project. The data collected from the Balance Sheet, Profit and Loss

Account, and Cash Flow Statement and through interview was mostly

qualitative in nature. Through the primary data following statements are

analyses:

Operating Cycles Analysis

Common Size Statement

Trend Analysis

Ratio Analysis

Correlation Analysis


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All the above statements are helpful to know the financial position of the

firm, need of working capital and needs of resources etc.


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LIMITATIONS OF THE STUDY

This is my first project in finance and I am inexperienced

(although our professor helped us a lot).

The company APL has not revealed all the information to us, as no

organization reveals its facts to outsiders.

Time has been a killer to me as I got only 2 days in APL and

exactly 2 hours/day of discussions.

I also got eight weeks to complete my project.

The values in the projects are given in monetary terms and not in

quantitative terms. All the things are in rupees and nothing is in

kilograms or meters.


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To focus on the shareholders wealth maximization principle as

operationally desirable finance decision criterion.

To focus on the decision making role of accounting system.

To analysis the nature, content, form, and utility of 2 financial

statement viz. Balance sheet and Profit And Loss statement.

To study the need for analyzing the changes in a firms funds and

cash flow position.

To study the utility of financial ratios in credit analysis and

competitive analysis as well as in determining the financial capacity

of the firm.


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CHAPTER 3

SCOPE OF THE STUDY


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Scope of the study

This project will be a learning device for the finance student.

Through this project we would study the various methods of the

working capital management.

The project will be a learning of planning and financing working

capital.

This will show different methods of holding inventory and dealing

with cash and receivables.

This will show us the liquidity position of the company and also how

do they maintain a particular liquidity position.

The company could also benefit from our views and

recommendations. They could get at least some hints and get better

off.


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CHAPTER 4

INTRODUCTIONADVANCE PRODUCT PRIVATE LIMITED


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INTRODUCTION

ADVANCE PRODUCT PRIVATE LIMITED

Mrs. Nishi Gupta founded APL in the year 1988. It works as a major

supplier of power cords to electronic industry. It is a leading OEM supplier

of ISI marked power cords to nationally reputed brands of home appliances

and information technology products. Power cord has longer life and

permanent connections to avoid many failure of the gadget.

Advance Product Private Limited is a company having an all India presence

and promoted by A Lady Entrepreneur and supported by highly skilled

professionals in their respective fields. It is the basic policy of the company

to produce high quality products standards (BIS). Co. is all set for getting

certification of ISO 9001 very soon for quality systems. Co.s regular and

reputed customers are, spread all over the country, which speaks about the

quality of the products. The Co. deal with about 45 reputed companies like

BPL Refrigerators, National Panasonic, Usha Lexus, TVS Electronic

Limited etc. and some computer manufacturer like Accord Communication

Ltd., Compaq India Ltd., and Novel Infocom etc.


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Registered Office

B- 1 & 2, Magnum House 1Karampura Commercial Complex

Shivaji Marg, New Delhi - 110015

Bankers

Bank of BarodaSSI Branch, Rajindera PlaceAuditors

A.K. Batra & Associates40/2971, Beadon Pura, Karol Bagh


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Organisation Chart

Managing

Director

Director

(Administration,

Customer Service)

G.M.

(Production)G.M.

(Finance)

Manager

(Production)

Manager

(Purchase)

Manager

(Q.C.)

Sales

Manager

Accounting

Head

Sales

Personnel

Account

Officer

Account

Personnel

Sr.

Supervisor

Production

Personnel

Purchase

Officer

Purchase

Personnel

Q.C.

Supervisor

Q.C.

Personnel


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CHAPTER 5

WORKING CAPITAL MANAGEMENT


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MANAGING WORKING CAPITAL

Working capital

Firms need cash to pay for all their day-to-day activities. They have to pay

wages, pay for raw materials, pay bills and so on. The money available to

them to do this is known as the firms working capital. The main sources of

working capital are the current assets as these are the short-term assets that

the firm can use to generate cash. However, the firm also has current

liabilities and so these have to be taken account of when working out how

much working capital a firm has at its disposal.

Working capital is therefore:-

WORKING CAPITAL = Current Assets

||

stock+ debtors + cash

- Current liabilities
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Thus working capital is the same as net current assets, and is an important

part of the top half of the firm'sbalance sheet. It is vital to a business to have

sufficient working capital to meet all its requirements. Many businesses

have gone under, not because they were unprofitable, but because they

suffered from shortages of working capital.

Current assets minus current liabilities. Working capital measures how much

in liquid assets a company has available to build its business. The number

can be positive or negative, depending on how much debt the company is

carrying. In general, companies that have a lot of working capital will be

more successful since they can expand and improve their operations.

Companies with negative working capital may lack the funds necessary for

growth. Also called net current assets or current capital.

Working Capital Needs
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Working capital is used to pay short-term obligations such as accounts

payable and buying inventory. If working capital dips too low, risk running

out of cash. Even very profitable businesses can run into trouble if they lose

the ability to meet their short-term obligations.

Definitions

Annual growth

The percent growth expect over the next year.

Total current assets

This is any cash or asset that can be quickly turned into cash. This

includes prepaid expenses, accounts receivable, most securities

and inventory.

Total current liabilities

This is a liability in the immediate future. This includes wages,

taxes, and accounts payable.


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Current ratio

Current Assets divided by current liabilities. Current ratio helps to

determine enough working capital to meet short-term financial

obligations. A general rule of thumb is to have a current ratio of

2.0. Although this will vary by business and industry, a number

above two may indicate a poor use of capital. A current ratio under

two may indicate an inability to pay current financial obligations

with a measure of safety.

Working capital

Working capital is used by lenders to help gauge the ability for a

company to weather difficult financial periods. Working capital is

calculated by subtracting current liabilities from current assets.

Due to differences in businesses and the fact that working capital

is not a ratio but an absolute amount, it is difficult to predict what

the ideal amount of working capital would be for your business. To

calculate working capital requirements this calculator uses the

"Current Ratio" to determine a target amount of working capital.


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1. Working Capital Cycle

Cash flows in a cycle into, around and out of a business. It is the business's

lifeblood and every manager's primary task is to help keep it flowing and to

use the cash flow to generate profits. If a business is operating profitably,

then it should, in theory, generate cash surpluses. If it doesn't generate

surpluses, the business will eventually run out of cash and expire. The faster

a business expands the more cash it will need for working capital and

investment. The cheapest and best sources of cash exist as working capital

right within business. Good management of working capital will generate

cash will help improve profits and reduce risks. Bear in mind that the cost of

providing credit to customers and holding stocks can represent a substantial

proportion of a firm's total profits.

There are two elements in the business cycle that absorb cash

Inventory (stocks and work-in-progress) and Receivables (debtors owing

you money). The main sources of cash are Payables (your creditors) and

Equity and Loans.


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Each component of working capital (namely inventory, receivables and

payables) has two dimensions:- 1)TIME and 2) MONEY.

When it comes to managing working capital - TIME IS MONEY. If you

can get money to move faster around the cycle (e.g. collect monies due from

debtors more quickly) or reduce the amount of money tied up (e.g. reduce

inventory levels relative to sales), the business will generate more cash or it

will need to borrow less money to fund working capital. As a consequence, a

firm could reduce the cost of bank interest or it will have additional free

money available to support additional sales growth or investment. Similarly,

if a firm can negotiate improved terms with suppliers e.g. get longer credit or

an increased credit limit; firm effectively create free finance to help fund

future sales.


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If you ....... Then ......

