Working Capital Management

Contents

Chapters Pages

1. Introduction 01

2. Company profile (HDFC Bank) 05

3. Various Sources of Working Capital 13

4. HDFC Bank: Policies, Procedures & Products 19

5. Usage of Working Capital 23

6. Business Approach Towards Working Capital 33

7. Indian Market Scenario 45

8. Research Methodology 48

9. Analysis and Interpretation 58

10. Conclusion 62

11. Suggestion 68

12. Bibliography 76

Introduction

Working capital is a valuation metric that is calculated as current assets

minus current liabilities. Also known as operating capital, it represents the amount of

day-by-day operating liquidity available to a business. A company can be endowed

with assets and profitability, but short of liquidity, if these assets cannot readily be

converted into cash.

Current assets and current liabilities include three accounts which are of special

importance. These accounts represent the areas of the business where managers have

the most direct impact:

accounts receivable (current asset)

inventory (current assets), and

accounts payable (current liability)

In addition, the current (payable within 12 months) portion of debt is critical,

because it represents a short-term claim to current assets. Common types of short-

term debt are bank loans and lines of credit.

A positive change in working capital indicates that the business has either

increased current assets (that is received cash, or other current assets) or has

decreased current liabilities, for example has paid off some short-term creditors.

Working capital is defined as the difference between assets and liabilities. It

measures how many liquid assets are available for a business to use for growth

opportunities. A lack of working capital can really hold a business back from

reaching their full potential. There are many different ways to obtain capital for your

business.

Working capital includes Business Micro Loans put out by the Small Business

Administration (SBA), credit card receipt advances, account receivable factoring,

business credit cards, sale and leaseback, and a standard business bank loan. It is

important that you are always conscious about building your business credit scores as

you obtain more capital. It is important to separate your personal credit from your

business credit. You can do this by obtaining financing that reports to the Small

Business Financial Exchange. Many business credit cards, for example, will require a

social security number and will build your personal credit. Business credit scores are

essential for obtaining larger bank loans, and also it is easier to get funding for a

business down the road.

Businesses use capital for construction, renovation, furniture, software,

equipment, or machinery. It is also commonly used to purchase inventory, or to make

payroll. Capital is also used often by businesses to put a down payment down on a

piece of commercial real estate. Working capital is essential for any business to

succeed. It is becoming increasingly important to have access to more working capital

when you need it.

Working capital management

Decisions relating to working capital and short term financing are referred to

as working capital management. These involve managing the relationship between a

firm's short-term assets and its short-term liabilities. The goal of Working capital

management is to ensure that the firm is able to continue its operations and that it has

sufficient cash flow to satisfy both maturing short-term debt and upcoming

operational expenses.

Working capital management involves the relationship between a firm's

short-term assets and its short-term liabilities. The goal of working capital

management is to ensure that a firm is able to continue its operations and that it has

sufficient ability to satisfy both maturing short-term debt and upcoming operational

expenses. The management of working capital involves managing inventories,

accounts receivable and payable, and cash.

Working capital management entails short term decisions - generally, relating to

the next one year period - which is "reversible". These decisions are therefore not

taken on the same basis as Capital Investment Decisions (NPV or related, as above)

rather they will be based on cash flows and / or profitability.

One measure of cash flow is provided by the cash conversion cycle - the net

number of days from the outlay of cash for raw material to receiving payment

from the customer. As a management tool, this metric makes explicit the inter-

relatedness of decisions relating to inventories, accounts receivable and

payable, and cash. Because this number effectively corresponds to the time

that the firm's cash is tied up in operations and unavailable for other activities,

management generally aims at a low net count.

In this context, the most useful measure of profitability is Return on capital

(ROC). The result is shown as a percentage, determined by dividing relevant

income for the 12 months by capital employed; Return on equity (ROE)

shows this result for the firm's shareholders. Firm value is enhanced when,

and if, the return on capital, which results from working capital management,

exceeds the cost of capital, which results from capital investment decisions as

above. ROC measures are therefore useful as a management tool, in that they

link short-term policy with long-term decision making.

