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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
mailto:[email protected]:[email protected]://www.rtekmould.com/http://www.autocrat.co.in/


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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.

Acknowle Dement

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