8/9/2019 W.C. Mgmt Project http://slidepdf.com/reader/full/wc-mgmt-project 1/81 A PROJECT REPORT ON WORKING CAPITAL MANAGEMENT SUBMITTED BY SHRI PRAKASH PANDEY T.Y.B.M.S. [Semester VI] BHAVAN’S C OLLEGE A NDHERI ( W ), M UMBAI - 400 058 S UBMITTED TO UNIVERSITY OF MUMBAI ACADEMIC YEAR 2007 - 2008 PROJECT GUIDE MR. KUTTY
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Working capital is a measurement of an entity’s current assets, after subtracting itsliabilities. Sometimes referred to as operating capital, it is a valuation of the amount of
liquidity a business or organization has for the running and building of the business.
Generally speaking, companies with higher amounts of working capital are better
positioned for success. They have the liquid assets needed to expand their business
operations as desired.
Sometimes, a company will have a large amount of assets, but have very little with
which to build the business and improve processes. Even a profitable company mayhave this problem. This can occur when a company has assets that are not easy to
convert into cash.
Working capital can be expressed as a positive or negative number. When a
company has more debts than current assets, it has negative working capital. When
current assets outweigh debts, a company has positive working capital.
Changes in working capital will impact a business’ cash flow. When working capital
increases, the effect on cash flow is negative. This is often caused by the liquidation of
inventory or the drawing of money from accounts that are due to be paid by the
business. On the other hand, a decrease in working capital translates into less money to
settle short-term debts.
Working capital is among the many important things that contribute to the success of
a business. Without it, a business may cease to function properly or at all. Not only does
a lack of working capital render a company unable to build and grow, but it may also
leave a company with too little cash to pay its short-term obligations. Simply put, a
company with a very low amount of working capital may be at risk of running out of
money.
When a company has too little working capital, it can face financial difficulties and
may even be forced toward bankruptcy. This is true of both very small companies and
Working capital management involves the relationship between a firm's short-termassets 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.
OBJECTIVES OF WORKING CAPITAL MANAGEMENT
a) Facilitate and further the cause of Corporate Financial Objective of :
Maximize Value of the Firm (Maximize Market Price of the shares).
Maximize Earning Per Share (EPS).
Any Other.
b) Balance Risks and Returns.
c) Balance Liquidity and Profitability – Liquidity and Profitability tend to be at
This represents the quantum of current assets required on a continuing basis for an
entire year. It is the minimum aggregate of cash, inventory and debtors maintained tocarry on business operations smoothly at any time during an accounting period.
Permanent working capital is locked in the business as long as it continues to exist. The
quantum of permanent working capital will vary according to the level of business
activities from time to time.
Permanent working capital is of two types:
a) Initial Working Capital AND
b) Regular Working Capital.
a) Initial Working Capital:
This is the amount of working capital required at the inception of an
organisation. In the initial stages, when the revenues are not regular, it may be
difficult for a company to obtain credit from the banks and at the same time it may
be required to grant credit to its customers. In such a case adequate workingcapital is required to activate the circulation of capital and keep it moving till the
collection from debtors and other cash receipts exceed the payment.
b) Regular Working Capital:
This is the amount of working capital required for the continuous operations of
an enterprise. It refers to the excess of current assets over current liabilities. Any
organisation has to maintain a minimum stock of materials, finished goods and
cash to ensure its smooth working and to meet its immediate obligations.
Thus, permanent working capital is the quantum of funds required permanently for
the production of goods and services on a continuing basis 10 satisfy the demands of
Permanent and Temporary Working Capital - distinguished
Permanent Working Capital Temporary Working Capital
This is required as long as the business
continues as a going concern.
This is required for a temporary period,
as for example, during seasons.
Permanent working capital never leaves
the business
Temporary working capital disappears
from the business process once purpose
is served.
The size of permanent working capital
Increases with the growth of business.
The size of temporary working capital we
need not necessarily Increase with
growth of business.
Positive and Negative Working Capital
Ω Positive working capital:
The company’s current assets are greater than their current liabilities.
Ω Negative working capital:
Working capital is simply current assets minus current liabilities and can be
positive or negative. Working capital is basically an expression of how much in
liquid assets the company currently has to build its business, fund its growth, and
produce shareholder value. If a company has ample positive working capital,then it is in good shape, with plenty of cash on hand to pay for everything it might
need to buy. If a company has negative working capital, then its current liabilities
are actually greater than their current assets, so the company lacks the ability to
spend with the same aggressive nature as a working capital positive peer. All
other things being equal, a company with positive working capital will always
outperform a company with negative working capital.