Management of working capital

Guided by the above criteria, management will use a combination of policies and

techniques for the management of working capital. These policies aim at managing

the current assets (generally cash and cash equivalents, inventories and debtors) and

the short term financing, such that cash flows and returns are acceptable.

Cash management. Identify the cash balance which allows for the business to

meet day to day expenses, but reduces cash holding costs.

Inventory management. Identify the level of inventory which allows for

uninterrupted production but reduces the investment in raw materials - and

minimizes reordering costs - and hence increases cash flow.

Debtor’s management. Identify the appropriate credit policy, i.e. credit terms

which will attract customers, such that any impact on cash flows and the cash

conversion cycle will be offset by increased revenue and hence Return on

Capital (or vice versa).

Short term financing. Identify the appropriate source of financing, given the

cash conversion cycle: the inventory is ideally financed by credit granted by

the supplier; however, it may be necessary to utilize a bank loan (or

overdraft), or to "convert debtors to cash" through "factoring".

Company profile:

HDFC Bank

HDFC Bank, one amongst the firsts of the new generation, tech-savvy

commercial banks of India, was set up in August 1994 after the Reserve Bank of

India allowed setting up of Banks in the private sector. The Bank was promoted by

the Housing Development Finance Corporation Limited, a premier housing finance

company (set up in 1977) of India. Net Profit for the year ended March 31, 2006 was

up 30.8% to Rs 870.8 crores.

Currently (2007), HDFC Bank has 583 branches located in 263 cities of India,

and all branches of the bank are linked on an online real-time basis. The bank offers

many innovative products & services to individuals, corporates, trusts, governments,

partnerships, financial institutions, mutual funds and insurance companies. The bank

also has over 1471 ATMs. In the next few months the number of branches and ATMs

should go up substantially.

Profile

The Housing Development Finance Corporation Limited (HDFC) was

amongst the first to receive an 'in principle' approval from the Reserve Bank of India

(RBI) to set up a bank in the private sector, as part of the RBI's liberalisation of the

Indian Banking Industry in 1994. The bank was incorporated in August 1994 in the

name of 'HDFC Bank Limited', with its registered office in Mumbai, India. HDFC

Bank commenced operations as a Scheduled Commercial Bank in January 1995.

Businesses

HDFC Bank offers a wide range of commercial and transactional banking

services and treasury products to wholesale and retail customers. The bank has three

key business segments:

Wholesale Banking Services:

The Bank's target market ranges from large, blue-chip manufacturing companies in

the Indian corporate to small & mid-sized corporates and agri-based businesses. For

these customers, the Bank provides a wide range of commercial and transactional

banking services, including working capital finance, trade services, transactional

services, cash management, etc. The bank is also a leading provider of structured

solutions, which combine cash management services with vendor and distributor

finance for facilitating superior supply chain management for its corporate customers.

Based on its superior product delivery / service levels and strong customer

orientation, the Bank has made significant inroads into the banking consortia of a

number of leading Indian corporates including multinationals, companies from the

domestic business houses and prime public sector companies. It is recognized as a

leading provider of cash management and transactional banking solutions to corporate

customers, mutual funds, stock exchange members and banks.

Retail Banking Services:

The objective of the Retail Bank is to provide its target market customers a full range

of financial products and banking services, giving the customer a one-stop window

for all his/her banking requirements. The products are backed by world-class service

and delivered to the customers through the growing branch network, as well as

through alternative delivery channels like ATMs, Phone Banking, Net Banking and

Mobile Banking.

The HDFC Bank Preferred program for high net worth individuals, the HDFC

Bank Plus and the Investment Advisory Services programs have been designed

keeping in mind needs of customers who seek distinct financial solutions, information

and advice on various investment avenues. The Bank also has a wide array of retail

loan products including Auto Loans, Loans against marketable securities, Personal

Loans and Loans for Two-wheelers. It is also a leading provider of Depository

Participant (DP) services for retail customers, providing customers the facility to hold

their investments in electronic form.

