Working Capital Project Report Dhanalaksmi

8/8/2019 Working Capital Project Report Dhanalaksmi

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1.1 GENERAL INTRODUCTION

All business organizations prepare financial statements after every financial year. The financial

statements clearly indicate the financial position of the business concern. Published financial statements

may be of considerable interest to shareholders, trade organizations, business analyst and many others.

Each of these groups may be interest in different aspects of the business concern according to their own

purposes.

The basis for financial planning, analysis and decision making is the financial information.

Financial information is needed to predict, compare and evaluate the firms earning ability. It is also

required to aid in economic decision making investment and financing decision making. The financial

information of an enterprise is contained in the financial statements or accounting reports.

The financial analysis is the process of analyzing the financial strengths and weaknesses of the

firm by properly establishing the relationships between the items of the balance sheet and profit and loss

account. It is the study of the performance of the unit and therefore is aimed at financial performance of

an individual unit.

This report deals with the financial performance of HDFC Standard Life Insurance Company Ltd.

for the financial year 2008 to 2010.

This report briefly explains the subject matter (financial statements analysis) of the study

conducted. The basis for the financial planning, analysis and decision-making is the financial information.

Financial information is needed to predict, compare and evaluate the firms earning ability. It is also

required to aid in economic decision making investment and financing decision making. The financial

information of an enterprise is contained in the financial statements or accounting reports.

The financial analysis is the process of identifying the financial strengths and weaknesses of the

firm by properly establishing relationship between the items of the balance sheet and profit and loss

account. It is the study of the performance of the unit and therefore is aimed at the financial performance

in an individual unit. This is therefore aimed at analyzing the performance, trend and the areas of

strengths and weaknesses of the firm.

International Business School, Bangalore

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The objective of the study was to thoroughly analyze the companys performance and the

financial position over the years i.e., the direction and the trend in which the company is performing and

the various and their uses.

The balance sheet and the income statement of the company provide some extremely useful

information to the extent that the balance sheet mirrors the financial position on a given date in terms of

the structure of assets, liabilities and owners equity etc. The comparison of the above statements is

therefore an important aid in determining the companys position and performance over a period of time.

The first task in the analysis is the selection of the information relevant to the decision under

consideration from the total information contained in the financial statements. The second task is to

arrange the information in a way to highlight comparison among different variables from balance sheet

and income statement of different years. The final step is that of drawing inferences and conclusions.

The best tool used for the purpose of finding out trends of an organizations growth over a period

of time is Ratio Analysis. The variables in the balance sheet provides considerable information which is

eventually helpful for the organization as the trends can be studied and it forms the basis of drawing

important inferences.

Working Capital is the capital required for the day-to-day operations of the business it maybe

regarded as the life blood of business. Its effective position can do much to ensure the success of a

business, while its inefficient management can lead not only to loss of profit but also the ultimate

downfall the study of working capital management is important because of its close relation with the day

to day operations of the business Therefore to keep healthy management of working capital business

needs professionalism and good skill thus the management of working capital varies from industry to

industry.

HDFC Standard Life Insurance Company Ltd. has been taken for the case study to analyze the

financial aspects to working capital for the better understanding of the financial standing of the Company.


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help of secondary data available. Though questionnaire was not prepared there was use of primary data in

the case of financing of working capital through paper work and discussions held with the senior financial

manger.

4. PLAN OF ANALYSIS:The data has been compiled, analyzed and tabulated in various forms. The tabulated financial data

has been further interpreted. These interpretations have been used to form conclusions and suggest

recommendation. Using various financial tools like fund flow statement, ratios and percentages the

analysis was done.

5. RESEARCH METHODOLOGY:

Two Years Balance sheet and Profit & Loss account stated in annual reports were used for

analysis Working Capital & concerned ratios that were used as tools of analysis based upon the

companies financial position, performance was evaluated suggestions were made. Regarding financing of

working capital both the methods were evaluated by extracting information from balance sheet for two

years, then the best alternative was chosen based on which the companies position regarding the financing

of working capital was known.


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About the HDFC Standard Life Insurance Company Ltd.

HDFC Standard Life Insurance Co. Ltd. was incorporated on 14th august 2000. It is a joint venture

between Housing Development Finance Corporation Limited (HDFC Ltd.) India and U.K. based

Standard Life Company

HDFC Standard Life, one of Indias leading private life insurance companies, offers a range of individualand group insurance solutions. It is a joint venture between Housing Development Finance Corporation


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Limited (HDFC), Indias leading housing finance institution and Standard Life plc, the leading provider

of financial services in the United Kingdom.

HDFC Ltd. holds 72.43% and Standard Life (Mauritius Holding) Ltd. holds 26.00% of equity in the jointventure, while the rest is held by others.

HDFC Standard Lifes product portfolio comprises solutions, which meet various customer needs such as

Protection, Pension, Savings, Investment and Health. Customers have the added advantage of

customizing the plans, by adding optional benefits called riders, at a nominal price. The company

currently has 32 retail and 4 group products in its portfolio, along with five optional rider benefits

catering to the savings, investment, protection and retirement needs of customers.

HDFC Standard Live continues to have one of the widest reaches among new insurance companies with

568 branches servicing customer needs in over 700 cities and towns. The company has a strong presence

in its existing markets with a base of 2,00,000 Financial Consultants.

HDFC Standard Life Insurance Company Profile

The MD and CEO of HDFC Standard Life Mr. Deepak Satwalekar, has given the company new

directions and has helped the company achieve the status it currently enjoys. HDFC Standard Life brings

to you a whole range of insurance solutions be it group or individual or NAV services for corporations;

they can be easily customized as per specific needs.

HDFC Standard Life Insurance India boasts of covering around 8.7 lakh lives by March'2007. The grossincomes standing at whopping Rs. 2,856 chores, HDFC Standard Life Insurance Corporation is sure to

become one of the leaders and the first preference for any life insurance customer.

The Banc assurance partners of HDFC Standard Life Insurance Co Ltd are HDFC, HDFC Bank India

Limited, Union Bank of India, Indian Bank, Bank of Baroda, Saraswat Bank and Bajaj Capital.

Areas of Operation:

HDFC Standard Life continues to have one of the widest reaches among new insurance

Companies. The company strengthened its number of offices from 103 to 572 across the country

in less than 3 years. Through these offices, the company today services customer needs in over


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730 cities and towns. HDFCSLIC is head quartered at Mumbai and has established its presence in

The states of:

Andhra Pradesh Assam

Bihar Chatthisgarh

Delhi GoaGujarat Haryana

Himachal Pradesh Jharakhand

Karnataka Kerala

Madhya Pradesh Maharashtra

Meghalaya Orissa

Punjab Rajasthan

Tamil Nadu Uttar Pradesh

Uttaranchal West Bengal

Some of the cities in which HDFCSLIC has its branches are:

Ahmedabad, Bangalore,

Chennai, Chandigarh,

Hyderabad, Jaipur,

Jalandar, Jodhpur,

Ludiana, Kanpur,

Kolkata, Lucknow,

Mangalore, Meerut

Mysore, New Delhi, Noida,

Pune, Trichur,

Trivandrum, Vishakapatnam, etc

HDFC Ltd.

HDFC was incorporated in 1977 with the primary objective of meeting a social need - that of

Promoting home ownership by providing long-term finance to households for their housing

needs. HDFC was promoted with an initial share capital of Rs. 100 million.