Some companies can generate cash so quickly they actually have a negative working capital. This is generally true of companies in the restaurant business
(McDonalds had a negative working capital of $698.5 million between 1999 and
2000). Amazon.com is another example. This happens because customers pay
upfront and so rapidly, the business has no problems raising cash. In these
companies, products are delivered and sold to the customer before the company
ever pays for them.
The operating cycles of companies with negative working capital are suchthat, thanks to a favorable timing mismatch, they collect funds prior to disbursing
certain payments. There are two basic scenarios: 1) supplier credit is much
greater than inventory turnover (see days’ inventory ratio), while at the same
time, customers pay quickly, in some cases in cash; 2) customers pay in
advance. A low or negative working capital is a boon to a company looking to
expand without recourse to external capital. Efficient companies, in particular in
mass-market retailing, all benefit from low or negative working capital.
The bottom line: A negative working capital is a sign of managerial efficiency
in a business with low inventory and accounts receivable (which means they
operate on an almost strictly cash basis). In any other situation, it is a sign a
company may be facing bankruptcy or serious financial trouble.
In short terms negative working capital usually means that on the balance
sheet the company’s current liabilities are greater than their current assets.
Usually mean that a company is borrowing or in overdraft to maintain its day today activities.
At times, business needs to estimate the requirement of working capital in advance
for proper control and management. The factors discussed above influence thequantum of working capital in the business. The assessment of working capital
requirement is made keeping these factors in view. Each constituent of working capital
retains its form for a certain period and that holding period is determined by the factors
discussed above. So for correct assessment of the working capital requirement, the
duration at various stages of the working capital cycle is estimated. Thereafter, proper
value is assigned to the respective current assets, depending on its level of completion.
The basis for assigning value to each component is given below:
Each constituent of the working capital is valued on the basis of valuation
enumerated above for the holding period estimated. The total of all such valuation
becomes the total estimated working capital requirement.
The assessment of the working capital should be accurate even in the case of smalland micro enterprises where business operation is not very large. We know that working
capital has a very close relationship with day-to-day operations of a business.
Negligence in proper assessment of the working capital, therefore, can affect the day-
to-day operations severely. It may lead to cash crisis and ultimately to liquidation. An
In other method, all raw materials, wages and overheads are introduced in
various steps and processes of production cycle for e.g. motor car manufacturing.
If wages and overheads accrue evenly during the time the process of
manufacture is in progress, then on an average the total cost of labour and
overheads outstanding will only be for half the time:
e) Finished Goods:
The period for which the finished goods have to remain in the warehousebefore sale has to be taken into account. This depends on seasonality, the sales
forecast, etc. For Example, if the sales are seasonal but production is throughout
the year, working capital requirements would be heavier during the slack season.
The finished goods must be valued at cost.
f) Sundry Debtors:
The length of the period of credit allowed to debtors is to be taken intoconsideration. This is known as the "time-lag in payments by debtors". If the
period of credit allowed to debtors is longer. The working capital required will be
higher in the absence of similar time-lags in payments to creditors or suppliers.
Some analysts, while calculating the time-lag in payments by debtors
estimate the book debts less the profit element in them while other analysts take
debtors at book values inclusive of the profit element.
However, debtors valued at sales price is always appropriate in working
This type of operating cycle is experienced by the companies/firms engaged in
trading activities.
The cash is utilized for procurement of a product/finished good, this good undergoesa certain value addition process (i.e. Packaging for exports). These are then sold to the
customers who make part payments. After the expiration of credit period, the cash is
received and this is again put back for purchases. This the cycle continues.
Manufacturing Concern: Operating Cycle
This cycle is modeled by the manufacturing concerns. The cash is utilized to pay for
Raw materials (purchases may be made on credit basis). This Raw material is
Processed through the manufacturing procedure (Sometimes, these goods have to be
stocked cause unavailability of machines, thus WIP). The Finished goods are sold to
customers, cash received and paid to the suppliers of raw material.
There are a number of factors which determine the working capital requirements of afirm. These factors are of different importance. The influence of an individual factor may
also change for a firm over time. Analysis of the relevant factors has to be made in
order to determine total investment in working capital. The following is a brief
description of important factors which determine the working capital requirements of a
firm:-
1. Nature of Business:
The working capital requirements are significantly influenced by the nature of the business carried on by the firm. Public utility undertakings like road-transport
corporations or electricity supply undertaking need very small working capital
because they offer were services rather than products and offer mostly cash
sales with the result that very small amount of capital remains invested in
inventory, and receivables. In manufacturing enterprises, the working capital
requirements are fairly large. The requirements differ from industry to industry.