Collect receivables (debtors) faster You release cash from

the cycle

Collect receivables (debtors) slower Your receivables soak

up cash

Get better credit (in terms of duration

or amount) from suppliers

You increase your cash

resources

Shift inventory (stocks) faster You free up cash

Move inventory (stocks) slower You consume more

cash

It can be tempting to pay cash, if available, for fixed assets e.g. computers,

plant, vehicles etc. If you do pay cash, remember that this is now longer

available for working capital. Therefore, if cash is tight, consider other ways

of financing capital investment - loans, equity, leasing etc. Similarly, if you

pay dividends or increase drawings, these are cash outflows and, like water

flowing downs a plughole, they remove liquidity from the business.

2. Sources of Cash

Sources of additional working capital include the following:

Existing cash reserves


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Frequent short-term emergency requests to the bank (to help pay

wages, pending receipt of a Cheque).

3.Handling Receivables (Debtors)

Cash flow can be significantly enhanced if the amounts owing to a business

are collected faster. Every business needs to know.... who owes them

money.... how much is owed.... How long it owes.... for what it is owed.

Late payments erode profits and can lead to bad

debts.

Slow payment has a crippling effect on business, in particular on small

businesses that can least afford it. If you don't manage debtors, they will

begin to manage your business as you will gradually lose control due to

reduced cash flow and, of course, you could experience an increased

incidence of bad debt. The following measures will help manage your

debtors:

1. Have the right mental attitude to the control of credit and make sure

that it gets the priority it deserves.

2. Establish clear credit practices as a matter of company policy.


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3. Make sure that these practices are clearly understood by staff,

suppliers and customers.

4. Be professional when accepting new accounts, and especially larger

ones.

5. Check out each customer thoroughly before you offer credit. Use

credit agencies, bank references, industry sources etc.

6. Establish credit limits for each customer... and stick to them.

7. Continuously review these limits when you suspect tough times are

coming or if operating in a volatile sector.

8. Keep very close to your larger customers.

9. Invoice promptly and clearly.

10.Consider charging penalties on overdue accounts.

11.Consider accepting credit /debit cards as a payment option.

12.Monitor your debtor balances and ageing schedules, and don't let any

debts get too large or too old.


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Recognize that the longer someone owes you, the greater the chance you

will never get paid. If the average age of your debtors is getting longer, or is

already very long, you may need to look for the following possible defects:

Weak credit judgment

Poor collection

procedures

Lax enforcement of

credit terms

Slow issue of invoices or

statements

Errors in invoices or

statements

Customer dissatisfaction.

Debtors due over 90 days (unless within agreed credit terms) should

generally demand immediate attention. Look for the warning signs of a

future bad debt.

For example...


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Longer credit terms taken with approval, particularly for smaller

orders

Use of post-dated checks by debtors who normally settle within

agreed terms

Evidence of customers switching to additional suppliers for the same

goods

New customers who are reluctant to give credit references

Receiving part payments from debtors.

Profits only come from paid sales.

The act of collecting money is one, which most people dislike for many

reasons and therefore put on the long finger because they convince

themselves there is something more urgent or important that demands their

attention now. There is nothing more important than getting paid for your

product or service. A customer who does not pay is not a customer. Here are

a few ideas that may help you in collecting money from debtors:

Develop appropriate procedures for handling late payments.

Track and pursue late payers.


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Get external help if your own efforts fail.

Don't feel guilty asking for money.... Its yours and you are entitled to

it.

Make that call now. And keep asking until you get some satisfaction.

In difficult circumstances, take what you can now and agree terms for

the remainder. It lessens the problem.

When asking for your money, be hard on the issue - but soft on the

person. Don't give the debtor any excuses for not paying.

Make it your objective is to get the money - not to score points or get

even.

4. Managing Payables (Creditors)

Creditors are a vital part of effective cash management and should be

managed carefully to enhance the cash position.

Purchasing initiates cash outflows and an over-zealous purchasing function

can create liquidity problems. Consider the following:

Who authorizes purchasing in your company - is it tightly managed or

spread among a number of (junior) people?


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Are purchase quantities geared to demand forecasts?

Do you use order quantities, which take account of stock holding and

purchasing costs?

Do you know the cost to the company of carrying stock?

Do you have alternative sources of supply? If not, get quotes from

major suppliers and shop around for the best discounts, credit terms,

and reduce dependence on a single supplier.

How many of your suppliers have a returns policy?

Are you in a position to pass on cost increases quickly through price

increases to your customers?

If a supplier of goods or services lets you down can you charge back

the cost of the delay?

Can you arrange (with confidence!) to have delivery of supplies

staggered or on a just-in-time basis?

There is an old adage in business that if you can buy well then you can sell

well. Management of your creditors and suppliers is just as important as the


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management of your debtors. It is important to look after your creditors -

slow payment by you may create ill-feeling and can signal that your

company is inefficient (or in trouble!).

Remember, a good supplier is someone who will work with you to enhance

the future viability and profitability of your company.

5. Inventory Management

Managing inventory is a juggling act. Excessive stocks can place a heavy

burden on the cash resources of a business. Insufficient stocks can result in

lost sales, delays for customers etc.

The key is to know how quickly your overall stock is moving or, put another

way, how long each item of stock sit on shelves before being sold.

Obviously, average stock-holding periods will be influenced by the nature of

the business. For example, a fresh vegetable shop might turn over its entire

stock every few days while a motor factor would be much slower as it may

carry a wide range of rarely-used spare parts in case somebody needs them.

Nowadays, many large manufacturers operate on ajust-in-time (JIT) basis

whereby all the components to be assembled on a particular today, arrive at

the factory early that morning, no earlier - no later. This helps to minimize


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Manufacturing costs as JIT stocks take up little space, minimize stock

holding and virtually eliminate the risks of obsolete or damaged stock.

Because JIT manufacturers hold stock for a very short time, they are able to

conserve substantial cash. JIT is a good model to strive for as it embraces all

the principles of prudent stock management.

The key issue for a business is to identify the fast and slow stock movers

with the objectives of establishing optimum stock levels for each category

and, thereby, minimize the cash tied up in stocks. Factors to be considered

when determining optimum stock levels include:

What are the projected sales of each product?

How widely available are raw materials,

components etc.?

How long does it take for delivery by suppliers?

Can you remove slow movers from your product

range without compromising best sellers?


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Remember that stock sitting on shelves for long periods of time ties up

money which is not working for you. For better stock control, try the

following:

Review the effectiveness of existing purchasing and inventory

systems.

Know the stock turn for all major items of inventory.

Apply tight controls to thesignificant few items and simplify controls

for the trivial many.

Sell off outdated or slow moving merchandise - it gets more difficult

to sell the longer you keep it.

Consider having part of your product outsourced to another

manufacturer rather than make it yourself.

Review your security procedures to ensure that no stock "is going out

the back door!

Higher than necessary stock levels tie up cash and cost more in insurance,

accommodation costs and interest charges.


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Used in

UsedIn

ProductionProcessWorkingCapitalCycle Used to Pyrchase

Generates

Via sales Generates CollectionProcess Used to Purchase

External FinancingReturn to Capital

Accrued FixedOperatingExpenses

Accrued DirectLabor andMaterials.

Cash and

marketablesecurities

Inventory

Accountsreceivable

Suppliersof Capital Fixed Assets


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Fig: RESOURCE FLOWS FOR A MANUFACTURING FIRM

Cash Flow Forecasts

CASH RECIEPTS

CASH PAYMENTS

Fig: Cash Flow in the Firm

1. Importance of Cash

When planning the short- or long-term funding requirements of a business, it

is more important to forecast the likely cash requirements than to project

profitability etc. Whilst profit, the difference between sales and costs within

a specified period, is a vital indicator of the performance of a business, the

generation of a profit does not necessarily guarantee its development, or

CUSTOM

ERS

DEPOSI

T BANK

DEPOSI

T BANK

DEPOSI

T BANK

INDIAN

OVERSEASBANK /STATEBANK OFINDIA /STATEBANK OFPATIALA

DISBURSEM

ENT

BANK

1

DISBURSE

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BANK1

SUPPLIE

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Net cash flow is the difference between the inflows and outflows within a

given period. A projected cumulative positive net cash flow over several

periods highlights the capacity of a business to generate surplus cash and,

conversely, a cumulative negative cash flow indicates the amount of

additional cash required to sustain the business.