HDFC Founder


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Hasmukhbhai Parekh, Founder and Chairman

Business ObjectivesThe primary objective of HDFC is to enhance residential housing stock in the country throughthe provision of housing finance in a systematic and professional manner, and to promote home

ownership. Another objective is to increase the flow of resources to the housing sector by

integrating the housing finance sector with the overall domestic financial markets.

Subsidiaries and associate Companies

HDFC Bank

HDFC Mutual Fund

HDFC Standard Life Insurance Company

HDFC Sales

HDFC General Insurance

Other Companies Co-Promoted By HDFC

Financial Information with regard to Subsidiary Companies

HDFC is a unique example of a housing finance company which has demonstrated the viability

of market-oriented housing finance in a developing country. It is viewed as an innovative

institution and a market leader in the housing finance sector in India. The World Bank considers

HDFC a model private sector housing finance company in developing countries and a provider

of technical assistance for new and existing institutions, in India and abroad. HDFCs executives

have undertaken consultancy assignments related to housing finance and urban development on

behalf of multilateral agencies all over the world.


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MISSION AND VISION OF HDFCSLIC

Mission: What we do

Our mission is to build valuable customer relationships by helping customers grow and protect

their assets.

HDFCSLIC aims to be the top new life insurance company in the market. This does not just mean

being the largest or the most productive company in the market. Rather it is a combination of

several things like-

Customer service of the highest order

Value for money for customers

Professionalism in carrying out business

Innovative products to cater to different needs of different customers

Use of technology to improve service standards

Increasing market share

Vision: What we aspire to achieve

Our vision is to help our customers around the world feel confident about their future wealth and

well being.

'To be the most successful and admired life insurance company, which means the most trusted

Company, the easiest to deal with, offer the best value for money, and set the standards in the

Industry'.

'The most obvious choice for all'.

Organizational Goals:HDFCSLIC's main goals are to

a). Develop close relationships with individual households,

b). Transform ideas into viable and creative solutions,

c). Provide consistently high returns to shareholders, and

d). To grow through diversification by leveraging off the existing client base.

Values: Values that the company observes while it works:

Integrity

Innovation

Customer centric

People Care One for all and all for one

Team work

Joy and Simplicity

Thinking holistically: taking a whole view of the person, their needs and how these can be met

Being flexible: developing innovative products, services and solutions that allow for change

and evolve with peoples needs Delivering performance: being a better place to grow and protect assets

Acting with integrity: ensuring each and every one of us does the right thing


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The various products by HDFC Standard Life include:

INDIVIDUAL PRODUCTS:

Protection Plans

o Term Assurance Plan

o Loan Cover Term

o Assurance Plan

Investment Plans:

o Single Premium Whole Life Plan

Pension Plans:

o Personal Pension Plan

o Unit Linked Pension Plan

o Unit Linked Pension Plus

Savings Plans:

o Endowment Assurance Plan

o Unit Linked Endowmento Unit Linked Endowment Plus

o Money Back Plan

o Children's Plan

o Unit Linked Youngster

o Unit Linked Youngster Plus

GROUP PRODUCTS

o Group Term Insurance

o Group Variable Term Insurance

o Group Unit Linked Plan

OTHER PRODUCTS

o Rural Products

o Social Development Insurance Plan

o Tax Benefit Schemes

The premium payment options available to the customers vary from online payment to direct deskpayments at the HDFC Standard Life Branches, by courier services or in drop boxes provided. You can

also pay by ECS or Automatic Debit System or credit cards or standing instruction mandate. HDFC

Standard Life Insurance Company is a customer oriented corporation and aim at complete customer


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satisfaction.

The lapsation and renewal policy of HDFC Standard Life are clearly defined on the official website.

Online renewal forms are also available. For any change in personal details like the contact details or the

nominee of the policy or policy benefits, online servicing is also available. Even the claim procedure has

been simplified since affect of the loss life is irreparable and is thus fully understandable at HDFCStandard Life. A completely hassle-free process has been formulated to provide maximum convenience.

Facility of HDFC Standard Life Insurance Company Ltd.

Protection Plans

HDFC Term Assurance Plan

HDFC Premium Guarantee Plan

HDFC Loan Cover Term Assurance Plan

HDFC Home Loan Protection Plan

Children's Plans

HDFC SLIC Youngster Super II

HDFC SLIC Youngster Super Premium

HDFC Children's Plan

Health Plans

HDFC Critical Care Plan

HDFC Surgicare Plan Savings & Investment Plans

HDFC SLIC Crest

HDFC SLIC ProGrowth Super II

HDFC SL ProGrowth Maximiser

HDFC Endowment Assurance Plan

HDFC SL New Money Back Plan

HDFC Single Premium Whole of Life Insurance Plan

HDFC Assurance Plan

HDFC Savings Assurance Plan

Retirement Plans

HDFC Personal Pension Plan

HDFC Immediate Annuity

Rural Products

HDFC GraminBima Kalyan Yojana

HDFC GraminBima Mitra Yojana


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HDFC BimaBachat Yojana

Social Products

HDFC Development Insurance Plan

Why do I need Protection Plans?

Protection Plans help you shield your family from uncertainties in life due to financial losses in terms of

loss of income that may dawn upon them incase of your untimely demise or critical illness. Securing the

future of ones family is one of the most important goals of life. Protection Plans go a long way in

ensuring your familys financial independence in the event of your unfortunate demise or critical illness.

They are all the more important if you are the chief wage earner in your family. No matter how much you

have saved or invested over the years, sudden eventualities, such as death or critical illness, always tend

to affect your family financially apart from the huge emotional loss.

For instance, consider the example of Amit who is a healthy 25 year old guy with a income of Rs.

1,00,000/- per annum. Let's assume his income increases at a rate of 10% per annum, while the inflation

rate is around 4%; this is how his income chart will look like, until he retires at the age of 60 years. At 50years of age, Amits real income would have been around Rs. 10,00,000/- per annum.

However, in case of Amits unfortunate demise at an early age of 42 years, the loss of income to his

family would be nearly Rs. 5,00,000/- per annum.

However, with a Protection Plan, a mere sum of Rs. 2,280/- annually (exclusive of service tax &

educational cess) can help Amit provide a financial cushion of up to Rs. 10,00,000/- for his family over a

period of 25 years.

Types of Protection Plans

HDFC Term Assurance Plan

HDFC Premium Guarantee Plan


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HDFC Loan Cover Term Assurance Plan

HDFC Home Loan Protection Plan

Why do I need Childrens Plans?

Childrens Plans helps you save so that you can fulfill your childs dreams and aspirations. These plans

go a long way in securing your childs future by financing the key milestones in their lives even if you are

no longer around to oversee them. As a parent, you wish to provide your child with the very best that life

offers, the best possible education, marriage and life style.

Most of these goals have a price tag attached and unless you plan your finances carefully, you may not beable to provide the required economic support to your child when you need it the most. For example, with

the high and rising costs of education, if you are not financially prepared, your child may miss an

opportunity of a lifetime.

Today, a 2-year MBA course at a premiere management institute would cost you nearly Rs. 3,00,000/- At

a assumed 6% rate of inflation per annum, 20 years later, you would need almost Rs. 9,07,680/- to finance

your child's MBA degree.

An illustration of how education expenses could rise with passing time due to inflation

Source: HDFC Standard Life Survey 2008. Inflation assumed as 6% p.a.


