BACKGROUND OF THE STUDY.

“THE MAJOR OBJECTIVE OF THIS STUDY IS FOR THE PROPER UNDERSTANDING OF THE WORKING CAPITAL OF ARABIAN INDUSTRIES LLC AND TO SUGGEST NECESSARY MEASURES TO OVERCOME THE SHORTFALLS IF ANY IN THE INDUSTRY.”

The project undertaken is on “Working Capital Management of Arabian

Industries LLC.”. It describes about how the company manages its working

capital and the various steps that are required in the management of working

capital. Cash is the lifeline of a company. If this lifeline deteriorates, so does the

company's ability to fund operations, reinvest and meet capital requirements and

payments. Understanding a company's cash flow health is essential to making

investment decisions. A good way to judge a company's cash flow prospects is

to look at its Working Capital Management (WCM).

Working capital refers to the cash of a business requires for day-to-day

operations or, more specifically, for financing the conversion of raw materials

into finished goods, which the company sells for payment. Among the most

important items of working capital are levels of inventory, accounts receivable,

and accounts payable. Analysts look at these items for signs of a company's

efficiency and financial strength.

The working capital is an important yardstick to measure the company’s

operational and financial efficiency. Any company should have a right amount

of cash and lines of credit for its business needs at all times. This project

describes how the management of working capital takes place at Arabian

Industries LLC..

There are numerous instances in the history of business world where

inadequacy of working capital has led to business failures when a firm finds it

difficult to meetings day to day affairs. Operating expenses essential out lays

may have to be postponed for want of funds, operating plans will go out of gear

& enterprise objectives on investment slumps the suppliers & creditors of the

firm may have to wait longer to raise their dues & will hesitate to extend further

credit to the firm.

Thus efficient management of working capital in an important prerequisite for

successful working of a business concern it reduces the chances of business

failure generates a felling of security and confidence in the minds of personnel

in the organization it assurance solvency of steady of the organization.

STATEMENT OF PROBLEM

In the management of working capital, the firm is faced with two key problems:

1. First, given the level of sales and the relevant cost considerations, what are

the optimal amounts of cash, accounts receivable and inventories that a firm

should choose to maintain?

2. Second, given these optimal amounts, what is the most economical way to

finance these working capital investments? To produce the best possible results,

firms should keep no unproductive assets and should finance with the cheapest

available sources of funds. Why? In general, it is quite advantageous for the

firm to invest in short term assets and to finance short-term liabilities.

Besides this followings are some other problem , a firm is facing. Through this

study we try to find answer for these problems.

1. What are root causes of working capital on business?

2. What are the major effects on accounts receivable?

3. What is the nature of relationship between working capital and capital

employed

4. What steps should be taken to ensure that it effect on the profit of the firm

will not be negative?

5. How can working capital be managed?

6. What make up the working capital cycle?

7. How can debtors be controlled?

NEED AND IMPORTANCE OF THE STUDY.

1.This projects is helpful in knowing the companies position of funds

maintenance and setting the standards for working capital inventory levels,

current ratio level, quick ratio, current asset turnover level & size of current

liability etc.

2. This project is helpful to the managements for expanding the dualism & the

project viability & present availability of funds.

3. This project is also useful as it combines the present year data with the

previous year data and there by it show the trend analysis, i.e. increasing fund or

decreasing fund.

4. The project is done as a whole entirely. It will give overall view of the

organization and it is useful in further expansion decision to be taken by

management.

OBJECTIVES OF THE STUDY

The main objective of the study is to determine the effect of working capital on

business profitability which has to do with:-

1. Maintenance of working capital at appropriate level, and

2. Availability of ample funds as and when they are needed

To accomplishment of these two objectives, the management has consider the

composition of current assets pool. The working capital position sets the various

policies in the business with respect to general operations like purchasing,

financing, expansion and dividend etc,

The subsidiary Objective of Working Capital Management is to provide

adequate support for the smooth functioning of the normal business operations

of a company. This Objective can be sub-divided into 2 parts:-

1. Liquidity

2. Profitability

1) Liquidity

The quantum of Investment in Current Assets has to be made in a manner that it

not only meets the needs of the forecasted sales but also provides a built in

cushion in the form of safety stocks to meet unforeseen contingencies arising

out of factors such as delays in arrival of Raw Material, sudden spurts in

demand etc. Consequently, the investment in current assets for a given level of

forecasted sales will be higher if the management follows a conservative

attitude than when it follows an aggressive attitude. Thus, a company following

a conservative approach is subject to a lower degree of risk than the one

following an aggressive approach. Further, in the former situation the high

amount of Investment in Current Assets imparts greater liquidity to the

company than under the latter situation wherein the quantum of investment in

Current Asset is less. This aspect exclusively covers the liquidity dimension of

Working Capital.

2) Profitability

Once we recognize the fact that the total amount of financial resources at the

disposal of a company is limited and these can be put to alternative uses, the

larger the amount of investment in current assets, the smaller will be the amount

available for investment in other profitable avenues at hand with the company.

A conservative approach in respect of Investment in Current Assets leaves

fewer amounts for other Investments than an aggressive approach does.

HYPOTHESIS

Hypothesis is a conjectural statement of the relationships between two or more

variables. It is testable, tentative problem explanation of the relationship

between two or more variables that create a state of affairs or phenomenon.E,C,

Osuola said hypothesis should always be in declarative sentence form, and they

should relate to them generally or specially variable to variables.

Hypothesis thus:-

1. Explain observed events in a systematic manner

2. Predict the outcome of events and relationships

3. Systematically summarized existing knowledge.

In essence, there exist null hypothesis set up only to nullify the research

hypothesis and the alternative hypothesis, for the purpose of the study. For the

efficiency of the study, the hypothesis is as follows:

H 0

1. Working capital does not help the business concern in maintaining the

goodwill

2. Working capital does not create an environment of security, confidence,

and overall efficiency in a business

H 1

1. Working capital helps the business concern in maintaining the goodwill.

2. Working capital creates an environment of security, confidence, and overall

efficiency in business.

METHODOLOGY

Methodology may be a description of process, or may be expanded to include a

philosophically coherent collection of theories, concepts or ideas as they relate

to a particular discipline or field of inquiry. This project requires a detailed

understanding of the concept – “Working Capital Management”. Therefore,

firstly we need to have a clear idea of, what is working capital, how it is

managed in Arabian Industries LLC, what are the different ways in which the

financing of working capital is done in the organization etc.

To recognize the various type of information which are necessary for the study

of working capital management.

The management of working capital involves managing inventories,

accounts receivable and payable and cash. Therefore one also needs to

have a sound knowledge about cash management, inventory management

and receivables management.

Then comes the financing of working capital requirement, i.e. how the

working capital is financed, what are the various sources through which it

is done.

And, in the end, suggestions and recommendations on ways for better

management and control of working capital are provided.

Collection of data from various department of AILLC to analyze the working

capital management of the firm.

COLLECTION OF DATA

There are several ways of collecting both data-Primary and Secondary datas,

which differ considerably in context of money, cost, time and other sources at

the disposable of the researcher.

There are two types of data:

· Primary data

· Secondary data

1-Primary Data

Definition:-

The first handed information/Fresh data collected through various methods is

known as primary data.

In respect of primary data which the researchers are directly collects data

that have not been previously collected.

The primary data was gathered through personal interaction with various

functional heads and other technical personnel. Some information was also

collected by observation.

2-Secondary Data :

Definition:-

The data which have been already collected & comprised for another

purpose. Secondary data was collected various reports, annual reports,

documents charts, management information systems, etc in AI LLC, And also

collected various magazines, books, newspapers etc.

The analysis of the information gathered has been made on the basis of the

clarifications sought during the personal discussions with the concerned people

and perception during the personal visits to the important areas of services.

In marking observations identifying problems and suggesting certain remedies

such emphasis was given on the basis of opinions gathered during the personal

discussions and with the personal experience gained during the academic study

of M.B.A course.

TOOLS EMPLOYED

The data presentation tools are mainly Mathematical tools, Tables and Charts

are used for this study.

The most important parts of tools include;

a) Table numbers

b) Title of the table

c) Caption

d) Stub or the designation of the rows and columns

e) The body of the table

f) The head note or prefatory note or explanatory just before the title.

g) Source note, which refers to the literally or scientific source of the table

has observed that a table has the following merits over a prose

information that;

h) A table ensures an easy location of the required figure;

i) Comparisons are easily made utilizing a table than prose information;

j) Patterns or trends within the figures which cannot be visualized in the

prose information can be revealed and better depicted by a table; and a

table is more concise and takes up a less space than a prose formation:

TIME SPAN

A period of six year i.e. 2004-2009 has been taken for the study.

LIMITATIONS OF THE STUDY.

The following are the various limitations involved in the study.

.

1. The study in limited 4 years (2004-2005) to (2005-2006) performance of the

company.

2. The data used in this study have been taken from published annual report

only.

3. This study in conducted within a short period. During the limited period the

study may not be retailed, full fledged and utilization in all aspects.

4. Financial accounting does not take into account the price level changes.

5. We cannot do comparisons with other companies unless and until we have

the data of other companies on the same subject.

6. Only the printed data about the company will be available and not the back–

end details.

7. Future plans of the company will not be disclosed to us.

8. Lastly, due to shortage of time it is not possible to cover all the factors and

details regarding the subject of study.

LITERATURE REVIEW - AN OVER VIEW

“A literature review is an essay or is part of the introduction to an essay,

research report, or thesis. It provides an overview and critical analysis of

relevant published scholarly articles, research reports, books, theses etc on

the topic or issue to be investigated. A detailed guide to the literature review

is available on the Language and Learning services website. Literature

search: A systematic and exhaustive search for published material on a

specific topic.”

It discusses published information in a particular subject area, and

sometimes information in a particular subject area within a certain time

period. It is a summary of research that has been published about a particular

subject. It provides the reader with an idea about the current situation in

terms of what has been done, and what we know. Sometimes it includes

suggestions about what needs to be done to increase the knowledge and

understanding of a particular problem.

It gives an overview of what has been said, who the key writers are, what are

the prevailing theories and hypotheses, what questions are being asked, and

what methods and methodologies are appropriate and useful. As such, it is

not in itself primary research, but rather it reports on other findings.

Literature reviews can give you an overview or act as a stepping stone. It

also provide a solid background for a research paper's investigation.

A LITERATURE REVIEW MUST DO THESE THINGS:

be organized around and related directly to the thesis or research question

you are developing

synthesize results into a summary of what is and is not known

identify areas of controversy in the literature

formulate questions that need further research

Structuring a literature review

It is often difficult to decide how to organize the huge amount of

information you have collected.

The structure of each dissertation will be different but there are some

general principles and these are really the guidelines you should use for

any piece of academic writing.

Structuring a literature review

Introduction to the literature review

Main part

Conclusions

A literature review is a piece of discursive prose, not a list describing or

summarizing one piece of literature after another.

It's usually a bad sign to see every paragraph beginning with the name of a

researcher. Instead, organize the literature review into sections that present

themes or identify trends, including relevant theory.

ABSTRACT OF LITERATURE REVIEW

The current study contributes to the literature by examining impact of working

capital management on the operating performance and growth of new public

companies. The study also sheds light on the relationship of working capital

with debt level, firm risk, and industry. Using a sample of a manufacturing, the

study finds a significant positive association between higher levels of accounts

receivable and operating performance. The study further finds that maintaining

control (i.e. lower amounts) over levels of cash and securities, inventory, fixed

assets, and accounts payables appears to be associated with higher operating

performance, as well. We find that the firms which are experiencing unusually

high growth tend not to perform as well as those with low to moderate growth.

Further firms which are experiencing high growth tend to hold higher levels of

cash and securities, inventory, fixed assets, and accounts payables. These

findings tend to suggest that firms are willing to sacrifice performance (accept

low or negative operating returns) to increase their growth levels. The higher

level of growth is also associated with higher operating and financial risk. The

findings of this study suggest that perhaps the firms should stay more focused

on their operating performance than on maintaining high growth levels.

INTRODUCTION AND LITERATURE REVIEW

Working capital policy refers to the firm's policies regarding 1) target levels for

each category of current operating assets and liabilities, and 2) how current

assets will be financed. Generally good working capital policy (i.e. under

conditions of certainty) is considered to be one in which holdings of cash,

securities, inventories, fixed assets, and accounts payables are minimized.

The level of accounts receivables should be used as a means of

stimulating sales and other income. Previous literature on working capital

management has found a negative association, overall, between level of

working capital and operating performance as measured by operating returns

and operating margins (Peterson and Rajan, 1997). Under conditions of

certainty (i.e. sales, costs, lead times, payment periods, and so on, are known),

firms have little reason to hold more working capital than a minimum level.

AN ANALYSIS OF WORKING CAPITAL MANAGEMENT RESULTS ACROSS INDUSTRIES :-

INTRODUCTION

The importance of efficient working capital management (WCM) is

indisputable. Working capital is the difference between resources in cash or

readily convertible into cash (Current Assets) and organizational commitments

for which cash will soon be required (Current Liabilities). The objective of

working capital management is to maintain the optimum balance of each of the

working capital components.

Business viability relies on the ability to effectively manage receivables,

inventory, and payables. Firms are able to reduce financing costs and/or

increase the funds available for expansion by minimizing the amount of funds

tied up in current assets. Much managerial effort is expended in bringing non-

optimal levels of current assets and liabilities back toward optimal levels. An

optimal level would be one in which a balance is achieved between risk and

efficiency.

A recent example of business attempting to maximize working capital

management is the recurrent attention being given to the application of Six

Sigma® methodology. When used to identify and rectify discrepancies,

inefficiencies and erroneous transactions in the financial supply chain, Six

Sigma® reduces Days Sales Outstanding (DSO), accelerates the payment cycle,

improves customer satisfaction and reduces the necessary amount and cost of

working capital needs. There appear to be many success stories, including

Jennifer Towne’s (2002) report of a 15 percent decrease in days that sales are

outstanding, resulting in an increased cash flow of approximately 2 million

dollars at Thibodaux Regional Medical Center. Furthermore, bad debts

declined from 3.4 million dollar to o 600,000 dollar.

Even in a business using Six Sigma® methodology, an “optimal” level of

working capital management needs to be identified. Industry factors may impact

firm credit policy, inventory management, and bill-paying activities. Some

firms may be better suited to minimize receivables and inventory, while others

maximize payables. Another aspect of “optimal” is the extent to which poor

financial results can be tied to sub-optimal performance. Fortunately, these

issues are testable with data published by CFO magazine (Mintz and Lazere

1997; Corman 1998; Mintz 1999; Myers 2000; Fink 2001), which claims to be

the source of “tools and information for the financial executive,” and are the

subject of this research.

The following section presents a brief literature review. Next, the research

method is described, including some information about the annual Working

Capital Management Survey published by CFO magazine. Findings are then

presented and conclusions are drawn.

Many researchers have studied working capital from different views and

in different environments. The following are some useful research:

3.1 RELATED LITERATURE

The importance of working capital management is not new to the finance

literature. Over twenty years ago, Largay and Stickney (1980) reported that the

then-recent bankruptcy of W.T. Grant, a nationwide chain of department stores,

should have been anticipated because the corporation had been running a deficit

cash flow from operations for eight of the last ten years of its corporate life. As

part of a study of the Fortune 500’s financial management practices. Following

are the important views of scholars about working capital management.

1 GILBERT AND REICHERT (1995 ) :

Find that accounts receivable management models are used in 59 percent of

these firms to improve working capital projects, while inventory management

models were used in 60 percent of the companies. More recently, Farragher,

`index complete some form of a cash flow assessment, but did not present

insights regarding accounts receivable and inventory management, or the

variations of any current asset accounts or liability accounts across industries.

Thus, mixed evidence exists concerning the use of working capital management

techniques. Theoretical determination of optimal trade credit limits are the

subject of many articles over the years (e.g., Schwartz 1974; Scherr 1996), with

scant attention paid to actual accounts receivable management. Across a limited

sample,

2 WEINRAUB AND VISSCHER (1998) :

Observe a tendency of firms with low levels of current ratios to also have low

levels of current liabilities. Simultaneously investigating accounts receivable

and payable issues, Hill, Sartoris, and Ferguson (1984) find differences in the

way payment dates are defined. Payees define the date of payment as the date

payment is received, while payers view payment as the postmark date.

Additional WCM insight across firms, industries, and time can add to this body

of research. Maness and Zietlow (2002, 51, 496) presents two models of value

creation that incorporate effective short-term financial management activities.

However, these models are generic models and do not consider unique firm or

industry influences. Maness and Zietlow discuss industry influences in a short

paragraph that includes the observation that, “An industry a company is located

in may have more influence on that company’s fortunes than overall GNP”

(2002, 507).

3 ELJELLY, 2004 :

Elucidated that efficient liquidity management involves planning and

controlling current assets and current liabilities in such a manner that eliminates

the risk of inability to meet due short-term obligations and avoids excessive

investment in these assets. The relation between profitability and liquidity was

examined, as measured by current ratio and cash gap (cash conversion cycle) on

a sample of joint stock companies in Saudi Arabia using correlation and

regression analysis.

The study found that the cash conversion cycle was of more importance as a

measure of liquidity than the current ratio that affects profitability. The size

variable was found to have significant effect on profitability at the industry

level. The results were stable and had important implications for liquidity

management in various Saudi companies. First, it was clear that there was a

negative relationship between profitability and liquidity indicators such as

current ratio and cash gap in the Saudi sample examined. Second, the study also

revealed that there was great variation among industries with respect to the

significant measure of liquidity.