For example the working capital requirements of an edible oil mill. The workingcapital requirements of trading and financial enterprises are the maximum as
they have to maintain a sufficiently large amount of cash, inventories and
receivable.
2. Size of Business:
Larger the size of business, the greater will be the working capital
requirements of the firm as more funds will be locked up in inventories and
receivables to meet the demand of bigger size of business.
3.. Manufacturing Cycle:
Manufacturing cycle refers to the time-span between the purchase of raw
materials and their conversion into finished goods by means of manufacturing
process. Funds remain tied up in semi-finished goods during the manufacturing
process. Longer the manufacturing cycle the larger the working capital needed
and vice versa. For example, a distillery requires heavy investment in inventories
because it has an ageing process. On the other hand, in a bakery, raw materials
are soon converted into finished goods and not much funds are looked up
inventories.
4.. Production Policy:
In certain industries, there are wide seasonal changes in demand for the
product manufactured by the firm. In such a case, if the firm adopts a steady
production policy, inventories of finished goods will accumulate during the off-season period requiring a higher amount of working capital. If the firm opts to
vary its production schedules in accordance with changing demand, there may
be serious production problems. During the slack season, the firm will have to
maintain its working force and fixed assets without adequate production and sale.
During the peak period, it will have to operate at full capacity. This arrangement
may be a costly affair. One has to manufacture some other product during the
off-season and concentrate on the main line during the season of the main
product. But it may not be feasible in all the cases.
5. Business Cycles:
There are business cycles resulting in marked variations in business
conditions. There is an upward swing of business conditions leading to a boom
when the business activities are at their peak. It is followed by a downward phase
called recession when business activities decline. The downward phase ends in
a depression, completing the business cycle. Then again, there is a recovery tostart a new business cycle. During the recovery, the working capital requirement
In an industry where raw material is available only in a particular season and
the firm has to buy raw material in bulk in that reason to ensure uninterruptedproduction of finished goods, the working capital requirements will be more.
When in cases where the supply of raw material is unpredictable, the firm may
have to accumulate stock of raw material requiring more working capital.
7. Terms of Credit to Customers:
The terms of credit granted to customers normally depend upon the norms
followed in the industry in which the firm is engages. But the firm has some
flexibility within the norms. Ideally, the firm should be use discretion in granting
credit to its customers. Different terms of credit should be offered to different
types of customers. A liberal credit policy without caring much for the
creditworthiness of the customers will land the firm in trouble and the
requirements of working capital will also unnecessarily increase.
8. Credit from Suppliers:
If the firm is able to procure liberal terms of credit from suppliers of rawmaterial, its net working capital requirements will be reduced.
9. Stock Turnover Ratio:
Stock turnover ratio refers to the speed with which finished goods are
converted into sales. If a firm has a high stock turnover ratio as in the case of a
bakery, its working capital requirements will be less. On the other hand, if a firm
has a low stock turnover ratio as in the case of fancy jewellery shop; its workingcapital requirements will be high.
10. Price Level Changes:
Price level changes also affect the working capital requirements. In times of
rising prices, a firm will require a larger amount of working capital to maintain the
There are two strategies of working capital management:
1. Conservative Working Capital Strategy
It suggests high level of current assets in relation to sales. Surplus current
assets enable the firm to absorb the variations in sales, production plans, and
procurement time without any disturbance of the production plans. Higher level of
liquidity reduces the risk of insolvency. But this leads to higher interest and
carrying costs. It ensures continuous flow of operation. It will also help to absorbthe day to day business risks. Excess cash is invested in short term marketable
securities. In case of need, the securities invest old out to meet the urgent
requirement of working capital.
2. Aggressive Working Capital Strategy
As per this strategy current assets are maintained just to meet the liabilities
without keeping any margin. The core working capital is financed by long-termsources and the seasonal variations are met through short term borrowings. This
strategy will minimize the investment in net working capital and it will lower the
cost of financing working capital. However, it requires frequent financing. It also
Increases the risk of sudden shocks.
Working Capital Leverage
It refers to the Impact of level of working capital on the profitability of acompany. The management should improve the productivity of Investment in
current assets. It will ultimately increase the return on capital employed. Higher
level of Investment in current assets than required will mean Increase In the cost
of Interest charges. This will bring down the return on capital employed. Working
income earned by maximizing investments and/or reducing interest paid by
minimizing borrowings.