HDFC Bank was the first bank in India to launch an International Debit Card in

association with VISA (VISA Electron) and issues the MasterCard Maestro debit card

as well. The Bank launched its credit card business in late 2001. By September 30,

2005, the bank had a total card base (debit and credit cards) of 5.2 million cards. The

Bank is also one of the leading players in the "merchant acquiring" business with over

50,000 Point-of-sale (POS) terminals for debit / credit cards acceptance at merchant

establishments.

Treasury

Within this business, the bank has three main product areas - Foreign Exchange and

Derivatives, Local Currency Money Market & Debt Securities, and Equities. With the

liberalisation of the financial markets in India, corporates need more sophisticated

risk management information, advice and product structures. These and fine pricing

on various treasury products are provided through the bank's Treasury team. To

comply with statutory reserve requirements, the bank is required to hold 25% of its

deposits in government securities. The Treasury business is responsible for managing

the returns and market risk on this investment portfolio.

Capital Structure

The authorised capital of HDFC Bank is Rs.450 crore (Rs.4.5 billion). The

paid-up capital is Rs.311.9 crore (Rs.3.1 billion). The HDFC Group holds 22.1% of

the bank's equity and about 19.4% of the equity is held by the ADS Depository (in

respect of the bank's American Depository Shares (ADS) Issue). Roughly 31.3% of

the equity is held by Foreign Institutional Investors (FIIs) and the bank has about

190,000 shareholders. The shares are listed on the The Stock Exchange, Mumbai and

the National Stock Exchange. The bank's American Depository Shares are listed on

the New York Stock Exchange (NYSE) under the symbol "HDB".

Management

Mr. Jagdish kapoor took over as the bank's Chairman in July 2001. Prior to

this, Mr. Capoor was a Deputy Governor of the Reserve Bank of India. The

Managing Director, Mr. Aditya Puri, has been a professional banker for over 25

years, and before joining HDFC Bank in 1994 was heading Citibank's operations in

Malaysia. The Bank's Board of Directors is composed of eminent individuals with a

wealth of experience in public policy, administration, industry and commercial

banking. Senior executives representing HDFC are also on the Board. Senior banking

professionals with substantial experience in India and abroad head various businesses

and functions and report to the Managing Director. Given the professional expertise

of the management team and the overall focus on recruiting and retaining the best

talent in the industry, the bank believes that its people are a significant competitive

strength.

Promoter

HDFC is India's premier housing finance company and enjoys an impeccable

track record in India as well as in international markets. Since its inception in 1977,

the Corporation has maintained a consistent and healthy growth in its operations to

remain the market leader in mortgages. Its outstanding loan portfolio covers well over

a million dwelling units. HDFC has developed significant expertise in retail mortgage

loans to different market segments and also has a large corporate client base for its

housing related credit facilities. With its experience in the financial markets, a strong

market reputation, large shareholder base and unique consumer franchise, HDFC was

ideally positioned to promote a bank in the Indian environment.

Technology

HDFC Bank operates in a highly automated environment in terms of

information technology and communication systems. All the bank's branches have

online connectivity, which enables the bank to offer speedy funds transfer facilities to

its customers. Multi-branch access is also provided to retail customers through the

branch network and Automated Teller Machines (ATMs).

The Bank has made substantial efforts and investments in acquiring the best

technology available internationally, to build the infrastructure for a world class bank.

In terms of software, the Corporate Banking business is supported by Flex cube,

while the Retail Banking business by Finware, both from i-flex Solutions Ltd. The

systems are open, scaleable and web-enabled. The Bank has prioritized its

engagement in technology and the internet as one of its key goals and has already

made significant progress in web-enabling its core businesses. In each of its

businesses, the Bank has succeeded in leveraging its market position, expertise and

technology to create a competitive advantage and build market share.

