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Transcript of Acknowle Dement
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SUMMER TRAINING PROJECT REPORT ON
QUALITY MANAGEMENT IN R-TEK MOULD
FOR THE PARTIAL FULFILLMENT OF THE
REQUIREMENT FOR THE AWARD OF DEGREE OFM.COM BUSINESS INNOVATIONS
OF PANJAB UNIVERSITY CHANDIGARH
(Under the Innovative Programme Schedule of University Grants
Commission)
Under the guidance of Under the
supervision ofMr. Ashwani Bhalla Mr. Ravinder
Singh
Submitted By:
Anuj Kumar Kapoor
M.Com Business Innovation 2012-2013
POST GRADUATE DEPARTMENT OF COMMERCE AND
BUSINESS INNOVATIONS
S.C.D GOVERNMENT COLLEGE LUDHIANA
CERTIFICATE
This is to certify that the project work done on Quality Management
in R-Tek Mould is a bonafide work carried out by Mr. Anuj KumarKapoor under my supervision and guidance. The project report is
submitted towards the partial fulfilment of 2 year, full time degree
of M.Com Business Innovations
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This work has not been submitted anywhere else for any other
diploma/degree. The original work is carried during 1st June 2012 to
15th July 2012 in R-Tek Mould
Name and Sign of Industry Guide Name and Sign ofFaculty
Mr. Ravinder Singh Mr. Ashwani Bhalla
_________________ __________________
Date:
Name of Student : Anuj Kumar Kapoor
Roll no.
___________________________
ACKNOWLEDGEMENT
This report could not have been possible without the help of certain
people and utilising support of R-Tek Mould.
I would like to express my sincere gratitude towards Mr. Ravinder
Singh (General Manager) for his indicious and technical guidance,
invaluable and constructive criticism and vital encouragement
throughout the entire project which helped me to get inside into theworking of R-Tek Moulds and to relate the theoretical knowledge
imparted by our esteemed faculty members in the course of M.Com
Business Innovations to the present scenario of corporate body.
I also express my sincere thanks to Dr. Ashwani Bhalla professor
and program co-ordinator and my respective Major Advisor Mrs.
Leenu Narang, professor of Department of Commerce and Business
Innovation, S.C.D. Government College Ludhiana, under whose
able guidance this project was completed.
I express my sincere thanks to the whole R-Tek for giving all the
facilities during my training period.
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Indeed, the words at my command are not adequate to convey my
heart full thanks to respective parents for the encouragement and
inspiration given by them.
Anuj Kumar Kapoor
Contents
Chapter 1
Introduction to R-Tek Mould
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R-Tek Mould came into existence in 1985 under the very special
guidance of Sh. Kulwant Singh Matharu. Started from a scratch,
much more research and development work was done till 1990 and
the lead was taken by Sh. Ravinder Singh Matharu who is son of Sh.
Kulwant Singh Matharu.
The concern was established as a small-scale industrial unit and now
its one of leading suppliers of plastic injection Moulding tools,
pressure, rubber compression moulds and polyurethane moulds and
their mouldings. It is serving the industry for about 17 years.
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Besides straightening its hold on domestic market, the company has
strong potential in foreign market. The company has done some
marvellous jobs dealing with some leading brands like J.J. Jonex for
Sports Dye and mould, Indian Air Force for spare parts, tools and
dye, Aluminium Casting, with Eastman Industries the company is
dealing Injection Moulds, Hero Cycle Limited is buying tool and
dye, Em Cee Cee Sports Private Limited is dealing in tools and dye.
The company is enjoying a prestigious market all over the globe and
working with a motive of customer satisfaction. The company
prioritize is maintaining quality, accuracy, competitive prices and
professional work force.
R-Tek Mould strictly adheres to international quality and safety
norms of the automobile industry followed by leading manufacturers
and automobile giants and works to ensure zero-defect products.
The company has a dedicated quality assurance department along
with a team of experienced quality control supervisors, who ensures
quality at all levels of production process. The company was
endowed with ISO 9001:2008 certification and is in process to
achieve more in this line. The company is in process of getting TS
16949 certification
Autocrat is an integral part of R-Tek Mould. Autocrat is a reputed
company since 1992, engaged in manufacture of Automobile parts,
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Bike Headlights Lens, Motorcycle parts, Bike Visor, Auto parts,
Visors, and other plastic products. It is one of leading
manufacturers, suppliers of Headlight glass. It provides headlight
glass to Bajaj CT 100, Bajaj Discover, Bajaj Platina, Bajaj Pulsar,
and Honda Activa. These products are fabricated with the high
grade raw material that is procured from reliable vendors to ensure
that the products are of high quality and meet the global standards.
Objectives of the Company
Excellent distribution network
To achieve and maintain a lead position as manufacturer of
automotive components
To ensure steady growth in business and fulfil its social
obligations
To build up high degree of customer confidence by sustaining
standards of excellence in product quality.
To develop human resource to increase their efficiency and
productivity
Care of environment and to discharge factory waste
responsibly
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To build a strong customer base by satisfying them
Maintaining high quality output by implementing various
quality checks
Organisational Chart
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Departments
The researcher encompassed the study of four departments namely
Accounts and Administration, Designing, Production and
Marketing. The basis for departmentalization was functional.
Accounts And Administration Department: This
Department is headed by Mr. Balwinder Singh. Two
executives assist him. This department is broadly concerned
with acquisition and use of funds by the company. It also
analyzes plans and controls the companys financial affairs.
Moreover, the in house administration of the company is also
taken care of. It also includes maintenance of showroom and a
look into the requirements and problems of day to day
administration. In a nutshell this department deals with trouble
shooting any problem.
Designing Department: This department is headed by Mr
Inderpal Singh. Eight creative designers assist him. The team
of designer tailor makes the products according to the needs of
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customers. Two aspects namely affordability and aesthetics
are focused upon. Major activities under taken in this
department are as follows:
Setting the normal design: According to initial
measurement told by customer, a normal design is set.
Once the normal design is finalised by the customer, a
designer accompanied by marketing personnel visits the
construction site and takes the final measurement. Then
according to it a design is set and the price quotation is
made.
Setting production design: When the deal is finalized
and 50 per cent of amount is received from customer, the
designer makes the production design. The design
clearly demarcates the technicalities so that it becomes
easier for production personnel to understand.
Innovative designs: The team of designers also trigger
out the brain cells to create innovative designs.
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Marketing Department: This department deals with
springboard of all activities. The department is headed by Mr.
Sandeep Sharma. Eight marketing executives assist him.
Various activities like product packaging, branding,
advertisement and sales promotions are taken care under this.
Marketing department is assisted by two IT personals who
help in online advertising and Search Engine Optimisation
(SEO).
Human Resource Department: This department is headed
by Mr. Tajinder Singh. He is assisted by 2 executives. Various
aspects of HR are taken care of :
Leave Facility: All employees are entitled to 12 days of
casual leave and 2 days of sick leave (monthly). In case
of long leave, say more than a week, one need to inform
it 10-12 days before.
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Recruitment: The company spells out its requirements
to the consultancies about the suitable candidates.