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So, how can you cope with these costs? Childrens Plans help you save steadily over the long term so that

you can secure your childs future needs, be it higher education, marriage or anything else. A small sum

invested by you regularly can help you build a decent corpus over a period of time and go a long way in

providing your child a secured financial future along with

Types of Childrens Plans

Conventional Plans

HDFC Childrens Plan

Unit Linked Insurance Plans

HDFC SL Young Star Super II

HDFC SL Young Star Super Premium

Why do I need Health Plans?

Health plans give you the financial security to meet health related contingencies. Due to changing

lifestyles, health issues have acquired completely new dimension overtime, becoming more complex in

nature. It becomes imperative then to have a health plan in place, which will ensure that no matter how

critical your illness is, it does not impact your financial independence.

In the race to excel in our professional lives and provide the best for our loved ones, we sometimes

neglect the most important asset that we have our health. With increasing levels of stress, negligible

physical activity and a deteriorating environment due to rapid urbanization, our vulnerability to diseases

has increased at an alarming rate.


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Source: National Commission on Macroeconomics and Health Report 2005.

Note: Current figures are for the year 2000(Cardiovascular diseases)), 2001 (COPD and Asthma), 2004

(Cancer) and 2005(Diabetes and Mental Health). All figures above are on a per lakh basis.

As can be seen in the above chart, lifestyle diseases are set to spread at disturbing rates. The result

increased expenditure. In many cases, people need to borrow money or sell assets to cover their medical

expenses. All it takes is a suitable plan to help you overcome the financial woes related to your health by

paying marginal amounts as premiums. For example, if you are 30 years old, then a mere sum of

approximately Rs 3500* annually (exclusive of taxes) can provide you a health insurance plan of Rs 5

lakh over a period of 20 years, and a worry-free future for you and your family.

*Note: The assumption is based on the HDFC Critical Care Plan. The figure is only indicative and the actual premium

may depend upon numerous factors such as age, sum assured, gender, policy term, premium payment frequency and

additional benefits opted for. It also differs from plan to plan and option to option

Types of Health Plans

HDFC Critical Care Plan

HDFC Surgi Care Plan


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Why do I need Savings & Investment Plans?

You have always given your family the very best. And there is no reason why they shouldnt get

the very best in the future too. As a judicious family man, your priority is to secure the well-being of

those who depend on you. Not just for today, but also in the long term. More importantly, you have toensure that your familys future expenses are taken care, even if something unfortunate were to happen to

you.

A big factor that you need to consider while building your wealth is inflation. It has a dual impact on your

hard-earned savings. Inflation not only erodes your current purchasing power but also magnifies your

monetary requirements for the future. Sample this: An 35 Year individual needs to invest Rs. 36,000/- per

year with 8% returns to build a corpus of Rs. 10,00,000/- by the age of 50 Years.

However, Rs. 10,00,000/- after 15 years would be worth roughly around half of what it is today once

adjusted for inflation at the rate of 4%. Therefore, an individual will need to save nearer to Rs 50,000/-

annually to reach your targeted savings at the age of 50 Years, if you consider inflation.

Our Savings & Investment Plans provide you the assurance of lump sum funds for your and your familys

future expenses. While providing an excellent savings tool for your short term and long term financial

goals, these plans also assure your family a certain sum by way of an insurance cover. With HDFC

Standard Lifes range of Saving & Investment Plans, you can therefore ensure that your family always

remains financially independent, even if you are not around.


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Types of Savings & Investment Plans

Type Conventional Plans Unit Linked Insurance Plans

Regular Premium HDFC SL New Money Back Plan

HDFC Assurance Plan#

HDFC Savings Assurance Plan^

HDFC Endowment Assurance Plan

HDFC SL ProGrowth

Super II

Single Premium/

Investment HDFC Single Premium Whole of Life

Insurance Plan

HDFCSL Pro Growth

Maximiser

Limited Premium

Payment

HDFC SL Crest

#HDFC Assurance Plan is available for sale through our Bancassurance Partners (HDFC Ltd., HDFCBank, Saraswat Bank and Indian Bank)

^HDFC Savings Assurance Plan is available for sale through HDFC Bank

Why do I need Retirement Plans?

Retirement Plans provide you with financial security so that when your professional income starts

to ebb, you can still live with pride without compromising on your living standards. By providing you a

tool to accumulate and invest your savings, these plans give you a lump sum on retirement, which is then

used to get regular income through an annuity plan. Given the high cost of living and rising inflation,

employer pensions alone are not sufficient. Pension planning has therefore become critical today.

Indias average life expectancy is slated to increase to over 75 years by 2050 from the present level of

close to 65 years. Life spans have been increasing due to better health and sanitation conditions in the

country. However, the average number of years of employment has not been rising commensurately. Theresult is an increase in the number of post-retirement years. Accordingly, it has become necessary to

ensure regular income for life after retirement, so that you can live with pride and enjoy your twilight

years.


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Priorities at different stages of life:-

However, skyrocketing costs can throw even a well-laid plan off balance. With costs rising every day,

you can just imagine how high they will be when you are ready to hang up your boots. So, what shouldyou do to counter this? Its time to plan your retirement and that too sooner than later.

The above illustration shows how with each passing year your annual savings requirement would

increase. For instance, if you are 30 years old and plan to retire at 60, then, with a current annual

expenditure of Rs. 3,00,000/- , you would need a corpus in excess of Rs. 2,00,00,000/- to maintain yourliving standards, assuming you live till 85 years and the inflation rate is 4%. To build this retirement

corpus, you need to invest Rs 3,60,000/- per annum in a retirement plan that offers 8% returns per annum.

In case you delay planning your retirement by 5 years then the investment amount would increase to Rs

6,90,000/- per annum.


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WORKING CAPITAL MANAGEMENT

Introduction:

Working capital is the lifeblood of every business. Its effective provision ensures success and

inefficient provision reduces the profit and results in downfall of the company. Mismanagement of

business failure. A study of working capital is of major importance to internal and external analysis

because of its close relationship with day-do-day operations of a business.

Definition:

In accounting concept working capital is nothing but, The difference between inflow and outflow

of cash. It is also known as the difference between current assets and current liabilities. Current assets

consists of cash/bank balance, short from investments, receivables, stocks advance payments etc., current

liabilities include creditors, bills payables, bank overdraft, short term loans etc.,


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GROSS WORKING CAPITAL

NET WORKING CAPITAL

NEGATIVE WORKING CAPITAL

RESERVE WORKING CAPITAL

PERMANENT WORKING CAPITAL

TEMPERARY WORKING CAPITAL

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1. Gross working capital:

It is the amount of funds invested in the various components of current assets.

2. Net working capital:

It is the difference between current assets and the current liabilities. The concept of net working

capital enables a firm to determine the exact amount available at its disposal for operational requirements.

It reflects the companys liquidity position.

3. Negative working capital:

When current liabilities exceed current assets negative working capital emerges. Such a situation

occurs when a firm is nearing a crisis of some magnitude.

4. Reserve working capital:

It refers to the short term financial arrangement made by the business units to meet uncertainties.

Business firms are always exposed to risks, which may be controllable or uncontrollable. In the event of

happenings of such events, reserve working capital strengthens the capacity of the company to face the

challengers.