Achievements

HDFC Bank has won many awards for its excellent service. Major among them

are "Best Bank in India" by Hong Kong-based Finance Asia magazine in 2005 and

"Company of the Year" Award for Corporate Excellence 2004-05.

Times Bank Amalgamation: In a milestone transaction in the Indian banking

industry, Times Bank Limited (another new private sector bank promoted by

Bennett, Coleman & Co. /Times Group) was merged with HDFC Bank Ltd.,

effective February 26, 2000. As per the scheme of amalgamation approved by

the shareholders of both banks and the Reserve Bank of India, shareholders of

Times Bank received 1 share of HDFC Bank for every 5.75 shares of Times

Bank. The acquisition added significant value to HDFC Bank in terms of

increased branch network, expanded geographic reach, enhanced customer

base, skilled manpower and the opportunity to cross-sell and leverage

alternative delivery channels.

Credit Rating: HDFC Bank has its deposit programmes rated by two rating

agencies - Credit Analysis & Research Limited. (CARE) and Fitch Ratings

India Private Limited. The Bank's Fixed Deposit programme has been rated

'CARE AAA (FD)' [Triple A] by CARE, which represents instruments

considered to be "of the best quality, carrying negligible investment risk".

CARE has also rated the Bank's Certificate of Deposit (CD) programme "PR

1+" which represents "superior capacity for repayment of short term

promissory obligations". Fitch Ratings India Pvt. Ltd. (100% subsidiary of

Fitch Inc.) has assigned the "tAAA (ind)" rating to the Bank's deposit

programme, with the outlook on the rating as "stable". This rating indicates

"highest credit quality" where "protection factors are very high". HDFC Bank

also has its long term unsecured, subordinated (Tier II) Bonds of Rs.4 billion

rated by CARE and Fitch Ratings India Private Limited. CARE has assigned

the rating of "CARE AAA" for the Tier II Bonds while Fitch Ratings India

Pvt. Ltd. has assigned the rating "AAA (ind)" with the outlook on the rating as

"stable". In each of the cases referred to above, the ratings awarded were the

highest assigned by the rating agency for those instruments.

Corporate Governance Rating: The bank was one of the first four

companies, which subjected itself to a Corporate Governance and Value

Creation (GVC) rating by the rating agency, The Credit Rating Information

Services of India Limited (CRISIL). The rating provides an independent

assessment of an entity's current performance and an expectation on its

"balanced value creation and corporate governance practices" in future. The

bank has been assigned a 'CRISIL GVC Level 1' rating which indicates that

the bank's capability with respect to wealth creation for all its stakeholders

while adopting sound corporate governance practices is the highest.

Best Domestic Bank in India in The Asset Triple A Country Awards 2005,

2004 and 2003.

“Company of the Year” Award in The Economic Times Awards for Corporate

Excellence 2004-05.

Asia money’s Awards for Best Domestic Commercial Bank as well as Best

Cash Management Bank - India in 2005.

The Asian Banker Excellence in Retail Banking Risk Management Award in

India for 2004.

Finance Asia “Best Bank - India” in 2005, "Best Domestic Commercial Bank

– India” in 1999, 2000 and 2001 respectively and “Best Local Bank – India”

in 2002 and 2003.

Business Today “Best Bank in India” in 2003 and 2004.

“Best Overall Local/Domestic Bank – India” in the Corporate Cash

Management Poll conducted by Asia money magazine.

Selected by Business World as "one of India's Most Respected Companies" as

part of The Business World Most Respected Company Awards 2004.

In 2004, Forbes Global named HDFC Bank in its listing of Best under a

Billion, 100 Best Smaller Size Enterprises in Asia/Pacific and Europe.

In 2004, HDFC Bank won the award for “Operational Excellence in Retail

Financial Services” - India as part of the Asian Banker Awards 2003.