4 BERGAMI ROBERT (2007) :

Analysis that that international trade transactions carry inherently more risk than

domestic trade transactions, because of differences in culture, business

processes, laws and regulations. It is therefore important for traders to ensure

that payment is received for goods dispatched and that the goods received and

paid for comply with the contract of sale. One effective way of managing these

risks has been for traders to rely on the letter of credit as a payment method.

However for exporters in particular, the letter of credit has presented difficulties

in meeting the compliance requirements necessary for the payment to be

triggered.

The current rules that govern letter of credit transactions(UCP 500) have been

under review for the past three years and an updated set of rules (UCP 600) is

expected to be introduced on 1July 2007. This paper focuses on the changes

mooted for 2007and compares these main issues with the existing rules and

other associated guidelines and regulations governing this method of payment.

This paper considers the implication to changes of letter of credit transactions

and the sharing of risk. Firstly the paper provides some background to letters of

credit, then comments on existing literature and models, and subsequently an

analysis of the most important changes to the existing rules, before reaching a

conclusion. The conclusion is that the UCP 600 have not paid enough

consideration to traders and service providers and are likely to engender an

environment of uncertainty for exporters in particular.

INTRODUCTION- WORKING CAPITAL MANAGEMENT

“Working capital occupies a peculiar position in the capital structure of a

company. The decision as to the adequacy of working capital is a complicated

and yet a very important decision”.

Working capital is the life-blood of all types of enterprises, manufacturing and

trading both. It is constantly required to buy raw materials for payment of wages

and other day-to-day expenses. Without adequate working capital,

manufacturing operations will be crippled. For trading enterprises, the capacity

to stock a variety of goods for sale depends upon its working capital. It is a base

on which all the activities of business enterprise depend.

Many companies still under estimate the importance of working capital

management as a lever for freeing up cash from inventory, accounts receivable,

and accounts payable. By effectively managing these components, companies

can sharply reduce their dependence on outside funding and can use the released

cash for further investments or acquisitions. This will not only lead to more

financial flexibility, but also create value and have a strong impact on a

company’s enterprise value by reducing capital employed and thus increasing

asset productivity.

High working capital ratios often mean that too much money is tied up in

receivables and inventories. Typically, the knee-jerk reaction to this problem is

to apply the “big squeeze” by aggressively collecting receivables, ruthlessly

delaying payments to suppliers and cutting inventories across the board. But

that only attacks the symptoms of working capital issues, not the root causes. A

more effective approach is to fundamentally rethink and streamline key

processes across the value chain. This will not only free up cash but lead to

significant cost reductions at the same time.

Only those enterprises which have adequate working capital can survive in

times of depression. The investment in raw materials becomes long- term

investments during depression and cash flow declines due to fall in sale. In such

circumstances only enterprises with adequate working capital can survive.

Excessive working capital is equally unprofitable. The extra working capital is

not utilized in business operations and earns no profit for the firm. It results in

unnecessary accumulation of inventories, leading to inventory mishandling,

waste, theft etc. The abundance of working capital would lead to waste and

inefficiency

Shortage of working capital funds renders the firm unable to avail attractive

credit opportunities etc. The firm loses its reputation when it is not in a position

to honor its short term obligations. As a result, the firm faces tight credit terms.

It stagnates growth.

Definition:-

According to Guttmann & Dougall:-

“Working capital is defined as current assets minus current liabilities”.

A positive position means that a company is able to support its day-to-day

operations. i.e. to serve both maturing short-term debt and upcoming

operational expenses.

1. According to Park & Gladson:-

“The excess of current assets of a business (i.e. cash, accounts receivables,

inventories) over current items owned to employees and others (such as

salaries & wages payable, accounts payable, taxes owned to government)”

“Working capital like many other accounting terms and financial terms has been

used by different people in different senses.”

One school of thought believes that, as all capital resources available to a

business organization – From shareholders, bondholders, and creditors (secured

and unsecured) works up in the business activities to generate revenues and

facilitate future expansion and growth; they are to be considered as ‘working

capital’.

Another school of thought links working capital with current assets and

current liabilities. According to them, the excess of current assets over current

liabilities is to be rightly considered as the working capital of a business

organization.

According to “Shubin” working capital is “the amount of funds

necessary to cover the cost of operating the enterprise. Working capital in a

going concern is a revolving (circulating fund), it consists of cash receipts from

sales which are used to cover the cost of current operations.

“Circulating capital means current assets of the company that are changed in the

ordinary course of business from one form to another, as for example from cash

to inventories, inventories to receivables and receivables to cash.”

“Working capital is descriptive of that capital which is not fixed. But, the more

common use of working capital is to consider it as the difference between the

current assets and the current liabilities”. Current assets and current liabilities

are assets and liabilities which arise in the course of business. The WC

demonstrates the amount of liquid assets that are available to sustain and build

the business by measuring company’s efficiency and short-term financial health.

As such, it carries great value to those who might be interested in investing in

business or even purchasing it.

Working capital, also known as net working capital, is a measurement of

a business’s current assets, after subtracting its short-term liabilities, typically

short term. Sometimes referred to as operating capital, it is a valuation of the

assets that a business or organization has available to manage and build the

business. Generally speaking, companies with higher amounts of working

capital are better positioned for success because they have the liquid assets that

are essential to expand their business operations when required.

Characteristics of Working Capital

Working capital is the life blood and nerve centre of a business. Just as

circulation of blood is essential in the human body for maintaining life, working

capital is very essential to maintain the smooth running of a business. No

business can run successfully with out an adequate amount of working capital.

The features of working capital distinguishing it from the fixed capital are as

follows:

1 Short term Needs:

Working capital is used to acquire current assets which get converted into cash

in a short period. In this respect it differs from fixed capital which represents

funds locked in long term assets. The duration of the working capital depends

on the length of production process, the time that elapses in the sale and the

waiting period of the cash receipt.

2 Circular Movement:

Working capital is constantly converted into cash which again turns into

working capital. This process of conversion goes on continuously. The cash is

used to purchase current assets and when the goods are produced and sold out;

those current assets are transformed into cash. Thus it moves in a circular away.

That is why working capital is also described as circulating capital.

3 An Element of Permanency:

Though working capital is a short term capital, it is required always and forever.

As stated before, working capital is necessary to continue the productive

activity of the enterprise. Hence so long as production continues, the enterprise

will constantly remain in need of working capital. The working capital that is

required permanently is called “permanent or regular working capital”.

4 An Element of Fluctuation:

Though the requirement of working capital is felt permanently, its requirement

fluctuates more widely than that of fixed capital. The requirement of working

capital varies directly with the level of production. It varies with the variation of

the purchase and sale policy; price level and the level of demand also. The

portion of working capital that changes with production, sale, price etc. is called

“variable working capital”.

5 Liquidity:

Working capital is more liquid than fixed capital. If need arises, working capital

can be converted into cash within a short period and without much loss. A

company in need of cash can get it through the conversion of its working capital

by insisting on quick recovery of its bills receivable and by expediting sales of

its product. It is due to this trait of working capital that the companies with a

larger amount of working capital feel more secure.’

6 Less Risky:

Funds invested in fixed assets get locked up for a long period of time and can

not be recovered easily. There is also a danger of fixed assets like machinery

getting obsolete due to technological innovations. Hence investment in fixed

capital is comparatively more risky. As against this, investment in current assets

is less risky as it is a short term investment. Working capital involves more of

physical risk only, and that too is limited. Moreover, working capital gets

converted into cash again and again; therefore, it is free from the risk arising out

of technological changes.

7 Special Accounting System not needed:

Since fixed capital is invested in long term assets, it becomes necessary to adopt

various systems of estimating depreciation. On the other hand working capital is

invested in short term assets which last for one year only. Hence it is not

necessary to adopt special accounting system for them.

Among the most important items of working capital are levels of inventory,

accounts receivable, and accounts payable. Working capital can be expressed as

a positive or a negative number.

“When a company has more debts than current assets, it has negative

working capital; When current assets outweigh debts, a company has

positive working capital”.

A company will try to manage cash by:

Identifying the cash balance that allows it to meet day-to-day expenses

but minimizes the cost of holding cash;

Finding the level of inventory that allows for continuous production but

lessens the investment in raw materials and reduces reordering costs;

Identifying the appropriate source of financing, given the cash-conversion

cycle.

It may be necessary to use a bank loan or overdraft. However, inventory is

preferably financed by credit arranged with the supplier. If a company is not

operating efficiently, this will show up as an increase in the working capital.

This can be judged by comparing the amounts of working capital from one

period to another. Slow collection and inventory turnover may signal an

underlying problem in the company’s operations.

Advantages

Proper management of working capital gives a firm the assurance that it is able

to continue its operations and that it has sufficient cash flow to satisfy both

maturing short term debt and upcoming operational expenses.

Disadvantages

If a company’s current assets do not exceed its current liabilities, then it may

run into trouble paying back creditors in the short term.

A declining working-capital ratio over a longer time period could also be a red

flag that merits further analysis. For example, it could be that the company’s

sales volumes are decreasing and, as a result, its accounts receivable are

diminishing.

FACTORS INFLUENCING WORKING CAPITAL

4.1NEED OF WORKING CAPITAL

Working capital is among the many important things that contribute to the

success of a business. Without it, a business may cease to function properly or

at all. Not only does a lack of working capital render a company unable to build

and grow, but it may also leave a company with too little cash to pay its short-

term obligations. Simply put, a company with a very low amount of working

capital may be at risk of running out of money.

When a company has too little working capital, it can face financial difficulties

and may even be forced toward bankruptcy. This is true of both very small

companies and billion-dollar organizations. A company with this problem may

pay creditors late or even skip payments. It may borrow money in an attempt to

remain afloat. If late payments have affected the company’s credit rating, it may

have difficulty obtaining a loan at an affordable interest rate.

The need for working capital gross or current assets cannot be over

emphasized. As already observed, the objective of financial decision making is

to maximize the shareholders wealth. To achieve this, it is necessary to generate

sufficient profits can be earned will naturally depend upon the magnitude of the

sales among other things but sales can not convert into cash. There is a need for

working capital in the form of current assets to deal with the problem arising out

of lack of immediate realization of cash against goods sold. Therefore sufficient

working capital is necessary to sustain sales activity. Technically this is refers to

operating or cash cycle.

4.2CONCEPT OF WORKING CAPITAL

There are two concepts of working capital:

1.     Gross working capital

2.     Net working capital

Grossw Working Capital

“The gross working capital is the capital invested in the total current

assets of the enterprises. Current assets are those Assets which can

convert in to cash within a short period normally one accounting year.”

Constituents of Current Assets.

Current assets are assets which are expected to be sold or otherwise used within

one fiscal year. Typically, current assets include cash, cash equivalents,

accounts receivable, inventory, prepaid accounts which will be used within a

year, and short-term investments.

1 Cash in hand and cash at bank

2 Bills receivables/Sundry debtors

3 Short term loans and advances.

4 Inventories of stock as:

4.1 Raw material

4.2 Work in process

4.3 Stores and spares

4.4 Finished goods

5 Temporary investment of surplus funds.

6 Prepaid expenses

7 Accrued incomes.

8 Marketable securities.

Net Working Capital

“In a narrow sense, the term working capital refers to the net working

capital. Net working capital is the excess of current assets over current

liability”

“NET WORKING CAPITAL = CURRENT ASSETS – CURRENT“NET WORKING CAPITAL = CURRENT ASSETS – CURRENT

LIABILITIES.”LIABILITIES.”

Net working capital refers to the difference between current assets and current

liabilities. Current liabilities are those claims of outsiders which are expected to

mature for payment within an accounting year and include creditors, bills

payable and outstanding expenses. Net working capital can be positive or

negative

Constituents of Current liabilities

Current liabilities are considered as liabilities of the business that are to be

settled in cash within the fiscal year. Current liabilities include accounts payable

for goods, services or supplies, short-term loans, long-term loans with maturity

within one year, dividends and interest payable, or accrued liabilities such as

accrued taxes.

1. Accrued or outstanding expenses.

2. Short term loans, advances and deposits.

3. Dividends payable.

4. Bank overdraft.

5. Provision for taxation, if it does not amount to appropriation of profit.

6. Bills payable.

7. Sundry creditors.

The gross working capital concept is financial or going concern concept

whereas net working capital is an accounting concept of working capital. Both

the concepts have their own merits.

The gross concept is sometimes preferred to the concept of working capital for

the following reasons:

1.     It enables the enterprise to provide correct amount of working capital at

correct time.

2.     Every management is more interested in total current assets with which it

has to operate then the source from where it is made available.

3.     It take into consideration of the fact every increase in the funds of the

enterprise would increase its working capital.

4.     This concept is also useful in determining the rate of return on investments

in working capital. The net working capital concept, however, is also

important for following reasons:

1. It is qualitative concept, which indicates the firm’s ability to meet to its

operating expenses and short-term liabilities.

2. IT indicates the margin of protection available to the short term creditors.

3. It is an indicator of the financial soundness of enterprises.

4. It suggests the need of financing a part of working capital requirement out

of the permanent sources of funds.

Working capital, on the one hand, can be seen as a metric for evaluating a

company’s operating liquidity. A positive working capital position indicates that

a company can meet its short-term obligations. On the other hand, a company’s

working capital position signals its operating efficiency. Comparably high

working capital levels may indicate that too much money is tied up in the

business.

The most important positions for effective working capital management are

inventory, accounts receivable, and accounts payable. Depending on the

industry and business, prepayments received from customers and prepayments

paid to suppliers may also play an important role in the company’s cash flow.

Excess cash and no operational items may be excluded from the calculation for

better comparison.

4.3 CLASSIFICATION OF WORKING CAPITAL

Working capital may be classified in to ways:

On the basis of concept.

On the basis of time.

On the basis of concept working capital can be classified as gross working

capital and net working capital. On the basis of time, working capital may

be classified as:

Permanent or fixed working capital.

Temporary or variable working capital

A-Permanent OR Fixed Working Capital.

The operating cycle is a continuous feature in almost all the going concerns and

therefore creates the need for working capital and their efficient management.

However the magnitude of working capital required will not be constant, but

will fluctuate. At any time, there is always a minimum level of current assets

which is constantly and continuously required by a business unit to carry on its

operations. This minimum amount of current assets, which is required on a

continuous and uninterrupted basis, is after referred to as fixed or permanent

working capital. This type of working capital should be financed (along with

other fixed assets) out of long term funds of the unit. However in practice, a

portion of these requirements also is met through short term borrowings from

banks and suppliers credit.

Chart 4-1 Permanent Working Capital

Y

ValuePermanent Current Asset

O XTime

Permanent Working CapitalThe amount of current assets required to meet a firm’s long-term minimum

needs are called Permanent current assets.

For e.g., In a manufacturing unit, basic raw materials required for production

has to be available at all times and this has to be financed without any

disturbance.

B-Temporary OR Variable Working Capital.

Any amount over and above the permanent level of working capital is variable,

temporary or fluctuating working capital. This type of working capital is

generally financed from short term sources of finance such as bank credit

because this amount is not permanently required and is usually paid back during

The amount of Current Assets require to meet a firms long term minimum needs

off season or after the contingency. As the name implies, the level of fluctuating

working capital keeps on fluctuating depending on the needs of the unit unlike

the permanent working capital which remains constant over a period of time.

The Temporary or Variable working capital is the amount of working capital

which is required to meet the seasonal demands and some special exigencies.

Variable working capital can further be classified as Seasonal Working Capital

and Special Working Capital. The capital required to meet the seasonal need of

the enterprise is called seasonal working capital. Special working capital is that

part of working capital which is required to meet special exigencies such as

launching of extensive marketing for conducting research, etc.

Temporary working capital differs from Permanent working capital in the sense

that is required for short periods and cannot be permanently employed gainfully

in the business.

Chart 1-2 Temporary Working Capital

Y

Temporary current assets

Value

Permanent Working Capital

Time

Temporary Working Capital

The amount of Current Asset required

to meet short term minimum needs

4.4DETERMINANTS OF WORKING CAPITAL

Working capital management is an indispensable functional area of

management. However the total working capital requirements of the firm are

influenced by the large number of factors. It may however be added that these

factors affect differently to the different units and these keep varying from time

to time. In general, the determinants of working capital which are common to

all organizations can be summarized as under:

Nature of Business

This is one of the main factors. Usually in trading businesses the working

capital needs are higher as most of their investment is concentrated in stock or

inventory. Manufacturing businesses also need a good amount of working

capital to meet their production requirements. Whereas, those companies that

sell services and not goods, on a cash basis require least working capital

because there is no requirement on their part to maintain heavy inventories.

Size of Business

In 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 the small companies. But if the business start growing

after certain limit, the working capital requirements may adversely affect by the

increasing size.

Credit Terms / Credit Policy

Some 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 in debtors 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.

Credit terms greatly influence working capital needs. If terms are:

buy on credit and sell by cash, working capital is lower

buy on credit and sell on credit, working capital is medium

buy on cash and sell on cash, working capital is medium

buy on cash and sell on credit, working capital is higher.

Prevailing trade practices and changing economic condition do generally

exert greater influence on the credit policy of concern. A liberal credit policy if

adopted more trade debtors would result and when the same is tightened, size of

debtors gets slim.

Credit periods also influence the size and composition of working capital. When longer credit period is allowed to debtors as against the one extended to the firm by its creditors, more working capital is needed and vice versa.

Collection policy is another influencing factor. A stringent collection policy might not only deter away some credit customers, but also force the existing customers to be prompt in settling dues resulting in lower level of working capital. The opposite holds well with a liberal collection policy.

Collection procedure also influences the working capital needs. A decentralized collection of dues from customers and centralized payments to suppliers shall reduce the size of working capital. Centralized collections and centralized payments would lead to moderate level of working capital. But with centralized collections and decentralized payments, the working capital need would be the highest.