5. Permanent working capital:

It means the minimum amount of investment in all current assets which is regarded at all times to

carry on minimum level of business activities. The operating cycle is a continuous process and therefore,

the need for current assets. But, the magnitude of current assets increases and decreases over time. There

is always a minimum level of current assets required at all times by the firm to carry on its business

operations. The minimum level of current assets is known as permanent working capital or fixed working

capital.

6. Temporary working capital:

This is also called the fluctuating or variable working capital. The amount of temporary working

capital keeps on changing depending upon the changes in production and sales. For example extra

inventory of finished goods will have to be maintained to support the peak periods of sale and investment


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in receivable may also increase during such period. On the other hand investment in raw materials, work-

in-progress and finished goods will decrease. If the market is black. The extra working capital required

to support the changing production and sales activities is known as temporary working capital.

The figure above shows that the permanent level is fairly constant while temporary working

capital is fluctuating sometimes increasing and sometimes decreasing in accordance with seasonable

demands. In the case of an expanding firm the permanent working capital line may not be horizontal this

is because the demand for permanent current assets might be increasing or decreasing to support a rising

level of activity.

Both finds working capital are necessary to facilitate the sales process through the operation cycle.

Temporary working capital is created to meet liquidity requirements that are purely transient nature.

Need for working capital:

The basic objective of financial management is maximizing wealth of shareholders. This can be

achieved when a firm earns sufficient returns from its operations. The amount of such earnings largely

depends upon the magnitude of sales. There is always a time gap between sales of goods and the final

realization of cash. Current assets are required during time gap in order to sustain the sales activity.

Adequate working capital is required during this period for the purchase of raw material, payment of

images or other expenses required for the manufacturing of goods to be sold. Working capital is also

required to run the business smoothly.

Operating cycle:

The duration of the time required to complete the following cycle of events in a case of

manufacturing firm is called as operating cycle. The operating cycle consists of the following events.

1. Conversion of cash into raw material

2. Conversion of raw material into work-in-progress

3. Conversion of work-in-progress into finished goods

4. Conversion of finished goods into debtors and bills receivable through sales

5. Conversion of debtors and bills receivable into cash


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This cycle will be repeated again and again. This can be shown in the following chart.

OPERATING CYCLE

Determinants of working capital:

A large number of number of factors influence working capital needs of a firm. The basic

objectives of working capital management are to manage the firms current assets and current assets and

current liabilities in such a way that a satisfactory level of working capital is maintained.

The following factors determine the amount of working capital.


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RAW MATERIAL

CASH WORK-IN-PROGRESS

ACCOUNT RECIEVABLES FINISHED GOODS


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1. Nature of business:

The composition of current assets is a function of the size of a business and industry to which it

belongs. Small companies have smaller proportion of cash, receivables and inventory than large

corporations. This difference becomes more marked i.e., large corporations. A public utility concern, forexample, mostly employees fixed assets in its operations, while a merchandising department depends

generally on inventory and receivables. Need for working capital is thus determined by the nature of an

enterprise.

2. Size of business:

The size of business is also an important impact on its working capital needs. Size may be,

measured in terms of scale of operations. A firm with large scale of operation will need more working

capital than a small firm.

3. Length of the Manufacturing Process:

Larger the manufacturing process, the higher will be the requirement of working capital and vise

versa. This is because of the fact that highly capital-intensive industries require a large amount of

working capital to run their sophisticated and long production process. On the same principle of trading

concern requires a much lower working capital than a manufacturing concern.

4. Production policy:

The production policies by the management have a significant effect on the requirement on

working capital of the business. The production schedule has a great influence on the level of inventories.

The decision automation etc., will also have an effect on the working capital requirements.

5. Volume of sales:

This is the most important factor effecting the size and components of working capital. A firm

maintains current assets because they are needed to support the operational activities which resulting

sales. The volume of sales and size of the working capital are directly related to each other. As the

volume of sales increases there is an increase in the investment of working capital.

6. Terms of purchases and sales:

A Firm, which allows liberal credit to its customers, may enjoy higher sales but will need more

working capital as compared as compared to a firm enforcing strict credit terms. The working capital

requirements are also effected by the credit facilities enjoyed by the firm.


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7. Business cycle:

Business expands during the period of prosperity and declines during the period of depression;

consequently, more working capital is required during the period of prosperity and less during the period

of depression.

8. Growth and expansion:

If a business firm has ambitious plan for expansion, it requires more working capital, to fulfill

such requirements. Growth and expansion in business is more essential to exploit the available business

opportunity and to increase the existing market share.

9. Fluctuations in the supply of raw materials:

Certain companies have to obtain and maintain large reserve of raw materials due to their irregular

sales and intermittent supply. This is particularly true in case of companies requiring special kind of raw

materials available only from one or two sources. In such a case a large quantity of raw materials is to be

kept in store to avoid an possibility of the production process coming to a dead halt. Thus, the working

capital requirements in case of such industries would be large.

10. Price level changes:

The increasing shifts in price levels make the functions of financial managers difficult. He should

anticipate the effect of price level changes on working capital requirements of the firm. Generally, rising

price levels will require a firm to maintain higher amounts of working capital. The same levels of current

assets will need increased investment when prices are increasing.

11. Operating efficiency:

The operating efficiency of the firm relates to the optimum utilization of resources at a minimum

cost. The firm will be effectively contributing to its working capital if its efficient in controlling the

operating costs. The use of working capital is improved and pace of cash cycle is accelerated with

operating efficiency.

12. Profit margin:

Firms differ in their capacity to generate profit from business operations. Some firms enjoy a

dominant position, due to quality product or good marketing management or monopoly power in the


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market and earn a high profit margin. Some other firms may have to operate in an environment of intense

competition and may earn low margin of profits.

13. Profit appropriations:Even if the net profits are earned in cash at the end of the period, whole of it is not available for

working capital purposes. The contribution towards working capital would be effected by the way in

which profits are appropriated. The availability of cash generated from operations thus depends upon

taxation, dividend and retention policy and depreciation policy.

14. Credit Policy:

A, company which follows a liberal credit policy to its customers, may have higher sales but will need

higher working capital as compared to a company which has an efficient debt collection machinery and

observing strict terms. A company enjoying liberal credit facilities from its suppliers will need lower

amount of working capital as compared to a company, which does not enjoy such credit facilities.

PRINCIPLES OF WORKING CAPITAL MANAGEMENT:

Principle of risk variation:

Risk here refers to the inability of a firm to maintain sufficient current assets to pay for its

obligations, if working capital is varied relative to ales; the amount of risk that a firm assumes is alsovaried and the opportunity for gain or loss is increased.

As the level of working capital relative to sales decreases the degree of risk increases. When the

degree of risk increases the opportunity for gain or loss also increases. Thus if the level of working

capital goes up the amount of risk goes down and the opportunity for gain or loss is likewise adversely

affected. Depending upon this attitude, the management changes the size of working capital.

Principle of cost of capital:


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This principle emphasizes the different sources of finance, for each source has a different cost of

capital. It should be remembered that the cost of capital moves inversely with risk. Thus additional

capital results in the decline in the cost of capital.

Principle of equity position:

Accounting to this principle the amount of working capital invested in each corporate should be

adequately justified by a firms equity position. Every rupee invested in the working capital should be

contributed to the net worth of the firm.

Principle of maturity of payments:

A company should make every effort to relate maturity of payments be it flow of internally

generated funds. There should be the least disparity between the maturities of a firms short-term debt

instruments and its flow of internally generated funds because a greater risk is generated with greater

disparity. A margin of safety however should be provided for short-term debt payments.