Candidates are recruited after proper training.
Training: A selected candidate is put on training for 15
days to 1 month. During this period, he is not given any
individual project.
Job Rotation: Job rotation is adopted by the company
so that there is development of multi-faceted skills in
vacancies and to cope up with increasing work load.
Production Department: This department is headed by Mr.
Abhishek Kumar. Four supervisors are in charge of four
different activities such as quality control, product analyzing,
production and dispatch.
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2 Persons 2 Persons 26 Persons 1
Person
(Machine operators
And helpers)
Quality Control: This sub department is mainly
concerned with the inspection of raw materials and
finished products. The raw materials are supplied mainly
by four companies namely Novapan, Spacewood,
Bhutan Board and Nepal Board and Nuwood.
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Product Analyzing: This sub department is mainly
concerned with targeting and scheduling. After receiving
the product design, it targets as to when the work needs
to be completed and schedules the whole process. Again,
after completion of production and before dispatch, the
product is thoroughly inspected here.
Production: Twenty-six comprising of machine
operators and helpers are involved in this sub
department. It consists of five operations namely:
Cutting, Moulding, Edge Bending, Boring and Hot Press
and Post formed.
Dispatching: After the product is thoroughly inspected.
The process of dispatching begins. The marketing
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department helps the dispatching department in various
ways.
Chapter 2
Literature Review of R-Tek
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Infrastructure
Infrastructure is one of the main reasons that they provide effective
customisation services to their clients. R-Tek Mould has invested a
lot in infrastructure and ensures all the requisite facilities are
available in various sections of the company.
Their infrastructure is equipped with latest and sophisticated
machineries. The manufacturing unit is segregated into various
departments such as research and development, quality assurance,
production department, dispatching department, so that the business
can be carried out in synchronised manner.
Their infrastructure is segregated into following units:
Quality Testing
Production
Research and Development
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Logistics
Inventory and warehouse
Product Range
On the strength of its expertise in the development and
manufacturing components R-Tek has explored new horizons
to provide diverse range of products.
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Plastic Components
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Headlight Glass
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Achievements
Due to premium quality products, they have achieved new hikes
in the competitive market. Their products are widely applauded for
its special features and unmatched quality. The products offeredby R-TEK MOULD are widely used in many sectors. The company
cater its products to the sectors such as:-
Sports
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Sanitary & Water supply
Indian Railways
Hand Tools
Electrical
Indian Defence and Air Force
Automobile
Textile
Kitchen Ware
Agricultural
Quotations That R-Tek Mould Use:
Flying into the future, we shall rise above expectation and
bring about a renaissance that is unparallel.
Sourcing for better result.
Engineered for unmatched perfection.
Together we Excel.
Company Profile
Company Name: R-Tek Mould
Office and Works: Street No. 7 1/2, Hargobind Nagar, Industrial
Area - C, Ldh.
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Email: [email protected]
Website: www.rtekmould.com, www.autocrat.co.in
Business Type: Manufacturer, Exporter, Service Provider
Year of Establishment: 1985
Annual Turnover: Up to Rupees 1 Crore (approx.)
Export Percentage: Up to 20 per cent
Primary Competitive Advantage:
Experienced Research and Development Department
Good Financial Position and Total Quality Management
Large Product Line
No. of Employees: 50-60 People
Major Markets: Indian Subcontinent, Australia, New Zealand, East
Asia, North Africa, Caribbean
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THEORETICAL ASPECTS OF THE PROJECTS
NEED FOR WORKING CAPITAL
The need for working capital (gross) or net current assets
cannot be over emphasized. The objective of financial
decision making is to maximise the shareholders wealth. To
achieve this, it is necessary to generate sufficient profits. The
extent to which profits can be earned will naturally depended
upon the magnitude of the sales, among other things. A
successful sales programme is, in other words, necessary for
earning profits by any business enterprise. However, sales do
not convert into cash instantly; there is invariably a time-lag
between the sales of goods and the receipt of cash. There is,therefore, a need for working capital in the form of current
assets to deal with the problem arising out of the lack of
immediate realisation of cash against goods sold. Therefore,
sufficient working capital is necessary to sustain sales activity.
Technically, this is referred to as the operating or cash-cycle.
The operating cycle can be said to be at the heart of the need
for working capital. The continuing flow from cash to
suppliers, to inventory, to accounts receivable and back into
cash is what is called the operating cycle. In other words, the
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term cash cycle refers to the length of time necessary to
complete the following cycle of events.
(1) Conversion of cash into inventory
(2) Conversion of inventory into receivables
(3) Conversion of receivable into cash.
If it were possible to complete the sequences instantaneously,
there would be no need for current assets (working capital).But since it is not possible, the firm if forced to have current
assets. Since cash inflows and cash outflows do not match,
firms have to necessarily keep cash or invest in short term
liquid securities so that they will be in a position to meet
obligations when they become due. Similarly, firms must have
adequate inventory to guard against the possibility of not
being able to meet a demand for their products. Adequate
inventory, therefore, provides a cushion against being out of
stock. If firms have to be competitive, they must sell goods to
their customers on credit which necessitates the holding of
accounts receivable. It is in these way that an adequate levelof working capital is absolutely necessary for smooth sales
activity which, in turn, enhances the owners wealth.
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The operating cycle consists of three phases : In phase 1,
cash gets converted into inventory. This would include
purchase of raw materials; conversion of raw materials into
work-in-progress, finished goods and terminate in the transfer
of goods to stock at the end of the manufacturing process. In
the case of trading organisation, this phase would be shorter
as there would be no manufacturing activity and cash will be
converted into finished goods directly. The phase will, of
course, be totally absent in case of service organisations.
Phase 3
Phase 2
Phase 1
In phase 2 of the cycle, the inventory is converted into
receivables as credit sales are made to customers. Firms
which do not sell on credit will obviously not have phase 2 of
the operating cycle. The last phase, phase 3, represents the
stage when receivables are collected. This phase completes
Receivables
Inventory
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the operating cycle. Thus, the firm has moves from cash to
inventory, to receivables and to cash again.
MANAGEMENT OF WORKING CAPITAL
Working capital management is concerned with the problems
that arise in attempting to manage the current assets, current
liabilities and the inter-relationships between them. Its
operational goal is to manage the current assets and currentliabilities in such a way that a satisfactory level of working
capital is maintained. The term working capital refers to the
net working capital (NWC) i.e. , current assets minus current
liabilities. With reference to the management of working
capital, net working capital represents that part of the current
assets which are financed with long term funds.
The level of NWC has a bearing on the profitability as well as
the risk in the sense of the inability of the firm to meet
obligations as and when they become due. Therefore, the
trade-off between profitability and risk is an important elementin the evaluation of the level of NWC of a firm. In general, the
higher the NWC, the lower the risk, as also the lower is the
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profitability and vice-versa. Thus, the NWC measures the
degree of risk in the management of working capital.
