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CAPITAL BUDGETING When in long run a firm shift from a smaller
to a larger plant size then what the firm will have to do to made
such shift, changeover to a bigger plant size requires investment
in new capacity. Even keeping to the same plant size over time,
requires replacement of worn-out plant. All these require
investment of resources.
Investment is defined as the acquisition of durable productive
facilities in the expectation of a future gain. It normally
consists of physical capital like plant, equipment, building,
machinery etc. it may also include non- physical capital like
training of personnel etc.
Investment or capital expenditure usually involves a large sum
of money (although the amount need not be huge) incurred at a point
of time where as benefit are realized at different point of time in
future but it is very natural, investment decision becomes vital to
almost organization.
So how well this activity is planned and implemented. The value
of investment lies on potential profit. If a firm acquires a
capital asset which gives less revenue than its cost the business
will definitely suffer setback. Hence a correct estimation of the
worth of investment is essential before the investment is
undertaken.
Capital Budgeting Decision: Project which keep on generating
return for a long period (i.e. more than a year) are known as
capital project.
e.g. - factory building, transport vehicles, new plant.
The capital budgeting process can be classified into three broad
categories:-
1. Investment selection 2. Financing investment 3. Allocation of
funds among project
1) Investment selection :-
It involves decision regarding both the amount of investment in
the planning period and selection of project.
It consist of
Expansion of firm production facilities (to meet growing demand
for the product of the company)
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Replacement decision : (Replacing damaged or obsolete plant and
machinery by more efficient one.
New improved product decision (to bring new or changed product
in the market, certain investment are needed like expenditure on R
& D, market research, advertisement etc.
Make or buy decision :- To produce the product or to purchase it
from vendor (supplier)
Lease or buy decision :- A firm may decide to lease equipment
rather than invest sizeable funds for buying equipment.
2) Financing investment :-
There are certain norms against which the benefits are to be
judged from the long term investment.
E.g.:- minimum rate of return, required rate of return.
Sources of capital to the firm are presumed to be:
a) External sources (the capital market) b) Internal sources
(retained earning)
Each specific sources of capital has its own cost, which becomes
a component part of overall cost of capital to the firm.
3) Allocation of fund among project :-
Factors influencing investment decision;
a) Technological change: - new technology which is relatively
more efficient, takes place of old technology. However in taking
decision of this type, the mgmt has to consider the cost of new
equipment, salvage value of replaced equipment.
b) Competitors strategy:- many a times a investment taken to
maintain the competitive strength of the firm. If the competitors
are installing new equipment to expand output or to improve quality
of their product the firm under consideration will have no
alternative but to follow suit(go with).
c) Demand forecasting:- the long run forecast of demand is one
of the determinant of investment decision. If it is found that
there is market potential for the product in the long run, the
dynamic firm will have to take decision for capital expansion.
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d) Types of management:- whether capital investment would be
encouraged or not depend
to a large extent on the view point of the management.
If mgmt is modern & progressive then innovation is
encouraged.
e) Fiscal policy:- various tax policies of the government have
favorable or unfavorable
influence on capital investment. E.g. excise duties, method of
allowing depreciation.
f) Cash flow:- every firm makes a cash flow budget. Its analysis
influence capital investment decision. With its help the firms
plans funds for acquiring the capital asset.
g) Return expected from the investment:- in most of the cases,
investment decision are made in anticipation of increased return in
future. While evaluating investment proposal, it is therefore
essential for the firm to estimate future return or benefit
accruing from the investment.
Steps in capital project evaluation:-
In order to evaluate a project we need to have three kind of
information:
1. List of investment proposals (developing investment
proposals) 2. Estimate cash flow of each of these proposals. 3.
Knowledge about the various criteria used for project
evaluation.
1) Developing investment proposal: The capital budgeting process
begins with the generation of capital investment proposals. A firm
growth and development depend upon a constant flow of new
investment ideas. Many investment opportunities reveals themselves
in ordinary course of business (e.g.
need to replace worn-out machinery) Various corporate strategies
are made by the business acquisition to achieve competitive
edge over it competitors project. Which are not compatible with
corporate strategy are rejected and those that are essential to
implement, the strategy are accepted. It must be noted that the
strategy is not static - as time passes and circumstances changes,
new strategies involve. Thus the first step is screening process is
to assemble a list of proposed new investment, together with the
data necessary to evaluate them.
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This data include: a) Estimating investment requirement of the
project. b) Forecasting cash inflow of the project. c) The mgmt
attitude towards risk. d) Time value of money.
2) Estimating cash inflow:-
In capital expenditure proposal analysis the most important and
difficult step is to estimate cash flow associated with the
project. Cash flow is of two kinds:-
Cash outflows (Associated with building and equipment the new
production facility)
Cash inflow The annual cash inflows the project will generate
after it goes into operation. A large no. of variables are involved
in the cash flow forecast and many individual and departments
participate is developing them.
Guidelines for estimation of cash flows:-
a) Cash flow must be constructed on incremental basis. ( only
the difference of cash flow due to acceptance of the project are
relevant for inclusion in investment analysis).
b) Indirect cash flow must be taken. e.g. the impact of a new
product on the sales revenue of the existing product.
c) Cash flow should be constructed on an after tax basis
(because that represents net Flow from the point of view of the
firm).
3) Evaluation of project:- Capital project have a finite life
over which the project yield a stream(flow) of annual receipt. A
fundamental concept that must be understood while taking as out
stream of annual receipt is the notion of time value of money. The
investment in projects occurs only in initial years of the project.
The net return from the project comes in stream of annual
receipt.So net return from the project can be scientifically
calculated only when the cash inflow and outflow are expressed in
terms of common denominator.
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I.e. when the stream of annual cash flows is disconnected to
find the present value. Evaluation of project
Traditional method Time adjusted method
ARR P B Period NPV PI IRR
1) Return on investment or , average rate of return (ARR) :- ARR
= Average profit
Average investment * 100 Where, Average profit is = total profit
during the life of the project Number of years
2) Pay back period:- Pay back period means period required to
get back initial investment. Less the pay back period better the
project.
Modern techniques of investment:
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1) Net present value:- This method is based on the economic
reasoning of discounting future cash flow
to make comparable. NPV is calculated by discounting all future
flows to present and subtracting. The
present value of all cash out flow from the present value of all
inflows. If NPV of project is positive, this indicates that project
add more to revenue than
it adds to cost. Therefore accepted. NPV (+) = accepted
If NPV of project is negative the project should be rejected.
