Working Capital Management at CEAT LTD.

8/8/2019 Working Capital Management at CEAT LTD.

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Working capital

IntroductionCapital required for a business can be classifies under two main categories:1. Fixed CapitalEvery business needs funds for two purposes for its establishments and to carry out day to

day operations. Long term funds are required to create production facilities through purchase

of fixed assets such as plant and machinery, land and building, furniture etc. Investments inthese assets are representing that part of firms capital which is blocked on a permanent or

fixed basis and is called fixed capital.

2. Working CapitalIn simple words, Working capital refers to that part of the firms capital which is required

for financing short term or current assets such as cash, marketable securities, debtors and

inventories. Funds are also needed for short term purposes for the purchasing of rawmaterials, payments of wages and other day to day expenses etc. These funds are known as

working capital.

Classification of Working Capital

Working Capital can be classified in following ways:

Classification On the basis of Balance Sheet ConceptOn the basis of Balance Sheet concept, working capital can befurther classified into two

concepts:


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1. Gross Working CapitalThe term working capital refers to the Gross working capital and represents the amount of

funds invested in current assets. Thus, the gross working capital is the capital invested in total

current assets of the enterprises. The gross working capital concept is financial or going

concern concept.

Constituents of Current Assets:Current assets are those assets which are converted into cash within short periods of normallyone accounting year. Example of current assets is:

Cash in hand and Bank balance

Bills Receivable

Sundry Debtors

Short term Loans and Advances Inventories of Stock as:

Raw MaterialsWork in Process

Stores and SpacesFinished Goods

Temporary Investments of Surplus Funds Prepaid Expenses

Accrued Incomes

Gross Working Capital/Total Current Assets of the firm.Current Assets Amount (Rs. In Lacs)

Inventories406,07.57

Sundry Debtors 376,31.61

Cash and Bank Balances 139,98.91

Loan and Advances 110,10.26

Short term Investments 4,300.42

Total Current Assets 1032,48.35

2. Net Working CapitalNet working capital is an accounting concept of working capital. Net working capital is theexcess of current assets over current liabilities or say:

Net Working Capital = Current Assets Current Liabilities


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Constitutes of Current Liabilities:Current liabilities are those liabilities which are intended to be paid in the ordinary course of

business within a short period of normally one accounting year of the current assets or the

income of the business. Examples of current liabilities are:

Bills Payable

Sundry Creditors or Account Payable

Accrued or Outstanding Expenses

Short term Loans, Advances and Deposits

Dividends Payable

Bank Overdraft Provision for Taxation, If does not amount to appropriation of profit.

Current Liabilities of the firm

Current LiabilitiesAmount (Rs. In

Lacs)

Acceptances 155,67.00

Sundry Creditors 491,59.76Interest Accrued but not due 4,06.95

Deposit from Others 55.52

Other Liabilities 102,43.03

Unclaimed Dividends 34.46

Unclaimed Interest and matured Deposits 0.32

Provisions 36,35.82

Total Current Liabilities791,02.86

NET WORKING CAPITAL MAY BE NEGATIVE OR POSITIVE:When the current assets exceed the current liabilities, the working capital is positive and the

negative working capital results when the current liabilities are more than the current assets.

Net Working Capital/Net Current Assets of the firmRs. In Lacs

Total Current Assets 1032,48.35

Total Current Liabilities 791,02.86

Net Current Assets 241,45.49

y Classification On the basis of Time


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On the basis of time, working capital may be classified as:

1) Permanent or Fixed Working CapitalThe need for current assets arises, as already observed, because of the cash cycle. To carry on

business certain minimum level of working capital is necessary on continues and

uninterrupted basis. For all practical purpose, this requirement will have to be met permanent

as with other fixed assets. This requirement refers to as permanent or fixed working capital.

2) Temporary working capitalAny amount over and above the permanent level of working capital is temporary, fluctuating

or variable, working capital. This portion of the required working capital is needed to meet

fluctuation in demand consequent upon changes in production and sales as result of seasonalchanges.

Both kind of working capital permanent and fluctuating (temporary) are necessaryto

facilitate production and sales through the operating cycle. The amount over andabovepermanent working capital is temporarily variable or fluctuating.

In the above figure, it is shown that permanent working capital is stable over timewhile

temporary working capital is fluctuating some times increasing andsometimesdecreasing.


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Need for Working Capital Management

The basic objective of financial management is to maximize shareholders wealth. For this itis necessary to generate sufficient profits. The extent to it, which the profit can be earned,

largely depends on the magnitude of sales. However sales do not convert into cash instantly.

There is invariable the time gap between the sales of goods and receipts 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 realization of cash again goods sold. Therefore,

sufficient working capital is necessary to sustain sales activity.

Working capital is needed for the following purpose:

1. For the purchase of raw material, components and spares.

2. To incur day to day expenses and overhead costs such as fuel, power and office expenses,

etc.3. To meet selling costs as packing, advertisement etc.

4. To provide credit facilities to the customers.5. To maintain the inventories of raw material, work in progress, stores and spare and

finished goods.6. To pay wages and salaries.


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Determinants of working capitalWorking capital requirements of a concern depends on a number of factors, each of whichshould be considered carefully for determining the proper amount of working capital. It may

be however be added that these factors affect differently to the different units and these keeps

varying from time to time. In general, the determinants of working capital which re common

to all organizations can be summarized as under:1. Nature of Business

Working capital requirement of a firm are basically influenced by nature of business.

Trading and financial firms require a large sum of money to be invested in working capital to

carry large stocks of a variety of goods to satisfy varied and continuous demands of their

customers. Manufacturing and construction firms have to invest substantially in working

capital. In contrast, Public utilities may have limited need for working capital because they

may have only cash sales and supply services, not product. So such concern have to make

adequate investment in current assets depending upon the total assets structure and other

variables.

2. Size and growth of businessIn very small company the working capital requirement is quit high due to high overhead,

higher buying and selling cost etc. as such medium size business positively has edge over thesmall companies. But if the business start growing after certain limit, the working capital

requirements may adversely affect by the increasing size.