Apart from the profitability-risk trade-off, the determination of
the financing mix is the second ingredient of the theory of
working capital management. The financing mix refers to the
proportion of current assets to be financed by current liabilities
and long-term sources. One approach to determine the
financing mix is the hedging approach, according to which thelong-term funds should be used to finance the fixed/core
portion of the current assets and the purely
temporary/seasonal requirements should be met out of short-
term funds. This approach is a high-profit, high-risk financing
mix. According to the second approach, namely the
conservative approach, the estimate total requirements of the
current assets should be financed from long-term sources and
the short-term funds should be used only in emergency
situations. If effect, the conservative approach is a low-profit,
lowrisk combination. Neither of these two approaches is
suitable for efficient working capital management. A trade-offbetween these two extremes provides a financing plan
between these two approaches, and therefore, an acceptable
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financing strategy from the view point of the management of
working capital.
CASH MANAGEMENT
Cash management is one of the key areas of working capital
management. There are 4 motives for holding cash : (i)
transaction motive (ii) precautionary motive, (iii)
speculative motive, and (iv) compensating motive. Thetransaction motive refers to the holding of cash to meet
anticipated obligations whose time is not perfectly
synchronised with cash receipts. The cash balances held in
reserve for random and unforeseen fluctuations in cash flows
are called as precautionary balances. The speculative motive
indicates the desire of a firm to take advantage of
opportunities which present themselves at unexpected
moments and which are typically outside the normal course of
business. The compensating motive means keeping the bankbalance sufficient to earn a return equal to the cost of free
service provided by the banks.
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The basic objectives of cash management are to reconcile
two mutually contradictory and conflicting tasks : to meet the
payment schedule and to minimise funds committed to cash
balances.
Cash budget is probably the most important tool in cash
management. It is a device to help a firm to plan and control
the use of cash. The cash position of a firm as it moves from
one period to another period is high lighted by the cashbudget. A cash budget has normally three parts, namely, cash
collections, cash payments and cash balances. The major
sources of cash receipts and payments are operating and
financial. The operating sources are repetitive in nature while
the financial sources are non-recurring.
The cash management strategies are intended to minimise
the operating cash balance requirement. The basic strategies
that can be employed are (i) stretching accounts payable
without affecting the credit of the firm, (ii) efficient inventorymanagement and (iii) speedy collections of accounts
receivable. Some of the specific techniques and processes for
speedy collection of receivables from customers are ensuring
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prompt payment from customers and early
payment/conversion into cash.
Concentration banking and Lock-box system deservesspecific mention as principal methods of establishing a
decentralised collection network. The techniques to delay
payments of accounts payable include avoidance of early
payment, centralised disbursements and float.
Marketable securities are an outlet for surplus cash as liquid
security/asset. To be liquid a security must have two basis
characteristics, i.e., a ready market and safety of principal.
The selection criteria for marketable securities include the
evaluation of financial risk, interest-rate risk, liquidity, taxabilityand yield among different financial assets. The prominent
marketable securities available for investment are : treasury
bills, negotiable certificates of deposits, commercial paper,
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bankers acceptance, units of Unit Trust of India, inter-
corporate deposits, inter-bank call money, commercial bills
under the bill market scheme and short-term deposits.
MANAGEMENT OF RECEIVABLES
When a firm makes an ordinary sale of goods and servies and
does not receive payment, the firm grants trade credit and
creates accounts receivable which would be collected infuture. Thus, accounts receivable represent an extension of
credit to customers, allowing them a reasonable period of
time, in which to pay for the goods/services which they have
received.
The objective of receivables management is to have a trade-
off between the benefits and costs associated with the
extension of credit. The benefits are increased sales and
associated increased profits/marginal contribution. The major
categories of cost of accounts receivable are collection costs,
capital costs, delinquency costs and default costs.
The management of receivables involves crucial decision
in three areas : (i) credit policies, (ii) credit terms, and (iii)
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collection policies. The credit policy of a firm provides the
framework to determine whether or not to extend credit to a
customer and how must credit to extend. The two broad
dimensions of credit policy decision of a firm are credit
standards and credit analysis. The term credit standards
represents the basic criterion for the extension of credit to
customers. The criterion and, therefore, standards can be
tight/restrictive or liberal/non-restrictive. The credit analysis
component of credit policies includes obtaining creditinformation from different sources and its analysis.
The second decision-area in receivables management is the
credit terms, The credit terms specify the repayment terms,
comprising credit period, cash discount, if any, and cash
discount period.
The third area involved in the management of receivables is
collection policies. It refers to the procedure followed to collect
accounts receivable when they become due. The two relevant
aspects are the degree of efforts to collect the over dues andthe type of collection effort.
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The framework of analysis of all the three decision areas in
receivables management is to secure a trade-off between the
costs and benefits of the measurable effects on the sales
volume, capital cost due to change in accounts receivable,
collection costs, and bad debts and so on. The alternative will
be selected when the benefits exceed the costs.
INVENTORY MANAGEMENT
The term inventory refers to assets which will be sold in future
in the normal course of business operations. The assets
which the firm stores as inventory in anticipation of need are
raw materials, work-in-process/semi-finished goods and
finished goods. The management of inventory from the view
point of financial manager is different from the management of
other current assets in that practically all the functional areas
are interest. The job of the finance manager is to reconcile the
conflicting view points of the various functional areas
regarding the appropriate inventory level.
The objectives of inventory management consists of two
counter-balancing parts, namely, to minimise investments in
inventory and to meet the demand for products by efficient
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production and sales operations. In operational terms, the
goal of inventory management is to have a trade-off
between costs and benefits at different levels of
inventory.
The costs of holding inventory are ordering cost and carrying
cost. The major benefits of holding inventory are in the area of
purchasing, production and sales.
The non-mathematical inventory management techniques
illustrated here are : (i) ABC system which is useful in
determining the type and degree of control on inventory; (ii)
EOQ model which reveals the size of order for the acquisition
of inventory by the firm; (iii) the re-order point which shows
the level of inventory at which order should be placed to
replenish inventory; and (iv)safety stock, i.e. the minimum
additional inventory to serve as a safety margin to meet an
unanticipated increase in resulting from an unusually high
demand and/or an uncontrollable late receipt of incoming
inventory.
A B C System
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The first step in the inventory control process is classification
of different types of inventories to determine the type and
degree of control required for each. The A B C system is a
widely-used classification technique to identify various items
of inventory for purposes of inventory control. This technique
is based on the assumption that a firm should not exercise the
same degree of control on all items of inventory. It should
rather keep a more rigorous control on items that are (1) most
costly, and/or (2) slowest-turning while items that are lessexpensive should be given less control effort.
On the basis of the cost involved, the various inventory items
are, according to this system, categorised into three classes :
(1) A (2) B and (3) C. The items included in group A involved
the largest investment. Therefore, inventory control should be
the most rigorous and intensive and the most sophisticated
inventory control techniques should be applied to these items.
C group consists of items of inventory which involve relatively
small investments although the number of items is fairly large.
These items deserve minimum attention. B group stands mid-way. It deserves less attention than A but more than C. It can
be controlled by employing less sophisticated techniques.
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The task of inventory management is to properly classify all
the inventory items into one of these three groups/categories.