Cash flow planning entails forecasting and tabulating all significant cash

inflows relating to sales, new loans, interest received etc. and then analyzing

in detail the timing of expected payments relating to suppliers, wages, other

expenses, capital expenditure, loan repayments, dividends, tax, interest

payments etc. The difference between the cash in- and out-flows within a

given period indicates the net cash flow. When this net cash flow is added to

or subtracted from opening bank balances, any likely short-term bank

funding requirements can be ascertained.

5. Planning to Plan

Before using a model for short-term cash flow forecasting, a manager or

entrepreneur should:

Decide the central purpose of the exercise (internal planning and

control, negotiate a loan etc.).


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Identify the target audience (directors, bank manager etc.)

Set the time intervals and horizon (e.g. monthly for twelve months)

Sort out the level of detail required.

Check that all the necessary key assumptions and data are to hand and

have been adequately researched.

Compile opening balances for all items which will involve cash flows

within the forecasting period.

Think through the likely impact of the critical assumptions on the cash

flow projections. If necessary, prepare preliminary forecasts manually

to confirm their overall direction and consider the underlying strategic

issues relating to sales, funding, costs, stocks etc. As a guide, sales

forecasts and debtor & creditor terms are likely to have the most

profound impacts on short-term cash flows.

When preparing cash flow projections, be aware of the dangers of:

Overstating sales forecasts

Underestimating costs and delays likely to be encountered


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Ignoring historic trends or performances by debtors etc.

Making unduly-optimistic assumptions about the availability of bank

loans, credit, grants, equity etc.

Seeking spurious accuracy whilst failing to recognize matters of

strategic importance

These problems can arise as the result of a lack of foresight or knowledge, or

because of excessive optimism. They can lead to under-estimation of the

cash and other resources required sustaining or developing a business with

potentially disastrous consequences.

When forecasting bank requirements and preparing cash flow projections,

realistic views should always be taken about future prospects. There is often

merit in compiling "worst" case projections to complement "most likely" or

"best" forecasts and to accept that the "worst" case might occur and to plan

accordingly.

7. Ways of Improving Cash flow

Once the cash flow projections have been prepared, they should be critically

examined and used as a management tool to control and improve the

business's expected cash position. Issues which might be examined include

the following:


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30+ Ways of Improving Net Cash flow

1. Increase sales (particularly those involving cash

payments).

2. Reduce direct and indirect costs and overhead expenses.

3. Defer discretionary projects which cannot achieve

acceptable cash paybacks (e.g. within one year ???).

4. Increase prices especially to slow payers.

5. Review the payment performances of customers - involve

sales force.

6. Become more selective when granting credit.

7. Seek deposits or multiple stage payments.

8. Reduce the amount/time of credit given to customers.

9. Bill as soon as work has been done or order fulfilled.

10.Improve systems for billing and collection.

11.Use the 80/20 rule to control inventories, receivables and


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receipts from sales.

23.Defer or re-stage all capital expenditure.

24.Use alternative financing methods, such as leasing, to gain

access to the use (but not ownership) of productive assets.

25.Re-negotiate bank facilities to reduce charges.

26.Seek to extend debt repayment periods.

27.Net off or consolidate bank balances.

28.Sell off surplus assets or make them productive.

29.Enter into sale and lease-back arrangements for productive

assets.

30.Defer dividend payments.

31.Raise additional equity.

32.Convert debt into equity.

33.Make medium- and short-term cash flow forecasts and


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update them regularly

CONCEPTS OF WORKING CAPITAL

There are four concepts of Working Capital:-

Gross Working Capital refers to the firms investment in current

assets. Current assets are the assets which can be converted into cash

within an accounting year (or operating cycle) and include cash, short-

term securities, debtors, (accounts receivable or book debts) bill

receivable and stock. The Gross Working Capital concepts focuses

attention on two aspects of current assets management:

a) How to optimize investment in current assets?

b) How should current assets be financed?

The consideration of the level of investment in current assets should

avoid two danger points excessive and inadequate investment in

current assets. Investment in current assets should be just adequate,

not more not less, to the needs of the business firms. Another aspect

of the gross working capital points to the need of arranging funds to

finance current assets.


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Net Working Capital refers to the differences between current assets

and current liabilities. Current liabilities are those claims of outsiders

which are expected to mature for payment within an accounting year

and include creditors, bills payable and outstanding expenses. Net

working capital can be positive or negative. A positive Net working

capital will arise when current assets exceed current liabilities. A

negative working capital occurs when current liabilities are in excess

of current assets. Net working capital is a qualitative concept. It

indicates the liquidity position of the firm and suggests the extent to

which working capital needs may be financed by permanent sources

of funds. Net working capital also covers the question of judicious

mix of long term and short term funds for financing current assets.

A firm net working capital position is not only important as an index

of liquidity but it is also used as a measure of risk. Risk in this regard

means chances of the firm being unable to meet its obligation on due

date. The lender considers a positive net working as a measure of

Safety. All other things being equal, the more the net working capital

a firm has, the less likely that it will default in meeting its current

financial obligations. Lenders such as commercial banks insist that the

firm should maintain a minimum net working capital position.


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Permanent Working Capital: There is always a minimum level of

current assets which is continuously required by the firm to carry on

its business operation. This minimum level of the current assets is

referred to aspermanent, or fixed, working capital. It is permanent in

the same way as the firms fixed assets are. Depending upon the

changes in the production and sales, the need for working capital, over

and above permanent working capital, will fluctuate. For example,

extra inventory of finished goods will have to be maintained to

support the peak periods. On the other hand, investment in raw

material, work in process and finished goods will fall if the market is

slack.

Temporary Working Capital: The extra working capital, needed to

support the changing production and sales activities is called

Amounto

fWorkingCapital

(Rs)

Permanent

Fig: Permanent Working Capital


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fluctuating, or variable, or temporary working capital. Temporary

working capital is created by the firm to meet liquidity requirements

that will last only temporarily.

.

Temporary

Time

Fig: Temporary Working Capital

Temporay

Permanent

TimeFig:Temporary And Permanent Working Capital

Amounto f

working c

apital( R

s)

Amou

ntofworking

capital( R

s)


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businesses, such as tobacco manufacturers and construction firms,

also have to invest substantially in working capital and a nominal

amount in fixed assets. Working capital requires most of the

manufacturing concerns to fall between the two extreme

requirements of trading firms and public utilities. Such concerns

have to make adequate investment in current assets depending

upon the total assets structure and other variables.

2) Sales and Demand Conditions - The working capital needs of a

firm are related to its sales. It is difficult to precisely determine the

relationship between volume of sales and working capital needs. In

practice current assets will have to be employed before growth take

place. It is, therefore, necessary to make advance planning of

working capital for a growing firm on a continuous basis.

A growing firm may need to invest funds in fixed assets in order to

sustain its growing production and sales. Sales depend on demand

conditions. Most firms experience seasonal and cyclical fluctuation

in the demand for their products and services. These business

variations affect the working capital requirement, specially the


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temporary working capital requirement of the firm. When there is

an upward swing in the economy, sales will increase,

correspondingly, the firms investment in inventories and debtors

will also increase. Under boom period, additional investment in

fixed asset may be made by some firms to increase their productive

capacity. This act of firms will require further additions of working

capital. To meet their requirements of funds for fixed assets and

current assets under boom period, firms generally resort to

substantial borrowing. On the other hand when there is a decline in

the economy, sales will fall and consequently, levels of inventories

and debtors will also fall. Under recessionary condition, firms try

to reduce their short term borrowings.