In 2003, Forbes Global named HDFC Bank in its ranking of “Best under a

Billion, 200 Best Small Companies for 2003”.

The Financial Express named HDFC Bank the “Best New Private Sector Bank

2003” in the FE-Ernst & Young Best Banks Survey 2003.

Outlook Money named HDFC Bank the “Best Bank in the Private Sector” for

the year 2003.

NASSCOM and economictimes.com have named HDFC Bank the ‘Best IT

User in Banking’ at the IT Users Awards 2003.

Euro money magazine gave HDFC Bank the award for "Best Bank – India” in

1999, “Best Domestic Bank” in India in 2000, and “Best Bank in India” in

2001 and 2002.

Asia money magazine has named us “Best Commercial Bank in India 2002”

For its use of information technology, HDFC Bank has been recognized as a

“Computerworld Honors Laureate” and awarded the 21st Century

Achievement Award in 2002 for Finance, Insurance & Real Estate category

by Computerworld, Inc., USA. Its technology initiative has been included as a

case study in their online global archives.

Business India named HDFC Bank “India’s Best Bank” in 2000.

In 2000, Forbes Global named HDFC Bank in its list of “The 300 Best Small

Companies” in the world and as one of the “20 for 2001” best small

companies in the world.

Various Sources of Working Capital

Working capital are short term loans meant to increase your cash flow and

they are often used to fund the daily operations of your business. Working capital can

be of two types:

Secured

Unsecured

A secured Working Capital Loan is one that is backed by an asset and/or personal

guarantee.

The asset required can be a house, factory or inventory. They can be fully paid

up assets or assets with existing mortgages or loans.

How much collateral the bank or financial institution will ask for depends

very much on their assessment of your ability to pay back the loan.

The bank may also require personal guarantees from the owners and/or

directors. They must be ready and willing to put up their own personal assets

to back the loan e.g. family home, shares and stocks.

Lenders give unsecured loans only to borrowers whom they consider to be low

or no risk. Start-ups are generally viewed as risky and are unlikely to be granted

unsecured loans.

There are many different types of Working Capital Loans. To complicate matters,

different banks use different terms to describe the same type of loan.

Overdraft / Line-Of-Credit

Overdraft facility is granted for your commercial activities. This facility enables you

to overdraw your account up to an agreed limit for a period up to 12 months. Interest

on the overdraft facility is also competitive. Both Letters of Credit and Deferred

Letters of Credit facilities can be offered at the bank for your imports.

An overdraft allows you to draw funds beyond the available limit

of your bank account.

The maximum amount you can overdraw is your line of credit. The

terms and amount depend on the relationship you have with your

banker and his/her assessment of your credit worthiness.

Overdrafts are flexible and simple to operate. You pay interest

only on the amount you have overdrawn. However, the interest rate

charged is usually 1-2% above the bank's prime rate.

Key Features of Overdraft:

Your borrowing limit will be set upfront

You have the necessary cash flow to run your business

Monthly repayments are based on the amount of credit you are using

You don't have to worry if you overdraw the account

You can deal with the unforeseen

The facility will be reviewed every 12 months

Interest on your overdraft balance is charged monthly. The interest rate is

negotiated on application.

Short-Term Loan/ Small Business Loans

Small business loans are available through a variety of sources, including the Small

Business Association, banks and through government resources. There are many

small businesses in the India today and many are in need of resources for added

support and growth. There are approximately 10,000 lending institutions that provide

traditional loans to large businesses, but the small business owner often runs into

difficulty when trying to qualify under the rigorous requirements for such loans.

Unlike an overdraft, a short-term loan has a fixed repayment

period - usually 12 months - and fixed interest rates.

You may be asked to put up an asset as collateral for this loan.

If your track record and relationship with the bank is good, the

lender may even be willing to provide you with the loan without

collateral.

Confirmed Sales Orders or Accounts Receivable

Loans based on confirmed sales orders or accounts receivable is

another way to raise working capital.