Seasonality

Seasonality of Production

Agriculture and food processing and preservation industries have a seasonal production. During seasons, when production activities are in their peak, working capital need is high.

Seasonality in supply of raw materials

This also affects the size of working capital. Industries that use raw materials which are available during seasons only, have to buy and stock those raw materials. They cannot afford to buy these items in a phased way, since either supplies would get reduced or prices would be higher. Also, from the point of view of quality of raw materials, it pays to buy in bulk during the seasons. Hence the high level of working capital needed when season exists for raw materials.

Seasonality of demand for finished goods

In case of products like umbrella, rain-coats and other seasonal items, the demand is high during peak seasons. But the production of these items has to be continuous throughout the year to meet the high demand during peak seasons. Thus, working capital requirement would be higher.

“Since Arabian Industries LLC is a contracting company, the above mentioned seasonal factors do not affect its operation or its business cycle. “

Business Trade Cycle

Trade cycle refers to the periodic turns in business opportunities from extremely peak levels, via a slackening to extremely tough levels and from there, via a recovery phase to peak levels, thus completing a business cycle. There are 4 phases of trade cycle.

Boom Period – more business, more production, more working capital.

Depression period – less business, less production, less working capital.

Recession period – slackening business, stock pile-up, more working

capital.

Recovery period – recouping business, stock speedily converts to sales,

less working capital.

Inflation

Under inflationary conditions generally working capital increases, since with

rising prices demand reduces resulting in stock pile-up and consequent increase

in working capital.

Length of Production cycle

The time lapse between feeding of raw material into the machine and obtaining

the finished goods out from the machine is what is described as the length of

manufacturing process. It is otherwise known as conversion time. Longer this

time period, higher is the volume and value of work-in-progress and hence

higher the requirement of working capital and vice versa.

System of Production process

If capital intensive, high-technology automated system is adopted for

production, more investment in fixed assets and less investment in current assets

are involved. Also, the conversion time is likely to be lower, resulting in further

drop in the level of working capital. On the other hand, if labor intensive

technology is adopted, less investment in fixed assets and more investment in

current assets which would lead to higher requirement of working capital.

Growth and expansion plans

Growth and expansion industries need more working capital than those that are

static.

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.

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.

Apart from the above factors, dividend policy, depreciation policy, price level

changes, operating efficiency and government regulations also influence the

level and the size of working capital.

RESEARCH METHODOLOGY - INTRODUCTION

Research Methodology is a purposeful, precise and systematic search for new

knowledge, skills, attitudes and values, or for the re-interpretation of existing

knowledge, skills, attitudes and values.

Research methodology is a way to systematically solve the research problem. It

may be understood as a science of studying now research is done

systematically. In that various steps, those are generally adopted by a researcher

in studying his problem along with the logic behind them.

Data collection is important step in any project and success of any project will

be largely depend upon now much accurate you will be able to collect and how

much time, money and effort will be required to collect that necessary data, this

is also important step.

Various Steps for Research Methodology

This project requires a detailed understanding of the concept – “Working

Capital Management”. Therefore, firstly we need to have a clear idea of what is

working capital, how it is managed in AI LLC, what are the different ways in

which the financing of working capital is done in the company.

The management of working capital involves managing inventories, accounts

receivable and payable and cash. Therefore one also needs to have a sound

knowledge about cash management, inventory management and receivables

management.

Then comes the financing of working capital requirement, i.e. how the working

capital is financed, what are the various sources through which it is done.

And, in the end, suggestions and recommendations on ways for better

management and control of working capital are provided.

5.1SCOPE OF THE STUDY

This project is vital to us in a significant way. It does have some importance for

the company too. These are as follows:–

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

Through this project we would study the various methods of the working

capital management.

The project will be a learning of planning and financing working capital.

The project would also be an effective tool for credit policies of the

companies.

This will show different methods of holding inventory and dealing with

cash and receivables.

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

they maintain a particular liquidity position.

5.2TYPES OF DATA COLLECTION

There are two types of data collection methods available.

1. Primary data collection

2. Secondary data collection

5.2.1 Primary data collection method

Primary data is the data which the researcher collects through various

methods like interviews, surveys, questionnaires etc, to support the

secondary data. Some advantages and disadvantages of primary data are

as follows:

5.2.2 Secondary data collection method

Secondary data is data collected by someone other than the user.

Common sources of secondary data for social science include censuses,

surveys, organizational records and data collected through qualitative

methodologies or qualitative research. Primary data, by contrast, are

collected by the investigator conducting the research.

This project is based on primary data collected through personal interview of

head of Finance Department, head of Statistical Quality Control department and

other concerned staff member of finance department. But primary data

collection had limitations such as matter confidential information thus project is

based on secondary information collected through four years annual report of

the company, supported by various books and internet sides. The data collection

was aimed at study of working capital management of the company.

Project is based on:

Financial Report of Arabian Industries LLC – 2004-2005-2006-2007-2008-

2009

5.3OBJECTIVES OF THE STUDY.

This research is focusing on working capital management and its effects on

profitability for a sample of Omani firm. Study of the working capital

management is important because unless the working capital is managed

effectively, monitored efficiently planed properly and reviewed periodically at

regular intervals to remove bottlenecks if any the company can not earn profits

and increase its turnover. With this primary objective of the study, the following

further objectives are framed for a depth analysis.

5.3.1 The Main objectives of the studies are:

1. To study the way and means of working capital finance of the company.

2. To estimate the operating cash cycle and working capital requirement of

the company.

3. To establish a relationship between Working Capital Management and

Profitability over a period of five years of the company..

4. To find out the effects of different components of working capital

management on Profitability

5. To establish a relationship between the two objectives of liquidity and

profitability of the Omani firm.

6. To find out the relationship between debt used by Arabian Industry LLC

and its Profitability

7. To draw conclusion about relationship of working capital management

and profitability of the company.

8. To study the optimum level of current assets and current liabilities of the

company.

9. To study the liquidity position through various working capital related

ratios.

10. To study the working capital components such as receivables accounts,

cash management, Inventory position

5.3.2 Analysis Used in Study : Descriptive analysis .

Descriptive Statistics are used to describe the basic features of the data in a

study. They provide simple summaries about the sample and the measures.

Together with simple graphics analysis, they form the basis of virtually

every quantitative analysis of data. With descriptive statistics you are simply

describing what is, what the data shows

5.3.3 Research Design

STEP 1 - To study the Financial Statement of Arabian Industries LLC

STEP 2 – Data Analysis of working capital through Estimation of

Working Capital.

STEP 3 – Analysis of Inventory Management of Arabian Industries

LLC.

STEP 4 – Comparison of base year data’s with previous years datas.

5.3.4 Data Collection

5.3.4.1 The information is collected through the Primary Source like:-

Interviewing the employees of the department.

Getting information from MIS department.

Discussion with the head of the Finance department and

Procurement department.

5.3.4.2 The Data was collected from following Secondary Sources like:-

Corporate department

Procurement department

Finance department

Logistic Department

5.4SCOPE AND LIMITATIONS OF THE STUDY

5.4.1 Scope of the study

The scope of the study is identified after and during the study is conducted.

The study of working capital is based on tools like trend Analysis, Ratio

Analysis, working capital leverage, operating cycle etc. Further the study is

based on last 5 years Annual Reports of Arabian Industries LLC, and even

factors like competitor’s analysis, industry analysis were not considered

while preparing this project.

Limitations of the study

Following limitations were encountered while preparing this project:

1) Limited data:-

This project has completed with annual reports; it just constitutes one part of

data collection i.e. secondary. There were limitations for primary data

collection because of confidentiality.

2) Limited period:-

This project is based on five year annual reports. Conclusions and

recommendations are based on such limited data. The trend of last five year

may or may not reflect the real working capital position of the company

3) Limited area:-

Also it was difficult to collect the data regarding the competitors and their

financial information. Industry figures were also difficult to get.

Working Capital level

The guiding principle for working capital is called the hedging principle or

principle of self-liquidating debt or matching principle (different from the

matching principle used in measuring accounting profit).

It is an accepted belief in business that the term of a funding arrangement must

match the term of the investment itself. This means that any funds used for

short-term assets or purposes should be financed from short-term sources.

Likewise investments in long term-assets should be funded from long-term

sources.

Therefore a key criterion for acquiring additional finance is matching up the life

of the assets acquired with the term of the loan or other method of funding. For

example, the buying of an unusually large quantity of inventory should be

financed by a loan, or credit, with a repayment period of less than one year.

The level of any long-term assets funded by short-term debt shows the firm's

level of 'aggression' in its financing policy. Although this type of action may

increase profits (due to the lower cost of short-term debt) it greatly increases the

risk of cash shortages if short-term financing can't be renewed.

Table 6.1- Size of Working Capital

SOURCE: COMPANY REPORT

EXTRACTED FROM AUDITED BALANCE SHEET OF ARABIAN INDUSTRIES LLC

2004 2005 2006 2007 2008 2009CURRENT ASSET            

Bank Balances

45,595

196,78

6

67,900

562,828

143,351

1,892,37

2

Trade Debtors

2,188,3

48

2,921,7

99

7,702,72

7

12,543,1

78

20,194,2

01

13,437,9

81

Inventory

112,63

9

459,40

4

160,412

373,118

563,989

724,145

Work in Progress

1,758,7

19

2,142,7

70

2,773,63

5

1,275,52

3

1,422,62

5

2,274,69

0

Dues from Related Parties

-

-

214,325

191,658

316,956

4,632,78

9

Other Receivables

349,38

8

52,319

725,857

512,228

336,700

99,243 TOTAL CURRENT ASSETS

4,454,6

89

5,773,0

78

11,644,8

57

15,458,5

33

22,977,8

22

23,061,2

19  

- - - - - - CURRENT LIABILITIES

-

-

-

-

-

-

Short-term Borrowings

340,86

7

900,67

6

2,049,74

5 -

2,015,75

3

553,812 Current Portion of Long Term loan

147,49

3

184,71

7

498,801

1,436,56

7

1,503,56

9

2,188,44

6

Trade Creditors

1,171,3

01

3,013,7

26

5,154,02

3

6,840,68

8

10,293,7

95

6,186,85

4

Dues to Related Parties

449,84

2

2,043

23,504

31,073

1,499,97

3

420,900 Provisions - Tax

-

27,422

182,064

175,183

402,530

922,451

Other Payables

1,217,5

74

1,533,5

52

3,489,97

0

6,652,45

4

6,948,03

5

5,588,56

9 TOTAL CURRENT LIABILITIES

3,327,0

77

5,662,1

35

11,398,1

06

15,135,9

65

22,663,6

55

15,861,0

31 NET

WORKING CAPITAL -

(A-B)

1,127,612

110,943 246,751 322,568 314,167 7,200,18

8

1.1 WORKING CAPITAL TREND ANALYSIS

Trend analysis is an improvement over the year to year analysis. When a

comparison of Financial Statements covering more than 3 years is undertaken,

the year to year analysis becomes cumbersome. In trend analysis, the changes

are calculated for several successive years instead of two or three years.

Therefore the trend analysis is a company's financial position over a long period

of time. Trend analysis is important as it may point to basic changes in the

nature of business and also helps in drawing meaningful conclusions regarding

the operating performance over several years and the financial position of the

enterprise. It is based on the idea that what has happened in the past gives an

idea of what will happen in the future.

In working capital analysis the direction at changes over a period of time is of

crucial importance. Working capital is one of the important fields of

management. It is therefore very essential for an annalist to make a study about

the trend and direction of working capital over a period of time. Such analysis

enables as to study the upward and downward trend in current assets and current

liabilities and it’s effect on the working capital position.

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

today conversion trend, also called secular or long term need is the basic

tendency of population, sales, income, current assets, and current liabilities

to grow or decline over a period of time”.

According to R.C.Galeziem “The trend is defined as smooth irreversible

movement in the series. It can be increasing or decreasing.”

Emphasizing the importance of working capital trends, Man Mohan and Goyal

have pointed out that “analysis of working capital trends provide as base to

judge whether the practice and privilege policy of the management with regard

to working capital is good enough or an important is to be made in managing

the working capital funds.

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

comparison with Illustrated their ideas in these words, “An upwards trends

coupled with downward trend or sells, accompanied by marked increase in plant

investment especially if the increase in planning investment by fixed interest

obligation”

One of the main goals of trend analysis is to forecast future values of the series.

It allows a researcher to look at a pattern of change over a long period of time

rather than at a single discrete point in time or over a short time so that better

conclusions can be drawn.

Table 6.2 – Working Capital Variance Analysis.

ANALYSIS OF VARIANCE OF

WORKING CAPITAL

YEARS 2004 2005 2006 2007 2008 2009

TOTAL

CURRENT

ASSETS

4,454,6

89

5,773,0

78

11,644,8

57

15,458,5

33

22,977,8

22

23,061,2

19

TOTAL

CURRENT

LIABILITIES

3,327,0

77

5,662,1

35

11,398,1

06

15,135,9

65

22,663,6

55

15,861,0

31

NET

WORKING

CAPITAL - (A-

B)

1,127,6

12

110,94

3246,751 322,568 314,167

7,200,18

8

W-C

VARIATION –

in %

100% 9.84% 21.88% 28.61% 27.86%638.53

%

(“Index    =             100 X Index Year Amount / Base Year Amount”)

Chart-6.1- Working capital index

WORKING CAPITAL INDEX

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

2004 2005 2006 2007 2008 2009

YEARS

VA

LUE

TOTAL CURRENTASSETS

TOTAL CURRENTLIABILITIES

NET WORKINGCAPITAL - (A-B)

W-C VARIATION –in%

Table 6.3-Working capital size

ANALYSIS OF VARIANCE OF

WORKING CAPITAL

YEARS 2004 2005 2006 2007 2008 2009

TOTAL

CURRENT

ASSETS

4,454,6

89

5,773,0

78

11,644,8

57

15,458,5

33

22,977,8

22

23,061,2

19

TOTAL

CURRENT

LIABILITIES

3,327,0

77

5,662,1

35

11,398,1

06

15,135,9

65

22,663,6

55

15,861,0

31

NET

WORKING

CAPITAL - (A-

B)

1,127,6

12

110,94

3246,751 322,568 314,167

7,200,18

8

W-C

VARIATION –

in %

100% 9.84% 21.88% 28.61% 27.86%638.53

%

The computation of a series of Index Numbers requires the choice of a

base year that will for all times have an index number of 100. The base period

should be a normal year with regard to business conditions, since the base year

used as a reference should be representative. Generally, the earliest year is

selected as a base year. However, where the earliest year is selected as the

normal year then another year is chosen. All Index numbers are computed with

reference to the base year using this formula

1.1.1 OBSERVATIONS

It was observed that major source of liquidity problem is the mismatch between

current payments and current receipts from the Comparison of funds flow

statements of AI LLC for six years. It was observed that in the year 2005

current assets increased by around 29.6% compared to 2004 and current

liabilities increased by 70.18% which affect as working capital reduced by

9.84% in the year 2005 compared to 2004.because the net working capital was

OMR 1,127,612/- in 2004 but in 2005 it was reduced to OMR 110,943/- in the

year 2005 due to the increase in current liability of 70% compared to 2004. In

2004 current liability was OMR 3,327,077, where as in 2005 it was increased by

OMR 2,335,058/-; a total liability of OMR 5,662,135/- in 2005.

In the year 2006, 2007, 2008 a tremendous increase we can see in current

liability by 172.4%, 112.35%, and 226.26% res. and current asset also increased

accordingly compared to 2004 like 131.8%, 85.61% and 168.79% during the

year 2006, 2007, 2008. In the year 2009 we can see the growth of current asset

is very less compared to 2004 with a percentage of only 1.87% where as in the

current liability we can see there is a slop of -2004.46% compared to 2004,

where as an increase in current asset for 73.478% compared to 2004 and a good

nest asset (WC reserve) is with the firm for an increased percentage of 638.53%

in the year 2009.

The position of working capital is very good in 2009 because the bank balance

in 2008 was only 143,351/- OMR where as in 2009 it is increased to OMR

1,892,372/-; ie. 1220% compared to 2008, which is quite good and also we can

see that there is receivable from related parties is 4,632,789/- in the year 2009,

where as in 2008 it was only OMR 316,956/-; that means an increase is for

1361% in the year 2009 compared to 2008. That means the fund position is

quite good for 2009.

While compared to 2004 current assets have been increased by 417.68% and

current liabilities have been increased by 376.73%. But compared to 2008 and

2009 there is a short fall of -30.02% in current liabilities, where as an increase

in current asset is only an increase of .36%. The bank balance is increased to

OMR 1,892,372/- in 2009 from OMR 143,351/- in the year 2008.It shows that

management is using only it’s own fund for the short term requirements and

WC has been increased to OMR 7,200,186/- in the year 2009-A growth of

638.53%. This two together pushed down the net working capital to the present

level. The increase in working capital is a clear indication that the company is

utilizing its own funds and resources with efficiency.

Table 6.4 –Variance Analysis of Current Asset and Current Liability.