Seasonal Fluctuations not only affect working capital requirement

but also create production problems for the firm. During Periods of

peak demand, increasing production may be expensive for the

firm. Similarly, it will be more expensive during slacks periods

when the firm has to sustain its working force and physical

facilities without adequate production and sales. Unlike cyclical


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fluctuation, seasonal fluctuation generally conforms to a steady

pattern. Therefore, the financial arrangements for seasonal working

capital requirements can be made in advance. However, the

financial plan or arrangement should be flexible enough to take

care of some abrupt seasonal fluctuation.

3) Technology and manufacturing Policy: The manufacturing cycle

(or the inventory conversion cycle) comprises of the purchase and

use of raw materials and the production of finished goods. Longer

the manufacturing cycle, the larger will be the firms working

capital requirements. If there are alternative technologies of

manufacturing a product, the technological process with the

shortest manufacturing cycle may be chosen. In order to minimize

their investment in working capital, some firms, specifically firms

manufacturing industrial products, have a policy of asking for

advance payments from their customers.

4) Credit Policy: The credit policy affects the working capital; by

influencing the level of debtors. The credit terms to be granted to

customer may depend upon the norms of the industry to which the


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firm belongs. But a firm has the flexibility of shaping its credit

policy within the constraint of industry norms and practices. A

liberal credit policy, without rating the credit worthiness of

customers, will be detrimental to the firm and will cerate a problem

of collecting funds later on. A high collection period will mean tie-

up of large funds in book debts. Slack collection procedures can

increase the change of bad debts.

5) Availability of Credit : The availability of credit from banks also

influence the working capital needs of the firm. A firm, which can

get bank credit easily on favorable conditions, will operate les

working capital than a firm without such a facility.

6) Operating Efficiency : The operating efficiency of the firms

relates to the optimum utilization of resources at a minimum costs.

The firm will be effectively contributing operating costs and

utilizing current assets. The use of working capital is improved and

pace of cash conversion cycle is accelerated with operating

efficiency. Better utilization of resources improves profitability

and, thus, helps in releasing the pressure on working capital.


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Balanced Working Capital Position

The firm should maintain a sound working capital position. It should

have adequate working capital to run its business operations. Both

excessive as well as inadequate working capital positions are dangers

from the firms point of view. Excessive working capital means idle

funds which earn no profits for the firm. Paucity of working capital not

only impairs the firms profitability but also results in production

interruptions and inefficiencies.

The dangers of excessive working capital are as follows:

It results in unnecessary accumulation of inventories. Thus, chances

of inventory mishandling, waste, theft and losses increase.

It is an indication of defective credit policy and slack collection

period. Consequently, higher incidence of bad debts results, which

adversely affects profits.

Excessive working capital makes management complacent which

degenerates into managerial inefficiency.


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An enlightened management should, therefore, maintain the right amount of

working capital on a continuous basis. Only then a proper functioning of

business operation will be ensured. Sound financial and statistical

techniques, supported by judgment, should be used to predict the quantum of

working capital needed at different time periods.


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CHAPTER 6

DATA COLLECTION

BALANCE SHEET

PROFIT AND LOSS ACCOUNT

CASH FLOW STATEMENT


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DATA COLLECTION

BALANCE SHEET (Original Data)

(Rs. in Lacs)

Period ended June

1997

June

1998

June

1999

December

2000

March

2002

March

2003

No. Of months 12 12 12 18 15 12

SOURCES OF FUNDS:

Share Capital 1,500.00 1,500.00 1,500.00 1,500.00 1,717.08 1,717.08

Reserves & Surplus 1,886.58 3,582.34 4,094.83 2,987.99 861.46 851.10

Total Shareholders Funds 3,386.58 5,082.34 5,594.83 4,487.99 2,578.54 2,568.18

Secured Loans 1,468.02 5,792.07 6,223.96 6,547.78 8,280.82 8,275.67

Unsecured Loans 517.74 1,044.67 1,722.40 1,407.53 373.50 296.22

Total Debt 1,985.76 6,836.74 7,946.36 7,955.31 8,654.32 8,571.89

Deferred Liabilities 266.74 370.55 298.88 341.34 351.06 342.68

Total Liabilities 5,639.08 12,289.63 13,840.07 12,784.64 11,583.92 11,482.75

APPLICATION OF FUNDS:

Gross Block 1,816.06 5,533.96 7,466.30 7,717.73 7,672.56 7,503.98

Less: Accum. Depreciation (301.91) (622.80) (1,152.75) (2,005.81) (2,595.29) (2,917.31)

Net Block 1,514.15 4,911.16 6,313.55 5,711.92 5,077.27 4,586.67

Capital Work in Progress 439.43 791.35 238.90 - - -

Investments 2,176.65 2,352.93 4,295.73 4,215.33 4,282.08 4,368.83

Current Assets, Loans & Adv.

Inventories 927.63 1,283.46 1,229.23 1,295.60 935.38 541.70

Sundry Debtors 575.17 2,272.79 1,828.18 1,148.58 1,045.18 835.12


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Cash and Bank Balance 35.63 69.68 66.78 25.86 120.88 59.99

Other Current Assets 1.11 54.40 97.98 376.57 512.37 0.79

Loans and Advances 727.59 2,561.13 1,333.22 4,082.51 4,100.85 4,663.29

Less: Current Liab. & Prov.

Sundry Creditors (179.49) (520.62) (787.14) (723.14) (726.61) 812.29

Adv. From customers (368.27) (587.54) (345.18) (3,273.77) (3,621.06) 2,671.96

Interest accrued But not Due (10.29) (168.62) (163.91) (12.97) (23.06) 4.03

Other Liabilities (226.77) (396.99) (322.22) (239.74) (242.98) 178.93

Provisions (301.84) (618.62) (198.07) (27.09) (34.52) 32.94

Net Current Assets 1,180.47 3,949.54 2,738.87 2,651.81 2,066.43 2,400.74

Misc. Expenditure not w/o 328.38 284.65 253.02 205.58 158.14 126.51

Total Assets 5,639.08 12,289.63 13,840.07 12,784.64 11,583.92 11,482.75


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Profit & loss Account (Original)

(Rs. in Lacs)

Particulars June

1997

June

1998

June

1999

December

2000

March

2002

March

2003

No. Of months 12 12 12 18 15 12

INCOME:

Sales 5,611.61 11,009.25 6,160.96 3,348.97 3,446.45 4,340.46

Other Income 385.21 559.05 747.10 1,025.40 564.19 233.54

Stock Adjustments 182.57 237.57 264.43 77.89 (226.88) (322.13)

Total Income (A) 6,259.39 11,805.87 7,172.49 4,452.26 3,783.76 4,251.87

EXPENDITURE

Raw Materials 1,869.91 3,800.86 1,796.77 1,164.53 1,012.29 954.96

Excise Duty

Other Manufacturing Exp.