Cash management uses the knowledge of funds movement through thebanking system, coupled with banking services and other financial products, to
optimize liquidity. It is the scheduled gathering of information about a company’s
cash flow, its receipts, disbursements, and balances. This information is used to
manage these elements of working capital.
Effective cash management ensures the timely provision of cash resources
necessary to support the company’s operations. With the use of basic cash
management tools and techniques, cash becomes a corporate asset thatcontributes directly to the bottom line. Whether a company is flush with cash or
experiencing a shortfall of funds, good cash management is critical to the
success of every company.
Cash management is a financial discipline that uses the same principles,
regardless of the type of business, size or age of an enterprise. Cash
management is not an accounting function. The accountant records and reports
transactions historically; the cash manager plans and executes these financialtransactions. Cash managers use techniques, products and services to efficiently
manage cash resources and satisfactorily resolve cash shortages or surpluses.
The major elements of cash management are:
♦ Deposits: Receiving funds and depositing receipts into the bank account
as quickly as possible, while collecting adequate information to correctly
identify the source of the payment.
♦ Concentration: Moving funds to a central location from which they are
more efficiently managed for investing and disbursing.
♦ Disbursement: Paying funds by check or electronically to vendors,
Cash management in a corporate environment is an exciting and challenging issue.The technique usually used to understand cash flows is a cash budget, which maps out
the periodic – daily, weekly or monthly cash inflows and cash outflows. If the cash
inflows are greater than cash outflows, it is referred to as excess cash and vice versa.
Cash flows are also presented in terms of point of origination and end use viz
operations, investment and financing. The respective categories are evaluated for their
contribution or toll on the cash flows. Surfeit or deficit cash compels management to
identify options to tackle the situation. Deficit cash is easier to handle than surplus cash.
Deficit cash requires prudent deployment of payments and alertness to recoveries. It
also encourages parsimony and usually attracts an embargo on superfluous and
unaffordable luxuries. Last but not the least it motivates identification of timely
procurement of funds – right time, right amount, right lender, right rate, right country and
currency, right covenants regarding amortization - interest and loan installments. In a
boundary less world options for an entrepreneur, transcend beyond the national
frontiers into markets and currencies of other countries.
However surfeit cash is a big problem. If not handled in time with skill and dexterity,
it can lead to idle cash or liquid assets earning returns comparable to gilt edged returns
or even lower, thus depressing the overall return on capital or assets employed in the
business. If the assets employed in the core business are earning an overall return of
15% and the gilt edged returns on liquid assets is 8% the overall return on assets (core
business plus liquid assets) is depressed to the extent of the gap between efficiency of
capital in core assets vis-à-vis liquid assets. There are other issues too. If a large chunk
of reserves are blocked in liquid assets in lieu of plant and machinery (core business
assets) the question of taxes come into picture. Substantial amounts of depreciation
and possibly other incentives can and do provide tax shelter which protects the
operating excellence. Infact tax management plays a key role in facilitating the
transmission of operating excellence to the shareholders. However, this exercise is
rendered defunct if there are liquid funds blocked in assets of non-core businesses. This
may happen either because of lack of adequate reinvestment opportunities or
excellence in management, which generates a lot of free reserves matched by cash or
both. Thus the rate at which cash flows come into the business is far greater than the
rate at which new opportunities can absorb cash to create assets in core businesses or
even new diversified business ventures providing returns higher than liquid assets.
Hence surfeit cash is a serious problem – at best a blessing in disguise and at worst a
value destroyer if not laid to rest in time through right reinvestment opportunities.
