CREDIT MANAGEMENT OF ROOTS INDUSTRIES LIMITED
EXECUTIVE SUMMARY
Working capital management plays an important role in day to day
operations of the business; hence the performance of the company
mainly depends on it. The management of working capital involves
managing inventories, accounts receivable and payable, and cash.
The project aims to study the Working Capital Management that is
undertaken by the concern, to determine the Operating Cycle and
Cash Cycle. This study also includes the analysis of the projected
working capital requirements of the company and provides certain
suggestions to improve the performance of the company.
The Project highlights the investment options of the company,
the methods used to control the accounts receivables, Monitoring
and controlling of inventories. The Project is undertaken to
determine the various sources of finance that are used to support
the current assets of the company. The Project analyses Working
Capital leverage and Working Capital Components. Here, the Working
capital management takes place on two levels:
1) Ratio analysis that can be used to monitor overall trends in
working capital and to identify areas requiring closer
management.
2) The individual components of working capital can be
effectively managed by using various techniques and strategies like
credit, inventory, cash and liquidity management.
Both Primary and Secondary data are used for the project.
Primary data are collected from the organization through
interactions with the financial executives Secondary data that are
used here are the projected annual report, various details
including monthly sales, monthly receivables.
CONTENTS
DescriptionPage. No
AcknowledgementI
Executive SummaryII
ContentsIII
List of tablesIV
List of chartsV
1 Introduction
1.1 Topic1
1.2 Company Profile6
1.3 Need for the study7
1.4 Objective of the study8
1.5 Scope of the study9
1.6 Limitations of the study10
2 Literature Review11
3 Research Methodology18
4 Data Analysis and Interpretation19
5 Findings51
6 Suggestions57
7 Conclusion60
Bibliography61
LIST OF TABLESTable No.TITLEPage No.
1Inventory Period For The Year 2003-200721
2Accounts Receivable Period For The Year 2003-200721
3Operating Cycle For The Year 2003-200722
4Monthly Sales And Receivables Of The Year 200724
5DSO Of The Year 200724
6Collection Procedure Of The Year 200725
7Ageing Schedule26
8Current Assets Of The Year 200732
9Current Liabilities Of The Year 200732
10Inventory Turnover Ratio36
11Debtors Turnover Ratio37
12Average Collection Period39
13Current Ratio40
14Quick Ratio42
15Components Of Working Capital43
16Working Capital Turnover Ratio44
17Net Working Capital45
18Sales46
19Current Assets47
20Current Liabilities48
21Expenses 49
LIST OF CHARTS
CHART NO.CHART NAMEPAGE NO.
1Operating Cycle For The Year 2003-200722
2DSO For Each Quarter For The Year 200725
3Inventory Turnover Ratio37
4Debtors Turnover Ratio38
5Average Collection Period39
6Current Ratio41
7Quick Ratio42
8Working Capital Turnover Ratio44
9Projections On Net Working Capital46
10Projections On Sales47
11Projections On Current Assets48
12Projections On Current Liabilities49
13Projections On Expenses50
LIST OF FIGURES
FIGURE NO.FIGURE NAMEPAGE NO.
1Operating Cycle And Cash Cycle19
1. INTRODUCTION
1.1Topic
Working capital management involves the relationship between a
firm's short-term assets and its short-term liabilities. The goal
of working capital management is to ensure that a firm is able to
continue its operations and that it has sufficient ability to
satisfy both maturing short-term debt and upcoming operational
expenses. The management of working capital involves managing
inventories, accounts receivable and payable, and cash.
Working Capital is the money used to make goods and attract
sales. The less Working Capital used to attract sales, the higher
is likely to be the return on investment. Working Capital
management is about the commercial and financial aspects of
Inventory, credit, purchasing, marketing, and royalty and
investment policy. The higher the profit margin, the lower is
likely to be the level of Working Capital tied up in creating and
selling titles. The faster that we create and sell the books the
higher is likely to be the return on investment. Thus:
WORKING CAPITAL = CURRENT ASSETS CURRENT LIABILITIES
In a department's Statement of Financial Position, these
components of working capital are reported under the following
headings:
Current Assets
Liquid Assets (cash and bank deposits)
Inventory
Debtors and Receivables
Current Liabilities
Bank Overdraft
Creditors and Payables
Other Short Term Liabilities
Approaches to Working Capital Management
Working capital management takes place on two levels:
1) Ratio analysis can be used to monitor overall trends in
working capital and to identify areas requiring closer
management.
2) The individual components of working capital can be
effectively managed by using various techniques and strategies.
1) Ratio analysis:
Key working Capital Ratios:
a)Stock Turnover Ratio
Formula: Average Stock * 365 / Cost of goods sold
Result = x days
b)Receivables Ratio (in days)
Formula: Debtors * 365/ Sales
Result = x days
c)Payables Ratio (in days)
Formula: Creditors * 365/Cost of Sales (or Purchases)
Result = x days
d)Current Ratio
Formula: Total Current Assets/ Total Current Liabilities
Result = x times
e)Quick Ratio
Formula: (Total Current Assets - Inventory)/Total Current
Liabilities
Result = x times
f)Working Capital Ratio
Formula: (Inventory + Receivables - Payables)/Sales
Result = As % Sales
2) Specific Strategies
a)Inventory Management
Inventories are lists of stocks-raw materials, work in progress
or finished goods-waiting to be consumed in production or to be
sold. A department also needs a system of internal controls to
efficiently manage stocks and to ensure that stock records provide
reliable information.
The total balance of inventory is the sum of the value of each
individual stock line. Stock records are needed to provide an
account of activity within each stock line; as evidence to support
the balances used in financial reports.
Inventory management is an important aspect of working capital
management because inventories themselves do not earn any revenue.
Holding either too little or too much inventory incurs costs.
The best ordering strategy requires balancing the various cost
factors to ensure the department incurs minimum inventory
costs.
b)Debtor Management
Debtors (Accounts Receivable) are customers who have not yet
made payment for goods or services which the department has
provided. Cash flow can be significantly enhanced if the amounts
owing to a business are collected faster. Every business needs to
know.... who owes them money.... how much is owed.... how long it
is owing.... for what it is owed.
The objective of debtor management is to minimize the time-lapse
between completion of sales and receipt of payment. The costs of
having debtors are:
Opportunity costs (cash is not available for other
purposes);
Bad debts.
Debtor management includes both pre-sale and debt collection
strategies. Slow payment has a crippling effect on business; in
particular on small businesses who can least afford it. If you
don't manage debtors, they will begin to manage your business as
you will gradually lose control due to reduced cash flow and, of
course, you could experience an increased incidence of bad
debt.c)Creditor Management
Creditors (Accounts Payable) are suppliers whose invoices for
goods or services have been processed but who have not yet been
paid. Creditors are a vital part of effective cash management and
should be managed carefully to enhance the cash position.
Organizations often regard the amount owing to creditors as a
source of free credit. However, creditor administration systems are
expensive and time-consuming to run. The over-riding concern in
this area should be to minimize costs with simple procedures.
While it is unnecessary to pay accounts before they fall due, it
is usually not worthwhile to delay all payments until the latest
possible date., Regular weekly or fortnightly payment of all due
accounts is the simplest technique for creditor management.
d)Cash Management
Good cash management can have a major impact on overall working
capital management. Cash Management identify the cash balance which
allows for the business to meet day to day expenses, but reduces
cash holding costs.The key elements of cash management are:
Cash forecasting;
Balance management;
Administration;
Internal control.
e) Other components
Working capital, defined as the difference between current
assets and current liabilities, may also include the following
factors:
Prepayments to creditors;
Current portions of long-term liabilities;
Revenue received before it has been earned;
Provisions.
1.2 Company Profile
ACC Limited is Indias foremost manufacturer of cement and ready
mix concrete with a countrywide network of factories and marketing
offices. Established in 1936, ACC has been a pioneer and
trend-setter in cement and concrete technology. ACCs brand name is
synonymous with cement and enjoys a high level of equity in the
Indian market. Among the first companies in India to include
commitment to environment protection as a corporate objective, ACC
has won several prizes and accolades for environment friendly
measures taken at its plants and mines. The company has also been
felicitated for its acts of good corporate citizenship.