3. Business/ Trade cycle

If the company is the operating in the time of boom, the working capital requirement may bemore as the company may like to buy more raw material, may increase the production and

sales to take the benefit of favorable market, due to increase in the sales, there may more and

more amount of funds blocked in stock and debtors etc. similarly in the case of depressions

also, working capital may be high as the sales terms of value and quantity may be reducing,

there may be unnecessary piling up of stack without getting sold, the receivable may not be

recovered in time etc.

4. Length of production cycle

In some business like machine tools industry, the time gap between the acquisition of raw

material till the end of final production of finished products itself is quit high. As such

amount may be blocked either in raw material or work in progress or finished goods or even

in debtors. Naturally there need of working capital is high.

5.Fluctuations of supply and seasonal variationsSome companies need to keep large amount of working capital due to their irregular sales and

intermittent supply. Similarly companies using bulky materials also maintain large reservesof raw material inventories. This increases the need of working capital. Some companies

manufacture and sell goods only during certain seasons. Working capital requirements ofsuch industries will be higher during certain season of such industries period.

6. Production policies

Production policies of the organization effect working capital requirements very highly.Seasonal industries, which produces only in specific season requires more working capital.Some industries which produces round the year but sale mainly done in some special seasons

are also need to keep more working capital.

7. Operating efficiency

If the business is carried on more efficiently, it can operate in profits which may reduce the

strain on working capital; it may ensure proper utilization of existing resources by

eliminating the waste and improved coordination etc.


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8. Terms of purchase and salesSome time due to competition or custom, it may be necessary for the company to extend

more and more credit to customers, as result which more and more amount is locked up indebtors or bills receivables which increase the working capital requirement. On the other

hand, in the case of purchase, if the credit is offered by suppliers of goods and services, a part

of working capital requirement may be financed by them, but it is necessary to purchase on

cash basis, the working capital requirement will be higher.9. Profitability

The profitability of the business may be vary in each and every individual case, which is in

turn its depend on numerous factors, but high profitability will positively reduce the strain on

working capital requirement of the company, because the profits to the extend that they

earned in cash may be used to meet the working capital requirement of the company.

10. Current asset policiesThe quantum of working capital of a company is significantly determined by its current assets

policies. A company with conservative assets policy may operate with relatively high level of

working capital than its sales volume. A company pursuing an aggressive amount assets

policy operates with a relatively lower level of working capital.

11. Other factors

Effective co ordination between production and distribution can reduce the need for workingcapital. Transportation and communication means. If developed helps to reduce the working

capital requirement.

Meaning of Working Capital ManagementDecisions relating to working capital and short term financing are referred to as working

capital management. These involve managing the relationship between a firm's short-termassets and its short-term liabilities.

The goal of working capital management is to ensure that the firm is able to continue its

operations and that it has sufficient cash flow to satisfy both maturing short-term debt and

upcoming operational expenses.

Efficient management of working capital is one of the pre-conditions for the success of an

enterprise. Efficient management of working capital means management of various

components of working capital in such a way that an adequate amount of working capital is

maintained for smooth running of a firm and for fulfillment of twin objectives of liquidity

and profitability. While inadequate amount of working capital impairs the firms liquidity.

Holding of excess working capital results in the reduction of profitability. But the properestimation of working capital actually required, is a difficult task for the management because

the amount of working capital varies across firms over the periods depending upon the nature

of business, production cycle, credit policy, availability of raw material, etc. Thus efficient

management of working capital is an important indicator of sound health of an organizationwhich requires reduction of unnecessary blocking of capital in order to bring down the cost of

financing.


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Need of working capital managementThe need for working capital gross or current assets cannot be over emphasized.As already

observed, the objective of financial decision making is to maximizethe shareholders wealth.

To achieve this, it is necessary to generate sufficientprofits can be earned will naturally

depend upon the magnitude of the salesamong other things but sales cannot convert into cash.

There is a need forworking capital in the form of current assets to deal with the problemarisingout of lack of immediate realization of cash against goods sold. Thereforesufficient

working capital is necessary to sustain sales activity. Technically thisis refers to operating or

cash cycle. If the company has certain amount of cash,it will be required for purchasing the

raw material may be available on creditbasis. Then the company has to spend some amount

for labour and factoryoverhead to convert the raw material in work in progress, and

ultimatelyfinished goods. These finished goods convert in to sales on credit basis in theformof sundry debtors. Sundry debtors are converting into cash after expiry ofcredit period. Thus

some amount of cash is blocked in raw materials, WIP,finished goods, and sundry debtorsand day to day cash requirements. Howeversome part of current assets may be financed by

the current liabilities also. Theamount required to be invested in this current assets is alwayshigher than thefunds available from current liabilities. This is the precise reason why the

needsfor working capital arise.

Research MethodologyIntroductionResearch methodology is a way to systematically solve the research problem. Itmay be

understood as a science of studying now research is donesystematically. In that various steps,

those are generally adopted by a researcher in studying his problem along with the logic

behind them.It is important for research to know not only the research method but also

knowmethodology. The procedures by which researcher go about their work ofdescribing,

explaining and predicting phenomenon are called methodology.

Methods comprise the procedures used for generating, collecting and evaluatingdata. All this

means that it is necessary for the researcher to design hismethodology for his problem as thesame may differ from problem to problem.

Data collection is important step in any project and success of any project willbe largelydepend upon now much accurate you will be able to collect and howmuch time, money and

effort will be required to collect that necessary data, thisis also important steps. Datacollection plays an important role in research work. Without proper dataavailable for analysis

you cannot do the research work accurately.

Types of data collectionThere are two types of data collection methods available.1. Primary data collection

2. Secondary data collection

1) Primary dataThe primary data is that data which is collected fresh or first hand, and for firsttime which is

original in nature. Primary data can collect through personalinterview, questionnaire etc. to

support the secondary data.

2) Secondary data collection methodThe secondary data are those which have already collected and stored.

Secondary data easily get those secondary data from records, journals, annualreports of the

company etc. It will save the time, money and efforts to collectthe data. Secondary data also


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made available through trade magazines, balance -sheets, books etc.This project is based on primary data collected through personal interview ofhead of account

department, head of SQC department and other concerned staffmember of financedepartment. But primary data collection had limitations suchas matter confidential

information thus project is based on secondaryinformation collected through five years

annual report of the company,supported by various books and internet sides. The data

collection was aimed atstudy of working capital management of the companyProject is based on

1. Annual report of CEAT LTD. 2005-06



4. Annual report ofCEAT LTD. 2008-09


OBJECTIVES OF THE STUDYStudy of the working capital management is important because unless theworking capital is

managed effectively, monitored efficiently planed properlyand reviewed periodically atregular intervals to remove bottlenecks if any thecompany cannot earn profits and increase its

turnover. With this primaryobjective of the study, the following further objectives are framedfor a depthanalysis.