Globally Singapore Airlines (SQ) provides an excellent case study of a company with
excess cash from time to time. it makes half a billion USD net profit with a double digit
profit margin for a very long time – year on year basis. Infact in the mid nineties it was
said that SQ had a very difficult reputation with the banking fraternity because it didn’t
borrow money. SQ had to turn down bankers proposals to provide loans at competitive
interest rates. SQ was flushed with cash and was looking for profitable avenues to
deploy the surplus cash. As a policy SQ use to replace their aircrafts in five years (the
shortest useful life in the air line business). At one time in the late nineties SQ placed an
order for 77 triple sevens with a plea that they will pay cash on an upfront basis. Each
aircraft was around 140mn USD. Though this order did not actually go through it wasthe largest purchase order in aviation history at that point of time. Thus strategies to
deploy cash included accelerated depreciation policy through short useful life and an
active replacement, modernization and expansion policy. Of course accelerated
depreciation and short useful life have their own externalities of operating a modern and
new fleet and also reaping the bonanza of high realizable value of the aircrafts on sale
at the end of useful life of 5 years. Pending purchase of assets for the core business
and also investing in airline related business the airline had to identify profitable short-
term investment opportunities to absorb the bulging, surfeit, cash. Economic history is
replete with instances of several occasions, across the globe, where as and when
supply exceeds demand the excess has to be destroyed. In fact this goes well with the
fundamental tenets of economic management of capitalist societies viz mass
production, mass consumption and as and when need be mass destruction. Agricultural
gilt/non-gilt as the case may be. Thus the overall returns are depressed due to the
limited, rather low productivity of capital invested in the non-core business. And the
latter investments are a compulsion stemming from surfeit cash. The bottom line is as
follows cash rich companies face economic value dilution due to the limited
opportunities to use capital productivity and the increased cost of capital due to the high
role of equity capital in the capital structure. Hence the caveat surfeit cash is a rather
dangerous position – a double-edged razor.
There is one more point.
Cash rich companies trying to deploy surplus cash into financial assets/investments,
pending long term business opportunities, are bugged by higher taxation. Other incomes arising out of returns on temporary investments are usually exposed to taxation
without major deductions like depreciation. This tends to expose greater amounts of
incomes to taxation. Invariably investment decisions are tax driven. And tax incentive
embedded in depreciation is denied to the cash rich companies because of the absence
of asset formation that can attract the benefits of Section 32 of IT Act.
The important messages which come out of the above:
1) Liquidity and profitability are at loggerheads
2) Cash rich companies have severe problems in identifying profitable
investment opportunities.
3) Cash rich companies are saddled with an unduly high current ratio.
However, they are benefit of borrowings because they do not need
lenders in view of net worth being back up by adequate liquid assets.
4) Cash rich companies tend to be over capitalize with a very high ration of net worth to capital employed (net worth plus long term borrowings).
While business firms would like to sell on cash, the pressure of competition and theforce of custom persuades them to sell on credit. Firms grant credit to facilitate sales. It
is valuable to customers as it augments their resources-it is particularly appealing to
those customers who cannot borrow from other sources or find it very expensive or
inconvenient to do so.
The credit period extended by business firms usually ranges from 15 days to 60
days. When goods are sold on credit, finished goods get converted into accounts
receivable (trade debtors) in the books of the seller. In the books of the buyer, theobligation arising from credit purchase is represented as accounts payable (trade
creditors).
A firm's investment in accounts receivable depends on how much it sells on credit
and how long it takes to collect receivables. For example, if a firm sells Rs 1 million
worth of goods on credit a day and its average collection period is 40 days, its accounts
receivable will be Rs 40 million. Accounts receivable (or sundry debtors as they are
referred to in India) constitute the third most important asset category for businessfirms, after plant and equipment and inventories. Hence it behooves a firm to manage
its credit well.
TERMS OF PAYMENT
Terms of payment vary widely in practice. At one end, if the seller has financial
sinews it may extend liberal credit to the buyer till it converts goods bought into cash. Atthe other end, the buyer may pay cash in advance to the seller and finance the entire
trade cycle. Most commonly, however, some in-between arrangement is chosen
wherein the trade cycle is financed partly by the seller, partly by the buyer, and partly by
some financial intermediary. The major terms of payment are discussed below.
To streamline billings, it is a common practice to send a single bill every
month. For example at the end of every month, the customer may be sent a
consolidated bill for the purchases made from the 26th of the previous month to
the 25th of the current month.
Consignment
When goods are sent on consignment, they are merely shipped but not sold to
the consignee. The consignee acts as the agent of the seller (consignor). The title of
the goods is retained by the seller till they are sold by the consignee to a third party.
Periodically, sales proceeds are remitted by the consignee to the seller.
Bill of Exchange
Whether goods are shipped on open account or consignment, the seller does not
have strong evidence of the buyer's obligation. So, a more secure arrangement,
usually in the form of a bill of exchange, is sought. It represents an unconditionalorder issued by the seller asking the buyer to pay on demand or at a certain future
date, the amount specified on it. It is typically accompanied by shipping documents
that are delivered to the drawee when he pays or accepts it. When the drawee
accepts a bill of exchange it becomes a trade acceptance. The seller may hold it till it
matures or get it discounted.
The bill of exchange performs three useful functions: (i) It serves as a written
evidence of a definite obligation. (ii) It helps in reducing the cost of financing tosome extent. (iii) It represents a negotiable instrument.