NPV (-) = rejected
If NPV is zero than by any other evaluation method to evaluate
the project.
NPV = nt=1 Rt _ Co (1 + r )t
t = time period ( 0 to n year) Rt = cash inflow in period t Co =
initial investment or cash outflow R = discount rate (cost of
capital) N = last period of project
1) TIME VALUE OF MONEY: - Time value of money means that value
of a unit of money is different in different time periods. The
concept of time value of money refers to fact that the money
received today is different in its worth from the money receivable
at some other time in future. In other words, the same principal
can be stated as that the money receivable in future is less
valuable than the money received today.
The main reason for the time preference of money is to found in
the reinvestment opportunities for funds which are received early.
The funds so invested will earn a rate of return; this would not be
possible if the fund is received at a later time.
Example: Suppose a firm is selling a machine for RS. 20,000 .The
buyer offers to pay Rs.20, 000 either now or after one year. The
seller firm naturally accepts the first choice. i.e. to receive Rs.
20000 now. In this case firm reinvest the amount in fixed deposit
account for one year and get return 2000 @10%. So in first case co.
net income is 22,000 where as in second option co. income is
20,000. In this case interest amount is time value of money.
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So we can say that T.V.M. for the money is its rate of return
which the firm can earn by reinvesting its present money. This rate
of return can also be expressed as a required rate of return to
make equal the worth of money of two different time periods.
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CHAPTER NO.:-3
CAPITALIZATION
Meaning: - Capital Structure ordinarily implies the proportion
of debt and equity in the total capital of a company. Since company
can tap any one or more source of funds to meet its total financial
requirement .The total capital of a company may thus be composed of
all such tapped sources.
Capital may be defined as long term funds of the firm.
Capital is the aggregation of the items appearing on the left
hand side of balance sheet minus current liabilities (total
liabilities current liabilities).
Capital is also be expressed as total asset minus current
liabilities. (Total asset Current liabilities).
Types of Capital:-
Equity Capital:-
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Why its necessary to study the capital structure theories :
The basic objective of the financial management is to maximize
the shareholders wealth and therefore all financial decision in any
firm should be taken in light this objective. The decision
regarding the capital structure or the financial leverage or the
financial mix should also be based on the objective of achieving
the maximization of shareholder wealth. The capital structure
theories attempt to analyze the relationship between capital
structure and the value of the firm in terms of different theories
and models on the subject matter.
Concept of value of the firm: - The value of firm depends on the
earning of the firm and earning of the firm depends upon the
investment decision of the firm. The earnings of the firm are
capitalized at a rate equal to the cost of capital in order to find
out the value of the firm.
Thus the value of the firm depends on two basic factors.
i. The earning of the firm ii. Cost of capital
The operating profit (i.e. EBIT) of the firm is mainly divided
into three claimants
A. Debt Holders (debenture, banks loan .Others loan,) :- By way
of interest. B. Government : - By way of taxes. C. Shareholders : -
By way of dividend.
If we talk about size of EBIT, it is depend on investment
decision of the firm.
While capital structure of the firm determine how EBIT is to be
sliced among three above claimants.
The total value of the firm is sum of its value to the debt
holder and to its shareholders and is determine by the amount of
EBIT going to them respectively. Therefore the investment decision
can increase the value of the firm by increasing the size of the
EBIT where as the capital structure mix can affect the value only
by reducing the share of the EBIT going to the Government in the
form taxes.
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Capital structure or financial leverage or financing mix of the
firm does not affect the total earning of firm. However earnings
available to the shareholders may be influenced by capital
structure of the firm. For a given level of earnings lower the cost
of capital, the higher would be the value of firm. But, what is the
relationship between financing mix, cost of capital and the value
of the firm? Is there any optimal capital structure? Can value of
the firm be maximized by affecting the financing mix or by
affecting the cost of capital? If leverage affects the cost of
capital and the value of the firm, then the firm should try to
achieve an optimal capital structure or optimal financing mix and
minimizing the cost of capital .is there really a capital structure
which may be called the optimal capital structure?
Factors Determining Capital Structure
1) Control: - The mgt. control over the firm is one of the major
determinants of capital structure decision.
The equity shareholders are considered as the real owner of the
company, since they can participate in decision making through the
elected body of representatives called Boards of Director.
The preference shareholders and debenture holder cannot
participate in decision making.
When the promoters do not wish to dilute their control, the
company will rely more on debt fund. Any fresh issue of shares will
dilute the control of the existing shareholders.
2) Risk: - Mainly two risks are involved in capital structure
decision
(a) Business Risk (BR) (it is influenced by demand, price,
input, competition in market, fixed cost, etc.)
(b) Financial Risk (FR represents the risk from financial
leverage )
FR is least if the project is financed by equity capital, since
equity dividend is payable only when there is sufficient fund for
appropriation and equity capital need not to refunded during the
life time of the company.
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FR is high if the proportion of debt fund is more in capital
structure, since the interest is to be paid to the financer even if
profit is low and borrowed fund is to be paid off to them after
certain period or at the time of maturity.
3) Income: - Increase of return on equity shareholders depends
on the method of financing and its impact. (Explain at the time of
theories of capital structure).
4) Tax consideration: - Under provision of income tax
Equity & preference dividend paid to the shareholder are not
eligible for deduction under income tax act. However interest paid
for borrowed fund is deductible expenditure before calculation of
income tax. The tax saving on interest charge reduces the cost of
debt fund.
5) Cost of Capital :-
6) Trading on equity:-The firms wealth is increased, if after
tax earning is increased. A co. can raise debt at low cost with a
view to enhance the earning of equity share holder. The cost of
debt is less due to tax advantage.
7) Investor attitude: - All investor have different expectation
from their investment, so co. should tap that investor whose return
expectation is low, so that it will decrease total cost of
capital.
8) Flexibility: - One very important feature of debt fund is
that debt fund may be raised and can be paid off as when desired.
But in case of equity, once the fund is raised through issue of
equity shares, it cannot ordinarily be reduced except permission of
court and after by doing lot of compliances.
9) Timing: - Economic condition is also one of important
consideration need to be take care at the time of capital structure
decision. At the time of recession the equity share holder will not
show much of interest in investing. But at the time of boom it
would be easier for firm to raise equity capital.
10) Legal provision:-The legal formalities required before
issuing equity share is more complicated than raising debt.
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11) Profitability: - A co. with higher profitability will have
low reliance on outside debt fund and it will meet its additional
requirement through internal generation.