The typical break-down of inventory items is as shown in
following Table :
Inventory Break-down Between Number of items and
Inventory Value
Group No of Items (%) Inventory
Value (%)
A 15 70
B 30 20
C 55 10
---- ----
100 100
_________________________________________________
__________
Some points stand out from above Table. While group A is the
least important in terms of the number of items, it is by far the
most important in terms of the investments involved. With only
15% of the number, it accounts for as much as 70% of the
total value of inventory. The firm should direct most of its
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inventory control efforts to the items included in this group.
The items comprising B group account for 20% of the
investments in inventory. They deserve less attention that A,
but, more than C, which involves only 10% of the total value
although number wise its share is as high as 55%.
Economic Order Quantity (EOQ) Model
After various inventory items are classified on the basis of theA B C analysis, the management becomes aware of the type
of control that would be appropriate for each of the three
categories of the inventory items. The A group of items
warrants the maximum attention and the most rigorous
control. A key inventory problem particularly in respect of the
Group A items relates to the determination of the size or
quantity in which inventory will be acquired. In other words,
while purchasing raw materials or finished
goods, the questions to be answered are : How much
inventory should be bought in one lot under one order oneach replenishment ? Should the quantity to be purchased be
large or small ? Or, should the requirement of materials
during a given period of time (say, six months or one year) be
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acquired in on lot or should it be acquired in instalments or in
several smalllots ? Such inventory problems are called order
quantity problems.
The determination of the appropriate quantity to be purchased
in each lot to replenish stock as a solution to the order
quantity problem necessities resolution of conflicting goals.
Buying in large quantities implies a higher average inventory
level which will assure (1) smooth production/sale operations,and (2) lower ordering or set-up- costs. But, it will involve
higher carrying costs. On the other hand, small orders would
reduce the carrying costs of inventory by reducing the
average inventory level but the ordering costs would increase
as there is a likelihood of interruption in the operations due to
stock-outs. A firm should place neither too large nor too small
orders. On the basis of a trade-off between benefits derived
from the availability of inventory and the cost of carrying that
level of inventory, the appropriate or optimum level of the
order to be placed should be determined. The optimum level
of inventory is popularly referred to as the Economic OrderQuantity (EOQ). It is also known as the economic lot size.
The economic order quantity may be defined as that level of
inventory order that minimises the total cost associated with
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inventory management. As explained in the earlier section
dealing with the objectives of inventory management, the
costs associated with inventories are (1) ordering costs and
(2) carrying costs. Stated with reference to cost perspectives,
EOQ refers to the level of inventory at which the total cost of
inventory comprising acquisition/ordering/set-up costs and
carrying costs is minimal.
For analysing the EOQ, as an inventory managementtechnique, several sophisticated mathematical models are
available.Illustrate here the analysis of EOQ on the basis of
simple non-mathematical approach. Nevertheless, the main
elements of the order quantity problem are covered by the
analytical method followed here.
Assumptions
The EOQ model, as a technique to determine the economic
order quantity is based on three restrictive assumptions,
namely :(i) The firm knows with certainty the annual usage
(consumption) of a particular item of inventory.
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(ii) The rate at which the firm uses inventory is steady over
time.
(iii) The orders placed to replenish inventory stocks are
received at exactly that point in time when inventories
reach zero.
In addition, it may also be assumed that ordering and carrying
costs are constant over the range of possible inventory levels
being considered.
Approaches
The EOQ model can be illustrated by (1) the long analytical
approach or trial and error approach , and (2) the short-cut or
simple mathematical approach.
Trial and Error Approach
Given the total requirements of inventory during a given
period of time depending upon the inventory planning horizon,
a firm has different alternatives to purchase its inventories.
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For instance, it can buy its entire requirements in one single
lot at the beginning of the inventory planning period.
Alternatively, the inventories may be procured in small lots
periodically, say weekly, monthly, quarterly, six-monthly and
so on. If the purchases are made in one big lot, the firms
average inventory holding would be relatively large whereas it
would be relatively small when the acquisition of inventory is
in small lots : the smaller the lot, the lower the average, the
lower the average inventory and vice versa. High averageinventory would involve high carrying costs. On the other
hand, low inventory holdings are associated with high
ordering cost. The trial and error or long analytical approach
for the determination of EOQ uses different permutations and
combinations of lots of inventory purchases so as to find out
the least ordering and carrying cost combination. In other
words, according to this approach, the carrying and
acquisition costs for different sizes of orders to purchase
inventories are computed and the order-size with the lowest
total cost (ordering plus carrying) of inventory is the economic
order quantity.
Order Point
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The EOQ technique determines the size of an order to
acquire inventory so as to minimise the carrying as well as the
ordering costs. In other words, the EOQ provides an answer
to the question : how much inventory should be ordered in
one lot ? Another important question pertaining to efficient
inventory management is : when should the order to procure
inventory be placed ? This aspect of inventory management is
covered under the order point problem.
The re-order point is stated in terms of the level of inventory at
which an order should be placed for replenishing the current
stock of inventory. In other words, re-order point may be
defined as that level of inventory when fresh order should be
placed with the suppliers for procuring additional inventory
equal to the economic order quantity. Although some
sophisticated re-order point formulae are available, It is based
on the following assumptions :
(i) constant daily usage of inventory,
(ii) fixed lead time.
In other words, the formulae assumes condition of certainty.
The re-order point = Lead time in days x average daily usage
of inventory
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The term lead time refers to the time normally taken in
receiving the delivery of inventory after placing orders with the
suppliers. It covers the time span from the point when a
decision to place an order for the procurement of inventory is
made to the actual receipt of the inventory by the firm.
Another way of saying it is that the lead time consists of the
number of days required by the suppliers to receive and
process the order as well as the number of days during whichthe goods will be in transit from the supplier. The lead time
may also be called as the procurement time of inventory.
The average usage means the quantity of inventory
consumed daily. We can, therefore, define re-order point as
that inventory level which should be equal to the consumption
during the lead time.
COMPUTATION OF WORKING CAPITAL
The two components of working capital (WC) are currentassets (CA) and current liabilities (CL). They have a bearing
on the cash operating cycle. In order to calculate the working
capital needs, what is required is the holding period of various
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type of inventories, the credit collection period and the credit
payment period. The WC also depends on the budgeted level
of activity in terms of production/sales. The calculation of WC
is based on the assumption that the production/sales is
carried on evenly throughout the year and all costs accrue
similarly. The steps involved in estimating the different items
of CA and CL are as follows :-
ESTIMATION OF CURRENT ASSETS
Raw Material Inventory
The investment in raw materials inventory can be estimated
on the basis of
Budgeted production Cost of raw Averageinventory
(in units) x material(s) x holding periodper unit (months/days)
12 months/365 days
The relevant cost to determine work-in-process investments
are the proportionate share of cost of raw materials and
conversion cost (labour and manufacturing overhead costs
excluding (depreciation).