Liberalising the cash discount policy may mean that the discount percentage is
increased and/or the discount period is lengthened. Such an action tends toenhance sales (because the discount is regarded as price reduction), reduce the
average collection period (as customers pay promptly), and increase the cost of
discount.
Collection Effort
The collection programme of the firm, aimed at timely collection of receivables,
may consist of the following:
1. Monitoring the state of receivables.
2. Despatch of letters to customers whose due date is approaching.
3. Telegraphic and telephonic advice to customers around the due date.
4. Threat of legal action to overdue accounts.
5. Legal action against overdue accounts.
A rigorous collection programme tends to decrease sales, shorten the average
collection period, reduce bad debt percentage, and increase the collection expense.
A lax collection programme, on the other hand, would push sales up/ lengthen the
average collection period, increase the bad debt percentage, and perhaps reduce
the collection expense.
CREDIT EVALUATION
Proper assessment of credit risks is an important element of credit management.
It helps in establishing credit limits. In assessing credit risks, two types of errors
It is an inventory strategy implemented to improve the return on investment of a
business by reducing in-process inventory and its associated costs. The process is
driven by a series of signals, which can be Kanban ( Kanban ? ), that tell production
processes when to make the next part. Kanban are usually 'tickets' but can be simple
visual signals, such as the presence or absence of a part on a shelf. When implemented
correctly, JIT can lead to dramatic improvements in a manufacturing organization's
return on investment, quality, and efficiency. Some have suggested that "Just on Time"
would be a more appropriate name since it emphasises that production should create
items that arrive when needed and neither earlier nor later.
Quick communication of the consumption of old stock which triggers New stock to be
ordered is key to JIT and inventory reduction. This saves warehouse space and costs.
However since stock levels are determined by historical demand any sudden demand
rises above the historical average demand, the firm will deplete inventory faster than
usual and cause customer service issues. Some have suggested that recycling Kanban
faster can also help flex the system by as much as 10-30%. In recent years
manufacturers have touted a trailing 13 week average as a better predictor for JIT
planning than most forecastors could provide.
Philosophy
The philosophy of JIT is simple - Inventory is defined to be waste. Just-in-time (JIT)
inventory systems expose the hidden causes of inventory keeping and are therefore nota simple solution that a company can adopt; there is a whole new way of working that
the company must follow in order to manage its consequences. The ideas in this way of
working come from many different disciplines including statistics, industrial engineering,
production management and behavioral science. In the JIT inventory philosophy there
are views with respect to how inventory is looked upon, what it says about the
management within the company, and the main principle behind JIT.
Inventory is seen as incurring costs, or waste, instead of adding value, contrary totraditional accounting. This does not mean to say that JIT is implemented without an
awareness that removing inventory exposes pre-existing manufacturing issues. Under
this way of working, businesses are encouraged to eliminate inventory that doesn’t
compensate for manufacturing issues, and then to constantly improve processes so that
less inventory can be kept. Secondly, allowing any stock habituates the management to
stock keeping and it can then be a bit like a narcotic. Management are then tempted to
keep stock there to hide problems within the production system. These problems
include backups at work centres, machine reliability, process variability, lack of flexibility
of employees and equipment, and inadequate capacity among other things.
In short, the just-in-time inventory system is all about having “the right material, at
the right time, at the right place, and in the exact amount” without the safety net of
Inventory, the implications of which are broad for the implementors.
Stocks
JIT emphasises inventory as one of the seven wastes, and as such its practice
involves the philosophical aim of reducing input buffer inventory to zero. Zero buffer
inventory means that production is not protected from exogenous (external) shocks. As
a result, exogenous shocks reducing the supply of input can easily slow or stop
production with significant negative consequences. For example as noted in Liker
(2003) Toyota suffered a major supplier failure as a result of the 1997 Aisin fire which
rendered one of its suppliers incapable of fulfilling Toyota's orders. In the US the 1992
railway strikes resulted in General Motors having to shut down a 75,000 worker plant
temporarily as they had no inputs flowing in to the factory.
JIT reduces inventory in a firm, however unless it is used throughout the supply
chain, then it can be proposed that firms are simply outsourcing their input inventory tosuppliers (Naj 1993). This effect was investigated by Newman (1993) who found that on
average suppliers in Japan charged JIT customers a 5% price premium.