12) Growth rate: - The growing co. requires more and more funds
for its expansion schemes which will meet through raising debt. The
fast growing co. will rely more on debt fund than equity or
internal earning.
13) Government policy: - Increase in lending rate by govt. may
cause the companies to raise finance from capital market.
Meaning of optimal capital structure:-
The optimal capital structure is the capital structure at which
the weighted average cost of capital is minimum and there by
maximum value of the firm. It also may be defined as the capital
structure or combination of debt and equity that leads to the
maximum value of the firm.
Over capitalization & under capitalization
Over capitalization:-
Generally over-capitalization implies that the capital of the
company exceeds its requirements. A company is overcapitalized when
its earning capacity does not justify the amount of capitalization.
In other words, a company is said to be overcapitalized when its
actual profits are not sufficient to pay interest (on debentures
and borrowings) and dividends (on share capital) at fair rates.
A concern is said to be over-capitalized if its earnings are not
sufficient to justify a fair return on the amount of share capital
and debentures that have been issued.
It is said to be over capitalized when total of owned and
borrowed capital exceeds its fixed and current assets i.e. when it
shows accumulated losses on the assets side of the balance
sheet.
A company is said to be overcapitalized, when its total capital
(both equity and debt) exceeds the true value of its assets. It is
wrong to identify overcapitalization with excess of capital because
most of the overcapitalized firms suffer from the problems of
liquidity.
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Causes of Over Capitalization: Some of the important reasons of
over-capitalization are:
1. Idle funds: The Company may have such an amount of funds that
it cannot use them properly. Money may be living idle in banks or
in the form of low yield investments.
2. Over-valuation: The fixed assets, especially good will, may
have been acquired at a cost much higher than that warranted by the
services which that asset could render.
3. Fall in value: Fixed assets may have been acquired at a time
when prices were high. with the passage of time prices may have
been fallen so that the real value of the asset may also have come
down substantially even though in the balance sheet the assets are
being shown at book value less depreciation written off. Then the
book values will be much more than the economic value.
4. Inadequate depreciation provision: Adequate provision may not
have been provided on the fixed assets with the result the profits
shown by books may have been distributed as dividend, leaving no
funds with which to replace the assets at the proper time.
5. Lack of reserves 6. High rate taxation 7. Borrowing money at
high rates of interest 8. High promotional expenses
Disadvantage of over capitalization from Investor's or
shareholder's point of View:
1) Loss in the value of investment (shares) 2) Loss of easy
marketability 3) Irregular, uncertain and lower earnings on the
investment (dividend on
shares) 4) Speculation is encouraged 5) Reduction in the
liquidity of investment 6) Shares cannot be mortgaged easily as
their utility as collateral security is
reduce 7) Loss due to reorganization
The point of view of the Society:
1) Increase in prices or reduction in quality of goods 2) Wage
cuts or retrenchment of workers
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3) Increase in unemployment 4) Encouragement to reckless
speculation 5) Misutilization and wastage of resources 6) Reduced
efficiency of the management 7) Loss of public confidence in
investment etc.
Remedies for overcapitalization 1) Reduction of debt burden(debt
capital) 2) Negotiation with term lending institutions for
reduction in interest
obligation. 3) Redemption of preference share through a scheme
of capital reduction. 4) Reducing the face value and paid-up value
of equity shares. 5) Initiating merger with well managed profit
making companies interested
in talking over ailing company. Advantages or merits of
overcapitalization are:
1) Increase in the competitive power of the company. 2) Easy
expansion of the company's activities. 3) Morale of the management
is raised. 4) Risk-taking capacity is increased. 5) No fear of
shortage of capital. 6) Power to face depression period is
increased.
Example:- Under capitalization:-
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Leverage
Meaning (dictionary) : an increased means of accomplishing some
purpose (Leverage allows us to accomplish certain things which are
otherwise not possible ,viz; lifting of heavy object with the help
of leverage). Meaning (in financial mgt.): the term leverage is
used to describe the firm ability to use fixed cost asset or funds
to increase the return to its owners. The fixed cost (also called
fixed operating cost) and fixed charges (called financial cost)
remaining constant irrespective of change in volume of output of
sales. Thus employment of an asset or source of fund for which the
firm has to pay a fixed cost or return has considerable influence
on the earning available for equity shareholders.
Example: As per the Income statement of XYZ Ltd. Sales is Rs.4,
00,000 .Variable cost is60%.Fixed cost is Rs.50, 000
Then EBIT is = Sales = 4, 00,000 Less: Variable cost = 2,
40,000
Contribution = 1, 60,000 Less: Fixed cost = 50,000
(Operating profit) EBIT 1 =1, 10,000
If due to some reason sales is increased by 100% (doubled)
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Then EBIT will be = Sales = 8, 00,000 Less: Variable cost = 4,
80,000
Contribution = 3, 20,000 Less: Fixed cost = 50,000
(Operating profit) EBIT 2 = 2, 70,000
In above income statement you see the advantage of fixed cost in
total cost is that, if the sales are double than operating profit
will be more than double .this is happening due to sales work as
lever to carry fixed cost, by increase in sales the distribution of
fixed cost per unit start declining and it increases profit. That
is known as leverage effect.
The advantages of leverage
1. If the sales are doubles operating profit will be more than
double.
2. If the operating profit is the double then EBT to more than
double.
This to advantage also associated with leverages in case of
following & also the operating profit will decrease more than
decrease in sales.
3. If the EBIT is decrease than EBT will decrease more than
decrease of EBIT.
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The first effect due to fixed cost is known as operating
leverages &the second effect due to fixed interest is known as
financial leverages the formulas are as below
1. Operating leverage = Contribution EBIT
2. Financial leverage = EBIT EBT
3. Combined leverages = Contribution EBT Operating Leverage is
the responsiveness of the firms EBIT to the changes in sales value.
It referred to the sensitivity of operating profit before interest
and tax to the changes in quantity produced and sold. The firm OL
is higher if the firm has quantum of fixed cost and low variable
cost. The firm OL is low if the firm higher variable cost.low fixed
cost and higher variable cost. Cost of capital: - We are raising
long term fund from various sources and we have to return these
principal amount as per term and condition. In addition to this we
are also paying some periodical payments to the supplier of funds
these periodical payments we are paying because we are using these
funds.
Cost of capital is nothing but the periodical payments (other
than principal amount) to the supplier of capital on account of use
of capital.