ACC has a unique track record of innovative research, product
development and specialized consultancy services. It is an
important benchmark for the cement industry in respect of its
production, marketing and personnel management processes. ACC is
the only cement producer in India with its own in-house research
and development facility. This unit, recognized by the Department
of Scientific & Industrial Research (DSIR) in the Ministry of
Science and Technology, is engaged in research and development
activities related to cement and concrete areas. The R & D
programme addresses a spectrum of activities that cover technical
services for quality and technology up-gradation and development of
products and processes in the companys core business. Given the
inherent variability in the mineral resources used in cement
manufacture, considerable attention has been devoted to
continuously optimizing process conditions including raw materials
proportioning to ensure the highest quality.
Sustainable development is recognized by us as a process of
development that "meets the needs of the present without
compromising the ability of future generations to meet their own
needs". We believe this constitutes balancing the Triple Bottom
Line - defined as the achievement of three interdependent and
mutually reinforcing goals of economic development, social
development, and environmental protection.
1.3 Need for the study
Working capital Management is referred as short term Financial
Management which is in the terms of the timing of cash. The need of
working capital management is to:
Ensure that a firm is able to continue its operations and that
it has sufficient ability to satisfy both maturing short-term debt
and upcoming operational expenses.
Maintain the optimum balance of each of the working capital
components. Increase the Profitability of the company.
Highlight the necessity of managing current assets and current
liabilities
1.4 Objectives of the study
PRIMARY OBJECTIVE:
1) Determine Operating Cycle and Cash Cycle.
2) Evaluation of Cash requirements for working capital.
3) Analyzing and controlling of accounts receivables.
4) Monitoring and Controlling of Inventories.
5) Analysis of Working Capital Leverage.
SECONDARY OBJECTIVE:
1) Analyze the ratios which affect the Working capital
Requirements of the company and estimate the projections for the
year 2007.
2) Analysis of working capital components.
1.5 Scope of the study
In the project, we take into consideration
The Annual report of various years.
The Profit and Loss Statement of various years.
Detailed description and data regarding cash discounts,
collection effort, terms of payment of customers, credit policy
variables, interest rates, credit risk, average collection period,
credit period.
Information about the raw materials, their annual usage and the
price of each raw material. Information about the sources of
finance and their Investment options.1.6 Limitations of the
study
Profit Criterion for Working Capital is not analyzed due to lack
of data regarding the initial investment. Primary data that are
collected by interacting with the financial executives may not be
accurate. Details regarding the inventories such as the price of
the raw materials are not revealed by the organization. Few
assumptions are made in calculating the aging schedule. Credit
Management is done for the ACC cement works Company, Madukkarai
only whereas the rest of the project is done for the whole ACC
Company.2. LITERATURE REVIEW
Working Capital Management: Difficult, but rewarding1
The article focuses on the importance of management of the
working capital in a business enterprise. From the perspective of
the chief financial officer (CFO), the concept of working capital
management is relatively straightforward: to ensure that the
organization is able to fund the difference between short-term
assets and short-term liabilities. In practice, though, working
capital management has become the Achilles' heel of scores of
finance organizations, with many CFOs struggling to identify core
working capital drivers and the appropriate level of working
capital. By understanding the role and drivers of working capital
management and acting to reach the "right" levels of working
capital, companies can minimize risk, prepare for uncertainty and
improve overall performance. The most effective programs for both
improving working capital performance and forecasting are those
that look beyond the local organization and consider the broader
corporate environment. While working capital forecasting is
critical to a company's ability to make informed strategic business
decisions, many CFOs struggle with the process.
As a result, companies can be limited in their ability to
weather unforeseen or adverse events and ensure that cash is
readily available where it is needed, regardless of the
circumstances. By understanding the role and drivers of working
capital management taking steps to reach the "right" levels of
working capital, companies can minimize risk, effectively prepare
for uncertainty and improve overall performance.
For most CFOs, the greatest challenge with respect to working
capital management is the need to understand and influence factors
that are out of their direct control, in order to obtain a complete
picture of the company's needs. The CFO's span of control can be
limited in terms of functional silos, though corporate finance may
well have some powers of influence over operating units. While
organizations generally concentrate on the right processes, such as
cash, payables and their supply chain, they are less likely to take
into account various internal and external constraints that can
dictate how effectively those processes are executed. For
example, the legal and business environments can have a significant
impact on performance. Similarly, internal considerations such as
organizational structure, shared systems, autonomous business
units, multinational operations and even information technology can
impact working capital, creating barriers that can hinder a CFO's
ability to truly understand, and therefore manage, the company's
needs. The human factor is another important consideration. If
management is focused purely on top-line growth, insufficient
attention may be applied to cash flow management and
forecasting.
A hard-line focus on year-end or quarter-end results can produce
a flattering, but inaccurate, picture of working capital
performance and lead to counter-productive behavior. Consider the
impact on working capital of a year-end sales push where production
has been building up inventory (which may not be the appropriate
inventory) to meet this artificial demand and the quality of
receivables deteriorates during the yearly part of the following
year. While there is no magical solution for effecting robust
working capital management, there are a number of prerequisites for
gaining control of the complex process.
Efficiency of Working Capital Management and Corporate
Profitability2
Efficient working capital management is an integral part of the
overall corporate strategy to create shareholder value. We
investigate the relation between the firm's net-trade cycle and its
profitability. This relationship is examined using correlation and
regression analysis, by industry and working capital intensity.
Using a Compustat sample of 58,985 firm years covering the period
1975-1994, we find, in all cases, a strong negative relation
between the length of the firm's net-trade cycle and its
profitability. In addition, shorter net-trade cycles are associated
with higher risk-adjusted stock returns.
Efficient working capital management is an integral component of
the overall corporate strategy to create shareholder value. Working
capital is the result of the time lag between the expenditure for
the purchase of raw materials and the collection for the sale of
the finished product. The continuing flow of cash from suppliers to
inventory to accounts receivable and back into cash is usually
referred to as the cash conversion cycle. The way in which working
capital is managed can have a significant impact on both the
liquidity and profitability of the company. Smith (1980) first
signaled the importance of the trade-offs between the dual goals of
working capital management, i.e., liquidity and profitability. In
other words, decisions that tend to maximize profitability tend not
to maximize the chances of adequate liquidity. Conversely, focusing
almost entirely on liquidity will tend to reduce the potential
profitability of the company.
This paper empirically investigates the relationship between the
firm's efficiency of working capital management and its
profitability. It is an empirical question whether a short cash
conversion cycle is beneficial for the company's profitability; A
firm can have larger sales with a generous credit policy, which
extends the cash cycle. In this case, the longer cash conversion
cycle may result in higher profitability. However, the traditional
view of the relationship between the cash conversion cycle and
corporate profitability is that, ceteris paribus, a longer cash
conversion cycle hurts the profitability of a firm. For
Example, America's leading retailing giants, Wal-Mart and Kmart,
reported very different returns over 1994, notwithstanding a
similar capital structure, i.e., about 31% debt financing. The
return on sales, assets, and equity were respectively 0.87%, 1,
74%, and 4, 91 % for Kmart while they were 3.25%, 10,1% and 24,9%
for Wal-Mart. The difference in profitability can be partly
explained by the different cash conversion cycle, i.e. 61 days for
Kmart and only 40 days for Wal-Mart,' A 21 -day shorter cash cycle
applied to Kmart's 1994 sales of $34 billion, assuming a 10% cost
of capital results in savings of $198.3 million a year.
Measuring associations between Working Capital and Return on
Investment3
Investigates the associations between traditional and
alternative working capital measures and return of investment (ROI)
of industrial firms listed on the Johannesburg Stock Exchange.
Importance of working capital management in decision making;
Measurement based on profitability and liquidity concepts; Large
influence of traditional working capital leverage ratio on ROI.