Sources of working capital:

There are two approaches for sources of finance:

a. Hedging approach

b. Conservative approach

A. Heading approach:

The term hedging approach is often used in the sense of risk reducing investment strategy

involving transactions of simultaneous but opposite nature so that the effect of one is likely to counter

balance the effects of the other. With reference to an appropriate financing mix, the term hedging can be

said to refer to a process of matching maturity of financial needs. This approach to financing decision to

determine an appropriate financing mix is, therefore also called as maturity approach.

According to this approach the maturity of the source of funds should match the nature of the assets to be

financed for the purpose of analysis, the assets can be broadly classified into two classes.

1. Those that are required in a certain amount for a given level of operation and hence do not vary

over time.

2. Thos that fluctuates over time.


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When the firm follows marching approach, long term financing will be used to finance permanent

working capital. Temporary working capital should be financed out of short-term funds. The rationale

underlying marching approach is treat the maturity of sources of funds should match the nature of assets

to be financed.

Estimated total funds for company X for the year Y

MonthsTotal Funds required

(Rs)

Permanent

RequirementsSeasonal Requirements

1 2 3 4

January 9500 7900 1600

February 9000 7900 11000

March 8500 7900 600

April 8000 7900 100

May 7900 7900 0

June 8150 7900 250

July 9000 7900 1100

August 9350 7900 1450

September 9500 7900 1600

October 10000 7900 2100

November 9000 7900 1100

December 8500 7900 600

According to the hedging approach the permanent portion of funds should be financed with long-

term funds and the seasonal portion with short-term funds. With the approach, the short term financing

requirements (current assets) would be just equal to the short term financing (current liabilities). There

would therefore be on net working capital.

B. Conservative approach:

This approach suggests that the estimated requirements of funds should be met from long term

sources, the use of short term funds should be restricted to only emergency situations or when there is an


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unexpected outflow of funds. In the case of Hypothetical Company X in the total requirements,

including the entire rupees 10,000 needed in October, will be financed by long term services. The short-

term funds will be used to meet contingencies. The amount given represent the extent to which short term

financial needs are being financed by long term funds, that is the net working capital.

Estimated total funds for company X for the year Y

Months Total Funds require (Rs)Permanent

RequirementsSeasonal Requirements

1 2 3 4

January 9500 7900 1600

February 9000 7900 1100

March 8500 7900 600

April 8000 7900 100

May 7900 7900 0

June 8150 7900 250

July 9000 7900 1100

August 9350 7900 1450

September 9500 7900 1600

October 10000 7900 2100November 9000 7900 1100

December 8500 7900 600

Other sources of working capital:

1. Loans from financial institutions

2. Floating of debentures

3. Accepting public deposits

4. Rising of funds by internal financing

5. Issue of shares

1. Loans from financial institutions:

The option is ruled out because banks do not finance always for working capital requirement.

This facility may not be available to all companies.


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2. Floating of debentures:

Probability of sources is less because still Indian capital market could not get popularity. The

company not associated with reputed groups fails to attract investors. However issue of convertible

bonds is gaining momentum.

3. Accepting public deposits:

The success is directly related to the image of the company problem of low profitability in many

companies is very common.

4. Issue of shares:

It can be considered but the companies have to command respect of investors how profit margin

and lack of knowledge of the company makes this sources not an attractive one.

5. Raising of funds by internal financing:

It is a problem for many companies because the prices of end products are controlled and do not

permit the companies to pay reasonable dividend and retain profit for additional working capital

requirement.

However feasible solution lies in increasing the profitability through cost control, reduction,

managing cash operating cycle and rationalizing inventory or stock etc.,

MANAGEMENT OF CASH, INVENTORY AND RECEIVABLES

Cash management:

What is cash?

Cash is the most liquid asset that a business owns. It includes money and such instruments as

cheques, money orders and bank drafts. Cash in the business enterprise may be compared to the blood in

the human body. In broad sense it includes rear cash items such as time deposits with banks,

marketable securities etc., and such securities / deposits can be immediately sold or converted into cash if

necessary. The term cash management includes both cash and rear cash assets.

Motives of holding cash:

1. Transaction motive:


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A firm enters into a variety of business transactions in both in flows and outflows of cash. At time

the cash outflows may exceed the cash inflows. In order to meet the business obligations in such

situations, it is necessary to maintain adequate cash balance. The firms with the motive of meeting

routine business payments keep this cash balance.

2. Precautionary motive:

A firms cash balance to meet unexpected contingencies such as floods, strikes, presentment of

bills for payment earlier than the expected date, unexpected showing down of collection of accounts

receivables, sharp increase in price of raw materials etc., the more is the possibility of such contingencies;

the more is the amount of cash kept by this firm.

3. Speculative motive:

A firm also keeps cash balance to take advantage of unexpected opportunities typically outside the

normal cause of the business. Such move is therefore of purely a speculative nature. For example a firm

may like to take a payment of immediate cash or delay purchase of materials in the anticipation of

declining prices. Similarly, it may like to keep some cash balance to make profit by buying securities in

times when prices fall on account of tight money conditioned.

Compensation motive:

Banks provide certain services to their clients free of charge. They therefore, usually require

clients to keep minimum cash balance with them, which helps to earn interest and thus compensate them

for free services provided.

Business firms normally do not enter into speculative activities and therefore out of four motives

of holding cash balance the two most important motives are the cash transactions and compensation

motive.

How to have effective cash management?

Big corporations with sizable funds generally display a highly independent management of cash

assets. In these firms a responsible fiscal officer is charged with responsibility of managing working cash


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balance in relation to the needs for the payment of obligations. To search for the optimum cash probably

overstates the companys capabilities.

A proper cash management necessitates the development and application of some practicaladministrative procedures to accelerate the inflow of cash and to improve the utilization of excess funds.

This practical administrative procedure includes:

1. Planning of cash requirements

2. Effective control of cash flow

3. Production utilization of exceeds funds

Objectives of cash management:

A highly liquid, vital asset is cash. It is needed to meet every type of expenditure. Hence it should be

sufficiently made available. If a firm falls to provide funds to meet the obligations, it will be clear

indication of technical insolvency of firm. If the cash position of the firm is strong, it can command

business operations. Cash discounts can be obtained on purchases. Obligations can be met immediately.

Cost of capital will be minimized. However, it cannot also hold cash in an idle way. It should be made

productive. Keeping these two views, viz., liquidity and profitability, the following objectives of cash

management can be identified.

i. To make cash payments

j. ii. To maintain minimum cash reserve

To make cash payments:

The very objective of holding cash is to meet the various types of expenditure to be incurred in

business operations. Several types of expenditures have to be met at different points of time and the firm

should be prepared to make such cash payments. The firm should remain liquid to meet the obligations.

Otherwise the business suffers.

It is observed that cash is an oil to lubricate the every turning wheels of business, without it the process

of grinds to stop. Thus one of the basic objectives of cash management is to maintain the images of theorganization by making a prompt payment to creditors and to avail cash discounts facilities.


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To maintain minimum cash reserve:

Another important objective of cash management is to maintain reserve. This means in the

process of meeting obligations on time, the firm should not maintain unnecessarily heavy cash reserves.