Employee Cost 280.11 463.38 448.72 840.10 740.48 645.59

Selling and Admin. Exp. 454.47 868.03 855.42 739.35 624.14 537.84

Interest & Financial Charges 247.64 470.49 1,129.58 1,439.34 1,382.67 790.80

Depreciation 153.72 325.66 547.67 865.05 620.93 464.17

TOTAL (B) 4,375.38 9,133.59 6,315.21 5,748.11 5,214.45 4,259.93

PROFIT/LOSS (A-B) 1,884.01 2,672.28 857.28 (1,295.85) (1,430.69) (8.06)

Provision For Taxation (300.00) (325.00) (180.00) (1.37) (4.96) (3.06)

Prior Period Expenses - - - - (720.34)

Adjustment For Earlier years

Short/ Excess provisions(4.77) 10.84 0.21 25.38 29.46 0.76

Proposed Dividend, not

approved (96-97)- - - 150.00 - -


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Corporate Tax on Dividend, not

approved (96-97)- - - 15.00 - -

B/F Surplus Balance in P&L A/c 1,511.79 404.95

PROFIT AVAILABLE

FOR APPROPRIATION

1,579.24 2,358.12 677.49 404.95 (1,721.58) (10.36)


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Cash flow Statement (Original)

(Rs. in Lacs)

Period ended June

1998

June

1999

December

2000

March

2002

March

2003

No. Of months 12 12 18 15 12

CASH FLOW FROM OPERATING

ACTIVITIES

Net profit before Tax & other items 2,672.28 857.28 (1,295.85) (1,430.69) (8.06)

Adjustments:

Depreciation 325.66 547.67 865.05 620.93 464.17

Exchange rate fluctuations (30.67) 49.47 (4.35) 0.02 (1.70)

Profit/loss on sale of investments (net) 127.50 (32.55) (5.70) - (7.43)

Profit/loss on sale of fixed asset (net) (46.82) 7.25 (8.98) (2.92) 11.60

Interest paid 470.49 1,129.58 1,439.34 1,382.67 790.80

Interest received (82.72) (115.60) (458.87) (143.49) (1.94)

Dividend received (125.28) (128.08) (5.00) - -

Miscellaneous income (85.78) (140.60) (152.65) (138.07) (44.91)

Miscellaneous exp. Written off 31.63 31.63 47.44 47.44 31.63

584.01 1,349.17 1,716.28 1,766.58 1,242.22

Operating profits W.C. changes 3,256.29 2,206.45 420.43 335.89 1,234.16

Adjustments for:

Trade and other receivables (3,584.45) 1,628.94 (2,348.28) (50.74) 159.20

Inventories (355.83) 54.23 (66.37) 360.22 393.68

Trade and other payables 906.10 (40.40) 2,625.79 370.92 (948.08)

(3,034.18) 1,642.77 211.14 680.40 (395.20)

Cash generated from operating 222.11 3849.22 631.57 1,016.29 838.96


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activities

Interest paid (470.49) (1,129.58) (1,439.34) (1,382.67) (790.80)

Income/wealth tax paid (net) (314.16) (179.79) 24.01 (4.96) (3.21)

Exchange rate fluctuations 30.67 (49.47) 4.35 (0.02) 1.70

Prior paid expenses (interest) - - - (720.34) -

Excess provisions in earlier years - - - 29.46 0.91

(753.98) (1,358.84) (1,410.98) (2,078.53) (791.40)

Cash from operating activities (531.87) 2,490.38 779.41 (1,062.24) 47.56

(B) CASH FLOW FROM INVESTMENT

ACTIVITIES

Purchase of fixed assets (4,027.77) (1,405.26) (15.54) 16.64 22.26

Investments (net) (303.78) (1,910.25) 86.10 (66.75) (86.75)

Interest received 82.72 115.60 458.87 143.49 1.94

Dividend received 125.28 128.08 5.00 -

Miscellaneous income 85.78 140.60 152.65 138.07 44.91

(4,037.77) (2,931.23) 687.08 231.45 (17.64)

Net cash used in investment

activities(4,569.64) (440.85) (92.33) (830.79) 29.92

(C) CASH FLOW FROM FINANCNG

ACTIVITIES

Issue of equity share capital - - - 217.08 -

Proceeds from borrowings (net of

repayment)4,954.79 1,037.95 51.41 708.73 (90.81)

Capital issue exp. (50.26) - - - -

Dividend paid (300.84) (600.00) - - -

4,603.69 437.95 51.41 925.81 (90.81)


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Net cash used in financing activities 34.05 (2.90) (40.92) 95.02 (60.89)

Net increase in cash and cash

equivalents

Opening cash and cash equivalents 35.63 69.68 66.78 25.86 120.88

Closing cash and cash equivalents 69.68 66.78 25.86 120.88 59.99

34.05 (2.90) (40.92) 95.02 (60.89)

Original Annual Accounts Modified for analysis

BALANCE SHEET (Analyzed Data)

(Rs. in Lacs)

Period endedMarch

2000

March

2001

March

2002

March

2003

March

2004

March

2005No. Of months 12 12 12 12 12 12

SOURCES OF

FUNDS:Share Capital 1,500.00 1,500.00 1,500.00 1,500.00 1,717.08 1,717.08

Reserves & Surplus 3,158.40 3,966.71 3,541.41 2,562.68 861.46 851.10

Total Shareholders Funds4,658.40 5,466.71 5,041.41 4,106.10 2,578.54 2,568.18

Secured Loans 4,711.06 6,115.99 6,385.87 6,894.39 8,280.82 8,275.67

Unsecured Loans 912.94 1,552.97 1,564.97 1,200.72 373.50 296.22

Total Debt5,624.00 7,668.96 7,950.84 8,095.11 8,654.32 8,571.89


Total Liabilities 10,672.00 13,452.47 13,312.36 12,544.50 11,583.92 11,482.75


Gross Block 4,604.49 6,983.22 7,592.02 7,708.70 7,672.56 7,503.98

Less: Accum. Depreciation 542.58 1,020.26 1,579.28 2,123.71 2,595.29 (2,917.31)

Net Block4,061.91 5,962.96 6,012.74 5,584.99 5,077.27 4,586.67


Investments 2,308.86 3,810.03 4,255.53 4,228.68 4,282.08 4,368.83


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Current Assets, Loans &

Adv.

Inventories 1,194.50 1,242.79 1,262.42 1,223.56 935.38 541.70

Sundry Debtors 1,848.39 1,939.33 1,488.38 1,127.90 1,045.18 835.12



Loans and Advances 2,102.74 1,640.20 2,707.86 4,086.18 4,100.85 4,663.29

Less: Current Liab. & Prov.

Sundry Creditors (435.34) (720.44) (755.44) (724.31) (726.61) 812.29

Adv. From customers(532.72) (405.77) (1,809.48) (3,343.23) (3,621.06) 2,671.96

Interest accrued But not

Due(129.04) (165.09) (88.44) (14.99) (23.06) 4.03

Other Liabilities(354.43) (340.91) (280.99) (240.46) (242.98) 178.93

Provisions (539.07) (303.09) (112.58) (28.58) (34.52) 32.94

Net Current Assets

3,257.28 3,041.54 2,695.34 2,534.74 2,066.43 2,400.74

Misc. Expenditure not w/o 295.58 260.93 229.30 196.09 158.14 126.51

Net Total Assets10,627.00 13,452.47 13,312.36 12,544.50 11,583.92 1,1482.75


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Profit & loss Account (Analyzed Data)

(Rs. in Lacs)

ParticularsMarch

2000

March

2001

March

2002

March

2003

March

2004

March

2005PERIOD 12 12 12 12 12 12

INCOME:Sales 9,679.84 7,373.03 3,214.73 2,363.78 2,757.16 4,340.46

Other Income 515.59 700.10 699.48 625.54 451.35 233.54

Stock Adjustments223.82 257.71 105.05 (6.44) (181.50) (322.13)

Total Income (A) 10,419.25 8,330.84 4,019.26 2,982.88 3,027.01 4,251.87

EXPENDITURE

Raw Materials 3,318.12 2,297.80 1,031.46 784.73 809.83 954.96

Excise Duty

Other Manufacturing Exp. 2,170.30 1,392.50 450.49 279.51 318.97

Employee Cost 417.56 452.39 532.23 568.15 592.38 645.59

Selling and Admin. Exp. 764.64 858.57 583.53 494.50 499.31 537.84

Interest & Financial Charges 414.78 964.81 1,002.07 996.20 1,106.14 790.80

Depreciation282.68 492.16 569.44 556.71 496.57 464.17

TOTAL (B) 7,944.04 7,019.81 4,452.86 3,916.95 4,171.56 4,259.93

PROFIT/LOSS (A-B) 2,444.04 1,311.03 (433.60) (934.07) (1,144.55) (8.06)Provision For Taxation (318.75) (216.25) (45.69) (1.68) (3.97) (3.06)

Prior Period Expenses - - - (144.07) (576.27) -

Adjustment For Earlier years Short/

Excess provisions6.94 2.87 12.74 18.58 23.57 0.76

Proposed Dividend, not approved (96-

97)- - 75.00 75.00 - -

Corporate Tax on Dividend, not

approved (96-97)- - 7.50 7.50 - -

B/F Surplus Balance in P&L A/c - - 1,511.17 958.37 (20.37)

PROFIT AVAILABLE FOR

APPROPRIATION2,163.40 1,097.65 1,127.12 (20.37) (1,721.59) (10.36)


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CHAPTER 7

DATA INTERPRETATION AND ANALYSIS

OPERATING CYCLE STATEMENT

RATIO ANALYSIS


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Correlation Analysis

Common Size Statement

Trend Analysis

Ratio Analysis

All the above statements are helpful to know the financial position of the

firm, need of working capital and needs of resources etc.