The two conflicting goals of working capital management are
profitability and liquidity. This article looks at return on
investment as a measure of profitability and some traditional and
more recently developed working capital concepts as liquidity
measures. Associations were measured between profitability and the
liquidity concepts by using chi-square analysis and stepwise
forward regression. The statistical test results showed that a
traditional working capital leverage ratio, current liabilities
divided by funds flow, displayed the greatest associations with
return on investment. Well-known liquidity concepts such as the
current and quick ratios registered insignificant associations
whilst only one of the newer working capital concepts, the
comprehensive liquidity index, indicated significant associations
with return on investment.
Promoters of working capital theory share the axiom that
profitability and liquidity comprise the salient (albeit frequently
conflicting) goals of working capital management. The conflict
arises because the maximization of the firm's returns could
seriously threaten the liquidity, and, on the other hand, the
pursuit of liquidity has a tendency to dilute returns. Over the
years analysts have employed traditional ratio analysis as a
primary instrument in the measurement of corporate liquidity. Many
well-established liquidity ratios, for example the current ratio,
are simple to apply and have some theoretical merit: increases in,
say, accounts receivable will increase the current ratio (current
assets/current liabilities), suggesting improved liquidity.
However, the ability to match short-term obligations has only
improved from a liquidation perspective (providing current assets
may be liquidated at current market value), and not from a
going-concern approach (Shulman & Dambolena, 1986: 35).
Liquidity for the on-going firm is not reliant on the liquidation
value of its assets, but rather on the operating cash flow
generated by those assets (Soenen, 1993: 53).
In recent literature some alternative working capital concepts
have been advocated as likely (and possibly improved) measures of
liquidity. Four such measures are the cash conversion cycle, the
net trade cycle, the comprehensive liquidity index and the net
liquid balance. The purpose of this article is to report on some
results of research undertaken to measure associations between
traditional and alternative working capital measures and return on
investment (ROI), specifically in industrial firms listed on the
Johannesburg Stock Exchange (JSE).
The article proceeds with an assertion of the problem to be
investigated, followed by a short description of the traditional
and alternative working capital measures included in the study. It
then advances to the method of research and a brief discussion on
the data set, variables used and the statistical tests applied.
Working Capital Measure Examined3
Traditional working capital ratios may be classified according
to whether they measure working capital position, working capital
activity or leverage (Emery, 1984: 26; Lovemore & Brummer,
1993: 83). Working capital position ratios, typically the current
and quick ratios, measure the degree to which the firm's currently
maturing obligations are covered by currently maturing assets. The
current ratio is regarded as a broad measure of liquidity and is
expressed as current assets divided by current liabilities. The
quick ratio is considered to be a narrow measure of liquidity and
is expressed as current assets minus inventory divided by current
liabilities.
Working capital activity ratios attempt to measure the relative
efficiency of the firm's resources by relating the level of
investment in different current assets to the level of operations
(Gallinger & Healey, 1991: 73). Frequently cited activity
measures are inventory turnover, accounts receivable turnover,
accounts payable turnover and sales to net working capital.
Inventory turnover is defined as the cost of sales over average
inventory. Accounts receivable turnover measures the speed of
converting accounts receivable into cash, and is calculated as
credit sales divided by accounts receivable. Accounts payable
turnover reveals the effectiveness of the management of a firm's
short-term financing, and is represented by credit purchases
divided by accounts payable. Sales to net working capital centres
on the proficiency of the utilization of working capital, and the
higher the ratio, the greater the proficiency will be.
Leverage measures provide evidence of cash obligations
attributable to the firm's long-term financing, demonstrating the
existence of debt capacity that could be used to provide additional
liquidity (Emery, 1984: 26). Frequently used leverage measures
include long-term loan capital divided by net working capital,
accounts receivable divided by accounts payable, and total current
liabilities divided by gross funds flow. Long-term loan capital
divided by net working capital provides evidence of the magnitude
of the long-term loan capital financing of working capital.
Accounts receivable divided by accounts payable reflects the degree
to which credit extended by the firm is financed by the credit
supplied by creditors. Total current liabilities divided by gross
funds flow, expressed in years, reflects the ability of the firm to
repay the various short-term funds received from its gross funds
flow, the latter being defined as the income after taxation plus
the net nonfunds flow items of the firm (BFA, 1989: 39-40).
Alternative working capital measures developed over the years
(in an effort to surmount the imperfections of conventional ratio
analysis) include the cash conversion cycle, the comprehensive
liquidity index, the net liquid balance and the net trade cycle.
The cash conversion cycle, developed by Richards & Laughlin
(1980: 33-34), may be computed as follows: the average collection
period of accounts receivable is added to the average age of the
inventory; the sum of the two statistics represents the firm's
operating cycle, from which the average payment period is
subtracted. In this way, the working capital cycle is quantified to
portray the residual time interval for which nonspontaneous
financing needs to be negotiated to compensate for the
unsynchronized nature of the firm's working capital investment
flows.
The net trade cycle, similar to the cash conversion cycle,
measures liquidity on a flow basis. Where the measure differs from
the cash conversion cycle, instead of computing number of days of
cost of goods sold in inventory and number of days of purchases in
accounts payable, the net trade cycle calculates days of sales in
both (Kamath, 1989:26).
The comprehensive liquidity index developed by Melnyk &
Berati (Scherr, 1989: 357-372), is a liquidity-weighted version of
the current ratio, where each current asset and liability is
weighted based on its nearness to cash. The weighting is done by
multiplying the monetary value of each current asset or liability
by one minus the inverse of the asset or liability's turnover
ratio. Where more than two turnovers are required to generate cash
from the asset, the inverse of each of these ratios is deducted,
and the results added for all the current assets and liabilities.
The added totals depict liquidity-adjusted measures of total
current assets and liabilities. In this way the current ratio can
be computed, based on the adjusted values for current assets and
liabilities.
The net liquid balance approach, applied by Shulman &
Dambolena (1986: 35-38), differentiates operational assets from
liquid assets in an attempt to measure the true liquid balance of
financial assets after operational needs have been met. The net
liquid balance may be defined as cash plus marketable securities
less all liquid financial obligations including notes payable and
the current portion of long-term debt (Kamath, 1989: 28). A
positive net liquid balance would indicate the true liquid surplus
of a firm, while a negative net liquid balance would indicate a
dependence on short-term external funding. The net liquid balance
divided by total assets could be regarded as a relative measure of
liquidity.
Gross Margin Return on Working Capital: A Project Management
Technique4
Presents the Gross Margin Return on Working Capital for project
management technique. Improvement of return of assets criteria for
product management; Significance of graphic presentations in
implementing the technique; Relevance of the technique to gross
margin percent and inventory turnover.
1. Harris, Andrew, Working Capital Management: Difficult, but
rewarding, P 52-53.
2. Hyun-han Shin, Soenen, Luc, Efficiency of Working Capital
Management and Corporate Profitability, P37-45.
3. Smith, M. Beaumont, Begemann, E., Measuring Working Capital
and Return on Investment, P1-5.
4. Metcalf, Jerry, Gross Margin Return on Working Capital: A
Project Management Technique, P 27.
3. RESEARCH METHODOLOGY
RESEARCH DESIGN:
Descriptive Research
SOURCE OF DATA:
Both primary and secondary sources of data have been used in the
project.
PRIMARY DATA:
Primary data have been collected from the organization. These
data were obtained from the interactions with the financial
executives in the company. These are in the form of verbal reports,
computer reports, etc.
SECONDARY DATA:
Secondary data are drawn from annual reports, records, sales
report, Purchase order and Inventory Report.
TOOLS USED FOR ANALYSIS:
Financial Ratio Analysis
Trend Analysis
Time Series Analysis
4. DATA ANALYSIS AND INTERPRETATION
WORKING CAPITAL MANAGEMENT
4.1 To Determine Operating Cycle and Cash Cycle
The time that elapses between the purchase of raw materials and
the collection of cash for sales is referred to as the Operating
Cycle, whereas the time length between the payment of raw material
purchases and the collection of cash for sales is referred to as
the Cash Cycle.
Figure 1CASH CYCLE AND OPERATING CYCLE
The Operating Cycle is the sum of the inventory period and the
accounts receivable period, whereas the Cash Cycle is equal to the
Operating Cycle less the accounts payable period.