OBSERVATION OF WORKING

         

CAPITAL   YEARS 2004 2005 2006 2007 2008 2009TOTAL CURRENT ASSETS

529853 686666 1385071 1838680 2733045 2742964

YEARLY VARIATION 100 156813 698405 453609 894365 9920GROWT COMPARED TO 2004

100 29.60 131.81 85.61 168.79 1.87

YEARLY GROWTH IN %

100 29.60 101.71 32.75 48.64 0.3

6

             TOTAL CURRENT LIABILITIES

395732 673470 1355722 1800313 2695677 1886554

YEARLY VARIATION

395732 673470 1355722 1800313 2695677 1886554

GROWTH COMPARED TO 2004

100

70.18

172.40 112.35 226.26 (204.46

)

YEARLY GROWTH IN %

100

70.18 101.30 32.79 49.73 (30.02)

NET WORKING CAPITAL - (A-B)

134121 13196 29349 38367 37368 856410

WORKING CAPITAL SIZE

100 9.84 21.88 28.61 27.86 638.53

TOTAL CURRENT ASSETS 100

156812.76

855218.25

1308827.295

2203192.035

2213111.565

VARIATION COMPARED TO 2004 100 29.6 161.41 247.02 415.81 417.68TOTAL CURRENT LIABILITIES 100

277738.2

959990.265

1404581.445

2299945.455

1490822.82

VARIATION 100 70.18 242.59 354.93 581.19 376.73

COMPARED TO 2004

1.2CURRENT ASSETS

A balance sheet item which equals the sum of cash and cash equivalents,

accounts receivable, inventory, marketable securities, prepaid expenses, and

other assets that could be converted to cash in less than one year. A company's

creditors will often be interested in how much that company has in current

assets, since these assets can be easily liquidated in case the company goes

bankrupt. In addition, current assets are important to most companies as a

source of funds for day-to-day operations.

Table 6.5-Current Asset Size

CURRENT ASSET            2004 2005 2006 2007 2008 2009

CURRENT ASSET - A          

Bank Balances / Deposits

46,198

199,387

68,798

570,267

145,245 1,917,381

Trade Debtors (Net of Provisions)

2,217,269

2,960,413

7,804,526

12,708,947

20,461,085

13,615,576

Inventory 114,127

465,475

162,532

378,049

571,443 733,715

Work in Progress 1,781,962

2,171,088

2,810,291

1,292,380

1,441,426 2,304,752

Dues from Related Parties

-

-

217,158

194,191

321,144 4,694,015

Other Receivables 354,006

53,010

735,450

518,997

341,150 100,555

TOTAL CURRENT ASSETS

4,513,561

5,849,374

11,798,754

15,662,831

23,281,494

23,365,993

CURRENT ASSET INDEX 100 129.60 261.41 347.02 515.81 517.68

Chart 6.2- Current Asset Index.

1.2.1

Composition of current assets

Analysis of current assets components enable one to examine in which

components the working capital fund has locked. A large tie up of funds in

inventories affects the profitability of the business or the major portion of

current assets is made up cash alone, the profitability will be decreased because

cash is non earning asset

Table 6.6-Composition of Current Assets

CURRENT ASSET COMPOSITION           

  2004 2005 2006 2007 2008 2009CURRENT ASSET - A            

Bank Balances 1.02 3.41 0.58 3.64 0.62 8.21

Trade Debtors 49.12 50.61 66.15 81.14 87.89 58.27 Inventory 2.53 7.96 1.38 2.41 2.45 3.14 Work in Progress 39.48 37.12 23.82 8.25 6.19 9.86 Dues from Related - - 1.84 1.24 1.38 20.0

100 129.60

261.41347.02

515.81 517.68

0

100

200

300

400

500

600

VALUE

2004 2005 2006 2007 2008 2009

YEAR

CURRENT ASSET INDEX

CURRENTASSETINDEX

Parties 9 Other Receivables 7.84 0.91 6.23 3.31 1.47 0.43 CURRENT ASSET INDEX 100 100 100 10

0 1

00 10

0

Chart 6.3- Current Asset Components

1.2.2

Observations

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

sales. The excess of current assets is showing positive liquidity position of the

firm but it is not always good because excess current assets then required, it

may adversely affects on profitability.. We can see in each year there is

tremendous growth in current asset. Compared to 2007 the growth in current

asset in 2008, there is a growth of 48.64%, where as in 2009 the growth rate is

only .36%. The reason is that the debtors receivable in 2008 is 20,461,085 but in

2009 it has been reduced to 13,615,576/-, a drop of OMR 6,845,509/- ie.

33.46%. These shows that the a good cash collection from receivables in 2009

which shows a good working capital reserve of OMR 6,845,509/- which used

to pay back the current liabilities of sundry creditors, other payables and due to

related parties.

0%

20%

40%

60%

80%

100%

VAR

IATI

ON

IN %

2004 2005 2006 2007 2008 2009

YEARS

CURRENT ASSET COMPOSITION

Other Receivables

Dues from RelatedParties

Work in Progress

Inventory

Trade Debtors (Netof Provisions)

Bank Balances /Deposits

Compared to 2008 in 2009 the bank balance also increased to OMR 1,917,381/-

from OMR 145,245/- in the year 2008. Cash balance of the company increased

in the year 2009 because company had done good in it’s collection process,

which provides a good financial position in 2009. Current assets components

show sundry debtors are the major part in current assets it indicates that the

efficiency in collection management. Over investment in the debtors may

affects liquidity of firm for that company has raised funds from other sources

like short term loan which incurred the interest. Other main achievement is that,

if we compare the purchase level with inventory, we can see that inventory level

is not increased as compared to the volume of purchase. But same time we can

see that the receivable from related parties and work in progress has been

increased substantially. These show the proper utilization of materials and

resources.

1.3Current liabilities

Current liabilities are debts, accounts payable, interest due, trade credit, loans,

and other obligations that are due and payable within one year. Current

liabilities are calculated and identified on a business' balance sheet. Current

liabilities as a total are information that is used as one measure of the financial

condition of a company, especially in association with current assets to calculate

the level of working capital.

Table 6.7-Current liabilities size

  2004 2005 2006 2007 2008 2009

CURRENT            

LIABILITIES

- B

Short-term

Borrowings

345,37

1

912,57

9

2,076,8

340

2,042,3

93561,131

Current

Portion of

Long Term

Debt

149,44

3

187,15

8505,393

1,455,5

53

1,523,4

40

2,217,3

68

Trade

Creditors

1,186,7

80

3,053,5

55

5,222,1

37

6,931,0

94

10,429,

836

6,268,6

19

Dues to

Related Parties

455,78

82,070 23,814 31,484

1,519,7

96426,463

Provisions -

Tax0 27,784 184,470 177,498 407,850 934,642

Other Payables1,233,6

65

1,553,8

19

3,536,0

92

6,740,3

72

7,039,8

60

5,662,4

26

TOTAL

CURRENT

LIABILITIES

3,371,0

47

5,736,9

65

11,548,

742

15,336,

000

22,963,

175

16,070,

649

VARIATION

IN CURRENT

LIABILITIES

IN %

10

0.000

17

0.183

342

.586 454.933 681.188

47

6.726

Chart 6.4- Current Liability Index

Observations

Current liabilities show a tremendous growth till 2008, because company

creates the credit in the market by good transaction. To get maximum credit

from supplier which is profitable to the company it reduces the need of working

capital of firm. As the current liability increase in the year 2007, 2008 by 455%

and 682 % res. it increases the working capital size in the same year. But

subsequently it the liability has been reduced to 477%. But due to the good

collection process the change in working capital is not affected much and the

company enjoyed good credit terms over creditors which may include indirect

cost of credit terms. From the graph we can see that the requirementof working

capital has been increased drastically during the year 2006-2007-2008and it has

been paid and cleared n 2009, and still the firm is having a good reserve in it’s

working capital. This shows the efficiency in it’s collection policy.

VARIATION IN CURRENT LIABILITIES

100170.183

342.586

454.933

681.188

476.7258

0

100

200

300

400

500

600

700

800

2004 2005 2006 2007 2008 2009YEARS

VAR

IATI

ON

VARIATIONINCURRENTLIABILITIES

1.4Changes in working capital

The excess of current assets over current liabilities is referred to as the

company’s working capital. The difference between the working capital for two

given reporting periods is called the change in working capital.

1.4.1 Benefit

Changes in working capital is included in cash flow from operations because

companies typically increase and decrease their current assets and current

liabilities to fund their ongoing operations. When a company increases its

current assets, it’s a cash outflow: The company had to shell out money to buy

the extra assets. Likewise, when a company increases its current liabilities, it’s a

cash inflow: The added liabilities, such as short-term debt, provide money.

Changes in working capital simply shows the net affect on cash flows of this

adding and subtracting from current assets and current liabilities. When changes

in working capital is negative, the company is investing heavily in its current

assets, or else drastically reducing its current liabilities. When a change in

working capital is positive, the company is either selling off current assets or

else raising its current liabilities.

1.4.2 Origin

This information is found in the Statement of Cash Flow of the company’s

financial statement.

1.4.3 For the Processing:

For many growing companies, changes in working capital is a little like capital

spending: It’s money the company is investing—in things like inventory—in

order to grow. To get a true picture of the cash a company is generating before

investment, one can add back changes in working capital to cash flow from

operations. Another point: A negative value for changes in working capital

could mean the company is investing heavily in growth, or that something’s

gone wrong. If a company is having trouble selling its goods, inventories will

balloon, and changes in working capital will turn sharply negative.

There are so many reasons to changes in working capital as follows:-

1. CHANGES IN SALES AND OPERATING EXPANSES:-

The changes in sales and operating expanses may be due to three reasons

A) There may be long run trend of change e.g. The price of row material say

steel may constantly raise necessity the holding of large inventory.

B) Cyclical changes in economy dealing to ups and downs in business activity

will influence the level of working capital both permanent and temporary.

C) Changes in seasonality in sales activities

2. Policy changes:-

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

policy changes initiated by management. The term current assets policy may be

refined as the relationship between current assets and sales volume.

3. Technology changes:-

The third major point if changes in working capital are changes in technology

because change sin technology to install that technology in our business more

working capital is required

A change in operating expanses rise or full will have similar effects on the

levels of working following working capital statement is prepared on the base of

balance sheet of last two year.

“Net change in working capital is the difference in working capital

levels from one year to the next. When more cash is tied up in working

capital than the previous year, the increase in working capital is treated as

a cost against free cash flow”

. Table 6-8-Changes in Working Capital

CHANGES IN WORKING CAPITAL CHANGES IN W C

  2008 2009chang

es in %

INCREASE

DECREASE

CURRENT ASSET - A

Bank Balances / Deposits

145,245.0

0

1,917,381.2

0

1,403.

12

1,772,136.2

0 -

Trade Debtors (Net of Provisions)

20,461,085.2

0

13,615,575.6

5

(38.47

) -

6,845,509.5

5

Inventory 571,443.0

5

733,714.9

5

32.66

162,271.9

0 -

Work in Progress 1,441,426.1

0

2,304,751.8

0

68.88

863,325.7

0 -

Dues from Related Parties

321,144.4

0

4,694,014.8

0

1,565.

90

4,372,870.4

0 -

Other Receivables 341,149.8

0

100,554.8

5

(81.10

) #VALUE!

240,594.9

5

TOTAL CURRENT ASSETS-A

23,281,493.5

5

23,365,993.2

5 -

-

-

  -

-

-

-

-

CURRENT LIABILITIES - B

-

-

-

-

-

Short-term Borrowings

2,042,393.1

0

561,131.0

0

(83.40

)

1,481,262.1

0 -

Current Portion of Long Term Debt

1,523,439.5

0

2,217,367.9

0

52.38 -

693,928.4

0

Trade Creditors 10,429,836.4

5

6,268,618.9

5

(45.88

)

4,161,217.5

0 -

Dues to Related Parties

1,519,796.3

0

426,462.5

5

(82.73

)

1,093,333.7

5 -

Provisions - Tax 407,849.8

0

934,641.8

0

148.54 -

526,792.0

0

Other Payables 7,039,859.5

5

5,662,426.3

5

(22.50

)

1,377,433.2

0 -

TOTAL CURRENT LIABILITIES-B

22,963,174.7

0

16,070,648.5

5 -

-

-

NET WORKING CAPITAL - (A-B)

318,318.8

5

7,295,344.7

0 -

-

-

NET INCREASE IN WC

6,977,025.8

5 -

-

-

6,977,025.8

5

TOTAL 7,295,344.7

0

7,295,344.7

0 -

15,283,850.7

5

15,283,850.7

5

Chart 6.5- Changes in Working Capital

1.4.4 Observations

Working capital has been increased in the year 2008 to 2009 because:

Trade Receivables in the year 2008, for OMR 20,461085/- has been

reduced to OMR 13,615,575/-, ie. 33.45% less, compared to 2008. That

means there was a good cash collection effected in 2009, and therefore the

bank balance also has been increased from OMR 145,245/- to OMR

1,917,381/-, an increase of 1220%, where cost of raw material purchased

increased by 28.4%.

When the trade receivable has reduced in 2009, simultaneously there was a

decrease in trade creditors also. In 2008 trade creditors was 10,429,836/-,

but in 2009 it has been reduced to OMR 6,268,618/-, a reduction of 39.9%.

That means an increase in Working Capital is OMR 4,161,217/-. Same

way, Due to related parties; it was OMR 1,519,796/- in the year of 2008,

but it has been reduced to OMR 426,462/. A reduction of 71.9%. That

means the there is an increase in Working Capital for OMR.1, 093,333/-.

In the case of short-term borrowing; in the year 2008 the short-term

borrowing was OMR 2,042,393/-. But in 2009 it has been reduced to

561,131/-. There is a decrease of 72.5%. That means there is an in crease in

working capital for 1,481,262/-.

CHANGES IN WORKING CAPITAL

-

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

YEARS

VAR

IATI

ON

DECREASE

INCREASE

Even though the trade receivables and other receivables are reduced the

fund received from receivables has been utilized to clear the liabilities.

This leads to show a good performance and result in it’s working capital.

1.5 OPERATING CYCLE OR WORKING CAPITAL CYCLE

Working capital is also known as revolving capital and a circular path of

conversion/recon version takes place. This revolution of cycle is called as the

Operating Cycle Available cash tends to be tied up in what is known as the

Working Capital Cycle (WCC). Every business, regardless of what they do

operates this cycle. To start any business cash is required; this cash is then used

to purchase stock in order to generate a sale. When the stock is sold it is either

by way of a cash sale or is charged to an account, creating a debtor.

When the debt is collected the WCC continues on. In a service industry the

stock is client base or the service provided. The need of working capital arrived

because of time gap between production of goods and their actual realization

after sale. This time gap is called “Operating Cycle” or “Working Capital

Cycle”. The operating cycle of a company consist of time period between

procurement of inventory and the collection of cash from receivables. The

operating cycle is the length of time between the company’s outlay on raw

materials, wages and other expanses and inflow of cash from sales of goods.

Thus a revolution or cycle from cash to raw materials to Work-in-Progress,

to finished goods, to debtors, and back to cash takes place. This revolution

is called as operating cycle.

While waiting for cash to to return, more stock has to be purchased to keep the

business operating and to do so, many businesses use their overdraft facility

which is costing them money. If there is no overdraft they are using credit funds

that could be better utilised elsewhere. The faster you can turn the WCC the

faster the dollar returns and the less overdraft or credit funds you have to use.

This is where efficiency in debt collection and stock turnover is the key.

Managing cash in any business is important. Many profitable businesses end up

closing down simply because they could not get the cash to carry them in the

short term. Beyond Survival Workshops emphasize the difference between cash

flow and profits, constructs a cash flow budget for a business and analyses

where does all the cash go. It will demonstrate the importance on the efficient

operation of the working capital cycle, how to improve debtor collection and

stock turnover to help increase cash holdings and reduce the overdraft limit.

OPERATING CYCLE.

Thus, the term operating cycle, otherwise called as 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 debtors

3 Conversion of debtors into cash

Stage 1: Cash to Inventory – In this stage, cash first gets converted into raw

materials, then work-in progress and then finished goods in a typical

manufacturing concern. As regards non-manufacturing concerns, when the

goods are purchased, cash gets converted into inventory

.

Stage 2: Inventory to Debtors – The inventory thus produced or purchased, gets

converted into debtors or receivables upon credit sales.

Stage 3: Debtors to Cash -The debtors or accounts receivables get in turn

converted back into cash when they make payment

.

1.5.1 LENGTH OF OPERATING CYCLE:

When raw materials remain in store pending issue for production for a less

duration, when raw materials gets converted into WIP in a short duration, when

finished goods remain in warehouse pending for sales for a short duration only,

and when cash realizations out of sales are made quickly and finally when

payment to creditors is made slowly, the operating cycle would be smaller and

consequently the working capital will also be reasonable. Thus shorter duration

of operating cycle indicates an efficient working capital management.

Operating cycle is an important concept in management of cash and

management of cash working capital. The operating cycle reveals the time that

elapses between outlays of cash and inflow of cash. Quicker the operating cycle

less amount of investment in working capital is needed and it improves

profitability. The duration of the operating cycle depends on nature of industries

and efficiency in working capital management.

1.5.2 OPERATING CYCLE APPROACH OR WORKING CAPITAL CYCLE

APPROACH

According to this approach, the requirements of working capital depend upon

the operating cycle of the business.

The operating cycle begins with the acquisition of raw materials and ends with

the collection of receivables

It may be broadly classified into the following four stages viz.

1. Raw materials and stores storage stage.

2. Work-in-progress stage.

3. Finished goods inventory stage.

4. Receivables collection stage.

1.5.3 CALCULATION OF OPERATING CYCLE OR WORKING CAPITAL CYCLE

To calculate the operating cycle of AI LLC, used last five year data. Operating

cycle of the AI LLC vary year to year as changes in policy of management

about credit policy and operating control.

The duration of the operating cycle for the purpose of estimating Working

capital requirements is equivalent to the sum of the durations of each of these

stages less the credit period allowed by the suppliers of the firm.

Symbolically the duration of the working capital cycle can be put as follows: -

O=R+W+F+R-C

The gross operating cycle of a firm is equal to the length of the inventories and

receivables conversion periods.