OPERATING CYCLE

Operating Cycle is the time duration required to convert sales, after the

conversion of resources into inventories, into cash. The Operating Cycle of a

manufacturing company involves three phases:

Acquisition of resources such as Raw material, Labour, Power and

Fuel etc.

Manufacturing of the product which includes conversion of raw

material into work in progress into finished goods.

Sale of the product either for cash or on credit. Credit sales create

account receivable for collection.


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These phases affect cash flows, which most of the time, are neither

synchronized nor certain. They are not synchronized because cash outflows

usually occur before cash inflows. Cash inflows are not certain because sales

and collections which give rise to ash inflows are difficult to forecast

accurately. Cash Outflows, on the other hand, are relatively certain. The firm

is, therefore, required to invest in current assets for a smooth, uninterrupted

functioning.

Stock of raw material and work in process are kept to ensure smooth

production and to guard against non availability of raw material and other

components.

The firm holdsstock of finished goods to meet the demands of customers on

continuous basis and sudden demand from some customer.

Gross Operating Cycle(GOC) is also known as the length of the operating

cycle is the sum of i) Inventory conversion Period(ICP) and ii) Debtors

Conversion Period(DCP). TheInventory conversion periodis the total time


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needed for producing and selling the product. The Debtors conversion

period is the time required to collect the outstanding amount from the

customers.

The Payables Deferral Period (PDP) is the length of time the firm is able

to defer payments on various resource purchases.

Net Operating Cycle also represents the cash conversion cycle. It is net

time interval between cash collection from sale of the product and cash

payments for resources acquired by the firm. It also represents the time

interval over which additional funds, called working capital, should be

obtained in order to carry out the firms operations. The firm has tonegotiate

Working capital from sources such as commercial banks. The negotiated

sources of working capital financing are called non- spontaneous sources. If

net operating cycle of a firm increases, it means further needfor negotiated

working capital.


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FIG: OPERATING CYCLE OF A MANU7FACTURING FIRM

Purchase Payment Credit Sales Collection

RMCP + WIPCP + FGCP

Inventory conversion period Receivable conversion price

Payables Net operating cycle

Gross operating cycle


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(B) OPERATING CYCLE ANALYSIS

Calculation for Holding Periods: (Rs. In lacs)

Particulars

March

2000

March

2001

March

2002

March

2003

March

2004

March

2005

PERIOD 12 12 12 12 12 12

1Raw Material Consumed

3,318.

12

2,297.

80

1,031.4

6784.73 809.83 954.96

2 Average Raw Material

Inventory644.91 647.25 499.82 440.89 371.34 282.23

3 Raw Material Turnover (1/2) 5.15 3.55 2.06 1.78 2.18 3.38

4 Raw Material Holding Period

(365 days/ Raw Material

Turnover)

71

Days

103

Days

177

Days

205

Days

167

Days

108

Days

5Cost of Production

5,753.

59

3,841.

78

1,887.6

5

1,642.7

9

1,916.6

9

2,483.7

9

6Average Work-in-Progress

270.6

1497.26 711.33 769.39 666.44 418.00

7 Work-in-progress Turnover

(5/6)21.26 7.73 2.56 2.14 2.88 5.94

8 Work-in-Progress Holding

Period

(365 Days/7)

17

Days

47

Days

137

Days

170

Days

126

Days

63

Days

9 Cost of Goods Sold 5,682.

16

3,884.

98

1,909.1

2

1,638.8

3

1,902.6

8

2,504.5

6

10 Average Finished Goods

Inventory59.69 73.80 41.47 32.72 41.70 38.32

11 Finished Goods Turnover (9/10) 85.19 52.64 46.00 50.09 45.62 65.35

12 Finished Goods Holding Period

(365 Days/11)4 Days 7 Days 8 Days 7 Days 8 Days 6 Days

13Credit Sales

9,111.

32

6,753.

79

2,984.7

5

1,499.3

0730.12 606.89

14 Average Debtors 1,248. 1,893. 1,713.8 1,308.1 1,086.5 940.15


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15 86 6 4 4

15 Debtors Turnover (13/14) 7.30 3.57 1.74 1.15 0.67 0.64

16 Debtors Conversion Period

(365 Days/15)

50

Days

102

Days

210

Days

317

Days

545

Days

570

Days

17Credit Purchases

3,532.

23

2,088.

37

946.03 752.31 703.15 759.09

18 Average Creditors 294.78 577.93 737.98 739.88 725.46 769.45

19 Creditors turnover (17/18) 11.98 3.61 1.28 1.02 0.97 0.99

20 Deferral Payment Period

(365 Days/19)

30

days

101

days

285

days

359

days

376

days

370

days

Eg:

The length of the Operating Cycle of a manufacturing firm:

Gross Operating Cycle = Inventory + Debtors

conversion period conversion period

1) GOC = ICP + DCP

= 92 + 50

= 142 DAYS

2) ICP = RMCP + WIPCP + FGCP

= 71 + 17 + 4

= 92 DAYS

3) Payable deferral period (PDP) = 30 DAYS

4) Net operating Cycle = Gross + Payable

Operating cycle deferral period

NOC = GOC - PDP

= 142 - 30

= 112 DAYS


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Years 200

0

200

1

200

2

200

3

200

4

2005

Net Working Capital (In Days) 112 158 247 340 470 377

Net Working Capit

112158

247

340

470

377

0

100

200

300

400500

1998 1999 2000 2001 2002 2003

years

Networkingcapital

(Indays)

net working

capital

CORRELATION ANALYSIS

The Correlation is a statistical tool which studies the relationship between

two variables and correlation analysis involves various methods and


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techniques used for studying and measuring the extent of the relationship

between two variables.

Definitions:

Correlation is an analysis of the co-variation between two or more

variables

- By A.M.Tuttle.

When the relationship is of a quantitative nature, the appropriate statistical

tool for discovering and measuring the relationship and expressing it in a

brief formula is known as correlation.

- By Craxton and Cowden.

Two variables are said to be correlated if the change in one variable results

in a corresponding change in the other variable.

Types of Correlation

a) Positive and Negative Correlation: i) Positive Correlation: If

the values of the two variables deviate in the same direction i.e.,

if the increase in the values of one variable results, on an


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average, in a corresponding increase in the value of the other

variable and vis-a-versa.

ii) Negative Correlation: If the values of the two variables deviate

in the opposite direction i.e., if the increase in the values of one

variable results, on an average, in a corresponding decrease in

the value of the other variable and vis-a-versa.

b) Linear and Non Linear Correlation: i) Linear Correlation:

The Correlation between two variables is said to be linear if

corresponding to a unit change in one variable, there is a

constant change in the other variable over the entire range of

the values.

ii) Non Linear Correlation: The Correlation between two

variables is said to be non linear if corresponding to a unit

change in one variable, there is not a constant change but at a

fluctuating rate in the other variable over the entire range of the

values.