I. Cost of Debt capital (Kd)
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Kd = I (1- T) Amount Received Cost of debt is calculated as
annual interest paid divided by actual amount received multiplied
by (1- T).Cost of the debt is less than interest rate because when
we pay interest we get advantage in the amount of tax reduced due
to payment of interest. And i.e. the reason when cost of debt is
less than the amount of interest paid. 2) Cost of preference Share
(K p) Kp = Preference Dividend paid Amount Received Amount received
= Issue price discount on issue of share + Premium on issue of
share In case preference share capital we dont get any advantage of
tax benefit because dividend is paid after payments of tax and so
cost of preference share is some as dividend rate for preference
share.
3) Cost of equity capital (K e) Ke = (i) E.P.S. M.P.S. (ii)
D.P.S M.P.S. (iii) D.P.S. g M.P.S
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4) Cost of retained earnings (Kre) is same as cost of equity
Trading on equity :-
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CHAPTER NO.:-1
FINANANCE MANAGEMENT
(I) Approaches to Finance Management. Or,
Functions to Finance Management. Or,
Functions of finance manager.
Traditional View
Traditional View of finance, management looks into the following
function, that finance manager of business firm will perform.
(i) Arrangement of short term and long term fund for financial
institution. (ii) Mobilization of funds through financial
instrument like equity shares,
preference shares, debenture, bonds.etc. (iii) Orientation of
finance functions with accounting function and
compliance of legal provisions relating to funds procurement,
use distribution.
Modern View
Due to globalization & liberalization of economy the
function of finance manager in any organization becomes vary
diversified.
In today scenario finance manger is expected to do
(i) The total funds requirement of the firm. (ii) The assets to
be required and (iii) The pattern of financing the asset.
Thus finance manager of modern business firm role is divided
among three basic claimants.
(1) Investment Decision (2) Finance Decision
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(3) Dividend Decision
Investment Decision: - The investment decision of a finance
manager covers the following areas
(i) Ascertainment of total volume of funds (ii) Selection of
capital investment proposal.
(iii) Measurement of risk and uncertainty in the investment
proposal. (iv) Prioritization of investment decision (v) Fund
allocation and rationing (vi) Determination of fixed assets to be
required (vii) Determine the level of investment in current asset
(viii) Buy or lease decision (ix) Asset replacement decision (x)
Security analysis and portfolio Decision.
Finance Decision:-
The finance manager involve in the following finance
decision:
(i) Determine of degree or level of gearing. (ii) Determine of
financing pattern of long term funds requirement (iii) Determine of
financing pattern of short term funds requirement (iv) Raise funds
through issue of financial instrument (equity shares,
preference share, debenture, bonds, etc. (v) Arrangement of fund
through Banks and financial institution(Banks ) (vi) Arrangement of
finance for working capital requirement. (vii) Portfolio Management
(viii) Calculation of interest burden of the organization. (ix)
Evaluation of alternative use of fund. (x) Maintenance balance
between owners capital and borrowed capital (xi) Setting budget and
review of budget.
Dividend Decision:-
The dividend decision of finance manager is mainly concerned
with
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(a)The amount paid to shareholder as dividend to influence them
(b)The amount of profit retained for internal investment which
maximize the value of firm The investment, finance, dividend
decision are interrelated to each other and therefore finance
manager while taking any decision should consider the impact from
all three angles simultaneous.
(II) Objectives Objectives of finance or Objectives of Finance
Manager in any Corporate
Diagram Showing Changes in objectives of finance Manager with
change in market condition.(i.e.in earlier time it was profit
maximization ,than wealth maximization and currently value
maximization.)
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It is necessary to set objective or goals for measuring
performance and control. The setting of physical targets to be
achieved within a set of time period provides the basis of
conversion of the targets into financial objectives. The primary
financial objectives of a firm are as follows:
(i) Return to capital employed (ii) Value addition and
profitability (iii) Growth in earning per share and price /
earnings ratio (iv) Growth in the market value of the shares (v)
Growth in dividends to share holders (vi) Optimum level of leverage
(vii) Survival & growth of the firm (viii) Minimization of
financial charges (ix) Efficient utilization of short, medium, long
term sources of fund.
Profit Maximization Objective
Traditionally the size of firms are small, owned managed and
they are competing with same size of firm, thats why profit
maximization was rational objective of firm. The profit of the firm
became the income of the owner. Maximizing profit the ensured the
self interest of the owner/manager, who both decide actions of the
firm and ensured that these are carried out. The force of
competition imposed profit maximization upon the firm to survive in
business.
The profit maximization objective of firm is criticized for the
following reason (1) The concept of profit maximization is vague
and narrow (2) It ignores the risk factor, as well as timing of
return. (3) It may allow decision to be taken at the cost of long
run stability and
profitability of the concern (4) It emphasize the short run
profitability and short term project (5) It may cause decrease in
share price (6) It only thinks for owner where as other stake
holder also participates for
growth of organization. (Stake holder such as, share holder,
creditors, debtors, debenture holder, government, banks, etc.)
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(7) It fails to consider social responsibility of business,
because it moves around owner only.
Wealth Maximization Objective As the owner of the company is its
share holder, the primary objective of corporate finance is usually
stated to be maximization of share holder wealth .Since share
holder receives their wealth through dividends and capital gains
the shareholders wealth is maximize by maximizing the value of
dividends and capital gains that share holder receive overtime
Wealth maximization goal is advocated on the following ground
(i) It takes into consideration long run survival and growth of
the firm (ii) It is consistent with the object of the owners
economic welfare (iii) It suggest the regular and consistent
dividend payment to the share
holder (iv) The financial decisions are taken with a view to
improve the capital
appreciation of the share. (v) It consider risk and time value
of money (vi) It consider future cash flows, dividends and earnings
per share (vii) Maximization of firm value is reflected in the
market price of share,
since it depends on shareholders expectation as regards
profitability, long run prospects, risk, return, distribution of
return.
(viii) Profit maximization partly enables the firm in wealth
maximization (ix) The share holders always prefers wealth
maximization rather than
maximization of inflow of profits.
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Value Maximization Objective The goal of firm is to maximize the
present wealth of owner, i.e. equity share holder in a company. A
company equity shares are actively traded in the stock markets, the
wealth of the equity share holders is represented in the market
value of equity shares. The firm cash flow and its impact on the
value maximization is shown in below figure.
Short Term Fund Long Term Fund
Acquiring temporary working capital
Acquiring fixed Asset and Permanent working Capital Generate
Cash
inflows from Operation
Service Department Obligation
Retained Earnings available for re investment
Dividend Distribution
Firm Wealth Maximization
Value Maximization of equity share holders through increase in
stock market
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Other Objective are
1) Sales Maximization 2) Maximization of ROI 3) Social
Objective.