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Symbolically
Budgeted Estimated work- Average timespanProduction x in-process cost x of work-
in-process(in units) per unit inventory
(months/days)
12 months/365 days
Finished Goods Inventory
The WC required to finance the finished goods inventory is
given by factors summed up
Budgeted Manufacturing Cost Finished goodsProduction x per unit (excluding x holding
period(in units) depreciation) (months/days)
12 months/365 days
Debtors
The WC tied up in debtors should be estimated in relation tototal cost price (excluding depreciation).
Symbolically
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Budgeted Cost of sales per Average debtcollection
Credit sales x unit (excluding x period
(months/days)(in units) depreciation)
12 months/365 days
Cash and Bank Balances
Apart form WC needs for financing inventories and debtors,
firms also find it useful to have some minimum cash balances
with them. It is difficult to lay down the exact procedure of
determining such an amount. This would primarily be based
on the motives for holding cash balances of the business firm,
attitude of management torwards risk, the access to theborrowing sources in times of need and past experience, etc.
ESTIMATION OF CURRENT LIABILITIES
The working capital needs if business firms are lower to the
extent such needs are met through the current liabilities (other
than bank credit) arising in the ordinary course of the
business. The important current liabilities (CL), in this context
are, trade-creditors, wages and overheads :
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Trade Creditors :
Budgeted yearly Raw material Credit period
Production x requirement allowed bycreditors
(in units) per unit (months/days)
12 months/365 days
Note : Proportional adjustment should be made to the cashpurchases of raw materials.
Direct Wages :
Budgeted yearly Direct labour Average time-lag in
Production x cost per unit xpayment of wages
(in units) (months/days)
12 months/365 days
The average credit period for the payment of wages
approximates to a half-a-month in the case of monthly wage
payment : 1st days monthly wages are paid on 30th day of the
month, extending credit for 29 days, 2nd days wages are,
again, paid on 30th , extending credit for 28 days, and so on.
Average credit period approximates to half-a-month).
Overheads (other than depreciation and amortisation) :
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Budgeted yearly Overhead cost Average time-inProduction x per unit x payment of
overheads(in units) (months/days)
12 months/365 daysThe amount of overheads may be separately calculated for
different types of overheads. In the case of selling overheads,
the relevant item would be sales volume instead of production
volume.
Working capital meaning of working capital
Capital required for business can be classified under two main
categories via,
1) fixed capital
2) working capital
Every business needs funds for two purposes for its
establishment and to carry out its day-to-day operations. Long
terms funds are required to carry production facilities through
purchase of fixed assets such as p&m, land, building, furniture,
etc. investments in these assets represent that part of firm capital
which is blocked. On permanent or fixed basis and is called fixed
capital. Funds are also needed for short-term purposes for the
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purchase of raw material, payment of wages and other day-to-day
expenses etc.
In the words of SHUBIN working capital is that amount of
funds necessary to cover the cost of operating the enterprise.
According to GENESTENBERG circulating capital means
current assets of a company that are charged in the ordinary
course of business from one form to another, as for example,
from cash to inventories, inventories to receivables, receivables
to cash.
KINDS OF WORKING CAPITAL
Working capital may be classified into two ways
- on the basis of concepts
- on the basis of time
On the basis of concepts working capital is classified as gross
working capital & net working capital. On the basis of time
working capital is classified as permanent or fixed workingcapital & temporary or variable working capital.
GROSS WORKING CAPITAL
It represents the amount of funds invested in current assets.
Thus, the gross working capital is the capital invested in the total
current assets of the enterprise. Current assets are those assets
which in the ordinary course of business can be converted into
cash within a short period of normally one accounting year.
EXAMPLES OF CURRENT ASSETS ARE
1. cash in hand & bank balance
2. Bills receivables.
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3. sundry debtors ( less provision for bad debts)
4. Short term loans & advances.
5. Inventories of stocks.
6. Temporary investments of surplus funds.
7. Prepaid expenses.8. accrued incomes
NET WORKING CAPITAL
It is the excess of current assets over current liabilities. Net working
capital may be positive or negative. When the current assets exceed
the current liabilities the working capital is positive & the negative
working capital results when the current liabilities are more than the
current assets. Current liabilities are those liabilities which areintended to pay in the ordinary course of business within the short
period of normally one accounting year out of the current assets or
the incomes of the business.
EXAMPLES OF CURRENT LIABILITIES ARE
1) Bills payable
2) Sundry creditors or accounts payable
3) Accrued or outstanding expenses
4) Short term loans, advances & deposits5) Dividend overdraft
6) Provision for taxation, if it does not amount to appropriation of
profit
NET WORKING CAPITAL = CURRENT ASSETS
CURRENT LIABILITIES
PERMANENT OR FIXED WORKING CAPITAL
It is the minimum amount which is required to ensure effective
utilization of fixed facilities & for maintaining the circulation of
current assets. There is always a minimum level of current assets
which is continuously required by the enterprise to carry out its
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normal business operations. For example , every firm has to
maintain a minimum level of raw-material, work in process,
finished goods & cash balance. The minimum level of current
assets or called fixed or permanent working capital as this part of
working capital is permanently blocked in current assets. As thebusiness grows, the requirement of permanent working capital
also increases due to the increase in current assets. The
permanent working capital can further be classified as regular
working capital and reserve working capital. Capital required to
ensure circulation of current assets from cash to inventories, from
inventories to receivables, and from receivables to cash and so
on. Reserve working capital which may be provided for
contingencies that may arise at unstated periods such as strikes,rise in prices, depression, etc
TEMPORARY OR VARIABLE WORKING CAPITAL
It is that amount of working capital which is required to meet the
seasonal demand and some special exigencies. Variable working
capital can further be classified as seasonal working capital and
special working capital. Most of the enterprises have to provideadditional working capital to meet seasonal & special needs. The
capital required to meet the seasonal needs of the enterprise is
called seasonal working capital. Special working capital is that
part of working capital which is required to meet the special
exigencies such as launching of extensive marketing campaigns
for conducting research etc.
IMPORTNCE OF ASEQUATE WORKING CAPITAL
Working capital is the blood & nerve center of a business. Just ascirculation of blood is essential in the human body for
maintaining life, working capital is very essential to maintain the
smooth running of the business. No business can run successfully
without an adequate amount of working capital. The main
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advantages of maintaining adequate amount of working capital
are as follow
Solvency of the business Adequate working capital in
maintaining solvency of business by providing un interrupted
flow of production.
1. GOODWILL- sufficient working capital enables a
business concern to make prompt payments & hence
helps increasing & maintaining goodwill.
2. EASY LOANS- A concern having adequate working
capital, high solvency& good credit standing can arrange
loans from banks &other on easy and favorable terms.
3. CASH DISCOUNT- adequate working capital alsoenables a concern to avail cash discount on the purchases
and hence reduce costs.
4. REGULAR SUPPLY OF RAW MATERIAL- Sufficient
working capital ensures regular supply of raw material &
continuous production.
5. REGULAR PAYMENT OF SALARIES, WAGES &
OTHER DAY - TO - DAY COMMITMENTS. A
company which has ample working capital can makeregular payment of salaries, wages & other day to day
commitments which raises the morale of its employees,
increases their efficiency, reduces wastages & costs and
enhances production & profits.