It cannot keep cash idle. Excess cash balance should be productive. Maintaining minimum cash reserveis made possible by synchronizing cash inflows and outflows through cash budgeting. Cash collection

should be expedited and cash outflows should be controlled to conserve cash resources. Thus as far as

possible the firm should maintain minimum cash reserve to attain the objective of profitability.

Importance of cash management:

Cash management assumes more important than other current assets because cash is the mostsignificant and the least productive asset that the firm holds. It is significant because it is used to

pay firms obligations. However, cash is unproductive and as such, the aim of cash management

is to maintain adequate cash position to keep the firm sufficiently liquid to use excess cash in

some profitable way.

Management of cash is also important because it is difficult to predict cash flows accurately and

that there is not perfect coincidence between inflows and outflows of cash. Thus, during some

periods, cash outflows exceed cash inflows, because payments for taxes, dividends, excise duty,

seasonal inventory build up etc., are met through it. At other times cash inflows will be more than

cash payments, because there may be large cash sales and debtors may be realized in large sums

promptly.

Cash management is also important cash constitutes the smallest portion of the total current assets;

even then, considered time management is devoted for it.

Strategies of cash management:

1. Cash planning:

Cash inflows and outflows should be planned to project cash surplus or deficit for each period of

planning. Cash budget should be prepared for this purpose.

2. Managing cash flows:


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amounts are to be dimensional, which means an annuity multiplied by a price. Cash flow amounts passes

the perverse third dimension of time and indeed, it is the time dimension which is at the root of the

various problems created by accounting concepts, therefore it the long term profit are aimed at but in

short term the cash flow is much more important.

2. Environment:

There are environmental constraints that create cash flow problems for a firm. Such problem may

be created by the very nature of its operations, such a location or season ability of the market place.

Every firm should, therefore, examine its own position in respect of its environment that will affect its

short-term flow.

3. Managerial decisions:

A cash flow does not flow of its own accord. It is direct consequence of management decisions.

The management procedures employed for maximizing the use of cash through the control of payable and

related payments are:

Timings payments to vendors so that bills are paid only as they fall due.

Establishing procedure that will prevent or minimize the loss of discounts.

Centralizing payable and disbursement procedures.

Reducing compensating balance a deposit with banks.

Improving control over inter-company transfers

Utilizing manpower more effectively.

Strategic tax planning.

This need not be if management uses strategic tax planning to minimize its tax expenditure.

Currently, a management employs the following the techniques to reduce its tax payment.

1. It uses acerbated depreciation method or adopts guidelines and depreciation rate.

2. It uses investment credit to fall advantage by strategic acquisition and disposition of

property, plant and equipment.

3. It reduces research and developments, costs and similar expenses in the years in which

they are incurred instead of capitalizing them and amortizes such costs over a number of

years.

4. It adopts changes in accounting procedures particularly those initiated by the internal

reserve service or exploits changes in reporting periods.


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Cash forecasting:

Cash forecasts are required to prepare cash budgets. Cash forecasting may be done on short term

or long-term basis. Generally, forecast covering period of one year or less are considered short term,those beyond one year considered long term.

Types of cash forecast

Short term forecast:

It covers a period of one year or less. The important uses of short term cash forecast are:

It helps in determining cash requirements.

It helps in anticipating short term financing.

It helps in managing money market investments.

Long-term cash forecasting:

Long-term cash forecasts are prepared to give an idea of the companys financial requirements.

Once a company has developed a long term cash forecast, it can be used to evaluate the impact of new

product developments or plant acquisition on the firms financial position; three, five or more years in

future.

The Major uses of long-term cash forecasts are:

1. It indicates a companys future financial needs, especially for its working capital

requirements.

2. It helps in evaluating proposed capital projects. It pinpoints the cash required to finance

these projects as the cash to be generated by the company to support them.


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Short term

forecast

Long term

forecast


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3. It helps in improving corporate planning. Long-term cash forecasts compel each division

to plan for future and to formulate projects carefully. Long-term cash forecasts may be

two, three or five years.

How to manage debts?

a. Establish a credit policy:

The company should consider whether it is appropriate to offer credit at all and if so how much, to

whom and under what circumstances.

b. Assess customers credit worthiness:

From their banker or other sources before allowing trade credit.

c. Establish effective administration of debtors:

That not goods are dispatched until it has been vouched that the present order will take the

customer above his predetermined credit limit.

That invoices for supplied on credit go off the customers as soon as possible after the goods are

dispatched and this encourages the customers to initiate payments sooner rather than later.

That existing debtors are systematically reviewed and that slow payers are sent reminders

d. Establish a policy on bad debts:

The company should decide what is policy on writing off bad debts should be. This policy should

be planned except in unusual circumstances. It is important that writing off a bad debt only occurs when

all steps mentioned in the policy have been followed. Such writing off should be done at a senior level

management.

e. Consider offering discount for prompt payment:

It is possible to enter into agreement with a factoring company. In such cases, payment is

received from factoring company immediately after sale.

RATIO ANALYSIS AND CLASSIFICATION OF RATIOS


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Ratio Analysis:

Ratio analysis is a powerful tool of financial analysis. In such an analysis the ratios are used as

yardstick for evaluating the financial condition and performance of the firm. Analysis and interpretation

of various accounting ratios give a skilled and experienced analyst a better understanding of the financialcondition and performance of the firm than what he could have obtained only through a perusal of

financial statements.

Meaning of ratios:

The relationship between two accounting figures, expressed mathematically is known as a ratio

(financial ratio). The term ratio refers to the numerical or quantitative relationship between two figures.

A ratio is the relationship between two figures, and obtained by dividing the former by the later. Radios

are designed to show how one number is related to another. Ratios are relative form of financial

statements to measure the firms liquidity, profitability and solvency.

Significance of ratio analysis:

Following are the significance of ratio analysis

A. Managerial uses of ratio analysis:

1. Helps in decision-making:

Financial statements are prepared primarily for decision-making. But the information provided in

financial statements is not and in itself and no meaningful conclusion can be drawn from these statements

alone. Ratio analysis helps in making decisions from the information provided in these financial

statements.

2. Helps in financial forecasting and planning:

Ratio analysis is of much help in financial forecasting and planning. Planning is looking ahead

and the ratios calculated for a number of years work as a guide for the future. Meaningful conclusions

can be drawn for future from these ratios. Thus, ratio analysis helps in forecasting and planning.

3. Helps in communicating:


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The financial strength and weakness of a firm are communicated in a more easy and

understandable manner by the use of ratios. The information contained in the financial statements is

conveyed in a meaningful manner to the one for whom it is meant. Thus, ratios help in communication

and enhance the value of the financial statements.

4. Helps in co-ordination:

Radios even help in co-ordination, which is of utmost importance in effective business

management. Better communication of efficiency and weakness of an enterprise results in better

coordination in enterprise.

5. Helps in control:

Ratio analysis even helps in making effective control of the business. Standard ratio can be based

upon preformed financial statements and variances and deviations, if any, can be found by comparing the

actual with the standards so as to take a corrective action at the right time. The weakness or otherwise, if

any, come to the knowledge of the management which helps in effective control of the business.

6. Other uses:

These are so many other uses of the ratio analysis. It is an essential part of the budgetary control

and standard costing. Ratios are of immense importance in the analysis and interpretation of financial

statements as they bring the strength or weakness of a firm.