From the financial statement of the firm, we can estimate the
inventory period, the accounts receivable period, and the accounts
payable period. All the data is given in Rs. Crore)
Average Inventory
Inventory Period =
(Annual Cost of goods Sold / 365)
(600.95 + 542.38) / 2
= = 73.8 days
(2,823.9 / 365)
Average Accounts Receivable
Accounts Receivable Period =
Annual sales / 365
(199.17 + 190.54) / 2
= = 22.2 days
(3,203.41 / 365)
Average Accounts Payable
Accounts Payable Period =
Annual Cost of goods sold / 365
(103.78 + 105.65) / 2
= = 13.53 days
(2,823.9 / 365)
Operating Cycle = Inventory Period + Accounts Receivable
Period
= 73.8 days + 22.20 days
= 96 days
Cash Cycle = Operating Cycle - Accounts Payable Period
= 96 days - 13.53 days
= 82.47 days
Thus, ACC limited takes about 82.47 days to collect payment form
its customers from the time it pays for its inventory
purchases.
4.2 TIME SERIES ANALYSIS
TABLE 4.2.1: INVENTORY PERIOD FOR THE YEAR 2003-2007
YearAverage Inventory (in Rs. Crore)Annual Cost of goods Sold
(in Rs. Crore)Inventory Period (in days)
2003357.101,670.5678.02
2004416.531,890.1180.43
2005472.662,010.1085.83
2006644.002,800.9883.92
2007571.672,823.9073.80
TABLE 4.2.2: ACCOUNTS RECEIVABLE PERIOD FOR THE YEAR
2003-2007
YearAverage Accounts Receivable (in Rs. Crore)Annual Sales(in
Rs. Crore)Accounts Receivable Period (in days)
2003202.073,384.4321.79
2004178.953,657.0117.86
2005207.053,560.4421.23
2006208.594,227.2218.01
2007194.863,203.4122.20
TABLE 4.2.3: OPERATING CYCLE FOR THE YEAR 2003-2007
YearInventory Period(in days)Accounts Receivable Period (in
days)Operating Cycle (in days)
200378.0221.7999.81
200480.4317.8698.29
200585.8321.23107.06
200683.9218.01101.93
200773.822.2096.00
CHART 4.2.1: OPERATING CYCLE FOR THE YEAR 2003-2007
4.3 CREDIT MANAGEMENT
4.3.1 Control of Account Receivables
The customers of ACC limited are of two types. One is the direct
customers and the other one is the dealers. Dealers maintain the
security deposits with the company and the company will provide two
times of the value of the security deposits as credit. In case of
direct customers, these customers have to pay 60% of the amount as
advance payment. Cash discount of 2 percent is allocated to all the
customers. The remaining credit amount is paid by the customers in
installments. For example, if the sale is made between 1 and 7th of
the month, then the first installment should be made on 14th of the
same month. So, the average credit period is only about 10 days. If
the customers are not paying their installments properly, no cash
discount is allowed to them. The organization verifies the bank
statement of their customers before providing credit ti their
customers.
DAYS SALES OUTSTANDING The days sales outstanding(DSO) at a
given time t may be defined as the ratio of accounts receivable
outstanding at that time to average daily sales figure during the
preceding 30 days, 90 days, or some other relevant period.
Accounts receivables at time t
DSO t = _____________________________ __________ Eq 8
Average daily sales
The figure can be interpreted as either the average time lag
between a credit sale and payment for the sale or as the average
days worth of credit sales tied up in account receivables. Since
the collection period measures account receivables per unit sales,
a change in the collection period is a rough measure of changing
collection experience.
However, a major weakness of the ratio for this purpose is that
it is quite sensitive to seasonal variation in sales. Consequently,
unless sales are quite stable overtime, the collection period can
mask fundamental changes in collection experience.
To illustrate the calculation of this measure, consider the
monthly sales and receivable for ACC Limited for the year 2007.
TABLE 4.3.1.1: MONTHLY SALES AND RECEIVABLES OF THE YEAR
2007
MonthSales(rupees in lakhs)Accounts Received (rupees in
lakhs)Outstanding Receivables( rupees in lakhs )
January856770.490.8
February795801.180.1
March784785.179.0
April1,0561,484106.0
May1,0021,007.4100.0
June44249845.9
July564551.855.6
August462472.245.3
September768737.475.4
October890877.890.5
November873874.785.6
December774783.977.2
TABLE 4.3.1.2: DSO OF THE YEAR 2007
QuarterCalculationDays Sales Outstanding
First785.1/ [( 856 + 795 + 784)/90] 29.00
Second498/ [ (1056+1002+442) / 90 ]17.93
Third737.4 / [ (564+ 462+768)/ 90 ]36.99
Fourth783.9 / [(890 + 873 + 774) /90]27.81
CHART 4.3.1.1: DSO FOR EACH QUARTER FOR THE YEAR 2007
INTERPRETATION
The table above shows that the Days Sales Outstanding for each
quarter of the year 2007. For the first quarter the DSO was 29
days, for the second quarter it was 17.93 days, for the third
quarter it was 36.99 days and for the fourth quarter it was
27.81days. It decreased in the second quarter, increased in the
third quarter but decreased in the third quarter and again
increased in the fourth quarter.
4.3.2 COLLECTION PROCEDURE
TABLE 4.3.2.1: COLLECTION PROCEDURE OF THE YEAR 2007
Percentage of receivables collected during theJanuary
SalesFebruary SalesMarch SalesApril SalesMay SalesJune Sales
At the time of sales 606060606060
First following week101010101010
Second following week101010101010
Third following week101010101010
Fourth following week101010101010
INTERPRETATION
The Collection Procedure for the first six months of the year
2007 has been estimated. The credit sales during the month of
January are collected as follows: 60 percent is paid as the advance
payment in the month in which sale is made. 10 percent in the first
following week, 10 percent in the second following week, 10 percent
in the third following week, 10 percent in the fourth following
week. From the collection pattern it seems that the collection is
stable and they have a formalized procedure for collecting the
amount from their customers.
4.3.3 AGEING SCHEDULE
The ageing Schedule given below classifies outstanding accounts
receivables at a given point of time into different age
brackets.
TABLE 4.3.3.1: AGEING SCHEDULE
Age Group (in days)Percent of receivables receivedPercent of
receivables outstanding
0 10 days60%40%
11 20 days70%30%
21 30 days80%20%
31 40 days90%10%
41 50 days100%
INTERPRETATION
From the ageing schedule table, it is clear that ACC Limited
collects 60% as its advance payments and the customers pay their
remaining amount in four instalments. The first instalment 10
percent is received within 20 days from the day of sale, the second
instalment 10 percent is received within 30 days from the day of
sale, the third instalment 10 percent is received within 40 days
from the day of sale and the last instalment is received within 50
days from the day of sale. All its debt is collected within 50
days.
4.4 INVENTORY MANAGEMENT
4.4.1 MONITORING AND CONTROL OF INVENTORIES
ABC Analysis
In most inventories a small proportion of items accounts for a
very substantial usage (in terms of the monetary value of annual
consumption) and a large proportion of items accounts for a very
small usage (in terms of the monetary value of annual consumption).
ABC analysis, based on this empirical reality, advocates in essence
a selective approach to inventory control which calls for a greater
concentration of effort on inventory items accounting for the bulk
of usage value. This approach calls for classifying inventories
into three broad categories, A, B, and C. Category A, representing
the most important items, generally consists of 15 to 25 percent of
inventory items and accounts for 60 to 75 percent of annual usage
value. Category B, representing items of moderate importance,
generally consists of 20 to 30 percent of inventory items and
accounts for 20 to 30 percent of annual usage value. Category C,
representing items of least importance, generally consists of 40 to
60 percent of inventory items and accounts for 10 to 15 percent of
annual usage value.