6. EXPLOITAION OF FAVORABLE MARKET
CONDITIONS- Only concerns with adequate working
capital can exploit favorable conditions such as
purchasing its requirements in bulk when the prices are
lower & by holding its inventories for higher prices.7. ABILITY TO FACE CRISIS- Adequate working capital
enables a concern to face business crisis in emergencies
such as depression because during such periods,
generally, there is much pressure on working capital.
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8. QUICK ANDREGULAR RETURN ON
INVESTMENTS- Every investor wants a quick and
regular return on his investments. Sufficiency of working
capital enables a concern to pay quick and regular
dividend to its investors, a there may not be muchpressure to plough back profits. This gains the
confidence of its investors & creates a favorable market
to raise additional funds in the future.
9. HIGH MORALE- Adequacy of working capital creates
an environment of security, confidence, and high morale
and creates overall efficiency in the business.
EXCESS OR INADEQUATE WORKING CAPITAL
Every business concern should have adequate working
capital to run its business operations. I should have neither
redundant nor excess working capital or inadequate nor
shortage of working capital. Both excess as well as short
working positions are bad for any business. However, out
of the two, it is the inadequacy of working capital which is
more dangerous from the point of view of the firm.
DISADVANTAGES OF EXCESSIVE WORKING
CAPITAL
1. Excessive working capital means idle funds which
earn no profits for the business & hence the business
earns a proper rate of return on its investments.
2. When there is a redundant working capital, it may
lead to unnecessary purchasing & accumulation ofinventories causing more chances of theft, waste &
losses.
3. Excessive working capital implies excessive debtors
7defective credit policy, which may cause higher
incidence of bad debts.
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4. It may result into overall inefficiency in the
organization.
5. When there is excessive working capital, relations
with banks & other financial institutions may not be
maintained.6. Due to slow rate of return on investments, the value of
shares may also fall.
7. The redundant working capital gives rise to
speculative transactions.
DISADVANTAGE OF INADEQUATE WORKING CAPITAL
1) A concern which has inadequate working capital, cannot payits short term liabilities in time. Thus, it will loose its
reputation & shall not be able to get good credit facilities.
2) It cannot buy its requirements in bulk & cannot avail of
discounts, etc.
3) It becomes difficult for the firm to exploit favorable market
conditions & undertake profitable projects due to lack of
working capital.
4) The firms cannot pay day to day expenses of its operations &it creates inefficiencies, increases costs & reduces the profits
of the business.
5) It becomes impossible to utilize the fixed assets due to non-
availability of liquid funds.
6) The rate of return on investments also fails with the shortage
of working capital.
1. NATURE OR CHARACTER OF BUSINESS
The working capital requirement of a firm basically dependson the nature of its business. Public utility undertaking like
electricity, water supply & railways need very limited
working capital because they offer cash sales only & supply
services, not products & as such no funds are tied up in the
inventories & receivables. On the other hand trading &
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financial firms require less investment in fixed assets but
have to invest large amount of working capital. The
manufacturing undertaking also require sizable working
capital along with fixed investments. Generally speaking it
may be said that public utility undertaking require smallamount of working capital, trading & financial firms require
sizeable working capital between these two extremes.
2. SIZE OF BUSINESS/SCALE OF OPERATION-
The working capital requirements of a concern are directlyinfluenced by the size of its business which may be measured
in terms of scale of operations. Greater the size of business
unit, generally larger will be the requirements of working
capital. However, in some cases even a smaller concern may
need more working capital due to high overhead charges,
inefficient use of available resources & other economic
disadvantages of small size.
3. PRODUCTION POLICY In certain industries the subjectto wide fluctuations due to seasonal variations. The
requirement of working capital, in such cases, depends upon
the production policy. The production kept either steady by
accumulating inventories during slack periods with a view to
meet high demand during the peak season & increased
during the peak season. If the policy is to keep production
steady by accumulating inventories it will require higher
working capital.
4. MANUFACTURING PROCESS/LENGTH OF
PRODUCTION CYCLE In manufacturing business, the
requirements of working capital increases in direct
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proportion to length of manufacturing process. Longer the
process period of manufacture, larger is the amount of
working capital required. The longer the manufacturing time,
the raw-material & other supplies have to be carried for
longer period in the process with progressive increment oflabor & services costs before the finished product is finally
obtained. Therefore, if there are alternative processes of
production, the process with the shortest production period
should be chosen.
5. SEASONAL VARITIONS- In certain industries raw
material is not available throughout the year. They have to buyraw material in bulk during the season to ensure an
uninterrupted flow & process them during the entire year. A
huge amount is, thus, blocked in the form of material
inventories during such season, which give rise to more working
capital requirements. Generally, during the busy season, a firm
requires larger working capital than in the slack season.
. 6. WORKING CAPITAL CYCLE- In the manufacturing
concern, the working capital cycle starts with the purchase of
raw material & ends with the realization of cash from the sale
of finished products. The cycle involves purchase of raw
material and stores, its conversion into stocks of finished
goods through work - in - progress with the progressive
increment of labor and service costs, conversion of finished
stock into sales, debtors and receivables and ultimately
realization of cash and this cycle continues again from cash topurchase of raw material and so on .
7. RATE OF STOCK TURNOVER- There is a high degree
of inverse co- relationship between the quantum of working
capital and the velocity or speed with which the sales are
affected. A firm having a high rate of stock turnover will need
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lower amount of working capital as compared to a firm having
a lower rate of turnover. For example, in case of precious
stone dealers, the turnover is very slow . they have to maintain
a large variety of stocks and the movement of stocks is very
slow. Thus, the working capital requirements of such a dealershall be higher than of a provision store.
8. CREDIT POLICY- The credit policy of a concern in its
dealing with debtors and creditors influence considerably the
requirements of working capital. A concern that purchases its
requirements on credit and sells its product/services on cash
requires lesser amount of working capital. On the other hand a
concern buying its requirements for cash and allowing credit
to its customers, shall need larger amount of working capitalas very huge amount of funds are bound to be tied up in
debtors or bills receivables.
9. BUSINESS CYCLE Business cycle refers to alternate
expansion and contraction in general business activity. In a
period of boom i.e, when the business is prosperous, there is a
need for larger amount of working capital due to increase in
sales , rise in prices, optimistic expansion of business , etc. on
the contrary in the times of depression i.e, when there is adown swing of cycle, the business contracts, sales decline, and
difficulties are faced in collections from debtors and firms may
have a large amount of working capital lying idle.
10. RATE OF GROWTH OF BUSINESS- The working
capital requirements of a concern increase with the growth and
expansion of its business activities. Although, it is difficult to
determine the relationship between the growth in the volume
of business and the growth in the working capital business, yet
it may be concluded that for normal rate of expansion in thevolume of business, we may have retained profits to provide
for more working capital but in fast growing concerns, we
shall require larger amount of working capital.