If you need to fulfill a sizeable order of goods, but do not

have the funds to do so, you may apply for a Working

Capital Loan based on the value of the contract or order.

If there is new opportunity round the corner and you need

funds to take advantage of it, you may apply for a Working

Capital Loan based on the value of your accounts

receivable. Accounts receivable is the amount of money

you have billed your customers but have not yet received

payment.

Loans for Buying & Selling Goods

There are special loan facilities for businesses that buy and sell

goods, e.g. importers, manufacturers, exporters, etc.

Letters of Credit, Inventory Loans and Trust Receipts are some

examples.

Bid Securities & Performance Bonds

The bank can give you guarantee for the execution of your contract. Contract

awarding agents may require a performance bond from your bankers as a security

against your performance of your contract. We offer this facility at a reasonable fee.

Bank Guarantees

The bank can undertake to guarantee facilities obtained from other creditors suppliers

on behalf of its prospective customers.

Business Loans

Many traditional lending institutions offer small business loans. These business loans

are based on an amortization table from which a borrower is paying a portion of the

principle as well as interest. In addition, most traditional bank loans require a set

payment to be made each month.

Debtor Finance

Debtor Finance is a facility that improves your cash flow for immediate business

growth. It is a non-disclosed facility, which is designed to afford cash flow

acceleration against the security of your debtor's book.

Debtor Finance is suited to your business:

If you are in manufacturing, distribution or selected services industry

If you sell to other companies, trading concerns or institutions but not to

individual members of public

If your annual sales are in excess of approximately R12 million (this is

flexible)

If all aspects of administration are soundly managed, especially your debtor's

book

Key features and benefits

Provides funding of between 70% and 80% of your debtor's book

Improves your cash flow for immediate business growth

Allows you to negotiate discounts from suppliers for the early settlement of

accounts

Key balance sheet ratios are improved, as your debtors become a real asset

As part of the service, we will rate your debtors

Minimum contract is typically for 12 months

The administration and collection of debts is done by your company.

Flexi – Business Loans

This is ideal for the established business owner who wishes to undertake growth

projects. To apply, the business must have been operating for longer than 2 years,

have an annual turnover of up to 40 million, and be able to produce sound financials.

Key features and benefits

Repayments term from 12 to 60 months

Loans up to a maximum of R200 000

Competitive interest rates

Redraw up to the original capital amount without the hassle of having to

formally apply with financial documentation

Easy cash flow planning with the agreed minimum installment payable

Easy and immediate access to any prepaid amounts

Lending in the Business name, rather than personal, is tax efficient.

Working capital Loans offered by Government

Internationalization Finance (IF) Scheme

Need funds to expand overseas? Get a loan of up to S$15 million to buy fixed assets

and finance your overseas projects or orders.

Local Enterprise Finance Scheme (LEFS)

Strengthen, upgrade and expand your business with the help of a fixed interest rate

loan.

Loan Insurance Scheme (LIS)

Secure loans by getting them insured against default. The Government will subsidies

50% of the insurance premium.

Micro Loan Programme

Very small businesses can get loans of up to S$50,000.

Trade Credit Insurance (TCI) Programme

Get your accounts receivable insured against non-payment risk at rates normally

available only to companies with substantial trade volume. You can apply for TCI

Programme with trade financing to raise working capital.

HDFC Bank: Policies, Procedures & Products

HDFC Bank's mission is to be a World-Class Indian Bank. The objective is to

build sound customer franchises across distinct businesses so as to be the preferred

provider of banking services for target retail and wholesale customer segments, and to

achieve healthy growth in profitability, consistent with the bank's risk appetite. The

bank is committed to maintain the highest level of ethical standards, professional

integrity, corporate governance and regulatory compliance. HDFC Bank's business

philosophy is based on four core values - Operational Excellence, Customer Focus,

Product Leadership and People.