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Ratio Analysis Financial Statement analysis means study of
relationship among various factors in a business disclosed in
financial statement of firm
The basic objective of financial statement is as follows To
judge financial health of the firm To evaluate the profitability of
the enterprises To gauge the debt servicing capacity of firm To
understand long term and short term solvency of the firm To know
the return on capital employed or invested
Methods of Analyzing Financial Statement The method of analyzing
of financial statement Ratio are the mathematical tool for
comparing the two relative figures .One absolute figure is not much
informative but when compare one figure with other we get more
information.
Ratio Analysis is defined as systematic use of ratio to analyse
and interprate the financial statements that the strength and
weakness of the firm is clearly known.
Similarly by using the ratio we can do the comparative study. A
single figure by itself has no meaning but when we expressed in
term of related figure we get the significant figure.
Four types of comparison are done:
i) Trend Analysis: It is comparing the present ratio with the
past ratio
ii) Inter firm Comparison: It is comparing our ratio with the
competitors ratio.
iii) Comparison with standards:
iv) Comparison with plans:
Advantages of Ratio Analysis
The importance of ratio Analysis is the fact that it presents
the information on comparative basis and helps the decision maker
to decide the future plans.
Following is the list of certain advantages
1) Liquidity position of the company is clearly known.(by using
current ratio ,liquid ratio)
2) Long term Solvency is clearly shown by ratio analysis.
-
3) Operational efficiency is in clearly known i.e. how
efficiently you are using your stocks, debtors. etc.
4) Profitability of the organization is known by using Gross
profit, net profit ratio.
5) Inter firm comparison is possible
6) Comparison with plan and standard is possible
7) Investment decision or disinvestment decision can be taken by
using ratio analysis.
8) Ratio analysis highlights the weakness and strength of the
organization.
Types of ratios
For the sake of facilitation of Calculations and interpretation,
ratios may be classified
according to different basis. One of the ways of classification
is according to the financial
statements. In this method, ratios are calculated on the
following basis.
(i) Trading A/C ratios
(ii) Profit and Loss A/C ratios
(iii)Balance Sheet ratios
-
However, the classification according to the following basis
will be more effective for
analyzing and interpreting the financial statements.
(i) Profitability ratios (ii) Turnover ratios
(iii)Financial ratios
(iv) Leverage ratios
Profitability Ratios:
These ratios give an idea about the profitability of a business
firm. Profit and profitability
differ from each other as profit is the difference between
income and expenditure. While
profitability is measured by comparing the profit with some
other parameter like sales, capital
employed the total assets etc. The ratios are falling under this
category are usually expressed in
percentage. The following are the ratios under this
category:
(i) Gross Profit Ratio:
Gross profit is the difference between the net sales [sales
less
sales returns] and the cost of goods sold. This ratio is
calculated with the help of the following
formula:
This ratio shows the margin left after meeting the purchases and
manufacturing costs. It
measures the efficiency of production as well as pricing. A high
gross profit ratio means a high
margin for covering other expenses like administrative, selling
and distribution expenses. I.e.
other than the cost of goods sold therefore, higher the ratio,
the better it is. It is important for a
business to maintain this ratio on a higher side, otherwise it
will be difficult to cover other
expenses. A firm should compare its gross profit ratio with the
industry average to find out
where it stands. A firm can also compare its own ratio of the
past with the current years, ratio to
find out its performance. This is known as intra-firm
comparison.
-
(ii) Net profit ratio:
This ratio shows the earning left for shareholders [ equity
and
preference ] as a percentage of net sales . it measures overall
efficiency of all the functions of a
business firm like production, administration, selling,
financing, pricing, tax management etc.
This ratio is very useful for prospective investors because it
gives an idea of overall efficiency of
the firm. This ratio is calculated as follows:
(iii)Operating Net Profit ratio:
This ratio establishes the relationship between the net
sales and the operating net profit. The concept of operating net
profit is different from the
concept of net profit. Operating net profit is the profit
arising out of business operations only.
This is calculated as follows:
Alternatively, this profit can also be calculated by deducting
only operating expenses
from gross profit. This ratio is calculated with the help of the
following
Thus, higher this ratio, the lower is the margin of operating
profit .this ratio can be further
analyzed to find out the percentage of each type of expenses to
sales.
(iv) Return On capital Employed :
This ratio indicates the percentage of net
profits before interest and tax total capital employed .the
capital employed is calculated as
follows
Capital employed =equity capital + preference capital +Reserves
and surplus
+Long term debt fictitious Assets
-
This ratio is considered to be a very important one because it
reflects the overall efficiency
with which capital is used the ratio of a particular business
should be compared with other
business firms in the same industry to find out the exact
position.
(v) Return on equity:
This ratio, also known as return on shareholders funds or
return on proprietors funds or return on net worth, indicates
the percentage of net profit
available for equity shareholders to equity shareholders funds.
In other words, this ratio
measures the return only on equity shareholders funds and not on
total capital employed like
ratio number (v). The formula for calculation is as follows:
Note: equity shareholders funds = equity capital + reserve and
surplus
This ratio indicates the productivity of the owned funds
employed in the firm. However, in
judging the profitability of a firm, it should not be over
looked that during inflationary periods,
the ratio may show an up word trend because the numerator of the
ratio represents current values
whereas the denominator represents historical values.
(vi) Return on total asset:
This ratio compares the net profit after tax with the total
asset. The formula for calculations of this ratio is as
follows:
-
(vii) Earnings per share:
This is one of the important indicators of performance of a
company. Earning capital per share indicates the amount of
profits available for distributions
amongst the equity shareholders. This ratio is calculated as
shown below:
As mentioned above, EPS is one of the important criteria for
measuring the performance
of a company. If EPS increases, the possibility of a higher
dividend per share also increases.
However, the Dividend payment depends on the policy of the
company. Market price of shares
of a company may also show an upward trend if the EPS is showing
a rising trend. However, it
should be remembered that EPS of different companies may vary
from company to company due
to the following different practices by different companies
regarding stock in trade, depreciation,
source of rising finance, tax-planning measures etc.