1. To study the working capital management of CEAT Ltd.

2. To study the optimum level of current assets and current liabilities of thecompany.

3. To study the liquidity position through various working capital relatedratios.

4. To study the working capital components such as receivables accounts,cash management,

Inventory position.

5. To study the way and means of working capital finance of the CEAT Ltd.

6. To estimate the working capital requirement of CEAT Ltd.

7. To study the operating and cash cycle of the company.

SCOPE & LIMITATIONS OF THE STUDYScope of the studyThe scope of the study is identified after and during the study is conducted. Thestudy of

working capital is based on tools like trend Analysis, Ratio Analysis,working capitalleverage, operating cycle etc. Further the study is based on last5 years Annual Reports of

CEAT Ltd. And even factors likecompetitors analysis, industry analysis were not consideredwhile preparingthis project.

Limitations of the studyFollowing limitations were encountered while preparing this project:

1) Limited data:-This project has completed with annual reports; it just constitutes one part ofdata collection

i.e. secondary. There were limitations for primary data collectionIe of confidentiality.

2) Limited period:-This project is based on five year annual reports. Conclusions andrecommendations are based

on such limited data. The trend of last five yearmay or may not reflect the real workingcapital position of the company.

3) Limited area:-Also it was difficult to collect the data regarding the competitors and theirfinancial

information. Industry figures were also difficult to get.

Working capital level


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The consideration of the level investment in current assets should avoid twodanger pointsexcessive and inadequate investment in current assets. Investmentin current assets should be

just adequate, not more or less, to the need of thebusiness firms. Excessive investment incurrent assets should be avoidedbecause it impairs the firms profitability, as idle investment

earns nothing. Onthe other hand inadequate amount of working capital can be

threatenedsolvency of the firms because of its inability to meet its current obligation. Itshould

be realized that the working capital need of the firms may be fluctuatingwith changing business activity. This may cause excess or shortage of workingcapital frequently. The

management should be prompt to initiate an action andcorrect imbalance.

Table 4.1- Size of working capital

Particulars 2009-10 2008-09 2007-08 2006-07 2005-06

A) Current Assets

Inventories40607.57 21941.63 34106.00 22121.71 18345.44

Sundry Debtors37631.61 31870.85 30790.82 26317.07 25322.77

Cash & Bank Balance13998.91 20151.84 4158.70 4055.13 3961.27

Loan & Advances11010.26 7942.64 8142.41 5606.20 6304.06

Short Term

Investments 4300.42 4106.66 960.23 1711.13 1711.13

Total of A

(Gross W.C.) 107548.77 86013.62 78158.16 59811.24 55645.19

B)Current Liabilities

Current Liabilities75467.04 48905.12 52827.32 48964.85 47032.53

Provisions3635.82 1780.29 2524.81 3513.12 3853.78

Total of B79102.86 50685.41 55352.13 52477.97 50886.31

Net W.C.(A-B)28445.91 35328.21 22806.03 7333.27 4758.88

Working capital trend analysisIn working capital analysis the direction at changes over a period of time is ofcrucial


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importance. Working capital is one of the important fields ofmanagement. It is therefore veryessential for an annalist to make a study aboutthe trend and direction of working capital overa

period of time. Such analysisenables as to study the upward and downward trend in currentassets andcurrent liabilities and its effect on the working capital position.

In the words of S.P. Gupta The term trend is very commonly used in day-todayconversion

trend, also called secular or long term need is the basic tendencyof population, sales, income,current assets, and current liabilities to grow ordecline over a period of time

According to R.C.galeziem The trend is defined as smooth irreversiblemovement in the

series. It can be increasing or decreasing.

Emphasizing the importance of working capital trends, Man Mohan and Goyalhave pointed

out that analysis of working capital trends provide as base tojudge whether the practice and

privilege policy of the management with regardto working capital is good enough or an

important is to be made in managingthe working capital funds.

Further, any one trend by it self is not very informative and thereforecomparison with

Illustrated their ideas in these words, An upwards trends coupled withdownward trend orsells, accompanied by marked increase in plant investmentspecially if the increase in

planning investment by fixed interest obligation

Years 2005-06 2006-07 2007-08 2008-09 2009-10

Net W.C. (A-B) 4758.88 7333.27 22806.03 35328.21 28445.91

W.C. Indices 100 154.1 479.2 742.4 497.7


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ObservationsIt was observed that there are mismatches between changes in current assets and current

liabilities. In 2006-07 current assets increased by 7.5% and current liabilitiesincreased by

only around 3% while net working capital Increased by 54.1%. In 2007-08 current assets

increased by 30.7% and current liabilities increased only by 5.5%.Net working capital

increased by 325.7%. In 2008-09 current assets increased by 10% and current liabilities

decreased by 8.4% and there is an increase of 263.2% in net working capital. It shows that

management is using long term funds to short term requirement. In 2009-10 current assets

increased by 25% and current liabilities increased by 56% and there is a decrease of 245% in

net working capital. It indicates that firm is utilizing its short term resources efficiency.Current assets

Total assets are basically classified in two parts as fixed assets and currentassets. Fixed assets

are in the nature of long term or life time for theorganization. Current assets convert in thecash in the period of one year. Itmeans that current assets are liquid assets or assets which can

convert in to cashwithin a year.

Current Assets Size

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10

Inventories 18345.44 22121.71 34106.00 21941.63 40607.57

Sundry Debtors 25322.77 26317.07 30790.82 31870.85 37631.61

Cash & Bankbalances 3961.27 4055.13 4158.70 20151.84 13998.91

Loan & Advances 6304.06 5606.208142.41 7942.64 11010.26

Short term

Investments1711.13

1711.13 960.23 4106.66 4300.42

Total Current

100

154.1

479.2

742.4

497.7

0

100

200

300

400

500

600

700

800

2005-06 2006-07 2007-08 2008-09 2009-10

Net Working Capital Indices


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Assets 55645.19 59811.24 78158.16 86013.62 107548.77

Current Assets

Indices100 107.5 138.2 148.2 173.2

Composition of current assetsAnalysis of current assets components enables one to examine in whichcomponents theworking capital fund has locked. A large tie up of funds ininventories affects the profitability

of the business or the major portion ofcurrent assets is made up cash alone, the profitability

will be decreased becausecash is non earning assets.