B. Utility to share holders / investors:

An investor in the company will like to assess the financial position of the concern where he is

going to invest. His first interest will be the security of the investment and then a return in the form of

dividend or interest. For the first purpose he will try to assess the value of fixed assets and the loan raised

against them. The investor will feel satisfied only if the concern has sufficient amount of assets. Long-

term solvency ratios, on the other hand, will be useful to determine profitability position. Ratio analysis

will be useful to the investor in making up his mind whether present financial position of the concern

warrants further investment or not.

C. Utility to creditors:

The creditors or suppliers extend short-term credit to concern. They are interested to know

whether financial position of the concern warrants their payments at a specified time or not. The concern


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pays short-term creditors out of its current assets. If the current assets are quite sufficient to meet current

liabilities then the creditors will not hesitate in extending credit facilities. Current and acid test ratios will

be an idea about the current financial position of the concern.

D. Utility to employees:

The employees are also interested in the financial position of the concern especially profitability.

Their wage increases and amount of fringe benefits are related to the volume of profits earned by the

concern. The employees make use of information available in financial statements. Various profitability

ratios relating to gross profit, operating profit, net profit, etc enable employees to put forward their

viewpoint for the increase of wages of other benefits.

E. Utility to government:

Government is interested to know the overall strength of the industry. Various financial

statements published by industrial units are used to calculate ratios for determining short-term, long term

and overall financial position of the concerns. Profitability indexes can also be prepared with the help of

ratios. Government may base its future policies on the basis of industrial information available from

various units. The ratios may be used as indicators of overall financial strength of public as well as

private sector. In the absence of the reliable economic information, governmental plans and policies may

not prove successful.

F. Tax audit requirements:

The finance act, 1984, interested section 44 AB in the Income Tax Act. Under this section every

assess engaged in any business having turnover or gross receipts exceeding Rs. 40 lacks is required to get

the accounts audited by a chartered accountant and submits the tax audit report before the due date for

filing the return of income under section 139(1). In case of a professional, a similar report is required if

the gross receipts exceed Rs. 10 lacks. Clause 32 of the Income Tax Act requires that the following

accounting ratios should be given:

Gross profit / turnover

Net profit / turnover

Stock-in-trade / turnover

Material consumed / finished goods produced.


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Advantages of ratio analysis:

Simplifies financial statements

Facilitates inter-firm comparison

Makes inter-firm comparison possible

Helps in planning

Limitations of ratio analysis:

The ratio analysis is one of the most powerful tools of financial management. Though ratios are

simple to calculate and easy to understand, they suffer from some serious limitations.

1. Limited use of a single ratio:

A single ratio, usually, does not convey much of a sense. To make a better interpretation a

number of ratios have to be calculated which is likely to continue the analyst than help him in making any

meaningful conclusions.

2. No fixed standards:

No fixed standards can be laid down for ideal ratios. There are not well-accepted standards or

rules of thumb for all ratios, which can be accepted as norms. It renders interpretation of the ratios

difficult.

3. Inherent limitation of accounting:

Like financial statements, ratios also suffer from the inherent weakness of accounting records such

as their historical nature. Ratios of the past are not necessarily true indicators of the future.

4. Change of accounting procedure:

Change in accounting procedure by a firm often makes ratio analysis misleading, example, a

change in the valuation of methods of inventories, from FIFO to LIFO increases the cost of sales and

reduces considerably the value of closing stocks which makes stock turnover ratio to be lucrative and an

unfavorable gross profit ratio.

5. Window dressing:


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Financial statements can easily be window dressed to present a better picture of its financial and

profitability position to outsiders. Hence, one has to be very careful in making a decision from ratios

calculated from such financial statements. But it may be very difficult for an outsider to know about the

window dressing made by a firm.

6. Personal bias:

Ratios are only means of financial analysis and not an end in itself. Ratios have to be interpreted

and different people may interpret the same ratio in different ways.

7. Incomparable:

Not only industries differ in their nature but also the forms of the similar business viable differ in

their size and accounting procedures, etc., It makes comparison of ratios difficult and misleading.

Moreover, comparisons are made difficult due to differences in definitions of various financial terms used

in the ratio analysis.

8. Absolute figure distractive:

Ratios devoid of absolute figures may prove decorative, as ratio analysis is primarily a

quantitative analysis and not a qualitative analysis.

9. Price level changes:

While making ratio analysis, no consideration is made to changes in price levels and this makes

the interpretation of ratio invalid. If the price level changes are considered for ratio analysis, then it may

lead to misleading results.

10. Ratios are a composite of many figures:

Ratios are a composite of many different figures. Some over a time period, others are at an instant

of time while still others are only averages.


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FUNCTIONAL CLASSIFICATION OF THE RATIOS

1. Liquidity ratios or short-term solvency ratios:


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Liquidity refers to the ability of a firm to meet its obligations in the short run, certain the financial

condition of a firm. Liquidity ratios are calculated by establishing relationships between current assets

and current liabilities. To measure the liquidity of a firm, the following ratios can be calculated.

A. Current ratio:

Current ratio may be defined as the relationship between current assets and current liabilities.

This ratio, also know as working capital ratio. This ratio is most widely used to make the analysis of a

short-term financial position or liquidity of a firm. It is calculated by dividing the total of current assets

by current liabilities. Thus,

Current Assets

Current ratio =

Current liabilities

Components of current ratio:

Current assets:

1. Cash in hand

2. Cash at bank

3. Debtors

4. Bill receivable

5. Prepaid expenses

6. Money at calls and short notice

7. Stock

8. Sundry supplies

9. Other amounts receivable with in a year

Current liabilities:

1. Creditors

2. Bill payable

3. Bank overdraft

4. Expenses outstanding

5. Interest due or payable


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6. Reserve for unbilled expenses

7. Installment payable on long-term loans

8. Any other amount which is payable in short period (one year)

Significance of current ratio:

1. Current ratio indicates the firms ability to pay its current liabilities i.e., day-to-day financial

obligations.

2. It shows short-term financial strength and solvency of a firm.

3. It is a test of a credit strength and solvency of a firm.

4. It indicates the strength of the working capital.

5. It indicates the capacity to carry on work effective operations.

6. It discloses the over-trading or under-capitalization.

7. It shows the tendency of over investment in inventory.

8. Higher the ratio i.e., more than 2:1 indicates inadequate working capital.

9. Lower ratio i.e., less than 2:1 indicates inadequate working capital.

10. It discloses the quantity of working capital position.

Ideal Ratio:

A ratio equal or near to the thumb of 2:1 i.e., current assets double the current liabilities is

considered to be satisfactory

B. Quick ratio:

Quick ratio is also known as liquid ratio or acid test ratio or near money ratio. It is the ratio

between quick or liquid assets and quick liabilities. The term quick asset refers to current assets, which

can be converted into cash immediately or at a short notice without diminution of value. Liquid assetscomprise all current assets minus stock and prepaid expenses. Liquid assets liabilities comprise all

current liabilities minus bank overdraft The quick ratio can be calculated by dividing the total of the

quick assets by total current liabilities. Thus,

Quick or liquid assets

Quick ratio =

Liquid or current liabilities


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Sometimes bank overdraft is not included in current liabilities while calculating quick or acid test ratio,

on the argument that bank overdraft is generally a permanent way of financing and is not subject to be

called on demand. In such cases, the quick ratio is found by dividing the total quick assets by quick

liabilities (i.e., current liabilities bank overdraft).Significance of quick ratio:

1. It is the true test of business solvency.

2. Higher ratio i.e., more than 1:1 indicates financial difficulty.

3. Lower ratio i.e., less than 1:1 indicates financial difficulty.

4. This is an important ratio of financial institutions.

5. It is a stringent test of liquidity.

6. It gives better picture of firms ability to meet its short-term debts out of short-term assets.7. If the current ratio is more than 2:1 but liquid ratio is less than 1:1 it indicates excessive

inventory.