(viii) Price Earnings ratio :
This ratio is calculated with the help of the following
Formula:
(ix) Dividend payout ratio:
EPS described above indicates the amount of profit
available for equity shareholders. Dividend payout ratio
indicates the percentage of profit
distributed as dividends to the shareholders. A higher ratio
indicates that the organization is
following a liberal policy regarding the dividend while a lower
ratio indicates a conservative
approach of the management towards the dividend. The ratio is
calculated as shown below:
-
(x) Dividend Yield ratio :
This ratio compares the dividend per share with the market
This ratio is price of the shares. The formula for calculation
is a follows very important for
investors who purchase their shares in a open market. They will
evaluate their return against their
investment, i.e. the market price paid by them. The higher the
ratio, the more attractive are their
investment.
Turnover ratios:
These ratios are also known as activity ratios or asset
management ratios. These ratios are
very important for a business concern to find out how will the
facilities at the disposal of the
concern are being used. These ratios are usually calculated on
the basis sales or cost of goods
sold. High turnover ratios indicate better utilization of
resources. The important turnover ratios
are discussed below.
(i) Working capital turnover ratio:
This ratio compares the net sales with net
working capital of the business firm. The indication given by
this ratio is the number of times
working capital is turned around in a particular period. The
ratio is calculated with the help of the
following formula.
(Net Working capital = Current asset Current liability)
The higher this ratio, the better is the utilization of the
working capital and also indication
of lower working capital. However, a very high working capital
turnover ratio is a sign of over
trading and a firm may face shortage of working capital. A firm
should compare this ratio with
the ratio of other firm in the same industry and also with the
industry average to find out its
position as compared to other firm.
-
(ii) Debtors turnover ratio:
One of the important decision regarding financial
management is about the credit to be granted to the customers.
There should be a well-defined
credit policy, which should be followed carefully by the firm.
The credit policy followed by a
firm is indicated by this ratio. This ratio is calculated with
the help of the following formula.
(Average Account receivables = Opening balance of debtors +
Closing balance of debtors / 2
and Opening balance of Bills receivables + Closing balance of
Bills receivables / 2)
(iii) Creditors Turnover Ratio:-
Debtors Turnover Ratio as described above indicates
the credit period allowed by the firm to its customers.
Creditors turnover Ratio indicates the
credit period allowed by the creditors to the firm. In other
words, it is exactly apposite the above
ratio. Formula is below:
( Average Accounts Payable = Opening Balance of Creditors +
Closing Balance of Creditors
/ 2 And Opening Balance of Bills payables + Closing Balance of
Bills payables / 2)
(iv) Inventory / Stock Turnover Ratio:-
This ratio establishes a relationship between the
cost of goods sold during given period And the average amount of
inventory held during that
period. The indication given by this ratio is the number of
times the finished stock is turned over
during a given accounting period. The formula is given
bellow:
.
-
(v) Fixed Asset Turnover Ratio:-
This ratio indicates the amount of sales realized per
rupee of investment in fixed assets. Fixed assets are those
assets, which are not acquired for re-
sale. In other words, they are meant for utilization in the
business for the purpose of improving
its earning capacity. Whether this purpose is being fulfilled or
not is indicated by this ratio. The
formula is given bellow;
Cost of goods sold may be taken in place of sales
Net fixed assets = Cost Depreciation
(vi) Sales to capital Employed:-
This ratio is also known as Capital Turnover Ratio
and indicates sales per rupee of capital employed. The formula
is bellow
Capital employed = Shareholders funds + long term
Liabilities
Financial Ratios:-
As the name suggest, these ratios are calculated to judge
financial position firm from the long term as well as short term
angle. The Following
ratios are included in this category.
(i) Current ratio: -
This ratio is calculated by dividing current assets by
current
liability. Current ratio is also known as Solvency ratio as it
indicates how the expected current
claims are covered by current assets. The formula is bellow
-
Current asset means assets, which have been purchased in order
to convert them into cash or
into other current assets within a period of normally one
year.
(ii) Liquid / Quick / Acid Test Ratio: -
This ratio is a better tool to measure the ability
to honor day to day commitments. It is the ratio between the
liquid assets and liquid liabilities.
From The balance sheet, liquid assets are calculated by
deducting inventories and prepaid
expenses from current assets. liquid liabilities are current
liabilities less Bank overdrafts. The
formula is bellow.
(iii)Debt-Equity Ratio:-
This ratio is calculated to measure the comparative
proportion
of borrowed funds and Shareholders funds invested in the firm. A
firm raises funds through
owned funds, which are also called as Shareholders funds, or
Proprietors funds as well as
borrowed funds. The proportion between these two sources should
be properly balanced;
otherwise the firm may face problems. The formula is bellow
(iv) Proprietary Ratio:-
It is primarily the ratio between the proprietors funds and
total
assets. The formula is bellow
-
(v) Debt Ratio The Debt Ratio refers to the ratio of long-term
debt to the total of
external and internal funds (capital employed or net assets). It
is computed as follows:
Capital employed is equal to the long-term debt + shareholders
fund.
Alternatively, it may be taken as net assets which are equal to
the total non-fictitious assets
current liabilities
Significance: Like debt equity ratio, it shows proportion of
long-term debt in capital
employed. Low ratio provides security to creditors and high
ratio helps management in
trading on equity. In the above case, the debt ratio is less
than half which indicates
reasonable funding by debt and adequate security of debt. It may
be noted that Debt
Ratio can also be computed in relation to total assets. In that
case, it usually refers to the
ratio of total debt (long-term debt + current liabilities) to
total assets, i.e. total of fixed
and current assets (or shareholders funds + long-term debt +
current liabilities), and is
expressed as Debt Ratio = Total Debt / Total Assets
(vi) Current Assets to Fixed Assets:-
This ratio shows the proportion of current assets
to fixed assets. As described in current ratio, current assets
are held for converting them into cash
in a short period of time while fixed assets are held for long
term purposes, i.e. to enhance the
earning capacity of the firm. This ratio indicates the
proportion between the two and is calculated
with the following formula
-
Leverages Ratios:-
In this category, the following ratio is significant.
(i) Capital Gearing Ratio :-
The ratio indicates the proportion between fixed Charge bearing
security and equity capital. A firm raises finance through owned
funds and borrowed funds. Owned funds include equity capital,
preference capital and retained earnings while borrowed funds
include term loans and debentures. In case of equity capital, it is
not compulsory to pay dividend as it depends on the profit position
and also on the discretion of the board of directors.
Capital Gearing Ratio: - Fixed charges capital / Equity
Capital
-
Working Capital management is the management of assets that are
current in nature. Current assets, by accounting definition are the
assets normally converted in to cash in a period of one year. Hence
working capital management can be considered as the management of
cash, market securities receivable, inventories and current
liabilities. In fact, the management of current assets is similar
to that of fixed assets in the sense that is both in cases the firm
analyses their effect on its profitability and risk factors, hence
they differ on three major aspects:
1. In managing fixed assets, time is an important factor
discounting and compounding aspects of time play an important role
in capital budgeting and a minor part in the management of current
assets.