Composition of Current Assets

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10

Inventories 32.96 36.98 43.63 25.5 37.75

Sundry Debtors 45.5 44.0 39.4 37.05 34.99

Cash and Bank Balances 7.11 6.77 5.32 23.43 13.02

Short Term Investments 11.33 9.37 10.41 9.23 10.23

Loan and Advances 3.07 2.86 1.23 4.77 4.0

Total of Current Assets 100 100 100 100 100

0

20

40

60

80

100

120

140

160

180

200

2005-06 2006-07 2007-08 2008-09 2009-10

Current Assets Indices

Current Assets Indices


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It was observed that the size of current assets is increasing with increases in thesales. The

excess of current assets is showing positive liquidity position of thefirm but it is not alwaysgood because excess current assets then required, itmay adversely affects on profitability.

Current assets include some fundsinvestments for which company pay interest. Company ismanaging its Debtors efficiently which is a source of liquidity.

Current liabilitiesCurrent liabilities mean the liabilities which have to pay in current year. Itincludes sundry

creditors means supplier whose payment is due but not paidyet, thus creditors called as

current liabilities. Current liabilities also includeshort term loan and provision as tax

provision. Current liabilities also includesbank overdraft. For some current assets like bank

overdrafts and short termloan, company has to pay interest thus the management of current

liabilities hasimportance

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10

Current Liabilities 47032.53 48964.85 52827.32 48905.12 75467.04

Provisions 3853.78 3513.12 2524.81 1780.29 3635.83

Total Current Liabilities 50886.31 52477.97 55352.13 56685.41 79102.86

Indices of C.L. 100 102.88 108.78 111.40 155.50

0

5

10

15

20

25

30

35

40

45

50

2005 -06 2006 -07 20 07-08 200 8-09 20 09-10

Inventories

Sundry Debtors

ash and Bank Balances

Short Term Investments

Loan and Advances


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ObservationsCurrent liabilities show continues growth each year because company createsthe credit in the

market by good transaction. To get maximum credit fromsupplier which is profitable to thecompany it reduces the need of workingcapital of firm. As a current liability increase in the

year 2006-07 by 35% itreduce the working capital size in the same year. But companyenjoyed overcreditors which may include indirect cost of credit terms.

Changes in working capitalThere are so many reasons to changes in working capital as follow

1. Changes in sales and operating expanses:-

The changes in sales and operating expanses may be due to three reasons1. There may be long run trend of change e.g. the price of row materialsay oil may constantlyraise necessity the holding of large inventory.

2. Cyclical changes in economy dealing to ups and downs in businessactivity will influence

the level of working capital both permanent andtemporary.

3. Changes in seasonality in sales activities

4. Policy changes:-

The second major case of changes in the level of working capital is because ofpolicy changes

initiated by management. The term current assets policy may bedefined as the relationship

between current assets and sales volume.

. Technology changes:-

The third major point if changes in working capital are changes in technologybecause change

sin technology to install that technology in our business moreworking capital is required

A change in operating expanses rise or full will have similar effects on thelevels of working

following working capital statement is prepared on the baseof balance sheet of last two year.

0

20

40

60

80

100

120

140

160

180

2005-06 2006-07 2007-08 2008-09 2009-10

Current Liabilities Indices in %

rre

t Lia

ilities I

ices i

%


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Statements of Changes in Working Capital

Particulars 2008-09 2009-10Changes in W. C.

Increase Decrease

A) Current

Asset

Inventories 21941.63 40607.57 18665.94SundryDebtors 31870.85 37631.61 5760.76

Cash and

BankBalances 20151.84 13998.91 6152.93

Short TermInvestments 7942.64 11010.26 3067.62

Loan and

Advances 4106.66 4300.42 193.76

Total of A86013.62 107548.77

B) Current

Liabilities

Current

liabilities 48905.12 75467.04 26561.92

Provisions1780.29 3635.82 1855.53

Total of B50685.41 79102.86

W. C. (A - B)35328.21 28445.91

Decrease in

Net Working

Capital 6882.3

Total 35328.21 35328.21 62987.83


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Operating CycleThe need of working capital arrived because of time gap between productions ofgoods and

their actual realization after sale. This time gap is called OperatingCycle or Working

Capital Cycle. The operating cycle of a company consistof time period between

procurement of inventory and the collection of cashfrom receivables. The operating cycle is

the length of time between thecompanys outlay on raw materials, wages and other expansesand inflow ofcash from sales of goods.

Operating cycle is an important concept in management of cash andmanagement of cash

working capital. The operating cycle reveals the time thatelapses between outlays of cash and

inflow of cash. Quicker the operating cycleless amount of investment in working capital is

needed and it improvesprofitability. The duration of the operating cycle depends on nature of

industriesand efficiency in working capital management.

IntroductionRatio analysis is the powerful tool of financial statements analysis. A ratio isdefine as the

indicated quotient of two mathematical expressions and as therelationship between two ormore things. The absolute figures reported in thefinancial statement do not provide

meaningful understanding of theperformance and financial position of the firm. Ratio helps to

summaries largequantities of financial data and to make qualitative judgment of the

firmsfinancial performance.

5.2) Role of ratio analysisRatio analysis helps to appraise the firms in the term of there profitability andefficiency of

performance, either individually or in relation to other firms insame industry. Ratio analysis

is one of the best possible techniques available tomanagement to impart the basic functions

like planning and control. As futureis closely related to the immediately past, ratio calculated

on the basis historicalfinancial data may be of good assistance to predict the future. E.g. On

the basisof inventory turnover ratio or debtors turnover ratio in the past, the level

ofinventory and debtors can be easily ascertained for any given amount of sales.