RMCP = Raw Material Conversion Period

WIPCP = Work–In-Process Conversion Period

FGCP = Finished Goods Conversion Period

RCP = Receivables Conversion Period

CPP = Creditors Payment Period

However, a firm may acquire some resources on credit and thus defer payments

for certain period. In that case, Net Operating Cycle Period can be calculated as

below:

Further, following formula can be used to determine the conversion periods.

Each of the components of the Operating Cycle can be calculated as follows:-

Raw Material Conversion Period = Average Stock of Raw Material / Raw Material Consumption per day

Net Operating Cycle Period = Gross Operating Cycle Period – Payable Deferral period

Therefore Gross Operating Cycle = RMCP + WIPCP + FGCP + RCP - CPP

Work in process Conversion Period = Average Stock of Work-in-Progress / Total Cost of Production per day

Finished Goods Conversion Period = Average Stock of Finished Goods / Total Cost of Goods sold per day

Receivables Conversion Period = Average Accounts Receivables / Net Credit Sales per day

Payable Deferral Period = Average trade Creditors / Average Credit Purchase per day

After computing the period of one operating cycle, the total number of

operating cycles that can be computed during a year can be computed by

dividing 365 days with number of operating days in a cycle. The total

expenditure in the year when year when divided by the number of operating

cycles in a year will give the average amount of the working capital

requirement.

OPERATING CYCLE/WORKING CAPITALCYCLE

IF THE FIRM- THEN THE FIRM

WILL-

  Collect receivables (debtors) fasterRelease cash from the cycle

  Collect receivables (debtors) slower Receivables soak up cash

  Get better credit (in terms of duration   or amount) from suppliers

Increase THE cash resources

  Shift inventory (stocks) faster Free up cash

  Move inventory (stocks) slower Consume more cash1.5.4 CASH CONVERSION CYCLE OR NET OPERATING CYCLE

Operating cycle and cash cycle are two important components of working capital management.

Together they determine the efficiency of a firm regarding working capital

management. While the operating cycle is the time period from inventory

purchase until the receipt of cash, the cash cycle is the time period from when

cash is paid out, to when cash is received.

Refers to the delay between the buying of raw materials and the receipt of cash

from sales proceeds. In other words, operating cycle refers to the number of

days taken for the conversion of cash to inventory through the conversion of

accounts receivable to cash. It indicates towards the time period for which cash

is engaged in inventory and accounts receivable. If an operating cycle is long,

then there is lower accessibility to cash for satisfying liabilities for the short

term.

Operating cycle takes into consideration the following elements: accounts

payable, cash, accounts receivable, and inventory replacement. The following

formula is used for calculating operating cycle:

(1) Disregarding the capacity to defer payables, the cash conversion cycle is the

length of time between the payment of cash for inventory and receipt of cash

from accounts receivable.

(a) If a firm holds its inventory 50 days and collects its accounts receivable in

30 days, then it would take 80 days for the original investment to be converted

back into cash.

(b) However, if the firm has the option of creating an accounts payable for 20

days, the cash conversion cycle can be reduced from 80 days to 60 days.

(2) The cash conversion cycle is equal to the inventory conversion period, plus

the receivables collection period, minus the payables deferral period.

(a) The inventory conversion period is the average time between buying

inventory and selling the goods. We have: inventory conversion period =

inventory/(cost of sales/365) = 365/(inventory turnover).

(b) The receivables collection period, or days' sales outstanding (DSO), is the

average number of days that it takes to collect on accounts receivable. We have:

receivables collection period = receivables/(sales/365) = 365/receivables

turnover.

(c) The payables deferral period is (the accounts payable + wages, benefits, and

payroll taxes payable) / ([the cost of sales + selling, general, and administrative

expenses]/365).

Table 6.9- Operating cycle (No. of Days)

YEARS 2006 2007 2008 2009

Days Debtors 83 78 136 96

Days Inventory 80 45 18 17

Days Payable 75 66 84 55

Chart 6.6- Net Operating Cycle

83

80

75

78

45

66

136

18

84

96

17

55

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

DAYS

2006 2007 2008 2009

YEARS

NET OPERATING CYCLE

Days Payable

Days Inventory

Days Debtors

THE FIRMS GROSS OPERATING PROFIT (GOC) CAN BE DETERMINED

AS:-

INVENTORY CONVERSIONPERIOD (ICP) + DEBTORS CONVERSION

PERIOD (DCP).

GOC=ICP+DCP

Observations

ICP+RMCP+WIPCP

Operating cycle of AI LLC shows the numbers of day are decreasing in recent

year it is reflect the efficiency of management. Days of operating cycle shows

period of lack of funds in current assets, if no of day are more than it increases

the cost of funds as taken from outside of the business. In 2008/09 shows the

high no. of days because of reduced of creditors holding period.

1.6 WORKING CAPITAL LEVERAGE OR GEARING OF WORKING CAPITAL

In finance, leverage (also known as gearing or levering) refers to the use of debt

capital to supplement equity capital. Companies usually leverage to attempt to

increase returns on equity capital, as it can increase the scope for gains or

losses. The temporary increases in stock prices due to leverage at some banks

have been blamed for the unusually high overall remuneration for top

executives during the financial crisis of 2007–2010, since gains in stock prices

were often rewarded regardless of how they were achieved. Deleveraging is the

action of reducing borrowings. In macroeconomics, a key measure of leverage

is the debt to GDP ratio.

One of the important objectives of working capital management is by

maintaining the optimum level of investment in current assets and by reducing

the level of investment in current assets and by reducing the level of current

liabilities the company can minimize the investment in the working capital

thereby improvement in return on capital employed is achieved. The term

working capital leverage refers to the impact of level of working capital on

company’s profitability. The working capital management should improve the

productivity of investment in current assets and ultimately it will increase the

return on capital employed. Higher level of investment in current assets than is

actually required means increase in the cost of Interest charges on short term

loans and working capital finance raised from banks etc. and will result in lower

return on capital employed and vice versa. Working capital leverage measures

the responsiveness of ROCE (Return on Capital Employed) for changes in

current assets. It is measures by applying the following formula,

The working capital leverage reflects the sensitivity of return on capital

employed to changes in level of current assets. Working capital leverage would

be less in the case of capital intensive capital employed is same working capital

leverage expresses the relation of efficiency of working capital management

with the profitability of the company.

Table 6.10- Calculation of working capital leverages.

WORKING CAPITAL LEVERAGE = % CHANGES IN ROCE / % CHANGES IN CURRENT ASSETS

RETURN ON CAPITAL EMPLOYED – (ROCE) = EBIT / TOTAL ASSETS

YEARS 2006 2007 2008 2009

ROCE 630%1650

% 1960% 2460% WC LEVERAGE 3.37 3.23 3.14 1.8

Chart 6.7- Working Capital Leverage

Working capital leverage of the company has decreased in the year 2009 as

compare to the year 2006, and increase in working capital shows the efficient

current assets management. In the year 2006 and 2007 the current assets has

increased by high rate of 261% and 347% respectively. It tends to increase

ROCE, which increased at the rate of 6.3% and 16.5% respectively, that

resulted in push down the working capital leverage to 3.37% and 2.32%

respectively. When investment in current assets and fixed asset will help the

firm to run with sufficient fund without any overdraft or interrupt in it’s fund

flow.

7.1INTRODUCTION TO FINANCIAL RATIO ANALYSIS – ARABIAN INDUSTRIES

LLC

6.30%

3.37%

16.50%

3.23%

19.60%

3.14%

24.60%

1.80%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

% CHANGES

2006 2007 2008 2009

YEARS

WORKING CAPITAL LEVERAGE

ROCE

WC LEVERAGE

Financial ratios are one of the most common tools of managerial decision

making. Financial ratios involve the comparison of various figures from the

financial statements in order to gain information about a company's

performance. It is the interpretation, rather than the calculation, that makes

financial ratios a useful tool for business managers. Ratios may serve as

indicators, clues, or red flags regarding noteworthy relationships between

variables used to measure the firm's performance in terms of profitability, asset

utilization, liquidity, leverage, or market valuation.

Financial statement analysis is a judgmental process. One of the primary

objectives is identification of major changes in trends, and relationships and the

investigation of the reasons underlying those changes. The judgment process

can be improved by experience and the use of analytical tools. Probably the

most widely used financial analysis technique is ratio analysis, the analysis of

relationships between two or more line items on the financial statement.

Financial ratios are usually expressed in percentage or times. Generally,

financial ratios are calculated for the purpose of evaluating aspects of a

company's operations and fall into the following categories:

Ratio analysis is the powerful tool of financial statements analysis. A ratio is

define as “the indicated quotient of two mathematical expressions” and as “the

relationship between two or more things”. The absolute figures reported in the

financial statement do not provide meaningful understanding of the

performance and financial position of the firm. Ratio helps to summaries large

quantities of financial data and to make qualitative judgment of the firm’s

financial performance

7.2ROLE OF RATIO ANALYSIS

Ratio analysis helps to appraise the firms in the term of there profitability and

efficiency of performance, either individually or in relation to other firms in

same industry. Ratio analysis is one of the best possible techniques available to

management to impart the basic functions like planning and control. As future is

closely related to the immediately past, ratio calculated on the basis historical

financial data may be of good assistance to predict the future, the ratio analysis

may be able to locate the point out the various arias which 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 for further introduction

of long term finance in order to increase the liquidity position. As the ratio

analysis is concerned with all the aspect of the firm’s financial analysis

liquidity, solvency, activity, profitability and overall performance, it enables the

interested persons to know the financial and operational characteristics of an

organization and take suitable decisions.

7.3LIMITATIONS OF RATIO ANALYSIS

1 The basic limitation of ratio analysis is that it may be difficult to find a basis

for making the comparison

2 Normally, the ratios are calculated on the basis of historical financial

statements. An organization for the purpose of decision making may need

the hint regarding the future happiness rather than those in the past. The

external analyst has to depend upon the past which may not necessary to

reflect financial position and performance in future.

3 The technique of ratio analysis may prove inadequate in some situations if

there is differs in opinion regarding the interpretation of certain ratio.

4 As the ratio calculates on the basis of financial statements, the basic

limitation which is applicable to the financial statement is equally applicable

In case of technique of ratio analysis also i.e. only facts which can be

expressed in financial terms are considered by the ratio analysis.

5 The technique of ratio analysis has certain limitations of use in the sense that

it only highlights the strong or problem arias, it dose not provide any

solution to rectify the problem arias.

Ratio analysis is very important for the franchisor to establish norms and seek

patterns of financial operations over a period of time. Unfortunately, few

franchisors (or any kind of business) use ratio analysis -- it is estimated that just

two percent compute financial ratios and use them in managing their businesses.

The franchisor can use ratio analysis also to obtain a bank loan.

There are different financial ratios which may

1 liquidity ratios,

2 leverage ratios, 

3 operating ratios, and 

4 profitability ratios

7.4CLASSIFICATION OF WORKING CAPITAL RATIO

Working capital ratio means ratios which are related with the working capital

management e.g. current assets, current liabilities, liquidity, profitability and

risk turnoff etc. these ratio are classified as follows

7.4.1 EFFICIENCY RATIO

The ratios compounded under this group indicate the efficiency of the

organization to use the various kinds of assets by converting them the form of

sale. This ratio also called as activity ratio or assets management ratio. As the

assets basically categorized as fixed assets and current assets and the current

assets further classified according to individual components of current assets

viz. investment and receivables or debtors or as net current assets, the important

of efficiency ratio as follow

1) Working capital turnover ratio

2) Inventory turnover ratio

3) Receivable turnover ratio

4) Current assets turnover ratio

7.4.2 LIQUIDITY RATIO

The ratios compounded under this group indicate the short term position of the

organization and also indicate the efficiency with which the working capital is

being used. The most important ratio under this group is follows

1. Current ratio

2. Quick ratio

3. Absolute liquid ratio

7.5EFFICIENCY RATIO

7.5.1 WORKING CAPITAL TURNOVER RATIO

It signifies that for an amount of sales, a relative amount of working capital is

needed. If any increase in sales contemplated working capital should be

adequate and thus this ratio helps management to maintain the adequate level of

working capital. The ratio measures the efficiency with which the working

capital is being used by a firm. It may thus compute net working capital

turnover by dividing sales by working capital.

Working Capital Turnover Ratio = Sales / Net Working Capital

This ratio maker a comparison between net sales and net working capital in

order to find the working capital turnover ratio the working capital turnover

ratio for the year 2004-2009. We can see an increase in working capital turnover

ratio for the next 5 year has increased in a gradual way in the last year the net

sales has been increased and the working capital in being similarly that of

previous year hence the working that of previous year hence the working that

capital turnover ratio is 27.63 in 200 but 1.59 in 2009 after clearing all bills

payables.

Table 7-1 Working Capital Turnover Ratio

YEAR 2004 2005 2006 2007 2008 2009

GROSS SALES 6,927,072 11,279,759 24,739,046 39,165,363 43,850,144 63,664,311

Cost of Goods

sold

-

5,939,978 -9,866,566

-

21,708,552

-

33,554,054

-

35,055,556 52,042,769

NET SALES 987,094 1,413,192 3,030,494 5,611,309 8,794,588 11,621,541

NET WORKING

CAPITAL 1,142,515 112,409 250,012 326,831 318,319 7,295,345

WC TURN

OVER RATIO 0.86 12.57 12.12 17.17 27.63 1.59

Chart 7-1 Working Capital Turnover

WORKING CAPITAL TURNOVER

0

2000000

4000000

6000000

8000000

10000000

12000000

14000000

16000000

18000000

2004 2005 2006 2007 2008 2009

YEARS

WC

TU

RN

OVE

R

WC TURN OVERRATIO

NET WORKINGCAPITAL

NET SALES

YEAR

Observations

High working capital ratio indicates the capability of the organization to achieve

maximum sales with the minimum investment in working capital. Company’s

working capital ratio shows mostly more than two, except for the year 2005-06

because of excess of cash balance in current assets which occurred due to

encashment of deposits. In the year 2004 and 2008 The ratio was above 3, it

indicates that the capability of the company to achieve maximum sales with the

minimum investment in working capital. But in the year 2009 the WC graph

has gone down to 1.59% from 27.63 % in 2008. In 2009 wecan see that the

payables are also gone down. That means after clearing all bills payables, still

AI LLC is having a good working capital reserve.

7.5.2 INVENTORY TURNOVER RATIO:

Inventory turnover ratio, defined as how many times the entire inventory of a

company has been sold during an accounting period, is a major factor to success

in any business that holds inventory. It shows how well a company manages its

inventory levels and how frequently a company replenishes its inventory. In

general, a higher inventory turnover is better because inventories are the least

liquid form of asset. Inventory turnover ratio explanations occur very simply

through an illustration of high and low turnover ratios. Despite this, many

businesses do not survive due to issues with inventory.

Average inventory and cost of goods sold are the two elements of this ratio.

Average inventory is calculated by adding the stock in the beginning and at the

and of the period and dividing it by two. In case of monthly balances of stock,

all the monthly balances are added and the total is divided by the number of

months for which the average is calculated.

A low inventory turnover ratio shows that a company may be overstocking or

deficiencies in the product line or marketing effort. It is a sign of ineffective

inventory management because inventory usually has a zero rate of return and

high storage cost.

Higher inventory turnover ratios are considered a positive indicator of effective

inventory management. However, a higher inventory turnover ratio does not

always mean better performance. It sometimes may indicate inadequate

inventory level, which may result in decrease in sales.

Although the first calculation is more frequently used, COGS (cost of goods

sold) may be substituted because sales are recorded at market value, while

inventories are usually recorded at cost. Also, average inventory may be used

instead of the ending inventory level to minimize seasonal factors.

This ratio should be compared against industry averages. A low turnover

implies poor sales and, therefore, excess inventory. A high ratio implies either

strong sales or ineffective buying.

High inventory levels are unhealthy because they represent an investment with a

rate of return of zero. It also opens the company up to trouble should prices

begin to fall.

(a) [Inventory Turnover Ratio = Cost of goods sold / Average inventory at

cost]

(b) [Inventory Turnover Ratio = Net Sales / Average Inventory at Cost]

(c) [Inventory Turnover Ratio = Net Sales / Average inventory at Selling

Price]

(d) [Inventory Turnover Ratio  = Net Sales / Inventory]

Table 7-2- Inventory Turnover

YEAR 2004 2005 2006 2007 2008 2009COST OF GOODS SOLD

5,939,9

78

9,866,5

66

21,708,5

52

33,554,0

54

35,055,5

56

52,042,7

69

AVERAGE INVENTORY

1,896,0

89

2,636,5

64

2,972,82

2

1,670,42

9

2,012,86

9

3,038,46

7 INVENTORY TURNOVER 3.1 3.7 7.3 20.1 17.4 17.1

Chart 7-2 Inventory Turnover Ratio

INVENTORY TURNOVER RATIO

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

45,000,000

50,000,000

2004 2005 2006 2007 2008 2009

YEARS

INV

EN

TOR

Y

COST OFGOODSSOLD

AVERAGEINVENTORY

INVENTORYTURNOVER

Observations

It was observed that Inventory turnover ratio indicates maximum sales achieved

with the minimum investment in the inventory. As such, the general rule high

inventory turnover is desirable but high inventory turnover ratio may not

necessary indicates the profitable situation. An organization, in order to achieve

a large sales volume may sometime sacrifice on profit, inventory ratio may not

result into high amount of profit.

The result represents the turnover or inventory or how many times inventory

was used and then again replaced. This number is representative for a one year

time period. If the value of the inventory-turnover ratio is low, then it indicates

that the management team doesn't do its job properly in managing inventories.

Importance of   Inventory   Turnover:

If the company can quickly sell its inventory, then the Inventory Turnover will

be higher.  Conversely, if the company cannot sell its inventory very well, then

the Inventory Turnover will be low.  We have to watch this figure closely - if

the Inventory Ratio climbs too high, then the company may be keeping too little

inventory.  This could cause lost profits due to customer orders that had to wait

until inventory arrived.