Policies for Working Capital of HDFC BANK

Non Manufacturers Working Capital (Cash Credit) Requirements:

Minimum Requirement: Rs. 10 Lacs

Pricing: 10.5% - 11%

Indicative Limits – 15% (of turnover)

Target Segment:

1. Traders

2. Stockist

3. Distributor

4. Retailer

Located at all the centers where the bank has its own branches.

Filtering Criteria: - Five Point Questionnaire

1. Turnover of Business: >= Rs. 100 Lacs

Yes/No

2. Business Vintage: >= 3 years

Yes/ No

3. Profitable Business (Profit after tax): >= 3 years

Yes/No

4. Owned funds in Business: = 100% facility

Yes/No

5. Availability of Collateral ž Residential of commercial property

(Avoid factory Land & Building / Godowns and galas)

Yes/No

Incase all of above criteria are affirmative, then the documents (As listed below)

need to be collected and send to the Relationship Manager at the regional credit hub.

1. Audited Financials – P/L accounts & balance sheet (along with IT Returns &

sales tax returns for the last 3 years), with schedules to accounts, auditors

report and tax auditors report.

2. Provisional Financials – P/L accounts and Balance Sheet for the current year

3. Copy of the sanction letter of existing bankers

4. Bank Statement of the existing business banker

5. 3 Months stocks and receivables statement as submitted to existing bankers.

6. Any Pat repayment track records (Loan Statements) of the establishments

&/or its promoters

7. Projected financials for the next 3 to 5 years (if it is a term loan case).

Products Offered under the Working Capital Umbrella

1. Fund Based:

Cash Credit (CC): It is an arrangement of short term working capital

facilities under which the bank allows a credit limit to the customer

and allows him to draw up to that limit. This facility is given against

the securities of stipulated tangible assets in stock and book debts.

Eligibility for traders – 10% - 15% of turnover

Term Loan (TL):- Term loan is an advance allowed for a fixed period of time

i.e. for 3 years for meeting capital expenditure, requirements i.e. expansion,

renovation etc, against security of immovable properties e.g. Residential and

commercial properties etc. The two types of term loan are:-

1. Vanilla term loan : term loan allowed to meet capital expenditure

requirements (as above).

2. Merchant term loan (METL): Merchants are allowed a term loan facility of

up to 9 times of there card receivable provided collateral in the form of

residential or commercial properties is provided to banks.

Export Packing Credit (EPC): Financial assistance provided to exporters

before shipment (Pre-Shipment) of goods is known as export packing credit.

Once the shipment is send the pre shipment finance converts to post shipment

finance in the following two forms –

Foreign Bill Purchase(FBP): Bills payable on “Demand’ for which there is no

underlying LC’s are available are purchased by the bank.

Bills discounting under Letter of Credit: Bills payable after particular period

of time i.e. other then on “Demand” for which underlying LC is available are

discounted by the bank for the customers.

Merchant Overdraft against Card Receivables (MEOD): Overdraft facilities

given to merchants against assessment of card receivable. It is given up to 2-3

times of card receivables provided average card volume are Rs. 50000/- per

month for the past 6 months.

Invoice Discounting: Bills which are payable after a particular period of time

are discounted by the bank by paying the face value of the bill less discount to

the seller of goods and acquires all the rights under the bill.

2. Non Fund Based:-

Letter of Credit (LC): These are instruments issued by bank at the

request of buyers in favor of seller undertaking to honor the documents

drawn by the seller in accordance with the terms of credit.

Bank Guarantee (BG): Guarantee given by the bank to the third person

on behalf of the customer who pay a certain sum of money on the

customer failing to fulfill his obligations legal/contractual, as the case

maybe. These are of two types

1. Performance Guarantee

2. Financial Guarantee

Usage of Working Capital

Working capital is used to pay short-term obligations such as your accounts

payable and buying inventory. If working capital dips too low, you risk running out of

cash. Even very profitable businesses can run into trouble if they lose the ability to

meet their short-term obligations. The calculator assists you in determining working

capital needs for the next year.