Similarly, the ratio analysis may be able to locate the point out the various ariaswhich need

the management attention in order to improve the situation. E.g.Current ratio which shows a

constant decline trend may be indicate the need forfurther introduction of long term finance

in order to increase the liquidityposition. As the ratio analysis is concerned with all the aspect

of the firmsfinancial analysis liquidity, solvency, activity, profitability and

overallperformance, it enables the interested persons to know the financial andoperationalcharacteristics of an organization and take suitable decisions.

5.3) Limitations of ratio analysis1. The basic limitation of ratio analysis is that it may be difficult to find abasis for making the

comparison

2. Normally, the ratios are calculated on the basis of historical financialstatements. An

organization for the purpose of decision making mayneed the hint regarding the future

happiness rather than those in the past.

The external analyst has to depend upon the past which may notnecessary to reflect financial

position and performance in future.

3. The technique of ratio analysis may prove inadequate in some situationsif there is differs in

opinion regarding the interpretation of certain ratio.

4. As the ratio calculates on the basis of financial statements, the basiclimitation which is


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applicable to the financial statement is equallyapplicable In case of technique of ratio analysisalso i.e. only facts whichcan be expressed in financial terms are considered by the ratio

analysis.5. The technique of ratio analysis has certain limitations of use in the sensethat it only

highlights the strong or problem arias, it dose not provide anysolution to rectify the problem

arias

5.4) Classification of working capital ratioWorking capital ratio means ratios which are related with the working capitalmanagement

e.g. current assets, current liabilities, liquidity, profitability andrisk turnoff etc. these ratio are

classified as follows

1. Efficiency ratioThe ratios compounded under this group indicate the efficiency of theorganization to use the

various kinds of assets by converting them the form ofsale. This ratio also called as activity

ratio or assets management ratio. As theassets basically categorized as fixed assets and

current assets and the currentassets further classified according to individual components of

current assetsviz. investment and receivables or debtors or as net current assets, theimportantof efficiency ratio as follow

1. Working capital turnover ratio2. Inventory turnover ratio

3. Receivable turnover ratio4. Current assets turnover ratio

5. Liquidity ratioThe ratios compounded under this group indicate the short term position of theorganization

and also indicate the efficiency with which the working capital isbeing used. The most

important ratio under this group is follows

1. Current ratio

2. Quick ratio

3. Absolute liquid ratio

5.5) Efficiency ratio1) Working capital turnover ratio

It signifies that for an amount of sales, a relative amount of working capital isneeded. If any

increase in sales contemplated working capital should beadequate and thus this ratio helps

management to maintain the adequate level ofworking capital. The ratio measures the

efficiency with which the workingcapital is being used by a firm. It may thus compute net

working capitalturnover by dividing sales by working capital.

WCTR = Sales/ Net Working Capital

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10Sales 195199.32 239061.20 260296.57 275843.13 298997.20

Net W. C. 4758.88 7333.27 22806.03 35328.21 28445.91W. C. TOR 41.01 32.60 11.41 7.8 10.11


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ObservationsHigh working capital ratio indicates the capability of the organization toachieve maximum

sales with the minimum investment in working capital.Companys working capital ratioshows mostly more than two, except for theyear 2005-06 because of excess of cash balance in

current assets whichoccurred due to encashment of deposits. In the year 2007 the ratio wasaround3, it indicates that the capability of the company to achieve maximum sales withthe

minimum investment in working capital.

2) Inventory turnover ratio

Inventory turnover ratio indicates the efficiency of the firm in producing andselling its

products. It is calculated by dividing the cost of good sold by averageinventory:

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

The average inventory is the average of opening and closing balance ofinventory in a

manufacturing company like JISL inventory of finished goods isused to calculate inventory

turnover ratio

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10Cost of goodssold

176483.44 209830.27 223567.36 259582.23 261062.82

Average

Inventory

17582.93 20233.57 28113.85 28023.81 31274.6

InventoryTOR

10.04 10.37 7.95 9.26 8.34

0

5

10

15

20

25

30

35

40

45

2005-06 2006-07 2007-08 2008-09 2009 -10

Working Capital Turnover Ratios

Working Capital Turnover

Ratios


20/34

ObservationsIt was observed that Inventory turnover ratio indicates maximum sales achievedwith the

minimum investment in the inventory. As such, the general rule highinventory turnover isdesirable but high inventory turnover ratio may notnecessary indicates the profitable

situation. An organization, in order to achievea large sales volume may sometime sacrifice onprofit, inventory ratio may notresult into high amount of profit.

3) Receivable turnover ratio

The derivation of this ratio is made in following way

Receivable turnover ratio = Gross Sales /Average Account Receivables

Gross sales are inclusive of excise duty and scrap sales because both may enterin to

receivables by credit sales. Average receivable calculate by opening plusclosing balance

divide by 2. Increasing volume of receivables without amatching increase in sales is reflected

by a low receivable turnover ratio. It isindication of slowing down of the collection system or

an extend line of creditbeing allowed by the customer organization. The latter may be due to

the factthat the firm is loosing out to competition. A credit manager engage in the taskof

granting credit or monitoring receivable should take the hint from a fallingreceivable turnover

ratio use his market intelligence to find out the reasonbehind such failing trend.Debtorturnover indicates the number of times debtors turnover each year.Generally the higher the

value of debtors turnover, the more is themanagement of credit.

Debtors turnover ratio = 365/ Receivable turnover ratio

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10Gross Sales 195199.32 239061.20 260296.57 275843.13 298997.20

Average

Debtors

24491.4 25819.92 28553.94 31330.83 34751.23

ReceivableTOR

7.97 9.25 9.11 8.80 8.60

0

2

4

6

8

10

12

2005-06 2006 -07 2007 -08 2008 -09 2009 -10

Inventory TOR

I

ve

t

ry TO


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It was observed from receivable turnover ratio that receivables turned aroundthe sales were

less than 4 times. The actual collection period was more thannormal collection period

allowed to customer. It concludes that over investmentin the debtors which adversely affect

on requirement of the working capitalfinance and cost of such finance.)

Current assets turnover ratioCurrent assets turnover ratio is calculate to know the firms efficiency ofutilizing the current

assets .current assets includes the assets like inventories,sundry debtors, bills receivable, cash

in hand or bank, marketable securities,prepaid expenses and short term loans and advances.This ratio includes theefficiency with which current assets turn into sales. A higher ratioimplies amore efficient use of funds thus high turnover ratio indicate to reduced the lockup of

funds in current assets. An analysis of this ratio over a period of timereflects working capital

management of a firm.