7.5.3 RECEIVABLE TURNOVER RATIO

Debtors turnover ratio or accounts receivable turnover ratio  indicates the

velocity of debt collection of a firm. In simple words it indicates the number of

times average debtors (receivable) are turned over during a year.

Formula of Debtors Turnover Ratio:

[Debtors Turnover Ratio = Net Credit Sales / Average Trade Debtors]

The two basic components of accounts receivable turnover ratio are net credit

annual sales and average trade debtors. The trade debtors for the purpose of this

ratio include the amount of Trade Debtors & Bills Receivables. The average

receivables are found by adding the opening receivables and closing balance of

receivables and dividing the total by two. It should be noted that provision for

bad and doubtful debts should not be deducted since this may give an

impression that some amount of receivables has been collected. But when the

information about opening and closing balances of trade debtors and credit sales

is not available, then the debtors turnover ratio can be calculated by dividing the

total sales by the balance of debtors (inclusive of bills receivables) given. and

formula can be written as follows.

[Debtors Turnover Ratio = Total Sales / Debtors]

The derivation of this ratio is made in following way

Receivable turnover ratio = Gross sales/Average account receivables

Average receivable calculate by opening plus closing balance divide by 2.

Increasing volume of receivables without a matching increase in sales is

reflected by a low receivable turnover ratio. It is indication of slowing down of

the collection system or an extend line of credit being allowed by the customer

organization. The latter may be due to the fact that the firm is loosing out to

competition. A credit manager engage in the task of granting credit or

monitoring receivable should take the hint from a falling receivable turnover

ratio use his market intelligence to find out the reason behind such failing trend.

Debtor turnover indicates the number of times debtors turnover each year.

Generally the higher the value of debtor’s turnover, the more is the management

of credit.

Debtor’s turnover ratio = 365 days/Receivable turnover ratio

Table 7-3- Debtor’s Turnover Ratio

YEAR 2004 2005 2006 2007 2008 2009

GROSS SALES

6,927,0

72

11,279,7

59

24,739,0

46

39,165,3

63

43,850,1

44

63,664,3

11 AVERAGE ACCOUNT RECEIVABLE

2,217,2

69

3,697,47

5

6,862,67

6

14,158,9

99

22,939,4

89

27,268,8

74 RECEIVABLE TURNOVER RATIO

3.12 3.05 3.60 2.77 1.91 2.33

Table 7-3- Receivable Turnover Ratio

RECEIVABLE TURNOVER RATIO

-

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

70,000,000

80,000,000

90,000,000

2004 2005 2006 2007 2008 2009

YEARS

TUR

NO

VE

R

RECEIVABLETURNOVERRATIO

AVERAGEACCOUNTRECEIVABLE

GROSS SALES

Observations

It was observed from receivable turnover ratio that receivables turned around

the sales were less than 4 times. The actual collection period was more than

normal collection period allowed to customer. It concludes that over investment

in the debtors which adversely affect on requirement of the working capital

finance and cost of such finance.

Significance of the Ratio:

Accounts receivable turnover ratio or debtors turnover ratio indicates the

number of times the debtors are turned over a year. The higher the value of

debtors turnover the more efficient is the management of debtors or more liquid

the debtors are. Similarly, low debtors turnover ratio implies inefficient

management of debtors or less liquid debtors. It is the reliable measure of the

time of cash flow from credit sales. There is no rule of thumb which may be

used as a norm to interpret the ratio as it may be different from firm to firm.

7.5.4 CURRENT ASSETS TURNOVER RATIO

Current assets are a major component of the balance sheet and represent assets

that are expected to be sold or used, typically within the next 12 months.  They

are also an important measure of a companies liquidity position.  Current assets

have become a very important factor in evaluating the financial strength of a

company, in the event of a weak economic environment or one of lower

demand.  Many of the popular financial ratios will utilize the current assets

when performing analysis to gauge financial performance and stability.

Current Assets Turnover ratio, shows the productivity of the company's current

assets. The formula is the following:

= turnover / average (current assets, other + stocks + debtors + cash & equivalents)

Current assets turnover ratio is calculate to know the firms efficiency of

utilizing 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 the

efficiency with which current assets turn into sales. A higher ratio implies a

more efficient use of funds thus high turnover ratio indicate to reduced the lock

up of funds in current assets. An analysis of this ratio over a period of time

reflects working capital management of a firm.

Current assets TOR= Sales / Current assets

Table 7.-4-Calculation of Current Assets Turnover Ratio

YEAR 2004 2005 2006 2007 2008 2009

SALES

6,927,0

72

11,279,7

59

24,739,0

46

39,165,3

63

43,850,1

44

63,664,3

11 TOTAL CURRENT ASSETS

8,673,1

17

11,645,7

37

22,644,9

00

30,612,4

73

45,900,6

93

41,937,4

17 CURRENT 0.80 0.97 1.09 1.28 0.96 1.52

ASSET TOR

Chart No.7-4-Current assets Turnover Ratio

-

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

TUR

NO

VE

R

2004 2005 2006 2007 2008 2009

YEARS

CURRENT ASSET TURNOVER RATIO

SALES

TOTALCURRENTASSETS

CURRENTASSET TOR

Observations

It was observed that current assets turnover ratio does not indicate any trend

over the period of time. Turnover ratio was 0.80 in the year 2004 and increase

to 1.09 and 1.28 in the year 2006 and 2007 respectively, but it decreased in the

year 2008, because of high cash balance. Cash did not help to 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 1.28 from 1.09 in the year 2006.

7.6 LIQUIDITY RATIO

7.6.1 CURRENT RATIO

Current ratio may be defined as the relationship between current assets and

current liabilities. This ratio is also known as "working capital ratio". It is a

measure of general liquidity and is most widely used to make the analysis for

short term financial position or liquidity of a firm. It is calculated by dividing

the total of the current assets by total of the current liabilities.

The ratio is mainly used to give an idea of the company's ability to pay back its

short-term liabilities (debt and payables) with its short-term assets (cash,

inventory, receivables). The higher the current ratio, the more capable the

company is of paying its obligations. A ratio under 1 suggests that the

company would be unable to pay off its obligations if they came due at that

point. While this shows the company is not in good financial health, it does not

necessarily mean that it will go bankrupt - as there are many ways to access

financing - but it is definitely not a good sign.

The current ratio can give a sense of the efficiency of a company's operating

cycle or its ability to turn its Product into cash. Companies that have trouble

getting paid on their receivables or have long inventory turnover can run into

liquidity problems because they are unable to alleviate their obligations.

Because business operations differ in each industry, it is always more

useful to compare companies within the same industry.

This ratio is similar to the acid-test ratio except that the acid-test ratio does not

include inventory and pre paid as assets that can be liquidated. The components

of current ratio (current assets and current liabilities) can be used to derive

working capital (difference between current assets and current liabilities).

Working capital is frequently used to derive the working capital ratio, which is

working capital as a ratio of sales.

[Current Ratio = Current Assets / Current Liabilities]

Or

[Current Assets: Current Liabilities]

Components :

The two basic components of this ratio are current assets and current liabilities.

Current assets include cash and those assets which can be easily converted into

cash within a short period of time, generally, one year, such as marketable

securities or readily realizable investments, bills receivables, sundry debtors,

(excluding bad debts or provisions), inventories, work in progress, etc.

Prepaid expenses should also be included in current assets because they

represent payments made in advance which will not have to be paid in near

future.

Current liabilities are those obligations which are payable within a short period

of tie generally one year and include outstanding expenses, bills payable, sundry

creditors, bank overdraft, accrued expenses, short term advances, income tax

payable, dividend payable, etc. However, some times a controversy arises that

whether overdraft should be regarded as current liability or not. Often an

arrangement with a bank may be regarded as permanent and therefore, it may be

treated as long term liability. At the same time the fact remains that the

overdraft facility may be cancelled at any time. Accordingly, because of this

reason and the need for conversion in interpreting a situation, it seems advisable

to include overdrafts in current liabilities.

Limitations of Current Ratio :

This ratio is measure of liquidity and should be used very carefully because it

suffers from many limitations. It is, therefore, suggested that it should not be

used as the sole index of short term solvency.

1 It is crude ratio because it measures only the quantity and not the quality of

the current assets.

2 Even if the ratio is favorable, the firm may be in financial trouble, because of

more stock and work in process which is not easily convertible into cash,

and, therefore firm may have less cash to pay off current liabilities.

3 Valuation of current assets and window dressing is another problem. This

ratio can be very easily manipulated by overvaluing the current assets. An

equal increase in both current assets and current liabilities would decrease

the ratio and similarly equal decrease in current assets and current liabilities

would increase current ratio.

Table 7-5-Current Ratio

YEAR 2004 2005 2006 2007 2008 2009TOTAL CURRENT ASSETS

4,513,561

5,849,374

11,798,754

15,662,831

23,281,494

23,365,993

TOTAL CURRENT LIABILITIES

3,903,540

6,264,607

13,384,679

15,336,000

22,963,175

16,070,649

CURRENT RATIO 1.16 0.93 0.88 1.02 1.01 1.45

Chart No. 7.5 Current Ratio

CURRENT ASSET RATIO

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

2004 2005 2006 2007 2008 2009

YEARS

RA

TIO

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

TOTALCURRENTASSETS

TOTALCURRENTLIABILITIES

CURRENTRATIO

Observations

The current ratio indicates the availability of funds to payment of current

liabilities in the form of current assets. A higher ratio indicates that there were

sufficient assets available with the organization which can be converted in cash,

without any reduction in the value.: Generally, the higher the ratio, the more

liquid the company is. This means the company would have a better short-term

financial standing to meet its debt obligations.

A low current ratio is can often be supported by a strong operating cash flow.

On the other hand, if a company is able to operate with a low current ratio, it

means that the company is more efficient about using its capital. Therefore, a

low current ratio can lead to higher return of assets. Generally speaking, the

more liquid the current assets, the smaller the current ratio can be without cause

for concern. For most industrial companies, 1.5 is an acceptable current ratio

7.6.2 QUICK RATIO

The quick ratio, defined also as the acid test ratio, reveals a company's ability to

meet short-term operating needs by using its liquid assets. It is similar to the

current ratio, but is considered a more reliable indicator of a company’s short-

term financial strength. The difference between these two is that the quick ratio

subtracts inventory from current assets and compares the quick asset to the

current liabilities. Similar to the current ratio, value for the quick ratio analysis

varies widely by company and industry. In theory, the higher the ratio is, the

better the position of the company is. However, a better benchmark is to

compare the ratio with the industry average.

Quick ratios are often explained as measures of a company’s ability to pay their

current debt liabilities without relying on the sale of inventory. Compared with

the current ratio, the quick ratio is more conservative because it does not include

inventories which can sometimes be difficult to liquidate. For lenders, the quick

ratio is very helpful because it reveals a company’s ability to pay off under the

worst possible condition.

Although the quick ratio gives investors a better picture of a company’s ability

to meet current obligations the current ratio, investors should be aware that the

quick ratio does not apply to the handful of companies where inventory is

almost immediately convertible into cash.

Quick Ratio Formula

Quick Ratio = (Current assets – Inventories) / Current liabilities

Or

Quick assets / Current liabilities

Or

(Cash + Accounts Receivable + Cash equivalents) / Current liabilities

Quick Ratio Calculation

Quick ratio calculation is a useful skill for any business that may face cash flow

issues. Quick assets include those current assets that presumably can be quickly

converted to cash at close to their book values. It normally includes cash,

marketable securities, and some accounts receivables. The quick ratio,

sometimes called the acid-test, is a more stringent test of liquidity than the

current ratio. This is because it removes inventory from the equation. Inventory

is the least liquid of all the current assets. A business has to find a buyer if it

wants to liquidate inventory, or turn it into cash. Finding a buyer is not always

easy.

Quick ratios establish the relationship between quick or liquid assets and

liabilities. An asset is liquid if it can be converting in to cash immediately or

reasonably soon without a loss of value. Cash is the most liquid asset .other

assets which are consider to be relatively liquid and include in quick assets are

debtors and bills receivable and marketable securities. Inventories are

considered as less liquid. Inventory normally required some time for realizing

into cash. Their value also be tendency to fluctuate. The quick ratio is found out

by dividing quick assets by current liabilities

Table 7-.6- Quick Ratio

YEAR 2004 2005 2006 2007 2008TOTAL CURRENT ASSETS

4,513,561

5,849,374

11,798,754

15,662,831

23,281,494

INVENTORY 1

14,127 4

65,475 162,532

378,049

571,443

LIQUID CURRENT ASSET

4,399,434

5,383,899

11,636,222

15,284,782

22,710,051

TOTAL CURRENT LIABILITIES

3,903,540

6,264,607

13,384,679

15,336,000

22,963,175

QUICK RATIO 1.13 0.86 0.87 1.00 0.99

Chart No.7-.6 Quick ratio

QUICK RATIO

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

45,000,000

2004 2005 2006 2007 2008 2009

YEARS

VA

LUE

S

QUICK RATIO

TOTALCURRENTLIABILITIES

LIQUIDCURRENTASSET

Observations

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

payment of current liabilities. In some ways, the quick ratio is a more

conservative standard.  If the quick ratio is greater than one, there would seem

to be no danger that the firm would not be able to meet its current obligations. 

If the quick ratio is less than one, but the current ratio is considerably above

one, the status of the firm is more complex. 

In this case, the valuation of inventories and the inventory turnover are

obviously in a better stage. The liquid ratio of 1:1 is suppose to be standard or

ideal. In the year 2007 and 2009 company had Rs.1.40 cash for every 1 rupee

of expenses; such a policy is called conservative policy of finance for working

capital, Rs.0.90 is the ideal investment which affects on the cost of the fund and

returns on the funds.

7.6.3 ABSOLUTE LIQUID RATIO

Absolute liquid ratio is the ratio, which expresses the relationship between

Absolute Liquid Assets and Quick Liabilities.

Components of Absolute Liquid Assets

Absolute Liquid assets

1. Cash in Hand and at Bank

2. Readily Marketable Securities

Quick Liabilities

1. Outstanding Expenses

2. Bills Payable

3. Sundry Creditors

4. Short- term Advances

5. Income Tax payable

6. Dividends Payable

Expression of Absolute liquid ratio

Absolute Liquid Ratio = Absolute Liquid assets / Quick Liabilities

Significance of Absolute liquid ratio

The ratio shows very clearly whether a concern is liquid or not. In other words,

it is the real measure of the liquidity or short-term solvency of a concern Even

though debtors and bills receivables are considered as more liquid then

inventories; it can not be converted in to cash immediately or in time.

Therefore the while calculation of absolute liquid ratio only the absolute liquid

assets as like cash in hand cash at bank, short term marketable securities are

taken in to consideration to measure the ability of the company in meeting short

term financial obligation. It calculates by absolute assets dividing by current

liabilities.

Table 7.7- Absolute Liquid Ratio

YEAR 2004 2005 2006 2007 2008 2009Current Assets            BANK/CASH

46,198

199,387

68,798

570,267

145,245

1,917,381

OTHER RECEIVABLES

354,006

53,010

735,450

518,997

341,150

100,555

TOTAL LIQUID ASSET

400,203

252,397

804,248

1,089,264

486,395

2,017,936

CURRENT LIABILITIES

3,371,04

7

5,736,96

5 11,

548,742 15,

336,000 22,

963,175 16,

070,649 ABSOLUTE LIQUID RATIO 0.119 0.044 0.070 0.071 0.021 0.126

Chart No.7.7- Cash and bank to current liabilities

ABSOLUTE LIQUID RATIO

2004 2005 2006 2007 20082009

2004

2005

2006

2007

2008

2009

2004

2005

2006

2007

2008

2009

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

2004 2005 2006 2007 2008 2009

YEARS

VA

LUE

S

ABSOLUTELIQUIDRATIO

CURRENTLIABILITIES

TOTALLIQUIDASSET

Observations

Absolute liquid ratio indicates the availability of cash with company is

sufficient because company also has other current assets to support current

liabilities of the company. In the year 2007 and 2008,absolute liquid ratio

increased because of company carry more cash balance, as a cash balance is

ideal assets company has to take control on such availability of funds which is

affect on cost of the funds. The absolute liquid ratio is the best for three years

like 2007/2008/2009, and the cash balances as to the current liability has

improved for the firm. Firm has large resources in cash and bank balances.

While large resources in cash and bank balances may seem to affect the revenue

the firm could have earned by investing it elsewhere as maintenance of current

assets as cash and in near cash assets may increase the liquidity position but not

the revenue or profit earning capacity of the firm.

8.1INTRODUCTION TO WORKING CAPITAL MANAGEMENT

Decisions 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-term assets 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.

Guided by the above criteria, management will use a combination of policies

and techniques for the management of working capital. These policies aim at

managing the current assets (generally cash and cash equivalents, inventories

and debtors) and the short term financing, such that cash flows and returns are

acceptable.

Debtors management . Identify the appropriate credit policy, i.e. credit

terms which will attract customers, such that any impact on cash flows and

the cash conversion cycle will be offset by increased revenue and hence

Return on Capital (or vice versa); see Discounts and allowances.

Cash management . Identify the cash balance which allows for the business

to meet day to day expenses, but reduces cash holding costs.

Inventory management . Identify the level of inventory which allows for

uninterrupted production but reduces the investment in raw materials - and

minimizes reordering costs - and hence increases cash flow; see Supply

chain management; Just In Time (JIT); Economic order quantity (EOQ);

Economic production quantity

Short term financing . Identify the appropriate source of financing, given

the cash conversion cycle: the inventory is ideally financed by credit granted

by the supplier; however, it may be necessary to utilize a bank loan (or

overdraft), or to "convert debtors to cash" through "factoring".