2. The large holdings of current assets, especially cash, may
strengthen the firms liquidity position, but is bound to reduce
profitability of the firm as ideal car yield nothing.
3. The level of fixed assets as well as current assets depends
upon the expected sales, but it is only current assets that add
fluctuation in the short run to a business.
To understand working capital better we should have basic
knowledge about the various aspects of working capital. To start
with, there are two concepts of working capital:
Gross Working Capital Net Working Capital
1. Working capital, sometimes called gross working capital,
simply refers to current assets used
in operations.
2. Net working capital is defined as current assets minus
current liabilities.
3. Net operating working capital (NOWC) is defined as operating
current assets
minus operating current liabilities. Generally, NOWC is equal to
cash, accounts
Receivable, and inventories, fewer accounts payable and
accruals.
The term working capital originated with the old Yankee peddler,
who would load
up his wagon with goods and then go off on his route to peddle
his wares.
WORKING CAPITAL MANAGEMENT
-
Working Capital
Capital required for a business can be classified under two main
categories via,
1) Fixed Capital
2) Working Capital
Every business needs funds for two purposes for its
establishment and to carry out
its day- to-day operations. Long terms funds are required to
create production facilities
through purchase of fixed assets such as p&m, land,
building, furniture, etc.
Investments in these assets represent that part of firms capital
which is blocked on
permanent or fixed basis and is called fixed capital. Funds are
also needed for short-
term purposes for the purchase of raw material, payment of wages
and other day to-
day expenses etc.
These funds are known as working capital. In simple words,
working capital
refers to that part of the firms capital which is required for
financing short- term or
current assets such as cash, marketable securities, debtors
& inventories. Funds, thus,
invested in current assts keep revolving fast and are being
constantly converted in to
cash and this cash flows out again in exchange for other current
assets. Hence, it is also
known as revolving or circulating capital or short term
capital.
CONCEPT OF WORKING CAPITAL
There are two concepts of working capital:
1. Gross working capital
2. Net working capital
-
The gross working capital is the capital invested in the total
current assets of the
enterprises current assets are those
Assets which can convert in to cash within a short period
normally one accounting
year.
CONSTITUENTS OF CURRENT ASSETS
1) Cash in hand and cash at bank
2) Bills receivables
3) Sundry debtors
4) Short term loans and advances.
5) Inventories of stock as:
a. Raw material
b. Work in process
c. Stores and spares
d. Finished goods
6. Temporary investment of surplus funds.
7. Prepaid expenses
8. Accrued incomes.
9. Marketable securities.
-
In a narrow sense, the term working capital refers to the net
working. Net working
capital is the excess of current assets over current liability,
or, say:
NET WORKING CAPITAL = CURRENT ASSETS CURRENT LIABILITIES.
Net working capital can be positive or negative. When the
current assets exceeds the
current liabilities are more than the current assets. Current
liabilities are those
liabilities, which are intended to be paid in the ordinary
course of business within a
short period of normally one accounting year out of the current
assts or the income
business
CONSTITUENTS OF CURRENT LIABILITIES
1. Accrued or outstanding expenses.
2. Short term loans, advances and deposits.
3. Dividends payable.
4. Bank overdraft.
5. Provision for taxation, if it does not amt. to app. Of
profit.
6. Bills payable.
7. Sundry creditors.
The gross working capital concept is financial or going concern
concept whereas net
working capital is an accounting concept of working capital.
Both the concepts have
their own merits.
-
The gross concept is sometimes preferred to the concept of
working capital for the
following reasons:
1. It enables the enterprise to provide correct amount of
working capital at correct time.
2. Every management is more interested in total current assets
with which it has to
operate then the source from where it is made available.
3. It take into consideration of the fact every increase in the
funds of the enterprise
would increase its working capital.
4. This concept is also useful in determining the rate of return
on investments in
working capital. The net working capital concept, however, is
also important for
following reasons:
It is qualitative concept, which indicates the firms ability to
meet to its operating
expenses and short-term liabilities.
IT indicates the margin of protection available to the short
term creditors.
It is an indicator of the financial soundness of
enterprises.
It suggests the need of financing a part of working capital
requirement out of the
permanent sources of funds
CLASSIFICATION OF WORKING CAPITAL
Working capital may be classified in to ways:
On the basis of concept.
On the basis of time.
On the basis of concept working capital can be classified as
gross working capital and
net working capital. On the basis of time, working capital may
be classified as:
-
Permanent or fixed working capital.
Temporary or variable working capital
PERMANENT OR FIXED WORKING CAPITAL
Permanent or fixed working capital is minimum amount which is
required to ensure
effective utilization of fixed facilities and for maintaining
the circulation of current
assets. Every firm has to maintain a minimum level of raw
material, work- in-process,
finished goods and cash balance. This minimum level of current
assets is called
permanent or fixed working capital as this part of working is
permanently blocked in
current assets. As the business grow the requirements of working
capital also increases
due to increase in current asset
TEMPORARY OR VARIABLE WORKING CAPITAL
Temporary or variable working capital is the amount of working
capital which is
required to meet the seasonal demands and some special
exigencies. Variable working
capital can further be classified as seasonal working capital
and special working
capital.
The capital required to meet the seasonal need of the enterprise
is called seasonal
working capital. Special working capital is that part of working
capital which is
required to meet special exigencies such as launching of
extensive marketing for
conducting research, etc.
Temporary working capital differs from permanent working capital
in the sense that is
required for short periods and cannot be permanently employed
gainfully in the
business.
IMPORTANCE OR ADVANTAGE OF ADEQUATE WORKING CAPITAL
-
SOLVENCY OF THE BUSINESS: Adequate working capital helps in
maintaining the
solvency of the business by providing uninterrupted of
production.
Goodwill: Sufficient amount of working capital enables a firm to
make prompt
payments and makes and maintain the goodwill.
Easy loans: Adequate working capital leads to high solvency and
credit standing can
arrange loans from banks and other on easy and favorable
terms.
Cash Discounts: Adequate working capital also enables a concern
to avail cash
discounts on the purchases and hence reduces cost.
Regular Supply of Raw Material: Sufficient working capital
ensures regular supply of
raw material and continuous production.
Regular Payment of Salaries, Wages and Other Day TO Day
Commitments: It leads to
the satisfaction of the employees and raises the morale of its
employees, increases
their efficiency, reduces wastage and costs and enhances
production and profits.