Current Assets TOR = Sales / Current Assets


Current Assets 55645.19 59811.24 78158.16 86013.62 107548.77Current Assets

TOR

3.50 3.99 3.30 3.20 2.78

7

7.5

8

8.5

9

9.5

2005-06 2006-07 2007-08 2008-09 2009-10

Receivable TOR

eceiva

le TO


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It was observed that current assets turnover ratio does not indicate any trendover the period of time. Turnover ratio was 0.92 in the year 2002-03 and

increase to 1.10 and 1.30 in the year 2004 and 2005 respectively, but itdecreased in the year 2005-06, because of high cash balance. Cash did not helpto increase in sales volume, as cash is non earning asset. In the year 2006-07

company increased its sales with increased investment in current assets, thus

current assets turnover ratio increased to 1.39 from 1.1 in the year 2005-06

Liquidity ratio1) Current ratioThe current is calculated by dividing current assets by current liabilities:

Current Ratio = Current Assets / Current Liabilities

Current assets include cash and those assets which can be converted in to cashwithin a year,such marketable securities, debtors and inventories. Allobligations within a year are include

in current liabilities. Current liabilitiesinclude creditors, bills payable accrued expenses, shortterm bank loan incometax liabilities and long term debt maturing in the current year. Current

ratioindicates the availability of current assets in rupees for every rupee of currentliability.

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

2005-06 2006-07 2007-08 2008-09 2009-10

Current Assets TOR

rre

t

ssets TO


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Current Assets 55645.19 59811.24 78158.16 86013.62 107548.77CurrentLiabilities

50886.31 52477.97 55352.13 56685.41 79102.86

Current Ratio 1.09 1.13 1.41 1.51 1.36

Quick ratioQuick ratios establish the relationship between quick or liquid assets andliabilities. An asset

is liquid if it can be converting in to cash immediately orreasonably soon without a loss of

value. Cash is the most liquid asset .otherassets which are consider to be relatively liquid andinclude in quick assets aredebtors and bills receivable and marketable securities. Inventories

areconsidered as less liquid. Inventory normally required some time for realizinginto cash.

Their value also is tendency to fluctuate. The quick ratio is found outby dividing quick assets

by current liabilities

Quick Ratio = (Current Assets Inventory)/ Current Liabilities

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10

LiquidCurrent

Assets

37299.75 37689.53 44052.16 64071.99 66941.20

Current

Liabilities50886.31 52477.97 55352.13 56685.41 79102.86

QuickRatio

0.73 0.71 0.79 1.13 0.84

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

2005-06 2006-07 2007-08 2008-09 2009-10

Current Ratio

Current Ratio


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ObservationsQuick ratio indicates that the company has sufficient liquid balance for the

payment of current liabilities. The liquid ratio of 1:1 is suppose to be standardor ideal but here ratio is more than 1:1 over the period of time, it indicates that

the firm maintains the over liquid assets than actual requirement of such assets.

In the year 2006-07 company had Rs.1.79 cash for every 1 rupee of expenses;such a policy is called conservative policy of finance for working capital, Rs.

0.79 is the ideal investment which affects on the cost of the fund and returns on

the funds.3) Absolute liquid ratioEven though debtors and bills receivables are considered as more liquid theninventories, it

can not be converted in to cash immediately or in time. Thereforewhile calculation of

absolute liquid ratio only the absolute liquid assets as likecash in hand cash at bank, short

term marketable securities are taken in toconsideration to measure the ability of the company

in meeting short termfinancial obligation. It calculates by absolute assets dividing by

currentliabilities.

Absolute Liquid Ratio = Absolute Liquid Assets / Current Liabilities

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10AbsoluteLiquid Assets

11976.98 11372.46 13261.34 32201.14 21309.59

CurrentLiabilities

50886.31 52477.97 55352.13 56685.41 79102.86

Absolute

Liquid Assets

0.23 0.22 0.24 0.56 0.26

0

0.2

0.4

0.6

0.8

1

1.2

2005-06 2006-07 2007-08 2008-09 2009-10

Quick Ratio

Q

ick

ati


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0

0.1

0.2

0.3

0.4

0.5

0.6

2005-06 2006 -07 2007 -08 2008-09 2009-10

Absolute Liquid Ratio

Abs

l

te Liq

i!

"

ati


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Receivables ManagementReceivables or debtors are the one of the most important parts of the currentassets which is

created if the company sells the finished goods to the customerbut not receive the cash for the

same immediately. Trade credit arises whenfirm sells its products and services on credit and

dose not receive cashimmediately. It is essential marketing tool, acting as bridge for the

movement ofgoods through production and distribution stages to customers. Tradecreditcreates receivables or book debts which the firm is expected to collect in thenear future.

The receivables include three characteristics

1) It involve element of risk which should be carefully analysis.

2) It is based on economic value. To the buyer, the economic value in goods orservices passes

immediately at the time of sale, while seller expects anequivalent value to be received later

on3) It implies futurity. The cash payment for goods or serves received by thebuyer will be

made by him in a future period.

Objective of receivable managementThe sales of goods on credit basis are an essential part of the moderncompetitive economic

system. The credit sales are generally made up onaccount in the sense that there are formalacknowledgements of debt obligationthrough a financial instrument. As a marketing tool,

they are intended topromote sales and there by profit. However extension of credit involves

riskand cost, management should weigh the benefit as well as cost to determine thegoal of

receivable management. Thus the objective of receivable managementis to promote sales and

profit until that point is reached where the return oninvestment in further funding of

receivables is less .than the cost of funds raisedto finance that additional credit

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10Sundry

Debtors25322.77 26317.07 30790.82 31870.85 37631.61

Indices 100 103.93 121.60 125.90 148.61

0

20

40

60

80

100

120

140

160

2005-06 2006-07 2007-08 2008-09 2009-10

Sundry Debtors Indices

S # $ % ry & ebt ' rs I $ % ices


27/34

Average collection periodThe average collection period measures the quality of debtors since it indicatethe speed of

there collection. The shorter the average collection period, thebetter the quality of the debtors

since a short collection period implies theprompt payment by debtors. The average collection

period should be comparedagainst the firms credit terms and policy judges its credit and

collectionefficiency. The collection period ratio thus helps an analyst in two respects.1. In determining the collectability of debtors and thus, the efficiency ofcollection efforts.