In ACC Limited, the raw materials used for consumption are
Limestone, Gypsum and fly ash. Category A represents the item
Gypsum which consists of 15 to 25 percent of inventory items and
accounts for 60 to 75 percent of annual usage value. Category B
represents the item fly ash which consists of 20 to 30 percent of
inventory items and accounts for 20 to 30 percent of annual usage
value. Category C, representing Limestone which consists of 40 to
60 percent of inventory items and accounts for 10 to 15 percent of
annual usage value.
Measures of Effectiveness
For purposes of monitoring the effectiveness of inventory
management it is helpful to look into the following ratios and
indexes:
Cost of goods sold
Overall inventory turnover ratio =
Average total inventories at cost
2,823.9
= = 4.94 days
571.67
Average consumption of raw material
Raw Material inventory turnover ratio =
Average raw material inventory
175.19
= = 0.49 days
359.57
Cost of Manufacture
Work- in- process inventory turnover ratio =
Average Work in Progress inventory at cost
2,685.03
= = 16.03 days
167.47
Cost of goods sold
Finished goods inventory turnover ratio =
Average inventory of finished goods at cost
2,823.9
= = 39.54 days
71.424.5 ESTIMATION OF WORKING CAPITAL NEEDS
The most appropriate method for calculating the working capital
needs of a firm is the concept of operating cycle. Three approaches
used to estimate the working capital requirements are:
Current assets holding period: To estimate working capital
requirements on the basis of average holding period of current
assets and relating them to costs based on the companys experience
in the previous years. This method is essentially based on the
operating cycle concept.
Ratio of sales: To estimate the working capital requirements as
a ratio of sales on the assumptions that the current assets change
with sales.
Ratio of fixed investment: To estimate working capital
requirements as a percentage of fixed investment.
The calculations are based on the following assumptions
regarding each of the three methods:
METHOD 1:
Inventory: One months supply of each of raw material,
semi-finished goods and finished materials.
Debtors: one months sales.
Operating cash: one months total cost.
METHOD 2: 25-35% of annual sales
METHOD 3: 10-20% of fixed capital investment
Calculations:
METHOD 1:
Raw material: one months supply: 362.06 / 12 = Rs 30.17
Crore.
Semi-finished material: One months supplies (based on raw
material plus assume one-half of normal conversion cost):
(30.17+ (184.84+31.23+299.52+3.32+99.43+60.14)/2)/12 = Rs 42.22
Crore.
Finished material: one months supply: 71.42/12 = Rs 5.95
Crore.
The total inventory needs = 30.17 + 42.22 + 5.95 = Rs 78.34
Crore.
After determining the inventory requirements, projection for
debtors and operating cash should be made:
Debtors: One months sales:3,203.41 / 12 = Rs 266.95 Crore.
Operating cash: One months total cost: 2,595/12 = Rs 216.25
Crore
Thus the total working capital required is: 78.34 +
266.95+216.25 = Rs 561.54 Crore
METHOD 2:
The average ratio is 30 percent. Therefore, 30 percent of annual
sales, Rs 3203.41 is Rs 961.023 crore.
METHOD 3:
The ratio of current assets to fixed investment ranges between
10 to 20 percent. The average ratio is 15 percent. The 15 percent
of the fixed investment Rs 293.75 Crore is Rs 44.06 crore.
The accuracy of these methods depends on various factors. The
production factor and credit and collection policy of the firm
would have an impact on working capital requirements. Therefore,
they should be given weightage in projecting working capital
requirements.
4.6 WORKING CAPITAL LEVERAGE
Working Capital Leverage reflects the sensitivity of return on
Investment (earning Power) to changes in the level of current
assets. To express the formula for working capital leverage the
following symbols are used:
CA = value of current assets (gross working capital)
CA = change in the level of current assets
FA = value of net fixed assets
TA = value of total assets (TA = CA +FA)
EBIT = Earnings before Interest and Taxes
ROI = Return on Investment defined as EBIT/ TA
Calculations:
Current assets = 1,421.16
Change in the level of current asset = 207. 45
Fixed asset = 3,122.03
Total asset = current asset + fixed asset = 1,421.16 + 3,122.03
= 4,543.19
EBIT = 2,976.92
ROI = EBIT/ TA
= 2,976.92/4,543.19 = 0.655
CA
Working Capital Leverage =
TA + CA
1,421.16
=
4,543.19 + 0.17*(1,421.16)
= 0.297
4.7 WORKING CAPITAL FINANCING
Maximum Permissible Bank Finance
Three methods are there to determine the maximum permissible
bank finance.
CA = Currents Assets as per the norms laid down
CL = non-bank current liabilities like trade credit and
provisions
CCA= Core Current Assets (this represents the permanent
component of working capital).
The methods for determining the MPBF are described below:
Method 1: MPBF = 0.75 (CA CL)
Method 2: MPBF = 0.75 (CA) CL
Method 3: MPBF = 0.75 (CA CCA) - CL
TABLE 4.7.1: CURRENT ASSETS OF THE YEAR 2007
Current Assetsin Rs. Crore
Inventories600.95
Sundry Debtors199.17
Cash and Bank Balances102.79
Other Current Assets31.79
Loans and Advances486.76
Total 1,421.16
TABLE 4.7.2: CURRENT LIABILITIES OF THE YEAR 2007
Current LiabilitiesIn Rs. Crore
Sundry Liabilities913.28
Provisions316.77
Total1,230.05
Calculations:
Method 1:
MPBF = 0.75 (CA CL)
= 0.75(1,421.16 1230.05)
= Rs 143.33 Crore
Method 2:
MPBF = 0.75 (CA) CL
= 0.75(1,421.16) - 1,230.05
= - 164.18
Method 3:MPBF= 0.75 (CA CCA) - CL
= 0.75(1,421.16-391.06) 1,230.05
= -457.43
Interpretation:
The first method can be adopted. The current liabilities
including MPBF are Rs1,373.38 Crore. Therefore, the current ratio
is 1.03.
4.8 ANALYSIS OF WORKING CAPITAL COMPONENTS
In order to understand the length of time for which resources
are committed to various components of working capital, operating
cycle analysis can be done. An extension of this analysis which may
be referred as the weighted operating cycle analysis may be done to
reflect the magnitudes of resources commitments.
Operating Cycle Analysis
The operating cycle of a firm begins with the acquisition of raw
materials and ends with the collection of receivables. There are
four aspects of the operating cycle which involve commitment of
resources: raw material stage; work- in- progress stage; finished
goods stage; and accounts receivable stage. There is one aspect of
the operating cycle which provides resources; accounts payable
stage (this is the period for which credit is provided by the
suppliers of the raw materials).
The duration of the Operating Cycle may be defined as
Doc = DRM + Dwip + Dfg + Dar - Dap
WhereDoc = duration of the Operating Cycle
DRM = duration of the raw materials and stores stage
Dwip = duration of work-in-progress stage
Dfg = duration of finished goods stage
Dar = duration of accounts receivable stage
Dap = duration of the accounts payable stage
Duration of the Raw materials and Stores Stage: This represents
the number of days for which raw materials and stores remain in
inventory before they are issued for production. It may be
calculated as:
Average stock of raw materials and stores
DRM =
Average raw materials and stores consumed per day
145.19
= = 16.71 days
8.69
Duration of Work-in-Process stage: This represents the number of
days required in the work-in-process stage. It may be measured
as:
Average work-in-process inventory
Dwip =
Average work-in-process value of raw materials committed per
day
167.47
= = 26.58 days
6.3
Duration of the Finished Goods Stage: This reflects the number
of days for which finished goods remain in inventory before they
are sold. It may be calculated as:
Average finished goods inventory
Dfg =
Average cost of goods sold per day
71.42
= = 9.23 days
7.74
Duration of the Accounts receivable Stage: This denotes the
number of days required to collect the accounts receivable. It may
be measured as:
Average accounts receivable
DRM =
Average sales per day
194.86
= = 22.19 days
8.78
Duration of the Accounts Payable stage: This represents the
number of days for which
the suppliers of raw materials offer credit. It may be
calculated as:
Average accounts Payable
DRM =
Average credit purchases per day
104.72
= = 8.38 days
12.50
The duration of the Operating Cycle may be defined as
Doc = DRM + Dwip + Dfg + Dar - Dap
= 16.71 + 26.58 + 9.23 + 22.19 - 8.38
= 66.33 days
4.9 RATIO ANALYSIS
Key Working Capital Ratios
4.9.1 Inventory Turnover Ratio
Inventory turnover ratio is the number of times the inventory is
turned over in the business during a particular period and it
measures the relationship between sales and average inventory. This
ratio measures how quickly inventory is sold and indicates whether
investment in inventory is within proper limits or not, signifying
the liquidity of the inventory. Higher the ratio more the sales and
minimum level of inventory is held and hence possessing good
inventory management.