11. EARNING CAPACITY OF BUSINESS- Some firms
more earning capacity than others due to quality of their
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products, monopoly conditions, etc. such firms with high
earning may generate cash profits from operations and
contribute to their working capital. The dividend policy of a
concern also influences the requirements of its working
capital. A firm that maintain a steady high rate of cashdividend irrespective of its generation of profits needs more
working capital than the firm that retains larger parts of its
profits and does not pay so high rate of cash dividend.
12. PRICE LEVEL CHANGES- Changes in the price also
affect the working capital requirements. Generally, the rising
prices will require the firm to maintain larger amount of
working capital, as more funds will be required to maintain the
same current assets. The effect of rising prices may bedifferent for different firms. Some firms may be affected much
while some others may no be affected at all by the rise in
prices.
SOURCES FOR THE FINANCING OF WORKING CAPITAL
There are various sources of financing of working capital,
which are as follows-
- sources for financing permanent or fixed working capital
- sources for financing temporary or variable working capital
SOURCES FOR FINANCING PERMAMNEBT OR FIXED
WORKING CAPITAL
1. SHARES
Issue of shares is the main source of long term finance. Shares
are issued by joint stock companies to the public. A company
divides its capital into units of a definite face value, say of Rs.
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10 each or Rs. 100 each. Each unit is called a share. A person
holding shares is called a shareholder.
CHARACTERISTICS OF SHARES
The main characteristics of shares are following:
1. It is a unit of capital of the company. 2. Each share is of a C
definite face value.
3. A share certificate is issued to a shareholder indicating the
number of shares and the amount.
4. Each share has a distinct number.
5. The face value of a share indicates the interest of a person in theCompany and the extent of his liability.
Investors are of different habits and temperaments. Some want to
take lesser risk and are interested in a regular income. There are
others who may take greater risk in anticipation of huge profits in
future. In order to tap the savings of different types of people, a
company may issue different types of shares.These are:
1. Preference shares, and
2. Equity Shares.
PREFERENCE SHARES-
Preference Shares are the shares which carry preferential rights over
the equity shares. These rights are (a) receiving dividends at a fixed
rate, (b) getting back the capital in case the company is wound-up.Investment in these shares are safe, and a preference shareholder
also gets dividend regularly.
EQIUTY SHARE -
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Equity shares are shares which do not enjoy any preferential
right in the matter of payment of dividend or reppayment of
capital. The equity shareholder gets dividend only after the
payment of dividends to the preference shares. There is no fixed
rate of dividend for equity shareholders. The rate of dividenddepends upon the surplus profits. In case of winding up of a
company, the equity share capital is refunded only after
refunding the preference share capital. Equity shareholders have
the right to take part in the management of the company.
However, equity shares also carry more risk.
Following are the merits and demerits of equity shares:
- To the shareholders:
1. In case there are good profits, the company pays dividend
to the equity shareholders at a higher rate.
2. The value of equity shares goes up in the stock market with
the increase in profits of the concern.
3. Equity shares can be easily sold in the stock market.
4. Equity shareholders have greater say in the management of
a company as they are conferred voting rights by the Articles
of Association.
- To the Management:
1. A company can raise fixed capital by issuing equity shareswithout creating any charge on its fixed assets.
2. The capital raised by issuing equity shares is not required
to be paid back during the life time of the company. It will be
paid back only if the company is wound up.
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3. There is no liability on the company regarding payment of
dividend on equity shares. The company may declare dividend
only if there are enough profits.
4. If a company raises more capital by issuing equity shares,
it leads to greater confidence among the investors and
creditors.
Demerits :
- To the shareholders
1. Uncertainly about payment of dividend:Equity share-holders get dividend only when the company is
earning sufficient profits and the Board of Directors declare
dividend.
2. Speculative:
Often there is speculation on the prices of equity shares.
This is particularly so in times of boom when dividend paid
by the companies is high.
3. Danger of overcapitalisation:
In case the management miscalculates the long term
financial requirements, it may raise more funds than required
by issuing shares. This may amount to over-capitalization
which in turn leads to low value of shares in the stock
market.
4. Ownership in name only :Holding of equity shares in a company makes the holder
one of the owners of the company. Such shareholders enjoy
voting rights. They manage and control the company. But
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then it is all in theory. In practice, a handful of persons control
the votes and manage the company. Moreover, the decision to
declare dividend rests with the Board of Directors.
5. Higher Risk :Equity shareholders bear a very high degree of risk. In case
of losses they do not get dividend. In case of winding up of
a company, they are the very last to get refund of the money
invested. Equity shares actually swim and sink with the
company.
-To the Management
1. No trading on equity :
Trading on equity means ability of a company to raise funds
through preference shares, debentures and bank loans etc. On
such funds the company has to pay at a fixed rate. This enables
equity shareholders to enjoy a higher rate of return when profits
are large. The major part of the profit earned is paid to the equity
shareholders because borrowed funds carry only a fixed rate of
interest. But if a company has only equity shares and does nothave either preference shares, debentures or loans, it cannot have
the advantage of trading on equity.
2. Conflict of interests :
As the equity shareholders carry voting rights, groups are
formed to corner the votes and grab the control of the ompany.
There develops conflict of interests which is harmful for the
smooth functioning of a company.
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2. DEBENTURES-
Whenever a company wants to borrow a large amount of
fund for a long but fixed period, it can borrow from thegeneral public by issuing loan certificates called Debentures.
The total amount to be borrowed is divided
into units of fixed amount say of Rs.100 each. These units
are called Debentures. These are offered to the public to
subscribe in the same manner as is done in the case of shares.
A debenture is issued under the common seal of the
company. It is a written acknowledgement of money
borrowed. It specifies the terms and conditions, such as rateof interest, time repayment, security offered, etc.
Characteristics of Debentur
Following are the characteristics of Debentures:
i) Debenture holders are the creditors of the company. Theyare entitled to periodic payment of interest at a fixed rate.
i i ) Debentures are repayable after a fixed period of time, say
five years or seven years as per agreed terms.
iii) Debenture holders do not carry voting rights.
iv) Ordinarily, debentures are secured. In case the company
fails to pay interest on debentures or repay the principal
amount, the debenture holders can recover it from the sale of
the assets of the company.
TYPES OF DEBENTURES-
Debentures may be classified as:
a) Redeemable Debentures and Irredeemable Debentures
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b) Convertible Debentures and Non-convertible Debentures.
Redeemable Debentures :
These are debentures repayable on a pre-determined date or atany time prior to their maturity, provided the company so
desires and gives a notice to that effect.
Irredeemable Debentures :
These are also called perpetual debentures. A company is not
bound to repay the amount during its life time. If the issuing
company fails to pay the interest, it has to redeem such
debentures.
Convertible Debentures :
The holders of these debentures are given the option to convert
their debentures into equity shares at a time and in a ratio as
decided by the company.
Non-convertible Debentures:
These debentures cannot be converted into shares.
MERITS OF DEBENTURS
Following are some of the advantages of debentures:
1) Raising funds without allowing control over the company:
Debenture holders have no right either to vote or take part in
the management of the company.
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2) Reliable source of long term finance :
Since debentures are ordinarily issued for a fixed period, the
company can make the best use of the money. It helps long
term planning.