8. It is more of qualitative nature of test.

Ideal Ratio:

An acid test ratio of 1:1 is considered satisfactory as a firm can easily meet current claims. It is the

true test of the firms solvency. It gives a better picture of firms ability to pay its short-term debts out ofshort-term assets. It is more of a qualitative nature of test.

C. Absolute liquidity ratio or cash position ratio:

It is a variation of quick ratio. When liquidity is highly restricted in terms of cash and cash

equivalents, this ratio should be calculated. Liquidity ratio measures the relationship between cash and

near cash items on the one hand, and immediately maturing obligations on the other. The inventory and

the debtors are excluded from current assets, to calculate this ratio.

Cash + Marketable securities

Cash position ratio =

Current Liabilities

Generally, 0.75:1 ratio is recommended to ensure liquidity. This test is more rigorous measure of

a firms liquidity position. If the ratio is 1:1, then the firm has enough cash on hand to meet all current

liabilities. This type of ratio is not widely used in practice


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D. Inventories to working capital ratio:

It represents the relationship between inventory or stocks and working capital of the firm.

Inventory or stock refers to closing stock of raw materials, work-in-progress (i.e., semi-finished good)and finished goods. Working capital is the excess of current assets over current liabilities. It is usually

expressed as a percentage. It is expressed as:

Inventory

Inventory to working capital ratio = x 100

Working capital

The ratio indicates the portion of working capital tied up in inventories or stocks and thereby

throws some light on the liquidity of a concern. It also indicates whether there is overstocking or under

stocking. As per the standard or ideal inventory to working capital ratio, the inventories should not

absorb more than 75% of working capital.

Ideal Ratio:

As per the standard, in the inventory to working capital ratio, the inventories should not absorb

more than 75 percentage of working capital.

3. Activity ratios or turnover ratio:

It is also refers to as assets management ratios measures the efficiency or effectiveness with which

a firm manages its resources or assets. The ratios are called turnover ratios because they indicate the

speed with which assets are converted or turned over into sales. These ratios are calculated by

establishing relationship between sales and assets. The various turnover ratios are as follows:

A. Inventory turnover ratio:

This is also known as stock velocity. This ratio is calculated to consider the adequacy of the

quantum of capital and its justification for investing in inventory. A firm must have reasonable stock in


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comparison to sales. It is the ratio of cost of sales and average inventory. This ratio helps the financial

manager to evaluate inventory policy. This ratio reveals the number of times finished stock is turned over

during a given accounting period. This ratio is used for measuring the profitability. The various ways in

which stock turnover ratios may be calculated are as follows:

Cost of goods sold

Stock turnover ratio =

Average stock

Cost of goods sold may be calculated as under:

Cost of goods sold = Opening stock + purchases + Direct

Expenses closing stock

This ratio indicates whether investment is inventory is within proper limit or not. The quantum of stock

should be sufficient to meet the demands of the business but it should not be too large to indicate

unnecessary lock-up of capital in stock and danger of stock-items obsolete and getting it wasted by

passing of time. The inventory turnover ratio measures how quickly inventory is sold. It is a test of

efficient inventory management. To judge whether the ratio of the firm is satisfactory or not, it should be

compared over time on the basis of trend analysis

Cost of Goods Sold Includes = Opening Stock + Purchases + Manufacturing expenses-Closing stock

Average Stock =Opening stock + Closing stock/2

B. Debt collection period ratio:

It indicates the numbers of time on the average the receivable are turnover in the each year. The

higher the value of ratio, the more is the efficient management of debtors. It measures the accounts

receivable (trade debtors and bill receivables) in terms of number of days of credit sales during a

particular period. It is calculated as follows:

Average debtors

Debt collection period= x 365


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Net credit sales

The purpose of this ratio is to measure the liquidity of the receivables or to find out the period over which

receivable remain uncollected.

Ideal Ratio:

The shorter the collection period the better is the quality of debtors as a short collection period

implies quick payment by debtors. Similarly a higher collection period implies an inefficient collection

performance, which in turn adversely affects the liquidity or short term paying capacity of a firm out of its

current liabilities.

Analysis and Interpretation:

Debtors turnover ratio indicates the number of times the debtors are turn over during a year.

Higher debtors velocity shows good management while low debtors velocity shows inefficient

management of debtors/sales and less liquid are the debtors. But a precaution is needed while interpreting

a very high debtors turnover ratio because a very high ratio may imply a firms inability due to lack of

resources to sell on credit.

C. Debt payment period ratio:

This is also known as accounts payable or creditors velocity. A business firm usually purchases

on credit goods, raw materials and services from other firms. The amount of total payables of a business

concern depends upon the purchases policy of the concern, the quantity of purchases and suppliers credit

policy. Longer the period of outstanding payable is, lesser is the problem of working capital of the firm.

But when the firm does not pay off its creditors within time, it may have adverse effect on the business.

Creditors turnover indicates the number of times the payable rotate in a year. It signifies the

credit period enjoyed by the firm paying creditors. Accounts payable include sundry creditors and bills

payable.

Payables turnover shows the relationship between net purchases for the whole year and total

payable (average or outstanding at the end of the year).


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Accounts creditors

Debt payment ratio = x 365

Net credit purchase

Net purchase = all credit purchases purchase returns

Ideal Ratio:

A higher ratio shows that the creditors are not paid in time. A lower ratio shows that the business is not

taking the full advantage of credit period allowed by the creditors.

Analysis & Interpretation:

A higher payment period implies that greater credit period is enjoyed by the firm and

consequently larger the benefit reaped by the credit suppliers. A higher ratio may also imply lesser

discount facilities availed or higher prices paid for the goods purchased on credit.

From the above table, one can ascertain that the company is moderately using its used its credit

facilities provided to it by its creditors.

D. Cash turnover ratio:

Its calculated as

Net annual sales

Cash turnover ratio =

Cash

Cash for the purpose means cash in hand, cash at bank, and readily realized marketable securities.

Turnover refers to the total annual sales (cash sales credit sales) effected during the year however, sales

means net annual sales i.e., total sales sales returns.


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This ratio indicates the extent to which cash resources are efficiently utilized by the enterprise. It

also helps in determining the liquidity of the concern.

Analysis & Interpretation:This ratio measures the velocity of sales turnover with a minimum cash balance. From the above

information it is clear that the company has achieved favorable sales figure in the year 2002-03 as well as

in the preceding years.

E. Working capital turnover ratio:

This ratio is a measure of the efficiency of the employment of the working capital. It indicates

over trading and under trading and is harmful for the smooth conduct of business. This ratio finds out the

relation between cost of sales and working capital. It helps in determining the liquidity of a firm in as

much as it gives the rate at which inventories are converted to sales and then to cash.

Net sales

Working capital turnover ratio =

Net working capital

(Net working capital = current assets current liabilities)

A higher sale in comparison to working capital means overtrading and lower sales in comparison

to working capital means under trading. A higher working capital turnover ratio shows that there is low

investment in working capital and there is more profit.

Working Capital Project Report Dhanalaksmi

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