Coefficient of Correlation


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The Coefficient Correlation (rxy) is a numerical measures of linear

relationship between two variables series and is defined as the ratio of the

covariance between X and Y, to the product of the standard deviation of X

and Y, Symbolically,

Cov. (x,y)

r = S.Dx . S.Dy

Cov. (x,y) = 1/n (x-x )(y-y ) S.Dx = 1/n (x-x )2 S.Dy = 1/n (y-y ) 2

rxy = (x-x )(y-y )

(x-x )2 (y-y ) 2


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Part I

Financial Ratios Selected for Correlation Analysis

Period endedMarch

2000

March

2001

March

2002

March

2003

March

2004

March

2005No. Of months 12 12 12 12 12 12

(X1) Current Ratio 2.64 2.57 1.88 1.58 1.44 1.65

(X2) Quick Ratio 2.04 1.93 1.47 1.30 1.24 1.50

(X3) Cash Position Ratio 1.2% 1.4% 0.8% 0.7% 1.8% 0.1%

(X4) Working Capital Turnover Ratio 4.33 2.34 1.12 0.90 1.20 1.94

(X5) Inventory Turnover Ratio 5.82 3.88 1.52 1.32 1.76 3.39

(X6) Debtors Turnover Ratio 7.30 3.57 1.74 1.15 0.67 0.64

(X7) Cash Turnover Ratio 27.28 30.08 53.53 95.45 56.09 40.91

(X8) Net Working Capital Ratio 0.32 0.23 0.21 0.21 0.18 0.21

(X9)Current Assets Turnover Ratio

2.61 1.44 0.60 0.37 0.41 0.68

(X10) Average Collection Period50 days 102

days

210 days 317 days 545 days 570 days

(Y)PBDIT to Total Assets0.251 0.180 0.070 0.037 0.028 0.082


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EG:

X1 X2 U (X1-1.65) V( X2-1.47) U2 V2 UV

2.6 2.0 0.99 0.57 0.9801 o.3249 0.5643

2.5 1.9 0.92 0.46 0.8464 0.2116 0.4232

1.8 1.5 0.23 0.03 0.0529 0.0009 0.0069

1.6 1.4 0 0 0 0 0

1.5 1.3 -0.07 -0.17 0.0049 0.0289 0.119

1.4 1.2 -0.21 -0.23 0.0441 0.0529 0.0483

U = 1.86 V = 0.66 U2=1.9484

V2=0.6192

UV=1.0546

ruv = n UV ( U)( V)

[n U2 ( U)2][ n V2 ( V)2]

= 6*1.0546 1.86* 0.66

[6* 1.9484 (1.86)2] [6* 0.6192 (0.66)2]

= 0.981


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Correlation Among Ratios

X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X10.981 0.846 0.642 0.751 0.490 0.984 0.814 0.901 -0.328

X2 0.842 0.696 0.850 0.598 0.974 0.847 0.932 -0.647

X3 0.624 0.743 0.496 0.843 0.649 0.837 -0.530

X4 0.717 0.566 0.681 0.736 0.768 -0.476

X5 0.746 0.800 0.844 0.930 -0.725

X6 0.550 0.677 0.706 -0.916

X7 0.878 0.940 -0.445

X8 0.957 -0.445X9 -0.565

X10

Y 0.960 0.986 0.853 0.742 0.904 0.864 0.975 0.911 0.978 -0.573

GRAPHICAL REPRESENTATION OF

CORRELATION ANALYSIS

1)X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X1

0.981 0.846 0.642 0.751 0.490 0.984 0.814 0.901 -0.328

X1

0.981

0.846

0.6420.751

0.49

0.984

0.8140.901

-0.328-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1.2

X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X1


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2) X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X2 0.842 0.696 0.85 0.598 0.974 0.847 0.932 -0.647

X2

0.8420.696

0.850.598

0.9740.847 0.932

-0.647

-1

-0.5

0

0.5

1

1.5

X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X2

3) X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X3 0.624 0.743 0.496 0.843 0.649 0.837 -0.53

X3

0.6240.743

0.496

0.8430.649

0.837

-0.53

-1

-0.5

0

0.5

1

X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X3

4)


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X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X4 0.717 0.566 0.681 0.736 0.768 -0.476

X4

0.717

0.5660.681 0.736 0.768

-0.476

-1

-0.5

0

0.5

1

X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X4

5) X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X5 0.746 0.8 0.844 0.93 -0.725

X5

0.93

-0.725

0.8440.746 0.8

-1

-0.5

0

0.5

1

1.5

X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X5

6) X1 X2 X3 X4 X5 X6 X7 X8 X9 X10X6 0.55 0.677 0.706 -0.916

X7 0.878 0.94 -0.445

0.677 0.706

-0.916

0.878

0.55

-0.445

0.94

-1.5

-1

-0.5

0

0.5

1

1.5

X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X6 X7


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7) X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X8 0.957 -0.445

X9 -0.565

0.957

-0.445

-0.565

-1

-0.5

0

0.5

1

1.5

X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

X8

X9

8) X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

Y 0.96 0.986 0.853 0.742 0.904 0.864 0.975 0.911 0.978 -0.573

Y

0.96 0.9860.853

0.7420.9040.864

0.9750.9110.978

-0.573

-1

-0.5

0

0.5

1

1.5

X1 X2 X3 X4 X5 X6 X7 X8 X9 X10

Y


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COMPARATIVE STATEMENTS ANALYSIS

A simple method of tracing periodic changes in the financial performance of

a company is to prepare comparative statement. Comparative financial

statement will contain items at least for two years. Changes increases and

decreases in Income statement and Balance sheet over period can be

shown in two ways: 1) Aggregate Changes 2) Proportional

Changes.

Aggregate Changes can be indicated by drawing special columns for

aggregate amount or percentage, or both, of increases and decreases.

Recording percentage calculated in relation to a common base in special

columns on the other hand, shows relative, or Proportional, Change. For

e.g. in case of Profit and Loss statement, Sales figure is assumed to be

common base (and therefore, equal to 100) and all other items are expressed

as percentage of sales. Similarly, the Balance sheet items are expressed as

percentage of total assets or total funds. The financial statements prepared in

terms of common base percentages are called common size statements.

This kind of analysis is called Vertical analysis and it indicates static

relationships since relative changes are studied at a specific date.


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An investigation of the comparative statements helps to highlight the

significant facts and points out the items which need further analysis. From

analytical point of view, such statements are quite useful to investors.

(3) Common Size Statement Analysis

Calculation of Common Size Statement of Balance Sheet

Period ended March

2000

March

2001

March

2002

March

2003

March

2004

March

2005

No. Of months 12 12 12 12 12 12

SOURCES OF FUNDS:

Share Capital 14.12 11.15 11.27 12.30 14.82 14.95

Reserves & Surplus 29.72 29.49 26.60 20.43 7.44 7.41

Total Shareholders Funds 43.84 40.64 37.87 32.73 22.26 22.36

Secured Loans 44.33 45.64 47.97 54.96 71.49 72.07

Unsecured Loans 8.59 11.55 11.76 9.57 3.22 2.58

Total Debt 52.92 57.01 59.73 64.53 74.71 74.65


TOTAL 100.00 100.00 100.00 100.00 100.00 100.00


Gross Block 43.33 51.91 57.03 61.45 66.23 65.35

Less: Accum. Depreciation 5.11 7.58 11.86 16.93 22.40 25.41

Net Block 38.22 44.33 45.17 44.53 43.83 39.94


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Investments 21.72 28.32 31.96 33.71 36.97 38.05