3) Tax Benefits :
Interest paid on debentures is treated as an expense and is
charged to the profits of the company. The company thus
saves income tax .
4) Investors Safety :
Debentures are mostly secured. On winding up of the
company, they are repayable before any payment is made tothe shareholders. Interest on debentures is payable irrespective
of profit or loss.
3. RETAINED EARNING -
Like an individual, companies also set aside a part of their
profits to meet future requirements of capital. Companies keep
these savings in various accounts such as General Reserve,Debenture Redemption Reserve and Dividend Equalization
Reserve etc. These reserves can be used to
meet long term financial requirements. The portion of the
profits which is not distributed among the shareholders
but is retained and is used in business is called retained
earnings or ploughing back of profits. As per Indian
Companies Act., companies are required to transfer a part of
their profits in reserves. The amount so kept in reserve may be
used to buy fixed assets. This is called internal financing.MERITS -
Following are the benefits of retained earnings:
1. Cheap Source of Capital :
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No expenses are incurred when capital is available from this
source. There is no obligation on the part of the company
either to pay interest or pay back the money. It can safely be
used for expansion and modernization of business.
2. Financial stability :
A company which has enough reserves can face ups and
downs in business. Such companies can continue with their
business even in depression, thus building up its goodwill.
3. Benefits to the shareholders:
Shareholders may get dividend out of reserves even if the
company does not earn enough profit. Due to reserves, there iscapital appreciation, i.e. the value of shares go up in the share
market .
Following are the limitations of Retained Earnings:
1. Huge Profit :
This method of financing is possible only when there are hugeprofits and that too for many years.
2. Dissatisfaction among shareholders :
When funds accumulate in reserves, bonus shares are issued to
the shareholders to capitalize such funds. Hence the company
has to pay more dividends. By retained earnings the real
capital does not increase while the liability increases. In case
bonus shares are not issued, it may create a situation of under
capitalisation because the rate of dividend will be much higheras compared to other companies.
3. Fear of monopoly :
Through ploughing back of profits, companies increase their
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financial strength. Companies may throw out their competitors
from the market and monopolize their position.
4. Mis-management of funds :
Capital accumulated through retained earnings encouragemanagement to spend carelessly.
4. PUBLIC DEPOSIT-
It is a very old source of finance in India. When modern banks
were not there, people used to deposit their savings with
business concerns of good repute. Even today it is a very
popular and convenient method of raising medium termfinance. The period for which business undertakings accept
public deposits ranges between six months to three years.
Procedure to raise funds through public deposits:
An undertaking which wants to raise funds through public
deposits advertises in the newspaper . T h e advertisement
highlights the achievements and future prospects of theundertaking and invites the investors to deposit their savings
with it. It declares the rate of interest which may vary
depending upon the period for which money is deposited. It
also declares the time and mode of payment of interest and the
repayment of deposits. A depositor may get his money back
before the date of repayment of deposits for which he will
have to give notice in advance.
FEATURES :1. These deposits are not secured.
2. They are available for a period ranging between 6 months
and 3 years.
3. They carry fixed rate of interest.
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4. They do not require complicated legal formalities as are
required in the case of shares or debentures.
Keeping in view the malpractices of certain companies, such
as not paying interest for years together and not refunding themoney, the Government has framed certain rules and
regulations regarding inviting public to deposit their savings
and accepting them.
RULES GOVERNING PUBLIC DEPOSITS :
Following are the main rules governing public deposits:
1. Deposits should not be made for less than six months or
more than three years.
2. Public is invited to deposit their savings through an
advertisement in the press. This advertisement should contain
all relevant information about the company.
3. Maximum rate of interest is fixed by the Reserve Bank of
India.4. Maximum rate of brokerage is also fixed by the Reserve
Bank of India.
5. The amount of deposit should not exceed 25% of the paid
up capital and general reserves.
6. The company is required to maintain Register of Depositors
containing all particulars as to public deposits.
7. In case the interest payable to any depositor exceeds Rs.
10,000 p.a., the company is required to deduct income-tax at
source.
ADVANTAGES :
Following are the advantages of public deposits:
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1. Simple and easy:
The method of borrowing money through public deposit is
very simple. It does not require many legal formalities. It has
to be advertised in the newspapers and a receipt is to be issued.
2. No charge on assets :
Public deposits are not secured. They do not have any charge
on the fixed assets of the company.
3. Economical :
Expenses incurred on borrowing through public deposits is
much less than expenses of other sources like shares anddebentures.
4. Flexibility :
Public deposits bring flexibility in the structure of the capital
of the company. These can be raised when needed and
refunded when not required.
Following are the disadvantages of public deposits:
1. Uncertainty :
A concern should be of high repute and have a high credit
rating to attract public to deposit their savings. There may be
sudden48 :: Business Studies withdrawals of deposits which
may create financial problems.
2. Insecurity :
Public deposits do not have any charge on the assets of the
concern. It may not always be safe to deposit savings with
companies particularly those which are not very sound.
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3. Lack of attraction for professional investors :
As the rate of return is low and there is no capital appreciation,
the professional investors do not appreciate this mode of
investment. 3
4. Uneconomical :
The rate of interest paid on public deposits may be low but
then there are other expenses like commission and brokerage
which make it uneconomical.
5. Hindrance to growth of capital-market :
If more and more money is deposited with the companies in
this form there will be less investment in securities. Hence thecapital market will not grow. This will deprive both the
companies and the investors of the benefits of good securities.
6. Overcapitalization :
As it is an easy, convenient and cheaper source of raising
money, companies may raise more money than is required. In
that case it may not be able to make the best use of the funds
or may indulge in speculative activities.
5. BORROWING FROM COMMOWING FROM BANKS :
Traditionally, commercial banks in India do not grant long
term loans. They grant loans only for short period not
extending one year. But recently they have started giving loans
for a long period. Commercial banks give term loans i.e. for
more than one year. The period of repayment of short term
loan is extended at intervals and in some cases loan is givendirectly for a long period. Commercial banks provide long
term finance to small scale units in the priority sector.
MERITS OF LONG TERM BORROWINGS FROM
COMMERCIAL BANKS :
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The merits of long-term borrowing from banks are as follows:
1. It is a flexible source of finance as loans can be repaid when
the need is met.2. Finance is available for a definite period, hence it is not a
permanent burden.
3. Banks keep the financial operations of their clients secret.
4. Less time and cost is involved as compared to issue of
shares, debentures etc.
5. Banks do not interfere in the internal affairs of the
borrowing concern, hence the management retains the
control of the company.6. Loans can be paid-back in easy instilments.
7. In case of small-scale industries and industries in villages
and backward areas, the interest charged is low.
DEMERITS:
Following are the demerits of borrowing from commercial
banks:
1. Banks require personal guarantee or pledge of assets and
business cannot raise further loans on these assets.
2. In case the short term loans are extended again and again,
there is always uncertainty about this continuity.
3. Too many formalities are to be fulfilled for getting term
loans from banks. These formalities make the borrowings
from banks time consuming and inconvenient.