TABLE 4.9.1: INVENTORY TURNOVER RATIO
YearSalesAverage InventoryRatio
2003 20043,348.43357.109.37
2004 20053,657.01416.538.77
2005 20063,560.44472.667.53
2006 20074,227.22644.006.56
20073,363.46629.135.34
INTERPRETATION
During the year 2003-04 the inventory turnover ratio was 9.37.
It shows a decreasing trend thereafter. The lowest ratio was during
2007 and was 5.34 because of decrease in sales and maximum level of
inventory held on stock.
CHART 4.9.1: INVENTORY TURNOVER RATIO
4.9.2 DEBTORS TURNOVER RATIO
Debtors turnover ratio is the relationship between net credit
sales and average debtors. This ratio shows how quickly receivables
or debtors are converted to cash. It is also called accounts
receivable. Sound credit and collection period results in efficient
receivables management. Net credit sales include sale of products,
recoveries, excise duty adjustment and products consumed
internally. The higher the ratio, the better debts are being
collected more promptly.
TABLE 4.9.2: DEBTORS TURNOVER RATIO
YearNet Credit SalesAverage DebtorsRatio
2003 20043,348.43165.4120.24
2004 20053,657.01173.2221.11
2005 20063,560.44195.3818.22
2006 20074,227.22212.1119.92
20073,363.46242.6213.86
INTERPRETATION
The debtors turnover ratio of ACC during 2003-04 was 20.24 and
reduced to 13.86 in 2007. The ratio shows a declining trend. This
was due to delay in collection of debts. This shows inefficient
credit management of the company. So it is to be concluded that
debtors turnover ratio shows unsatisfactory position of ACC because
of decreasing trend in the ratio.
CHART 4.9.2: DEBTORS TURNOVER RATIO
4.9.3 AVERAGE COLLECTION PERIOD
Average collection period measures the liquidity of the firm and
it is the time taken for collection of debts. It is calculated by
dividing days in a year by debtors turnover ratio. Shorter
collection of debts and quick payments by debtors increase the
liquidity of the firm. The longer collection period shows delayed
payment by debtors and hence declining liquidity position.
TABLE 4.9.3: AVERAGE COLLECTION PERIOD
YearDays in a yearDebtors Turnover RatioDays
2003 200436020.2418
2004 200536021.1117
2005 200636018.2220
2006 200736019.9218
200736013.8626
CHART 4.9.3: AVERAGE COLLECTION PERIOD
INTERPRETATION
Average collection period of ACC during 2003-04 was 18 days; it
has decreased to 17 days in 2004-05 again to 20 and 18 days in
2005-06 and 2006-07 and finally increased to 26 days. This increase
was due to the inefficiency in managing debtors by company.
4.9.4 CURRENT RATIO
Current ratio may be defined as the relationship between current
asset and current liabilities. This ratio is known as working
capital ratio and is a measure of general
Liquidity. Desirable current ratio is 2:1. Current ratio of a
firm represents the assets which
Can be converted into cash within a short period of time, not
exceeding one year. Current Liabilities include liabilities and
provisions which are short term maturing obligations to be net
within a year. The higher the current ratio, the more the firms
ability to meet current obligations and greater the safety of funds
of short term creditors.
TABLE 4.9.4: CURRENT RATIO
YearCurrent AssetsCurrent Liabilities Ratio
2003 2004951.53631.041.50
2004 2005949.05720.251.31
2005 20061,199.72905.081.32
2006 20071,371.291,057.411.29
20071,420.881,250.411.13
INTERPRETATION
The current ratio has decreased from the year 2003 to 2007. The
current assets are greater than current liabilities in all these
years. This shows that the company is always maintaining the
current assets more than the current liability.
CHART 4.9.4: CURRENT RATIO
4.9.5 QUICK RATIO
Quick ratio can be defined as the relationship between quick
assets and current liabilities. Quick assets are cash like assets
representing all current assets other than inventory. It is also
called Acid test ratio. It is more severe and stringent test of a
firms ability to meet current obligations assessing how liquid the
firm would be if the business operations come to an abrupt halt. A
quick ratio of 1:1 is considered as a fair indication of the good
financial condition of a business concern.
TABLE 4.9.5: QUICK RATIO
YearQuick AssetsCurrent Liabilities Ratio
2003 2004594.43631.040.94
2004 2005532.52720.250.73
2005 2006727.06905.080.80
2006 2007727.291,057.410.68
2007791.751,250.410.63
INTERPRETATION
The quick ratio during the year 2003-2004 was 0.94 which was
very close to the standard ratio and indicated a good financial
condition of the business. Then there was a constant decrease over
the years. This is because of the increase in the current
liabilities.
CHART 4.9.5: QUICK RATIO
4.9.6 WORKING CAPITAL TURN OVER RATIO
Net working capital ratio is the measure of the efficiency of
the employment of the working capital. It finds out the
relationship between the cost of sales and the working capital. It
helps in determining the liquidity of a firm in as much as it gives
the rate at which the inventories are converted to sales and then
to cash. Working Capital Turnover ratio is calculated in order to
analyze how working capital has been effectively utilized in making
sales. The higher the ratio the lower the investment in working
capital and greater the profit.
TABLE 4.9.6.1: COMPONENTS OF WORKING CAPITAL
Components2003 20042004 20052005 20062006 20072007
Current Assets
Investories357.10416.53472.66644.00629.13
Debtors202.07178.95207.05208.59217.87
Cash & Bank balances37.7845.66113.9387.29106.44
Other current assets6.043.153.564.6531.50
Loans & Advances348.54304.76402.52426.76435.94
Total951.53949.051,199.721,371.291,420.88
Current Liabilities
Sundry Liabilities555.54639.90773.44844.34931.93
Provisions75.5080.35131.64213.67318.48
Total631.04720.24905.081,057.411,250.41
Net Current Assets320.49228.80294.64313.88170.47
TABLE 4.9.6.2: WORKING CAPITAL TURNOVER RATIO
YearNet salesNet working capitalRatio
2003 20043,348.43320.4910.44
2004 20053,657.01228.8015.98
2005 20063,560.44294.6412.08
2006 20074,227.22313.8813.46
20073,363.46170.4719.73
INTERPRETATION
The working capital ratio of ACC during the year 2003-2004 was
10.44 which have increased during the next few years. The highest
net sales were in the year 20062007 and lowest working capital was
in the year 2007. This shows that there was lowest investment and
greater profit.
CHART 4.9.6: WORKING CAPITAL TURNOVER RATIO
4.10 TREND ANALYSIS
A trend means a basic tendency of a series to grow or decline
over a period of time. The concept of trend doesnt include short
range oscillation, but rather a steady movement over a long time.
The tendency of a particular data to grow over a period of time is
known as growth factor. On the other hand the tendency of economic
data to fall over a period of time is declining factor. The trend
has either growth factor or declining factor. It may have either
upward or downward movement.
4.10.1 PROJECTIONS FOR THE YEARS 2006 AND 2007
The Method of Least Squares has been used for making projections
for net working capital, sales, current assets, current liabilities
and expenses. By the method of least squares a straight line trend
can be fitted to a given time series of data. It is mathematical as
well as analytical data. The trend line is called the line of best
fit. The actual figures and the trend values have been plotted in a
graph. The following items have been projected.