Environmental concerns
During the birth of JIT multiple daily deliveries were often made by human powered
bicycle, however with increases in scale has come the adoption of vans and lorries for
these deliveries. Cusumano (1994) has highlighted the potential and actual problems
this causes with regard to gridlock and the burning of fossil fuels. This violates three JIT
wastes:
1) Time; wasted in traffic jams
2) Inventory; specifically pipeline (in transport) inventory and
3) Scrap; with respect to petrol or diesel burned while not physically moving.
Price volatility JIT implicitly assumes a level of input price stability such that it is desirable to
inventory inputs at today's prices. Where input prices are expected to rise storing inputs
may be desirable.
Quality volatility
JIT implicitly assumes that the quality of available inputs remains constant over time.
If not firms may benefit from hoarding high quality inputs.
Karmarker (1989) highlights the importance of relatively stable demand which can
help ensure efficient capital utilisation rates. Karmarker argues that without a significantstable component of demand, JIT becomes untenable in high capital cost production.
Kaizen
Kaizen ( , Japanese for "change for the better" or "improvement"; the common
English usage is "continuous improvement" or "continual improvement").
Kaizen is a daily activity whose purpose goes beyond simple productivity
improvement. It is also a process that, when done correctly, humanizes the workplace,
eliminates overly hard work (both mental and physical) "muri", and teaches people how
to perform experiments on their work using the scientific method and how to learn to
spot and eliminate waste in business processes.
To be most effective kaizen must operate with three principles in place:
1. Consider the process and the results (not results-only) so that actions to
achieve effects are surfaced;2. Systemic thinking of the whole process and not just that immediately in view
(i.e. big picture, not solely the narrow view) in order to avoid creating problems
elsewhere in the process; and
3. A learning, non-judgmental, non-blaming (because blaming is wasteful)
approach and intent will allow the re-examination of the assumptions that
resulted in the current process.
People at all levels of an organization can participate in kaizen, from the CEO down,
as well as external stakeholders when applicable. The format for kaizen can be
individual, suggestion system, small group, or large group. In Toyota it is usually a local
improvement within a workstation or local area and involves a small group in improving
their own work environment and productivity. This group is often guided through the
kaizen process by a line supervisor; sometimes this is the line supervisor's key role.
While kaizen (in Toyota) usually delivers small improvements, the culture of continual aligned small improvements and standardization yields large results in the
form of compound productivity improvement. Hence the English usage of "kaizen" can
be: "continuous improvement" or "continual improvement."
This philosophy differs from the "command-and-control" improvement programs of
the mid-twentieth century. Kaizen methodology includes making changes and
monitoring results, then adjusting. Large-scale pre-planning and extensive project
scheduling are replaced by smaller experiments, which can be rapidly adapted as newimprovements are suggested.
Translation
The original kanji characters for this word are:
In Japanese this is pronounced 'kaizen'.
('kai') KAI means 'change' or 'the action to correct'.
('zen') ZEN means 'good'.
In Chinese this is pronounced 'gai shan':
('gǎ i shàn') means 'change for the better' or 'improve'.
('gǎ i') means 'change' or 'the action to correct'.
('shàn') means 'good' or 'benefit'. 'Benefit' is more related to the Taoist or
Buddhist philosophy, which gives the definition as the action that 'benefits' thesociety but not one particular individual (i.e. multilateral improvement). In other
words, one cannot benefit at another's expense. The quality of benefit that is
involved here should be sustained forever, in other words the 'shan' is an act that
The foundation of the Kaizen method consists of 5 founding elements:
1. Teamwork,
2. Personal Discipline,
3. Improved Morale,
4. Quality circles, and
5. Suggestions for improvement.
Out of this foundation three key factors in Kaizen . arise:1. Elimination of waste (muda) and inefficiency
2. The Kaizen five-S framework for good housekeeping
a. Seiri - Tidiness
b. Seiton - Orderliness
c. Seiso - Cleanliness
d. Seiketsu - Standardized clean-up
e. Shitsuke – Discipline
3. Standardization.
Material Requirements Planning (MRP)
It is a software based production planning and inventory control system used tomanage manufacturing processes. Although it is not common nowadays, it is possible
to conduct MRP by hand as well.
An MRP system is intended to simultaneously meet three objectives:
The investment in raw materials, stock-in-process, finished goods, and receivables(the principal constituents of current assets) often varies a great deal during the
course of the year. Hence, the financial manager generally spends a good chunk of
his time in finding money to finance current assets.
Typically, current assets are supported by a combination of long-term and short-
term sources of finance. Long-term sources of finance, discussed elsewhere in this
book, primarily support fixed assets and secondarily provide the margin money for
working capital. Short-term sources of finance, the subject matter of this chapter, moreor less exclusively support the current assets.