Exploitation of Favorable Market Conditions: If a firm is having
adequate working
capital then it can exploit the favorable market conditions such
as purchasing its
requirements in bulk when the prices are lower and holdings its
inventories for higher
prices.
Ability to Face Crises: A concern can face the situation during
the depression.
Quick And Regular Return On Investments: Sufficient working
capital enables a
concern to pay quick and regular of dividends to its investors
and gains confidence of
the investors and can raise more funds in future.
High Morale: Adequate working capital brings an environment of
securities,
confidence, high morale which results in overall efficiency in a
business.
EXCESS OR INADEQUATE WORKING CAPITAL
-
Every business concern should have adequate amount of working
capital to run its
business operations. It should have neither redundant or excess
working capital nor
inadequate nor shortages of working capital. Both excess as well
as short working
capital positions are bad for any business. However, it is the
inadequate working
capital which is more dangerous from the point of view of the
firm.
DISADVANTAGES OF REDUNDANT OR EXCESSIVE WORKING CAPITAL
1. Excessive working capital means ideal funds which earn no
profit for the firm and
business cannot earn the required rate of return on its
investments.
2. Redundant working capital leads to unnecessary purchasing and
accumulation of
inventories.
3. Excessive working capital implies excessive debtors and
defective credit policy
which causes higher incidence of bad debts.
4. It may reduce the overall efficiency of the business.
5. If a firm is having excessive working capital then the
relations with banks and other
financial institution may not be maintained.
6. Due to lower rate of return n investments, the values of
shares may also fall.
7. The redundant working capital gives rise to speculative
transactions
DISADVANTAGES OF INADEQUATE WORKING CAPITAL
Every business needs some amounts of working capital. The need
for working capital
arises due to the time gap between production and realization of
cash from sales. There
-
is an operating cycle involved in sales and realization of cash.
There are time gaps in
purchase of raw material and production; production and sales;
and realization of cash.
Thus working capital is needed for the following purposes:
For the purpose of raw material, components and spares.
To pay wages and salaries
To incur day-to-day expenses and overload costs such as office
expenses.
To meet the selling costs as packing, advertising, etc.
To provide credit facilities to the customer.
To maintain the inventories of the raw material,
work-in-progress, stores and spares
and finished stock.
For studying the need of working capital in a business, one has
to study the business
under varying circumstances such as a new concern requires a lot
of funds to meet its
initial requirements such as promotion and formation etc. These
expenses are called
preliminary expenses and are capitalized. The amount needed for
working capital
depends upon the size of the company and ambitions of its
promoters. Greater the size
of the business unit, generally larger will be the requirements
of the working capital.
The requirement of the working capital goes on increasing with
the growth and
expensing of the business till it gains maturity. At maturity
the amount of working
capital required is called normal working capital.
There are others factors also influence the need of working
capital in a business.
FACTORS DETERMINING THE WORKING CAPITAL REQUIREMENTS
-
1. NATURE OF BUSINESS: The requirements of working is very
limited in public
utility undertakings such as electricity, water supply and
railways because they offer
cash sale only and supply services not products, and no funds
are tied up in inventories
and receivables. On the other hand the trading and financial
firms requires less
investment in fixed assets but have to invest large amt. of
working capital along with
fixed investments.
2. SIZE OF THE BUSINESS: Greater the size of the business,
greater is the requirement
of working capital.
3. PRODUCTION POLICY: If the policy is to keep production steady
by accumulating
inventories it will require higher working capital.
4. LENTH OF PRODUCTION CYCLE: The longer the manufacturing time
the raw
material and other supplies have to be carried for a longer in
the process with
progressive increment of labor and service costs before the
final product is obtained.
So working capital is directly proportional to the length of the
manufacturing process.
5. SEASONALS VARIATIONS: Generally, during the busy season, a
firm requires
larger working capital than in slack season.
6. WORKING CAPITAL CYCLE: The speed with which the working cycle
completes
one cycle determines the requirements of working capital. Longer
the cycle larger is
the requirement of working capital.
-
fig no- 1.1(Operating Cycle)
7. RATE OF STOCK TURNOVER: There is an inverse co-relationship
between the
question of working capital and the velocity or speed with which
the sales are affected.
A firm having a high rate of stock turnover will needs lower
amount of working capital
as compared to a firm having a low rate of turnover.
8. CREDIT POLICY: A concern that purchases its requirements on
credit and sales
its product / services on cash requires lesser amt. of working
capital and vice-versa.
9. BUSINESS CYCLE: In period of boom, when the business is
prosperous, there is
need for larger amt. of working capital due to rise in sales,
rise in prices, optimistic
expansion of business, etc. On the contrary in time of
depression, the business
contracts, sales decline, difficulties are faced in collection
from debtor and the firm may
have a large amt. of working capital.
-
10. RATE OF GROWTH OF BUSINESS: In faster growing concern, we
shall
require large amt. of working capital.
11. EARNING CAPACITY AND DIVIDEND POLICY: Some firms have
more
earning capacity than other due to quality of their products,
monopoly conditions,
etc. Such firms may generate cash profits from operations and
contribute to their
working capital. The dividend policy also affects the
requirement of working
capital. A firm maintaining a steady high rate of cash dividend
irrespective of its
profits needs working capital than the firm that retains larger
part of its profits and
does not pay so high rate of cash dividend.
12. PRICE LEVEL CHANGES: Changes in the price level also affect
the working
capital requirements. Generally rise in prices leads to increase
in working capital.
Others FACTORS: These are:
Operating efficiency.
Management ability.
Irregularities of supply.
Import policy.
Asset structure.
Importance of labor.
Banking facilities, etc.
-
MANAGEMENT OF WORKING CAPITAL
Management of working capital is concerned with the problem that
arises in
attempting to manage the current assets, current liabilities.
The basic goal of working
capital management is to manage the current assets and current
liabilities of a firm in
such a way that a satisfactory level of working capital is
maintained, i.e. it is neither
adequate nor excessive as both the situations are bad for any
firm. There should be no
shortage of funds and also no working capital should be ideal.
WORKING CAPITAL
MANAGEMENT POLICES of a firm has a great on its probability,
liquidity and
structural health of the organization. So working capital
management is three
dimensional in nature as
1. It concerned with the formulation of policies with regard to
profitability, liquidity
and risk.
2. It is concerned with the decision about the composition and
level of current assets.
3. It is concerned with the decision about the composition and
level of current
liabilities.