TABLE 4.10.1: Net Working Capital
YearNet Working Capital (y)Deviation (x)x2xyTrend
2003320.49(2)4(640.98)297.28
2004228.80(1)1(228.80)287.15
2005294.64000.00 277.02
2006313.8811313.88 266.89
2007227.2924454.59 256.76
20083246.63
20094236.50
CHART 4.10.1: PROJECTIONS ON NET WORKING CAPITAL
INFERENCE
The trend for Net Working Capital is a decreasing trend. It
decreases from Rs 298 Crore to Rs 236 Crore in the period of seven
years.
TABLE 4.10.2: Sales
YearSales (y)Deviation (x)x2xyTrend
20033,348.43(2)4(6,696.86)3,287.03
20043,657.01(1)1(3,657.01)3,571.29
20053,560.44000.00 3,855.54
20064,227.22114,227.22 4,139.80
20074,484.61248,969.23 4,424.06
200834,708.32
200944,992.57
Chart 4.10.2: Projection on Sales
INFERENCE
The trend for Sales is an increasing trend. It is expected to
increases from Rs3,287 Crore to Rs 4,992 Crore in the period of
seven years.
TABLE 4.10.3: Current Assets
YearCurrent Assets (y)Deviation (x)x2xyTrend
2003951.53(2)4(1,903.06)811.58
2004949.05(1)1(949.05)1,042.40
20051,199.72000.00 1,273.22
20061,371.29111,371.29 1,504.04
20071,894.51243,789.01 1,734.86
200831,965.68
200942,196.50
CHART 4.10.3: Projection on Current Assets
INFERENCE
The trend for current asset is an increasing trend. It is
expected to increases to Rs 2,196 Crore for the year 2007.
TABLE 4.10.4: Current Liabilities
YearCurrent Liabilities (y)Deviation (x)x2xyTrend
2003631.04(2)4(1,262.08)514.30
2004720.25(1)1(720.25)755.25
2005905.08000.00 996.20
20061,057.41111,057.41 1,237.15
20071,667.21243,334.43 1,478.10
200831,719.05
200941,960.00
CHART 4.10.4: Projection on Current Liabilities
INFERENCE
The trend for current liabilities is an increasing trend. It is
expected to increases to Rs 1,960 Crore for the year 2007.
TABLE 4.10.5: Expenses
YearCurrent Assets (y)Deviation (x)x 2xyTrend
20032,840.69(2)4(5681.38)2,973.54
20043,203.72(1)1(3203.72)3,129.19
20053,518.23000.003,284.85
20063,281.55113281.553,440.50
20073,580.04247160.083,596.15
200833,751.81
200943,907.46
CHART 4.10.5: Projections on Expenses
Inference
The trend for Expense is an increasing trend. It is expected to
increases to Rs3,907 Crore for the year 2007.
5. FINDINGS
5.1 DETERMINATION OF OPERATING CYCLE AND CASH CYCLE
The inventory period for ACC Limited is 73.8 days, the accounts
receivable period is 22.2 days and the accounts payable period is
13.53 days. So, the operating cycle is 96 days and the cash cycle
is 82.47 days. The firm has higher operating and cash cycle. Thus,
ACC limited takes about 82.47 days to collect payment from its
customers from the time it pays for its inventory purchases.5.2
TIME SERIES ANALYSIS
5.2.1 Inventory Period
Inventory period for the year 2003 2007 are 78, 80, 86, 84 and
74 days. The inventory period has been increasing from the year
2003 2006 and it has decreased in the year 2007.
5.2.2 Accounts Receivable Period
Accounts receivable period for the year 2003 2007 are 22 days,
18 days, 21 days, 18 days, 22 days. The accounts receivable period
has decreased from 22 days to 18 days in the year 2006 but it has
again increased to 22 days in the year 2007.
5.2.3 Operating Cycle
Operating Cycle for the year 2003 2007 are 100 days, 98 days,
107 days, 102 days, 96 days. The operating Cycle has increased to
107 days in the year 2005 and it has been decreased to 96 days in
the year 2007.
5.3 Credit Management
5.3.1 Control of Accounts Receivables
Days Sales Outstanding
For the first quarter the DSO was 29 days, for the second
quarter it was 17.93 days, for the third quarter it was 36.99 days
and for the fourth quarter it was 27.81days. It decreased in the
second quarter, increased in the third quarter but decreased in the
third quarter and again increased in the fourth quarter.
COLLECTION PROCEDURE
The Collection Procedure for the first six months of the year
2007 has been estimated. The credit sales during the month of
January are collected as follows: 60 percent is paid as the advance
payment in the month in which sale is made. 10 percent in the first
following week, 10 percent in the second following week, 10 percent
in the third following week, 10 percent in the fourth following
week. From the collection pattern it seems that the collection is
stable and they have a formalized procedure for collecting the
amount from their customers.
AGEING SCHEDULE
From the ageing schedule table, it is clear that ACC Limited
collects 60% as its advance payments and the customers pay their
remaining amount in four installments. The first installment 10
percent is received within 20 days from the day of sale, the second
installment 10 percent is received within 30 days from the day of
sale, the third installment 10 percent is received within 40 days
from the day of sale and the last installment is received within 50
days from the day of sale. All its debt is collected within 50
days.
5.4 INVENTORY MANAGEMENT
5.4.1 MONITORING AND CONTROL OF INVENTORIES
In ACC Limited, the raw materials used for consumption are
Limestone, Gypsum and fly ash. Category A represents the item
Gypsum which consists of 15 to 25 percent of inventory items and
accounts for 60 to 75 percent of annual usage value. Category B
represents the item fly ash which consists of 20 to 30 percent of
inventory items and accounts for 20 to 30 percent of annual usage
value. Category C, representing Limestone which consists of 40 to
60 percent of inventory items and accounts for 10 to 15 percent of
annual usage value.
5.4.2 MEASURE OF EFFECTIVENESS
The overall inventory turnover ratio is 5 days; the raw material
turnover ratio is 0.5 days, work-in-progress inventory turnover
ratio is 16.03 days and finished goods inventory turnover ratio is
40 days. The ratio is higher due to more sales and minimum level of
inventory is held and hence possessing good inventory
management.
5.5 ESTIMATION OF WORKING CAPITAL NEEDS
Three methods are used for calculating the cash requirements for
working capital. The working capital requirements calculated by the
three methods are Rs 562 Crore, Rs 961 Crore and Rs 44 Crore. The
accuracy of these methods depends on various factors. The
production factor and credit and collection policy of the firm
would have an impact on working capital requirements. Therefore,
they should be given weightage in projecting working capital
requirements.
5.6 WORKING CAPITAL LEVERAGE
Working Capital Leverage reflects the sensitivity of return on
Investment (earning Power) to changes in the level of current
assets. The working capital leverage thus calculated is 0.3. It
means that the percentage change in ROI is 0.3 times the percentage
change in Current Assets.
5.7 WORKING CAPITAL FINANCING
Three methods are used for determining the Maximum Permissible
Bank Finance (MPBF). The MPBF is calculated as Rs143.33 Crore.
Thus, the current ratio is 1.16.
5.8 ANALYSIS OF WORKING CAPITAL COMPONENTS
The duration of the raw materials and stores stage is 16.71
days, duration of work-in-progress stage is 26.58 days, duration of
finished goods stage is 9.23days, duration of accounts receivable
stage is 22.19 days and duration of the accounts payable stage is
8.38 days. Therefore, the duration of Operating Cycle is 66.33
days.
5.9 RATIO ANALYSIS
5.9.1KEY WORKING CAPITAL RATIO
5.9.1.1 INVENTORY TURNOVER RATIO
During the year 2003-04 the inventory turnover ratio was 9.37.
It shows a decreasing trend thereafter. The lowest ratio was during
2007 and was 5.34 because of decrease in sales and maximum level of
inventory held on stock. The increasing trend in the year 2007
after the amalgamation of ACC with Holcim, the multinational cement
manufacturing company, has shown the increase in sales and the
profit and thereby the substantial increase in the performance of
the company.