2. In ascertaining the firms comparative strength and advantages related toits credit policy

and performance.

The debtors turnover ratio can be transformed in to the number of days ofholding of debtors.


AverageDebtors

Receivable

TOR

7.97 9.25 9.11 8.80 8.60

AverageCollection

Period (days)

Inventory Management


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The term inventory is used to designate the aggregate of those items oftangible assets whichare

1. Finished goods (saleable)2. Work-in-progress (convertible)

3. Material and supplies (consumable)

In financial view, inventory defined as the sum of the value of raw material andsupplies,

including spares, semi-processed material or work in progress andfinished goods. The natureof inventory is largely depending upon the type ofoperation carried on. For instance, in the

case of a manufacturing concern, theinventory will generally comprise all three groups

mentioned above while in thecase of a trading concern, it will simply be by stock- in- trade or

finished goods.

Objective of inventory managementIn company there should be an optimum level of investment for any asset,whether it is plant,cash or inventories. Again inadequate disrupts productionand causes losses in sales. Efficient

management of inventory should ultimatelyresult in wealth maximization of owners wealth.It implies that while themanagement should try to pursue financial objective of turning

inventory asquickly as possible, it should at the same time ensure sufficient inventoriestosatisfy production and sales demand. The objectives of inventory managementconsist of

two counterbalancing parts:

1. To minimize the firms investment in inventory

2. To meet a demand for the product by efficiently organizing the firmsproduction and sales

operation.

This two conflicting objective of inventory management can also be expressedin term of cost

and benefits associated with inventory. That the firm shouldminimize the investment in

inventory implies that maintaining an inventorycost, such that smaller the inventory, the

better the view point .obviously, thefinancial manager should aim at a level of inventory

which will reconcile theseconflicting elements. Some objective as follow

1. To have stock available as and when they are required.

2. To utilize available storage space but prevents stock levels fromexceeding space available.3. To maintain adequate accountability of inventories assets.

4. To provide, on item by- item basis, for re-order point and order suchquantity as wouldensure that the aggregate result confirm with theconstraint and objective of inventory control.

To keep low investment in inventories carrying cost an obsolesce losses to theminimum.

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10Raw Material 6716.24 10277.85 18659.72 6553.97 20898.56

W.I.P. 2004.70 2224.78 2252.06 1720.79 3660.25

Finished

Goods

8003.40 8080.44 11480.27 11888.49 13276.47

Other

Inventory

1621.10 1538.64 1713.95 1778.38 2772.29

Total 18345.44 22121.71 34106.00 21941.63 40607.57

Indices 100 117.07 185.90 119.60 221.34


29/34

The manufacturing firms inventory consist following components

I) Raw material

ii) Work- in-progress

iii) Finished goods

To analyze the level of raw material inventory and work in progress inventoryheld by thefirm on an average it is necessary to examine the efficiency withwhich the firm converts raw

material inventory and work in progress intofinished goods.

0

50

100

150

200

250

2005-06 2006 -07 2007-08 2008-09 2009-10

Inventory Indices

I(

ve(

t)

ry I( 0

ices

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

2005-06 2006 -07 2007-08 2008-09 2009 -10

1

t2

er I(

ve(

t)

ries

Fi(

is2

e0

G) ) 0

s

3 .I.P.

Raw material


30/34

Inventory holding periodThe reciprocal of inventory turnover gives average inventory holding inpercentage term.

When the numbers of days in year are divided by inventoryturnover, we obtain days of

inventory holding (DIH).

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10Inventory

TOR

10.04 10.37 7.95 9.26 8.34

Days of

InventoryHolding

36 35 46 39 44

0

5

10

15

20

25

30

35

40

45

50

2005-06 2006-07 2007-08 2008-09 2009-10

Days of i ve tory Hol i g Perio

Days of inventory Holding

4

eriod


31/34

Management of CashCash is common purchasing power or medium of exchange. As such, it formsthe most

important component of working capital. The term cash with referenceto cash management is

used in two senses, in narrow sense it is used broadly tocover cash and generally accepted

equivalent of cash such as cheques, draft anddemand deposits in banks. The broader view of

cash also induce hear- cashassets, such as marketable sense as marketable securities and timedeposits inbanks. The main characteristics of this deposits that they can be really sold

andconvert in to cash in short term. They also provide short term investment outletfor excess

and are also useful for meeting planned outflow of funds. We employthe term cash

management in the broader sense. Irrespective of the form inwhich it is held, a distinguishing

feature of cash as assets is that it was noearning power. Company have to always maintain

the cash balance to fulfill thedally requirement of expenses. There are four primary motivefor maintain thecash as follow

Motive of holding cashThere are four motives for holding cash as follow1. Transaction motive

2. Precautionary motive3. Speculative motive

4. Compensating motive

Transaction motiveCash balance is necessary to meet day-to-day transaction for carrying on withthe operation of

firms. Ordinarily, these transactions include payment for material, wages, expenses,

dividends, taxation etc. there is a regular inflow ofcash from operating sources, thus in case

of JISL there will be two-way flow ofcash- receipts and payments. But since they do not

perfectly synchronize, aminimum cash balance is necessary to uphold the operations for the

firm if cashpayments exceed receipts.

Always a major part of transaction balances is held in cash, a part may be heldin theform of

marketable securities whose maturity conforms to the timing ofanticipated payments of

certain items, such as taxation, dividend etc.Precautionary MotiveCash flows are somewhat unpredictable, with the degree of predictabilityvarying among

firms and industries. Unexpected cash needs at short notice mayalso be the result offollowing:

1. Uncontrollable circumstances such as strike and natural calamities.2. Unexpected delay in collection of trade dues.

3. Cancellation of some order for goods due unsatisfactory quality.4. Increase in cost of raw material, rise in wages, etc.

The higher the predictability of firms cash flows, the lower will be thenecessity of holdingthis balance and vice versa. The need for holding theprecautionary cash balance is also

influenced by the firms capacity to haveshort term borrowed funds and also to convert shortterm marketable securitiesinto cash.