The major accrual items are wages and taxes. These are simply what the firm
owes to its employees and to the government. Wages are usually paid on a weekly,fortnightly, or monthly basis-between payment's, the amounts owed but not yet paid
is shown as accrued wages on the balance sheet Income tax is payable quarterly
and other taxes may be payable half-yearly or annually. In the interim, taxes owed
but not paid may be shown as accrued taxes on the balance sheet.
Accruals vary with the level of activity of the firm. When the activity level
expands, accrual increases and when the activity level contracts accruals decrease.
As they respond more or less automatically to changes in the level of activity,accruals are treated as part of spontaneous financing.
Since no interest is paid by the firm on its accruals, they are often regarded as a
'free' Source of financing. However, a closer examination would reveal that this may
not be so. When the payment cycle is longer, wages may be higher. For example,
an employee earning Rs 500 per week and receiving weekly payment may ask for a
slightly higher compensation ii the payment is made monthly. Likewise when the
payment period is longer, tax authorities may raise the tax rates to some extent.Even when such adjustments are made, the fact remains that between established
payment dates accruals do not carry any explicit interest burden.
While accruals are a welcome source of financing, they are typically not
amenable to control by management. The payment period for employees is
determined by the practice in industry and provisions of law. Similarly, tax payment
dates are given by law and postponement of payment normally results in penalties.
TRADE CREDIT
Trade credit represents the credit extended by the supplier of goods and
services. It is a spontaneous source of finance in the sense that it arises in the
limit. The borrower also enjoys the facility of repaying the amount, partially or
fully, as and when he desires. Interest is charged only on the running
balance, not on the limit sanctioned. A minimum charge may be payable,
irrespective of the level of borrowing, for availing this facility. This form of
advantage is highly attractive from the borrower's point of view because while
the borrower has the freedom of drawing the amount in instalments as and
when required, interest is payable only on the amount actually outstanding.
ii) Loans:
These are advances of fixed amounts which are credited to the current
account of the borrower or released to him in cash. The borrower is charged
with interest on the entire loan amount, irrespective of how much he draws. In
this respect this system differs markedly from the overdraft or cash credit
arrangement wherein interest is payable only on the amount actually utilised.
Loans are payable either on demand or in periodical instalments. When
payable on demand, loans are supported by a demand promissory note
executed by the borrower. There is often a possibility of renewing the loan.
iii) Purchase/Discount of Bills:
A bill arises out of a trade transaction. The seller of goods draws the bill
on the purchaser. The bill may be either clean or documentary (a
documentary bill is supported by a document of title to goods like a railway
receipt or a bill of lading) and may be payable on demand or after a usance
period which does not exceed 90 days. On acceptance of the bill by the
purchaser, the seller offers it to the bank for discount/purchase. When thebank discounts/purchases the bill it releases the funds to the seller. The bank
presents the bill to the purchaser (the acceptor of the bill) on the due date and
gets its payment.
The Reserve Bank of India launched the new bill market scheme in 1970
For working capital advances, commercial banks seek security either in the
form of hypothecation or in the form of pledge.
♦ Hypothecation:
Under this arrangement, the owner of the goods borrows money
against the security of movable property, usually inventories. The owner
does not part with the possession of property. The rights of the lender
(hypothecatee) depend upon the agreement between the lender and the
borrower. Should the borrower default in paying his dues, the lender
(hypothecatee) can file a suit to realise his dues by selling the goods
hypothecated.
♦ Pledge:
In a pledge arrangement, the owner of the goods (pledgor) deposits
the goods with the lender (pledgee) as security for the borrowing. Transfer
of possession of goods is a precondition for pledge. The lender (pledgee)
is expected to take reasonable care of goods pledged with him. The
pledge contract gives the lender (pledgee) the right to sell goods and
recover dues, should the borrower (pledgor) default in paying debt.
Margin Amount
Banks do not provide hundred per cent finance. They insist that the customer
should bring a portion of the required finance from other sources. This portion isknown as the margin amount. How is the margin amount established? While
there is no fixed formula for determining the margin amount, the following
guideline is broadly observed: "The margin is kept lowest for raw materials and
Thus, to ensure short term survival of the company, efficient working capital
management has to be undertaken. To achieve this end, the company can employ theexpertise of professionals or consultants, depending upon the financial capacity of the
company.
There are a number of sources from where the working capital can be financed, but
it should be noted that the specific cost of financing has to be worked out so as to better