5.9.1.2 DEBTORS TURNOVER RATIO
The debtors turnover ratio of ACC during 2003-04 was 20.24 and
reduced to 13.86 in 2007. The ratio shows a declining trend. This
was due to delay in collection of debts. This shows inefficient
credit management of the company. So it is to be concluded that
debtors turnover ratio shows unsatisfactory position of ACC because
of decreasing trend in the ratio. The study reveals that the
debtors turnover is increased and thereby an increase in the
average debt collection period indicates an unsatisfactory position
of trade receivables position. This was mainly due to increase in
the price of the product due to the unavailability of the raw
materials like fly ash and coal.
5.9.1.3 AVERAGE COLLECTION PERIOD
Average collection period of ACC during 2003-04 was 18 days; it
has decreased to 17 days in 2004-05 again to 20 and 18 in 2005-06
and 2006-07 and finally increased to 26 days. This increase was due
to the inefficiency in managing debtors by company.
5.9.1.4 CURRENT RATIO
The current ratio has decreased from the year 2003 to 2007. The
current assets are greater than current liabilities in all these
years. This shows that the company is always maintaining the
current assets more than the current liability.
5.9.1.5 QUICK RATIO
The quick ratio during the year 2003-2004 was 0.94 which was
very close to the standard ratio and indicated a good financial
condition of the business. Then there was a constant decrease over
the years. This is because of the increase in the current
liabilities.
5.9.1.6 WORKING CAPITAL TURNOVER RATIO
The working capital ratio of ACC during the year 2003-2004 was
10.44 which have increased during the next few years. The highest
net sales were in the year 20062007 and lowest working capital was
in the year 2007.This shows that there was lowest investment and
greater profit.
5.9.2 Trend Analysis
5.9.2.1 Net Working Capital
As from the projections on net working capital, it is clear that
the net working capital has decreasing trend. It was found that it
would decrease from Rs297 Crore to Rs236 Crore. This is due to the
decrease in the current liabilities. The firm is reducing its
current liabilities by paying back to its creditors from its
profit.
5.9.2.2 SALES
As from the projections on sales, it is clear that the sales
have an increasing trend. It was found that it would increase from
Rs 3,287 Crore to Rs 4,992 Crore. The increase in the sales is due
to the availability of raw materials and reduction in the price of
the cement.
5.9.2.3 CURRENT ASSETS
As from the projections on current assets, it is clear that the
current assets have an increasing trend. It was found it would
increase from Rs 811 Crore to Rs 2,196 Crore. The increase in the
current assets is due to increase in the inventories, cash and bank
balances, loans and advances. The inventories have increased from
Rs 357 Crore in the year 2003 to Rs 630 Crore in the year 2007, the
cash and bank balances have increased from Rs 37 Crore in the year
2003 to 106 in the year 2007. The loan and advances have increased
from Rs 348 Crore to Rs 435 Crore.
5.9.2.4 CURRENT LIABILITIES
As from the projections on current liabilities, it is clear that
the current liabilities have increasing trend. It has been
increased from Rs 514 Crore to Rs1960 Crore. The increase in the
current liabilities is due to increase in the Sundry liabilities
and provisions. The Sundry Liabilities have increased from Rs 555
Crore in the year 2003 to Rs 932Crore in the year 2007; the
provisions have increased from Rs 75 Crore in the year 2003 to Rs
318 Crore in the year 2007.
5.9.2.5 EXPENSES
As from the projections on Expenses, it is clear that the
expenses shows increasing trend. It was found that it would
increase from Rs 2,973Crore to Rs3,907Crore. The increase in the
expense is due to increase in the price of the raw materials.
6. SUGGESTIONS
6.1 DETERMINATION OF OPERATING CYCLE AND CASH CYCLE
The Operating Cycle is high for ACC Ltd because the inventory
period is high as it manufactures Cement which needs its raw
material, work in progress and finished goods to be stocked for
longer period and more time is taken to manufacture Cement which
cannot be avoided. But due to effective planning, the demand can be
estimated in advance and the raw materials can be purchased at the
required time thus reducing raw material inventory and the Cement
can be manufactured on demand.
The accounts receivable period is less which is satisfactory.
The organization follows a standard procedure to collect from its
debtors. So, the firm can follow the same procedure.
6.2 CREDIT MANAGEMENT
The Control of accounts receivables is done through DSO and
Collection Procedure. From DSO, it is clear that the firm has
improved their collection effort. The firm should strictly follow
the same collection procedure to decrease the DSO further.
From the Ageing Schedule, it is clear that the firm collects all
its debt within 40 days which is better but to further improve it
should collect its debt within 25 days.
6.3 INVENTORY MANAGEMENT
The Overall inventory turnover period is very high which means
that the inventory is sold quickly. This ratio is also used to
check that the investment in inventory is within the proper limits,
signifying the liquidity of the inventory. The firm can increase
the inventory turnover ratio by increasing the sales by decreasing
the price of the cement. Higher the ratio more the sales and
minimum level of inventory is held and hence possesses good
inventory management.
6.4 ESTIMATION OF WORKING CAPITAL NEEDS
The analysis of the projected working capital requirement has
given way to certain measures that can be incorporated so that the
operating profit of the company can be increased.
6.5 WORKING CAPITAL LEVERAGE
Working Capital Leverage is used to find out the sensitivity of
return on Investment (earning Power) to changes in the level of
current assets. So, the firm should increase the current assets
further to increase the return on investments.
6.6 RATIO ANALYSIS
INVENTORY TURNOVER RATIO
The inventory turnover ratio is high indicates good inventory
management. The firm can further increase the inventory turnover if
the firm replenishes its inventory in too many small lot sizes but
it would be costly. Thus, this high inventory turnover ratio should
be investigated further.
DEBTORS TURNOVER RATIO
The Debtors turnover ratio is high which indicates the number of
times debtors turnover each year. Higher the value of debtors
turnover, more efficient is the management of credit. This ratio
has been decreasing, so proper method should be followed to
increase the debtor turnover.
AVERAGE COLLECTION PERIOD
The average collection period indicates the quality of debtors.
It has been increased which shows the decrease in the quality of
debtor. The firm should not relax its credit and collection policy
in order to decrease the average collection period.
CURRENT RATIO
The current ratio should be 2 to 1. But the current ratio has
been decreasing. Even though the ratio is less than 2, the company
is doing well. So, too much reliance should not be made on the
current ratio.
QUICK RATIO
The quick should be 1 to 1.But, the quick ratio is less than
1.Eventhough the ratio is less than 1, and the firm is prospering
and paying its current obligations in time. Anyway the firm should
concentrate to increase the quick assets because the quick ratio
remains as an important index of the firms liability.
WORKING CAPITAL TURNOVER RATIO
The working capital turnover ratio is very high due to the
increase in sales. The firm should maintain this ratio high by
increasing the sales further by decreasing the price of the
cement.
7. CONCLUSION
The project revealed that the Working capital has a direct
impact on cash flow in a business. Since cash flow is the name of
the game for all business owners, a good understanding of working
capital is imperative to make any business enterprise successful.
Companies must seek granular detail to identify the underlying
drivers of working capital. By understanding the role and drivers
of working capital management and taking steps to reach the "right"
levels of working capital, companies can minimize risk, effectively
prepare for uncertainty and improve overall performance.
Successfully improving working capital management requires a
different approach. The better a company manages its working
capital, the less the company needs to borrow.
The financial performance of The Associated Cement Companies is
in a good and acceptable position. The study reveals that the firm
has increased sales which results in the increased profitability.
From the analysis it is obvious that the company has an upward
trend. The company is maintaining a good liquidity position to meet
all its current obligations. Though there were slight deviation in
the financial year 2002-03, still the overall profitability was
high, which shows that the company has a good growth trend. Thus
the company ensures the shareholders wealth maximization which is
the major objective of the company.BIBLIOGRAPHY
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5) Prasanna Chandra (1984), Financial Management, Theory and
Practice, Fifth Edition, Tata Mc Graw-Hill Publishing Company Ltd,
New Delhi
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8) Cooper, The Credit Management essential guide 2006, Credit
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9) Richard seadon, DSO Benchmarking, Risk Management Innovation,
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10) Matthew Waes, Liam Reddy, Effective Collections, Credit
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11) http:www.acc.com
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