8.2RECEIVABLES MANAGEMENT

Receivables or debtors are the one of the most important parts of the current

assets which is created if the company sells the finished goods to the customer

but not receive the cash for the same immediately. Trade credit arises when firm

sells its products and services on credit and dose not receive cash immediately.

It is essential marketing tool, acting as bridge for the movement of goods

through production and distribution stages to customers. Trade credit creates

receivables or book debts which the firm is expected to collect in the near

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 or

services passes immediately at the time of sale, while seller expects an

equivalent value to be received later on.

3) It implies futurity. The cash payment for goods or serves received by the

buyer will be made by him in a future period.

1. OBJECTIVE OF RECEIVABLE MANAGEMENT

The sales of goods on credit basis are an essential part of the modern

competitive economic system. The credit sales are generally made up on

account in the sense that there are formal acknowledgements of debt obligation

through a financial instrument. As a marketing tool, they are intended to

promote sales and there by profit. However extension of credit involves risk and

cost, management should weigh the benefit as well as cost to determine the goal

of receivable management. Thus the objective of receivable management is to

promote sales and profit until that point is reached where the return on

investment in further funding of receivables is less .than the cost of funds raised

to finance that additional credit

Table 8.1-Size of receivables

YEAR 2004 2005 2006 2007 2008 2009TRADE RECEIVABLES

2,217,2

69

2,960,41

3

7,804,52

6 12,

708,947 20,

461,085 13,

615,576 RECEIVABLE INDEX 100 134 352 573 923 614

Chart 8.1-Receivable Index

SIZE OF RECEIVABLES

20042005

2006

2007

2008

2009

12

3

4

5

6

-

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

18,000,000

20,000,000

2004 2005 2006 2007 2008 2009

YEARS

VA

LUE

S

0

100

200

300

400

500

600

700

800

900

1000

TradeDebtors

INDEX

2. AVERAGE COLLECTION PERIOD

The average collection period measures the quality of debtors since it indicate

the speed of there collection. The shorter the average collection period, the

better the quality of the debtors since a short collection period implies the

prompt payment by debtors. The average collection period should be compared

against the firm’s credit terms and policy judges its credit and collection

efficiency. The collection period ratio thus helps an analyst in two respects.

In determining the collect ability of debtors and thus, the efficiency of

collection efforts.

In ascertaining the firm’s comparative strength and advantages related to

its credit policy and performance. The debtor’s turnover ratio can be

transformed in to the number of days of holding of debtors.

Table 8.2- Average Collection Period

YEAR 2004 2005 2006 2007 2008 2009

GROSS

SALES

6,927,0

72

11,279,7

59

24,739,0

46

39,165,3

63

43,850,1

44

63,664,3

11

TRADE

RECEIVAB

LES

2,2

17,269

2,960,41

3

7,804,52

6

12,708,9

47

20,461,0

85

13,615,5

76

RECEIVAB

LE

TURNOVER 3.12 3.81 3.17 3.08 2.14 4.68

AVERAGE

COLLECTI

ON PERIOD 116.83 95.80 115.15 118.44 170.31 78.06

Chart No.8.2 Average Collection Period

3. Observations

3.12

116.83

3.81

95.80

3.17

115.15

3.08

118.44

2.14

170.31

4.68

78.06

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

160.00

180.00

VALU

ES

2004 2005 2006 2007 2008 2009

YEARS

AVERAGE COLLECTION PERIOD

RECEIVABLETURNOVER

AVERAGECOLLECTIONPERIOD

The size of receivables are staidly increasing it indicates that the company was

allowing more credit year to year, but it was not bad signal because as

receivables were supporting to the increase in the sales. Average collection

period are reducing to present situation, but as compare with the normal

collection period allowed to customer by JISL of 90 day’s, it was clear that the

company required to increase our efficiency of collection of receivables. All the

above factors directly or indirectly affects in the debtors turnover ratio, current

ratio and working capital ratio. For effective management of credit, the firm

should lay down clear cut guidelines and procedure for granting credit to

individual customers and collecting individual accounts should involve

following steps: (1) Credit information (2) Credit investigation (3) Credit limits

(4) Collection procedure.

8.3INVENTORY MANAGEMENT

Inventory management is primarily about specifying the size and placement of

stocked goods. Inventory management is required at different locations within a

facility or within multiple locations of a supply network to protect the regular

and planned course of production against the random disturbance of running out

of materials or goods. The scope of inventory management also concerns the

fine lines between replenishment lead time, carrying costs of inventory, asset

management, inventory forecasting, inventory valuation, inventory visibility,

future inventory price forecasting, physical inventory, available physical space

for inventory, quality management, replenishment, returns and defective goods

and demand forecasting. Balancing these competing requirements leads to

optimal inventory levels, which is an on-going process as the business needs

shift and react to the wider environment.

Inventory management involves a retailer seeking to acquire and maintain a

proper merchandise assortment while ordering, shipping, handling, and

related costs are kept in check.

Systems and processes that identify inventory requirements, set targets,

provide replenishment techniques and report actual and projected inventory

status.

Handles all functions related to the tracking and management of material.

This would include the monitoring of material moved into and out of

stockroom locations and the reconciling of the inventory balances. Also may

include ABC analysis, lot tracking, cycle counting support etc.

Management of the inventories, with the primary objective of

determining/controlling stock levels within the physical distribution function

to balance the need for product availability against the need for minimizing

stock holding and handling costs

The term ‘inventory’ is used to designate the aggregate of those items of

tangible assets which are:-

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 and

supplies, including spares, semi-processed material or work in progress and

finished goods. The nature of inventory is largely depending upon the type of

operation carried on. For instance, in the case of a manufacturing concern, the

inventory will generally comprise all three groups mentioned above while in the

case of a trading concern, it will simply be by stock- in- trade or finished goods.

1. OBJECTIVE OF INVENTORY MANAGEMENT

In company there should be an optimum level of investment for any asset,

whether it is plant, cash or inventories. Again inadequate disrupts production

and causes losses in sales. Efficient management of inventory should ultimately

result in wealth maximization of owner’s wealth. It implies that while the

management should try to pursue financial objective of turning inventory as

quickly as possible, it should at the same time ensure sufficient inventories to

satisfy production and sales demand. The objectives of inventory management

consist of two counterbalancing parts:

To minimize the firms investment in inventory

To meet a demand for the product by efficiently organizing the firms

production and sales operation.

This two conflicting objective of inventory management can also be expressed

in term of cost and benefits associated with inventory. That the firm should

minimize the investment in inventory implies that maintaining an inventory

cost, such that smaller the inventory, the better the view point .obviously, the

financial manager should aim at a level of inventory which will reconcile these

conflicting elements. Some objectives are as follows:-

To have stock available as and when they are required.

To utilize available storage space but prevents stock levels from exceeding

space available.

To maintain adequate accountability of inventories assets.

To provide, on item – by- item basis, for re-order point and order such

quantity as would ensure that the aggregate result confirm with the constraint

and objective of inventory control.

Table 8.3-Size of inventory

YEAR 2004 2005 2006 2007 2008 2009INVENTORY

114,127

465,475

162,532

378,049

571,443

733,715

WORK IN PROGRESS

1,781,962

2,171,088

2,810,291

1,292,380

1,441,426

2,304,752

TOTAL INVENTORY

1,896,089

2,636,564

2,972,822

1,670,429

2,012,869

3,038,467

INVENTORY INDEX 100 139 157 88 106 160

Chart No. 8.3 - Inventories index

100

139157

88106

160

-

20

40

60

80

100

120

140

160

180

VALUES

2004 2005 2006 2007 2008 2009YEARS

INVENTORY INDEX

INVENTORY INDEX

2. INVENTORY COMPONENTS

The manufacturing firm’s inventory consists following components:-

I) Inventory

II) Work- in-progress

To analyze the level of raw material inventory and work in progress inventory

held by the firm on an average it is necessary to examine the efficiency with

which the firm converts raw material inventory and work in progress into

finished goods.

Table No. 8.4-Components of inventories

YEAR 2004 2005 2006 2007 2008 2009

INVENTOR

Y

114,127

465,475

162,532

378,049

571,443

733,715

WORK IN

PROGRESS

1,

781,962

2,

171,088

2,

810,291

1,

292,380

1,

441,426

2,

304,752

Chart No. 8.4-Components of inventories

INVENTORY COMPONENTS

-

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

2004 2005 2006 2007 2008 2009

YEAR

VA

LUE

INVENTORY

WORK IN PROGRESS

3. INVENTORY HOLDING PERIOD

The reciprocal of inventory turnover gives average inventory holding in

percentage term. When the numbers of days in year are divided by inventory

turnover, we obtain Days of Inventory Holding (DIH).

Inventory management involves a retailer seeking to acquire and maintain a

proper merchandise assortment while ordering, shipping, handling, and related

costs are kept in check. Systems and processes that identify inventory

requirements, set targets, provide replenishment techniques and report actual

and projected inventory status.

Formula to calculate number of days inventory: 

Number of Days Inventory = 365 days / inventory turnover ratio. Number of day’s inventory ratio definition and explanation:

 The number of day’s inventory is also known as average inventory period and

inventory holding period. A high number of days inventory indicates that, their

is a lack of demand for the product being sold. A low days inventory ratio

(inventory holding period) may indicate that the company is not keeping enough

stock on hand to meet demands.    The number of days inventory and inventory

turnover ratios are included in the financial statement ratio analysis spreadsheets

highlighted in the left column, which provide formulas, definitions, calculation,

charts and explanations of each ratio. 

Table - 8. 5- Inventory Turnover Ratio

YEAR 2004 2005 2006 2007 2008 2009 INVENTORY TURNOVER RATIO 3.1 3.7 7.3 20.1 17.4 17.1 DAYS OF INVENTORY

117.74 98.65 50.00 18.16 20.98 21.35

HOLDING

Cost of Goods sold

5,939,9

78

9,866,5

66 21,

708,552 33,

554,054 35,

055,556 52,

042,769

Inventory

114,12

7

465,47

5

162,532

378,049

571,443

733,715 RAW MAT. TURN OVER 52.05 21.20 133.56 88.76 61.35 70.93 RAW MAT. HOLDING PERIOD 7.01 17.22 2.73 4.11 5.95 5.15

Chart No. 8.5 – Inventory Turnover Ratio

INVENTORY TURNOVER RATIO

3.13.7

7.3

20.1 17.4 17.1

1

10

100

2004 2005 2006 2007 2008 2009

YEARS

VA

LUE

S

INVENTORY TURNOVER RATIO

Table - 8.6-Inventory holding Period

YEAR 2004 2005 2006 2007 2008 2009 INVENTORY TURNOVER RATIO 3.1 3.7 7.3 20.1 17.4 17.1 DAYS OF 117.74 98.65 50.00 18.16 20.98 21.35

INVENTORY HOLDING COST OF GOODS SOLD

5,939,9

78

9,866,5

66

21,708,55

2

33,554,05

4 35

,055,556 52

,042,769

INVENTORY

114,12

7

465,47

5

162,532

378,049

571,443

733,715

WORK IN PROGRESS

1,781,9

62

2,171,0

88

2,810,29

1

1,292,38

0 1

,441,426 2

,304,752

TOTAL INVENTORY

1,896,0

89

2,636,5

64

2,972,82

2

1,670,42

9 2

,012,869 3

,038,467 RAW MAT. TURN OVER 3.13 3.74 7.30 20.09 17.42 17.13 RAW MAT. HOLDING PERIOD 116.51 97.54 49.98 18.17 20.96 21.31

Chart- 8.6-Inventory holding Period

116.51

97.54

49.98

18.17 20.96 21.31

0.00

20.00

40.00

60.00

80.00

100.00

120.00

VALUES

2004 2005 2006 2007 2008 2009

YEARS

RAW MAT. HOLDING PERIOD

RAW MAT.HOLDINGPERIOD

4. Observations

Size of inventory of AI LLC, was increasing gradually with the increase the

sales. The inventory size was increasing because of increment in the finished

goods stock; it indicates that the company reduced the liquidity of finished

goods. High inventory turnover ratio is showing that the maximum sales

turnover is achieved with the minimum investment in the inventories. Raw

material turnover has increased in the year 2007 it indicates that company are

investing more in raw material purchasing; thus raw material holding period has

reduced in the same year to 18 days from 49 days in the previous year 2006.

Overall inventory holding period has reduced because of increases in the

inventory turnover and sales volume.

8.4MANAGEMENT OF CASH

Cash is money that is easily accessible either in the bank or in the business. It is

not inventory, it is not accounts receivable, and it is not property. These might

be converted to cash at some point in time, but it takes cash on hand or in the

bank to pay suppliers, to pay the rent, and to meet the payroll. Profit growth

does not always mean more cash.

Profit is the amount of money you expect to make if all customers paid on time

and if your expenses were spread out evenly over the time period being

measured. However, it is not your day-to-day reality. Cash is what you must

have to keep the doors of your business open. Over time, a company's profits

are of little value if they are not accompanied by positive net cash flow. You

can't spend profit; you can only spend cash.

Cash Flow refers to the flow of cash into and out of a business over a period of

time. The outflow of cash is measured by the money you pay every month to

salaries, suppliers, and creditors. The inflows are the cash you receive from

customers, lenders, and investors.

1. POSITIVE CASH FLOW

If the cash coming into the business is more than the cash going out of the

business, the company has a positive cash flow. A positive cash flow is very

good and the only concern here is managing the excess cash prudently.

2. NEGATIVE CASH FLOW

If the cash going out of the business is more than the cash coming into the

business, the company has a negative cash flow. A negative cash flow can be

caused by a number of problems that result in a shortage of cash, such as too

much or obsolete inventory, or poor collections on accounts receivable. If the

company doesn't have money in the bank or can't borrow additional cash at this

point, it may be in serious trouble.

A Cash Flow Statement is typically divided into three components so that you

can see and understand both the internal and external sources and uses of cash.

3. OPERATING CASH FLOW (INTERNAL)

Operating cash flow, often referred to as working capital, is the cash flow

generated from internal operations. It is the cash generated from sales of the

product or service of your business. Because it is generated internally, it is

under your control.

4. INVESTING CASH FLOW (INTERNAL)

Investing cash flow is generated internally from non-operating activities. This

component would include investments in plant and equipment or other fixed

assets, nonrecurring gains or losses, or other sources and uses of cash outside of

normal operations.

5. FINANCING CASH FLOW (EXTERNAL)

Financing cash flow is the cash to and from external sources, such as lenders,

investors and shareholders. A new loan, the repayment of a loan, the issuance of

stock and the payment of dividend are some of the activities that would be

included in this section of the cash flow statement.

6. GOOD CASH MANAGEMENT MEANS:

Knowing when, where, and how your cash needs will occur, Knowing what the

best sources are for meeting additional cash needs; and, Being prepared to meet

these needs when they occur, by keeping good relationships with bankers and

other creditors. Daily cash, and Long-term (annual, 3-5 year) cash flow

projections to help firms to develop the necessary capital strategy to meet their

business needs. They also prepare and use historical cash flow statements to

gain an understanding about where all the money went.

7. PRECAUTIONARY MOTIVE

Cash flows are somewhat unpredictable, with the degree of predictability

varying among firms and industries. Unexpected cash needs at short notice may

also be the result of following:

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 firm’s cash flows, the lower will be the

necessity of holding this balance and vice versa. The need for holding the

precautionary cash balance is also influenced by the firm’s capacity to have

short term borrowed funds and also to convert short term marketable securities

into cash.

8. SPECULATIVE MOTIVE

Speculative cash balances may be defined as cash balances that are held to

enable the firm to take advantages of any bargain purchases that might arise.

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

aggressive in approach.

9. ADVANTAGES OF CASH MANAGEMENT

Cash does not enter in to the profit and loss account of an enterprise, hence cash

is neither profit nor losses but without cash, profit remains meaningless for an

enterprise owner.

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

An efficient cash management through a relevant and timely cash budget

may enable a firm to obtain optimum working capital and ease the strains of

cash shortage, fascinating temporary investment of cash and providing funds

normal growth.

Cash management involves balance sheet changes and other cash flow that

do not appear in the profit and loss account such as capital expenditure.

Table 8.7-Size and index of cash

YEAR 2004 2005 2006 2007 2008 2009

BANK/

CASH 46,198

199,38

7 68,798

570,26

7

145,24

5

1,917,38

1

CASHINDEX 100 432 149 1234 314 4150

Chart No. 8.7-Cash Index

1

10

100

1,000

10,000

100,000

1,000,000

10,000,000

INDEX

2004 2005 2006 2007 2008 2009

YEARS

CASH INDEX

BANK/CASH

CASHINDEX

10.CASH CONVERSION CYCLE:-

The cash conversion cycle is simply the duration of time it takes a firm to

convert its activities requiring cash back into cash returns. The cycle is

composed of the three main working capital components: Accounts Receivable

outstanding in days (ARO), Accounts Payable outstanding in days (APO) and

Inventory in days (IOD). The Cash Conversion Cycle (CCC) is equal to the time

is takes to sell inventory and collect receivables less the time it takes to pay

your payables,

OR

CCC = IOD + ARO – APO

Cash Cycle is very important, because it represents the number of days a firm's

cash remains tied up within the operations of the business. It is also a powerful

tool for assessing how well a company is managing its working capital. The

lower the cash conversion cycle, the more healthy a company generally is. If

you compare the results of the cycle over time and see a rising trend it is often a

warning sign that the business may be facing a cash flow crunch.