Speculative motive:Speculative cash balances may be defined as cash balances that are held toenable the firm to

take advantages of any bargain purchases that might arise.

While the precautionary motive is defensive in nature, the speculative motive isaggressive in

approach.

However, as with precautionary balances, firms today are more likely to rely onreserve

borrowing power and on marketable securities portfolios than on actualcash holdings for


32/34

speculative purposes.

Advantages of cash managementCash does not enter in to the profit and loss account of an enterprise, hence cashis neither

profit nor losses but without cash, profit remains meaningless for anenterprise owner.

1. A sufficient of cash can keep an unsuccessful firm going despite losses

2. An efficient cash management through a relevant and timely cash budgetmay enable a firmto obtain optimum working capital and ease thestrains of cash shortage, fascinating

temporary investment of cash andproviding funds normal growth.

3. Cash management involves balance sheet changes and other cash flowthat do not appear in

the profit and loss account such as capitalexpenditure.

Particulars 2005-06 2006-07 2007-08 2008-09 2009-10Cash andBank Balances

3961.27 4055.13 4158.70 20151.84 13998.91Cash & B.B.

Indices

100 102.37 104.98 508.72 353.39

Cash cycle:-One of the distinguishing features of the fund employed as working capital isthat constantly

changes its form to drive business wheel. It is also known ascirculating capital whichmeans current assets of the company, which arechanged in ordinary courseof business from

one form to another, as forexample, from cash to inventories, inventories to receivables and

receivables tocash.

Basically cash management strategies are essentially related to the cash cycletogether with

the cash turnover. The cash cycle refers to the process by whichcash is used to purchase the

row material from which are produced goods,which are then send to the customer, who later

pay bills. The cash turnovermeans the number of time firms cash is used during each year.

0

100

200

300

400

500

600

2005-06 2006-07 2007-08 2008-09 2009-10

Cash and Bank Balance Indices

5

ash a6 7

Ba6

k Bala6

ce I6 7

ices


33/34

) IntroductionFunds available for period of one year or less is called short term finance. InIndia short termfinance are used as working capital finance. Two mostsignificant short term sources of

finance for working capital are trade credit andbank borrowing. Trade credit ratio of current

assets is about 40%, it is indicatedby Reserve Bank of India data that trade credit has grown

faster than the growthin sales. Bank borrowing is the next source of working capital finance.

Therelative importance of this varies from time to time depending on the

prevailingenvironment. In India the primary source of working capital financing are

tradecredit and short term bank credit. After determine the level of working capital, afirm has

to consider how it will finance. Following are sources of workingcapital finance.

7.2) Sources of working Capital Finance1) Trade credit

2) Bank Finance

3) Letter of credit

1) Trade credit

Trade credit refers to the credit that a customer gets from suppliers of goods inthe normalcourse of business. The buying firms do not have to pay cashimmediately for the purchase

made. This deferral of payments is a short termfinancing called trade credit. It is major sourceof financing for firm.Particularly small firms are heavily depend on trade credit as a source

offinance since they find it difficult to raised funds from banks or other sources inthe capitalmarket. Trade credit is mostly an informal arrangement, and itgranted on an open account

basis. A supplier sends goods to the buyers accept,and thus, in effect, agrees to pay theamount due as per sales terms in theinvoice. Trade credit may take the form of bills payable.

Credit terms refer tothe condition under which the supplier sells on credit to the buyer, andthebuyer required to repay the credit. Trade credit is the spontaneous source of thefinancing.

As the volume of the firms purchase increase trade credit alsoexpand. It appears to be cost

free since it does not involve explicit interestcharges, but in practice, it involves implicit cost.

The cost of credit may betransferred to the buyer via the increased price of goods supplied by

him.

2) Bank finance for working capitalBanks are main institutional source of working capital finance in India. Aftertrade credit,

bank credit is the most important source of financing workingcapital in India. A banks

considers a firms sales and production plane anddesirable levels of current assets in

determining its working capitalrequirements. The amount approved by bank for the firms

working capital iscalled credit limit. Credit limit is the maximum funds which a firm can

obtainfrom the banking system. In practice banks do not lend 100% credit limit; theydeductmargin money.

Forms of bank finance:-1. Term Loan

2. Overdraft

3. Cash credit

4. Purchase or discounting of bills

1) Term Loan


34/34

In this case, the entire amount of assistance is disbursed at one time only, eitherin cash or thecompanys account. The loan may be paid repaid in installmentswill charged on outstanding

balance.

2) Overdraft

In this case, the company is allowed to withdraw in excess of the balancestanding in its Bank

account. However, a fixed limit is stipulated by the Bankbeyond which the company will not

able to overdraw the account. Legally,overdraft is a demand assistance given by the bank i.e.bank can ask repaymentat any point of time.

3) Cash creditIn practice, the operations in cash credit facility are similar to those of those ofoverdraft

facility except the fact that the company need not have a formalcurrent account. Here also a

fixed limit is stipulated beyond which the companyis not able to withdraw the amount.

4) Bills purchased / discountedThis form of assistance is comparatively of recent origin. This facility enablesthe company to

get the immediate payment against the credit bills / invoiceraised by the company. The banks

hold the bills as a security till the payment ismade by the customer. The entire amount of bill

is not paid to the company.The company gets only the present worth of amount of bill fromof discountcharges. On maturity, bank collects the full amount of bill from the customer.

3) Letter of creditIn this case the exporter and the importer are unknown to each other. Underthesecircumstances, exporter is worried about getting the payment from theimporter and importer

is worried as to whether he will get goods or not. In thiscase, the importer applies to his bankin his country to open a letter of credit infavor of the exporter whereby the importers bank

undertakes to pay the exporteror accept the bills or draft drawn by the exporter on theexporter fulfilling theterms and conditions specified in the letter of credit.

Banks have been certain norms in granting working capital finance tocompanies. These

norms have been greatly influenced by the recommendationof various committees appointed

by the Reserve Bank of India from time totime. The norms of working capital finance

followed by bank since mid-70were mainly based on the recommendations of the Tondan

committee. TheChore committee made further recommendations to strengthen theprocedureand norms for working capital finance by banks.

Working Capital Management at CEAT LTD.

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