Inventories 11.24 9.24 9.48 9.50 8.07 4.72

Sundry Debtors 17.39 14.42 11.18 8.99 9.02 7.27



Loans and Advances 19.79 12.19 20.34 32.57 35.40 40.61

Current Assets 49.39 37.00 43.13 54.89 57.96 53.13

Sundry Creditors 4.10 5.36 5.67 5.77 6.27 7.07

Adv. From customers 5.01 3.02 13.59 26.65 31.26 23.27

Interest accrued But not Due 1.21 1.23 0.66 0.12 0.20 0.04

Other Liabilities 3.34 2.53 2.11 1.92 2.10 1.56

Provisions 5.07 2.25 0.85 0.23 0.30 0.28

Current Liabilities 18.73 14.39 22.88 34.69 40.13 32.22

Net Current Assets(CA-CL) 30.65 22.61 20.25 20.20 17.83 20.91

2.78 1.94 1.72 1.56 1.37 1.10

TOTAL 100.00 100.00 100.00 100.00 100.00 100.00


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C Other Manufacturing Exp. (Exclude

Excise Duty)23.84 20.44 15.37 13.14 13.24 13.97

D Employee Cost 4.59 6.64 18.16 26.72 24.59 15.99

E Increase/decrease in Finished & WIP

Goods2.46 3.78 3.59 (0.30) (7.53) (7.98)

F Gross Profit (A-B-C-D+E)37.58 42.96 34.87 22.94 21.02 38.41

G Selling and Administration Exp. 8.39 12.60 19.91 23.25 20.73 13.32

H Other Income 5.66 10.28 23.86 29.41 18.74 5.78

I Operating Profit (F-G+H)) 34.85 40.64 38.82 29.10 19.03 30.87

J Depreciation 3.11 7.23 19.43 26.18 20.62 11.49

K Profit/Loss Before Interest & Tax

(J-I)

31.74 33.41 19.39 2.92 (1.59) 19.38

L Interest & Financial Charges 4.56 14.16 34.19 46.84 45.92 19.58

M

Profit/Loss Before Tax (K-L)27.18 19.25 (14.80) 43.92 (47.51) (0.20)

N Taxation 3.42 3.13 1.12 (0.78) (0.81) 0.06O Profit/loss After Tax (M-N) 23.76 16.12 (15.92) (43.14) (46.70) (0.26)

TREND ANALYSIS

In financial analysis the direction of changes over a period of years is of

crucial importance. Time series or trend analysis of ratios indicates the

direction of change. This kind of analysis is particularly applicable to the

items of profit and loss account. It is advisable that trends of sales and net

income may be studied in the light of two factors: the rate of fixed expansion

or secular trend in the growth of the business and the general price level. It

might be found in practice that a number of firms would show a persistent

growth over a period of years. But to get a true trend of Growth, the sales

figure should be adjusted by a suitable index of general prices. When the

resulting figures are shown on a graph, we will get trend of growth devoid of


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price changes. Another method of securing trend of growth and one which

can be used instead of the adjusted sales figures or as check on them is to

tabulate and plot the output or physical volume of sales expressed in suitable

units of measure. If the general price level is not considered while analyzing

trend of growth, it can mislead management. They may become unduly

optimistic in periods of prosperity and pessimistic in dull periods.

For, Trend analysis, the use of index numbers is generally advocated.

The procedure followed is to assign the number 100 to items of the base year

and to calculate percentage changes in each items of other years in relation

to the base year. This Procedure may be called as trend percentage

method.

(2) Index Analysis :Calculation of Index Trend of Balance Sheet

Period endedMarch

1998

March

1999

March

2000

March

2001

March

2002

March

2003No. Of months 12 12 12 12 12 12

SOURCES OF FUNDS:

Share Capital 100.00 100.00 100.00 102.89 114.47 114.47

Reserves & Surplus 100.00 125.59 112.13 81.14 27.28 26.95

Total Shareholders Funds 100.00 117.35 108.22 88.14 55.35 55.13

Secured Loans 100.00 129.82 135.55 146.34 175.77 175.66

Unsecured Loans 100.00 170.11 171.42 131.52 40.91 32.45

Total Debt100.00 136.36 141.37 143.94 153.88 152.42


TOTAL 100.00 126.59 125.27 118.04 109.00 108.05


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Gross Block 100.00 151.66 164.88 167.42 166.63 162.97

Less: Accum. Depreciation 100.00 188.04 291.07 391.41 478.32 537.67

Net Block100.00 146.80 148.03 137.49 125.00 112.91

Capital Work in Progress100.00 53.60 16.98 - - -

Investments 100.00 165.02 184.31 183.15 185.46 189.22

Inventories 100.00 104.04 105.69 102.43 78.31 45.35

Sundry Debtors 100.00 104.92 80.52 61.02 56.55 45.18



Loans and Advances 100.00 78.00 128.78 194.42 195.02 221.77

Current Assets 100.00 94.84 109.42 131.22 127.95 116.25

Sundry Creditors 100.00 165.49 173.53 166.38 166.91 186.59

Adv. From customers 100.00 76.17 339.67 672.58 679.73 501.57

Interest accrued But not Due 100.00 127.94 68.54 11.62 17.87 3.12

Other Liabilities100.00 96.19 79.28 67.84 68.56 50.48

Provisions 100.00 56.22 20.88 5.30 6.40 6.11

Current Liabilities 100.00 97.23 153.07 218.60 233.51 185.88

Net Current Assets(CA-CL)100.00 93.38 82.75 77.82 63.44 73.70

Miscellaneous Expenditure100.00 88.28 77.58 66.34 53.50 42.80

TOTAL100.00 126.59 125.27 118.04 109.00 108.05

Sales100.00 76.17 33.21 24.42 28.48 45.28


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Obsolete stock, slow moving lineswill extend overall stock turnoverdays. Faster production, fewer

product lines, just in time ordering

will reduce average days.

Receivables

Ratio

(in days)

Debtors *365/Sales

= xdays

It takes you on average x days tocollect monies due to you. If yourofficial credit terms are 45 day andit takes you 65 days... why?One or more large or slow debts candrag out the average days. Effectivedebtor management will minimizethe days.

Payables

Ratio

(in days)

Creditors *365/Cost of Sales(orPurchases)

= xdays

On average, you pay your suppliersevery x days. If you negotiate bettercredit terms this will increase. Ifyou pay earlier, say, to get adiscount this will decline. If yousimply defer paying your suppliers(without agreement) this will alsoincrease - but your reputation, thequality of service and any flexibility

provided by your suppliers maysuffer.

Current

Ratio

Total CurrentAssets/Total CurrentLiabilities

= xtimes

Current Assets are assets that youcan readily turn in to cash or will doso within 12 months in the course of

business. Current Liabilities areamount you are due to pay withinthe coming 12 months. For example, 1.5 times means that youshould be able to lay your hands on$1.50 for every $1.00 you owe. Lessthan 1 time e.g. 0.75 means that youcould have liquidity problems and

be under pressure to generatesufficient cash to meet oncoming


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demands.

Quick Ratio

(TotalCurrentAssets -

Inventory)/Total CurrentLiabilities

= x

times

Similar to the Current Ratio buttakes account of the fact that it may

take time to convert inventory intocash.

Working

Capital

Ratio

(Inventory +Receivables -Payables)/Sales

As %Sales

A high percentage means thatworking capital needs are highrelative to your sales.


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CHAPTER 8

LIMITATION

LIMITATION AND PROBLEMS OF THE STDY

LIMITATIONS OF THE STUDY

This is my first project in finance and I am inexperienced

(although our professor helped us a lot).


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The company APL has not revealed all the information to us, as no

organization reveals its facts to outsiders.

Time has been a killer to me as I got only 2 days in APL and

exactly 2 hours/day of discussions.

I also got eight weeks to complet

43 Analysis the Need of WOrking Capital Management

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