CASH CONVERSION CYCLE

Understanding the components of the cycle

When evaluating cash flow, those factors directly affecting profit, revenue and

expenses, are easy to understand and their affect on cash is straight forward;

decreases in costs or increases in profit margin results in less cash going out or

more cash coming in, and increased profits. However, the working capital

components of the CCC are a little more complex. In simple terms, an increase

in the amount of time accounts receivables are outstanding uses up cash, a

decrease provides cash; an increase in the amount of inventory uses cash, a

decrease provides cash; an increase in the amount of time it takes you to pay

your payables provides cash, a decrease uses cash.

The Operating Cycle consists of 3 phases:-

Phase 1

In Phase 1, Cash gets converted into Inventory. This includes purchase of Raw

Material, Conversion of Raw Material into Work-in-Progress, Finished Goods

and finally the transfer of goods to stock at the end of the manufacturing

process. In the case of Trading Companies, this phase is shorter as there would

be no manufacturing activity and cash is directly converted into Inventory. This

Phase is of course totally absent in the case of Service Organizations.

Phase 2

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 obviously don't

have the Phase 2 of the operating Cycle.

 

Phase 3

The Last Phase i.e. Phase 3 of the Operating Cycle, represents the stage when

Receivables are collected. This phase completes the operating cycle. Thus, the

firm has moved from cash to inventory, to receivables and to cash again.

Table 8.8-Operating Cycle

YEA

R 2004 2005 2006 2007 2008 2009

DAYS OF

INVENTORY

HOLDING 117 98 50 18 21 21

AVERAGE

COLLECTION

PERIOD 117 96 115 118 170 78

CREDITORS

PAYMENT

PERIOD 70 75 65 70 85 55

CASH

CONVERTION

CYCLE 163 118 100 67 106 44

Chart No. 8.8-Cash Conversion Cycle

CASH CONVERSION CYCLE

11798

50

18 21 21

117

96

115

118

170

78

70 7565 70

85

55

163

118

100

67

106

44

0

50

100

150

200

250

2004 2005 2006 2007 2008 2009YEARS

DA

YS

AVERAGECOLLECTION PERIOD

DAYS OFINVENTORYHOLDING

CASH CONVERTIONCYCLE

CREDITORSPAYMENT PERIOD

Observations

The size of the cash in the current assets of the company indicates the good cash

management of the company. After 2004, the cash balance in the year 2006 and

2008 was extremely increased; because of the good collection from Debtors.

Company failed to proper investment of available cash. After the study of cash

management it mentioned above it can be conclude that management of cash

involve three things: a) Managing cash flow into and out of the firm. b)

Managing cash inflow within the firm, c) Financial deficit or investing surpluses

cash and thus controlling cash balance at a point of a time. The firm should hold

an optimum balance of cash and invest any temporary excess amount in short

term bank deposits and inter corporate deposit. The high portion of cash balance

in the current assets it adversely affected on profitability of the company as cash

is ideal asset; it reduced the working capital leverage.

8.5WORKING CAPITAL FINANCE AND ESTIMATION

Introduction

Corporate finance is an area of finance dealing with financial decisions business

enterprises make and the tools and analysis used to make these decisions. The

primary goal of corporate finance is to maximize corporate value while

managing the firm's financial risks. Although it is in principle different from

managerial finance which studies the financial decisions of all firms, rather than

corporations alone, the main concepts in the study of corporate finance are

applicable to the financial problems of all kinds of firms.

The discipline can be divided into long-term and short-term decisions and

techniques. Capital investment decisions are long-term choices about which

projects receive investment, whether to finance that investment with equity or

debt, and when or whether to pay dividends to shareholders. On the other hand,

the short term decisions can be grouped under the heading "Working capital

management". This subject deals with the short-term balance of current assets

and current liabilities; the focus here is on managing cash, inventories, and

short-term borrowing and lending (such as the terms on credit extended to

customers).

The terms corporate finance and corporate financier are also associated with

investment banking. The typical role of an investment bank is to evaluate the

company's financial needs and raise the appropriate type of capital that best fits

those needs.

After determine the level of working capital, a firm has to consider how it will

finance. Following are sources of working capital finance.

8.6SOURCES OF WORKING CAPITAL FINANCE

1) Trade credit

2) Bank Finance

3) Letter of credit

1. Trade credit

Trade credit is an arrangement between businesses to buy goods or services on

account, that is, without making immediate cash payment. The supplier

typically provides the customer with an agreement to bill them later, stipulating

a fixed number of days or other date by which the customer should pay. It can

be viewed as an essential element of capitalization in an operating business

because it can reduce the required capital investment required to operate the

business if it is managed properly. Trade credit is the largest use of capital for a

majority of business to business (B2B) sellers in most of the countries, and is a

critical source of capital for a majority of all businesses.

2. BANK FINANCE FOR WORKING CAPITAL

Banks are main institutional source of working capital finance in India. After

trade credit, bank credit is the most important source of financing working

capital in India. A banks considers a firms sales and production plane and

desirable levels of current assets in determining its working capital

requirements. The amount approved by bank for the firm’s working capital is

called credit limit. Credit limit is the maximum funds which a firm can obtain

from the banking system. In practice banks do not lend 100% credit limit; they

deduct margin money.

Forms of bank finance:-

1) Over Draft

2) Term Loan

3) Cash credit

4) Purchase or discounting of bills

1) Overdraft

An overdraft occurs when withdrawals from a bank account exceed the

available balance. In this situation a person is said to be "overdrawn". If there is

a prior agreement with the account provider for an overdraft protection plan,

and the amount overdrawn is within this authorized overdraft limit, then interest

is normally charged at the agreed rate. If the balance exceeds the agreed terms,

then fees may be charged and higher interest rate might apply.

2) Term Loan

While the four prior debt instruments address cyclical working capital needs,

term loans can finance medium-term no cyclical working capital. A term loan is

a form of medium-term debt in which principal is repaid over several years,

typically in 3 to 7 years. Since lenders prefer not to bear interest rate risk, term

loans usually have a floating interest rate set between the prime rate and prime

plus 300 basis points, depending on the borrower’s credit risk. Sometimes, a

bank will agree to an interest rate cap or fixed rate loan, but it usually charges a

fee or higher interest rate for these features. Term loans have a fixed repayment

schedule that can take several forms. Level principal payments over the loan

term are most common. In this case, the company pays the same principal

amount each month plus interest on the outstanding loan balance.

3) Cash credit

In practice, the operations in cash credit facility are similar to those of those of

overdraft facility except the fact that the company need not have a formal

current account. Here also a fixed limit is stipulated beyond which the company

is not able to withdraw the amount.

4) Bills purchased / discounted

This form of assistance is comparatively of recent origin. This facility enables

the company to get the immediate payment against the credit bills / invoice

raised by the company. The banks hold the bills as a security till the payment is

made 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 from of discount charges.

On maturity, bank collects the full amount of bill from the customer.

3. LETTER OF CREDIT

A standard, commercial letter of credit is a document issued mostly by a

financial institution, used primarily in trade finance, which usually provides an

irrevocable payment undertaking. The letter of credit can also be source of

payment for a transaction, meaning that redeeming the letter of credit will pay

an exporter. Letters of credit are used primarily in international trade

transactions of significant value, for deals between a supplier in one country and

a customer in another. They are also used in the land development process to

ensure that approved public facilities (streets, sidewalks, storm water ponds,

etc.) will be built. The parties to a letter of credit are usually a beneficiary who

is to receive the money, the issuing bank of whom the applicant is a client, and

the advising bank of whom the beneficiary is a client.

Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled

without prior agreement of the beneficiary, the issuing bank and the confirming

bank, if any. In executing a transaction, letters of credit incorporate functions

common to General Inter bank Recurring Order and Traveler's cheques.

Typically, the documents a beneficiary has to present in order to receive

payment include a commercial invoice, bill of lading, and documents proving

the shipment were insured against loss or damage in transit. However, the list

and form of documents is open to imagination and negotiation and might

contain requirements to present documents issued by a neutral third party

evidencing the quality of the goods shipped, or their place of origin.

Chart No. 8.-9-Cash Conversion Cycle

YEAR 2004 2005 2006 2007 2008 2009

SHORTTERM BORROWINGS

345,37

1

912,57

9 2

,076,834 2,

042,393

561,131 INTEREST @8.5%

25,903

68,443

155,763

-

153,180

42,085

Chart No. 8.9-Cash Conversion Cycle

WORKING CAPITAL LOAN AND INTEREST

-

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

2,000,000

2004 2005 2006 2007 2008 2009

YEARS

BO

RR

OW

ING

S

SHORTTERMBORROWINGS

INTEREST@8.5%

Observations

Arabian Industries LLC, takes only very low working capital loan to fulfill the

requirement of working capital, thus company saved a lot from paying interest,

on working capital loan. Company raised the funds for working capital through

term loan from bank.. We can see that in 2007 firm doesn’t have any kind of

loan. The supplier extending trade credit incurs cost in the form of opportunity

cost of funds invested in accounts receivable. The annual opportunity cost of

forgoing cash discount can be very high. Therefore AI LLC, should compare the

opportunity cost of trade credit with the cost of other sources of credit while

making its financial decisions.

8.7Estimation of working capital

After considering the various factors affecting the working capital needs, it is

necessary to forecast the working capital requirements. For this purpose, first of

all estimate of all current assets should be made, these should be followed by

the estimation of all current liabilities. Difference between the estimated current

assets and estimated current liabilities will represent the working capital

requirements. The estimation of working capital requirement of Arabian

Industries LLC is based on few assumptions such as follows.

· Gross sales will increase by 40%

· Receivables collection period will be 90 day as per standards fixed by

company.

· Unnecessary balance of Cash may reduce by finance management.

· For working capital finance company can use maximum trade credit.

· Inventory holding period can be 60 days instead of present 95

ESTIMATED BALANCE SHEET OF ARABIAN INDUSTRIES LLC FOR THE YEAR 2010  2005 2006 2007 2008 2009 20%CURREN

T ASSET - A            BANK BALANCE

199,387

68,798

570,267

145,245

1,917,381

383,476

TRADE DEBTORS

2,960,413

7,804,526

12,708,947

20,461,085

13,615,576

2,723,115

INVENTORY 465,

475 162,5

32 378,0

49 571,4

43 733,7

15 146,

743 WORK IN PROGRESS

2,171,088

2,810,291

1,292,380

1,441,426

2,304,752

460,950

DUE FROM RELATED PARTIES

-

217,158

194,191

321,144

4,694,015

938,803

OTHER RECEIVABLE

53,010

735,450

518,997

341,150

100,555

20,111

TOTAL CURRENT ASSETS

5,849,374

11,798,754

15,662,831

23,281,494

23,365,993

-

  -

-

-

-

-

-

CURRENT LIABILITIES - B

-

-

-

-

-

-

SHORT TERM LOAN

912,579

2,076,834

-

2,042,393

561,131

112,226

CURRENT PORTION OF TERM LOAN

187,158

505,393

1,455,553

1,523,440

2,217,368

443,474

TRADE CREDITORS

3,053,555

5,222,137

6,931,094

10,429,836

6,268,619

1,253,724

DUE TO RELATED PARTIES

2,070

23,814

31,484

1,519,796

426,463

85,293

PROVISION FOR TAX

27,784

184,470

177,498

407,850

934,642

186,928

OTHER PAYABLES

1,553,819

3,536,092

6,740,372

7,039,860

5,662,426

1,132,485

TOTAL CURRENT LIABILITIES

5,736,965

11,548,742

15,336,000

22,963,175

16,070,649

-

NET WORKING CAPITAL - (A-B)

112,409

250,012

326,831

318,319

7,295,345

-

Table 8-10-Estimation of the Working Capital For the year 2010 For AI LLC.

Chart 8-10-Estimation of the Working Capital For the year 2010 For AI LLC.

ESTIMATION OF WORKING CAPITAL FOR 2010

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

2005 2006 2007 2008 2009 2010 2010

YEARS

VA

LUE

S

TOTALCURRENTASSETS

TOTALCURRENTLIABILITIES

NET WORKINGCAPITAL - (A-B)

Observations

Arabian Industries LLC has good credit in the market because it is No. 1

Engineering and Manufacturing Contracting Company in Sultanate of Oman,

and 3rd position in entire GCC countries. Company took benefit of such

position to raise the funds for working capital finance. In the year 2006 and

2008, term loan from bank was the major source of finance, but it reduced by

250% in the subsequent year, which shows the paying capacity due to the

efficient financial management and also it ndicate that company changed the

finance policy to get benefit sources like term credit (export package credit)

which is not directly affect on cost of finance. In the year 2006 and 08 company

used latter of credit but after that company not used such facility from third

person.. Company mainly used term loan and letter of credit for the working

capital requirement and clearing the debt for import within the year itself. For

working capital finance company use cash credit facility provided by scheduled

banks and national banks. Company required such huge amount for working

capital finance because liquidity of the company locked in debtors. Company

had around 50 % receivables account of total current assets. Company fixed

normal collection period of 90 days, but collection system of the company was

not able to collection from debtors within credit term. Company has receivable

but not liquidity to payment of creditors thus company took cash credit and

credit term, which increased the interest on working capital finance by around

126% from year 2006 compared to 2005, but in 2007 it become 126% and it

reduced to 38.5 % in the year 2009. Cash management of the company is more

efficient and conservative thus company carry huge amount in terms of liquid

assets.

9.1INDINGS

Working capital management is important aspect of financial management. The

study of working capital management of Arabian Industries LLC, has revealed

that the current ratio was as per the standard industrial practice but the liquidity

position of the company showed an increasing trend. The study has been

conducted on working capital ratio analysis, working capital leverage, working

capital components which helped the company to manage its working capital

efficiency and affectively.

1. Working capital of the company was increasing and showing positive

working capital each year. It shows good liquidity position.

2. Positive working capital indicates that company has the ability of

payments of short terms liabilities.

3. Working capital increased because of increment in the current assets is

more than increase in the current liabilities.

4. Company’s current assets were always more than requirement and it

affected on profitability of the company.

5. Current assets are more than current liabilities indicate that company used

long term funds for short term requirement, where long term funds are

most costly then short term funds.

6. Current assets components shows sundry debtors were the major part in

current assets it shows that the efficient receivables collection

management.

7. In the year 2009 working capital decreased because of increased the

expenses as manufacturing expenses and increase the price of raw

material as increased in the inflation rate.

8. Inventory was supporting to sales, thus inventory turnover ratio was

increasing, but company increased the raw material holding period.

9. Study of the cash management of the company shows that company have

a good control on cash management in the year 2009, where cash came

from receivables and short term funds.

10.When comparing Working capital is compared with net sales it is in

increasing trend indicating the effective utilization of the net working

capital.

11.The decrease in figures of sources and applications from the year 20004-

to the year 20009 makes at clear that the company is doing activity

increasing or standardizing of its operations.

9.2CONCLUSION

Working Capital is the lifeline of every industry, irrespective of whether it’s a

manufacturing industry, services industry. Working Capital is the prime and

most important requirement for carrying out the day to day operations of the

business. Working Capital gives the much-needed liquidity to the business.

Working Capital Finance reduces the overall fund requirement, required to

build up the Current Assets, which in turn help you improve your Turn Over

Ratio.

The company is performing exceptionally well due to the up wising in the

global market followed by the domestic market. It is an up coming one with

good and innovative ideas and believed in improving all the areas of its

operations. The company has a good liquidity position and does not delay its

commitment in case of both its creditors and debtors. The company being

mostly dependent on the working capital facilities, it is maintaining very good

relationship with their banks and their working capital management is well

balanced.

1. The working capital position of the company is sound and the various

sources through which it is funded are optimal.

2. The company has used its dividend policy, purchasing, financing and

investment decisions to good effect can be seen from the inferences made

earlier in the project.

3. The returns have been affected by a marked growth in working capital and

2009 return on investment is good, but it got reduced as compared to 2008.

4. The various ratios calculated are an indicator as to the fact that the

profitability of the firm and sales are on a rise and also the deletion of the

inefficiencies in the working capital management.

5. The firm has not compromised on profitability despite the high liquidity is

commendable.

6. Arabian Industries has reached a position where the default costs are as low

as negligible and where they can readily factor their accounts receivables for

availing finance is noteworthy.

9.3SUGGESTIONS

Suggestions can be use by the firm for the betterment increased of the firm

after study and analysis of project report on study and analysis of working

capital. The suggestions are:-

1. Company should raise funds through short term sources for short term

requirement of funds, which comparatively economical as compare to

long term funds.

2. Company should take control on debtor’s collection period which is

major part of current assets.

3. Company has to take control on cash balance because cash is non earning

assets and increasing cost of funds.

4. Company should reduce the inventory holding period with use of zero

inventory concepts.

5. The current assets should be managed more effectively so as to avoid

unnecessary blocking of capital that could be used for other purposes.

6. There are various global challenges that are faced by every company n

the present competitive environment and AI LLC is not any exemption.

To face the present global challenges the human resources department

should be develop to improve various skills among the employees

specially the motivational skills and having the regular training for the

employees about various developments in the market.

Over all company has good liquidity position and sufficient funds to repayment

of liabilities. Company has accepted conservative financial policy and thus

maintaining more current assets balance. Company is increasing sales volume

per year which supported to company for sustain 2nd position in Sultanate of

Oman and 3rd position in GCC Countries.

Summarizing the overall project work done during these 2 months, it can

be said that the project was a good learning experience. The entire staff of

finance department was very cooperative and they helped in all the phases of

this project. It was an opportunity to learn about inventory management at the

same time problems faced by the Company. These two months has given an

opportunity to conceptualize and implement a new initiative. There we could

learn how to interpret working capital and ratio analysis with the help of

guidance given by the Finance Manager. There were lot of difficulties in the

beginning of the project but slowly it got the grip on the road towards future.