Business financing is a quickly expanding industry, with over 10,000

individual lending or finance companies vying for company’s businesses. However,

many banks only offer personal or traditional loan products for their customers with

perfect credit or to those businesses that already have the working capital they need at

their disposal. Perhaps one would not qualify for a traditional loan because companies

are one-of-a-kind and the banks do not understand businesses.

Businesses need working capital for various modes of operations and it can be

utilized in form of many credit facilities provided by Banks i.e.

Financing of inventory & processing:

1. Overdrafts / Working Capital Loans: - To fund gaps in your operating

cash flows.

2. Short Term Loans: - Extended for bridging your short term fund

requirements.

3. Commercial Paper/Short term NCDs.

4. Pre-shipment Credit: - Rupee credit to finance your export processing

prior to shipment.

Financing of purchases

1. Domestic

- Discounting of your Supplier bills to finance your purchase of raw

materials

- Opening Letters of Credit to stand guarantee of payment covering

purchase of your local supplies.

2. Imports

- Opening Import L/Cs favoring your overseas sellers to provide

guarantee of payment covering these import purchases.

- Arranging overseas buyer’s credit through our network. The rate

quoted is usually a spread over LIBOR.

Financing of sales

Domestic

- Overdraft / loans against receivables

- Discounting Sales bills to finance your receivables

Exports

- Post shipment credit against export orders executed by you.

- Discounting export bills sent by you.

- Advance against bills sent on collection.

- Extending advance against bills sent on collection.

- Negotiating export bills with or without recourse – to finance your

funding requirements after shipment.

Working capital is the lifeblood of any business. Defined as your current

assets minus your current liabilities, think of it as the amount of cash that your

business has to operate. The challenge for entrepreneurs is to balance this amount i.e.

not too much (where it sits unused) and not too little (where your company, even if it

is profitable, can't function).

Successful entrepreneurs keep as much working capital available as possible

by managing it well. For example, you can shorten the terms of payment for

receivables or be sure your inventory levels reflect sales. This keeps the cash in your

business flowing and enables you to respond to daily operating needs.

Some banks also offer solutions for projects that may put a strain on your

working capital. BDC, for example, can provide long-term financing for increased

inventory or other fixed assets, market development or e-commerce initiatives, just to

name a few. In addition, BDC can arrange repayment schedules to help you keep as

much working capital available as possible.

Here are some of the most common sources:

Line of credit

Most businesses have a line of credit from their financial institution.

Depending on the institution, these are available from $10,000 to $100,000. Your

financial institution will extend credit on an as-needed basis, including a service

charge. In general, the repayment schedule is flexible. The amounts available, the

rates charged, and the requirements for obtaining a line of credit will also vary.

Overdraft protection

Generally available from $1,000 to $10,000, this type of credit is secured

through personal guarantees from the business owner. It is intended as a short-term

solution, much like a credit card, and can be an expensive option.

Credit card line of credit

A rather new invention, these generally offer amounts from $5,000 to

$50,000. They offer all the conveniences of a credit card, although since they are

secured by personal guarantees, the actual amount available depends on your personal

financial situation. As with any credit card, the balance should be paid off each month

as cash advances or carried-over balances can prove quite costly.

Bridge financing

In certain situations you may want to consider bridge financing, a temporary

loan to bridge the gap between now and when a guaranteed influx of cash comes in.

Examples of this include delays in insurance claims or guaranteed sales (such as to

government organizations).

Factoring

Factoring is a form of asset-based lending where specialized firms provide

financing secured by credit-worthy accounts receivables. This may be a good choice

for new, growing businesses that want to immediately realize the value of their

receivables rather than waiting for them to be paid by their customers. Factoring does

not require prerequisites like personal and corporate credit strength, historical

financial background or personal guarantees. Factoring can also be used in

complement to traditional lending and credit card financing.

Working Capital Cycle

Cash flows in a cycle into, around and out of a business. It is the business's

life blood and every manager's primary task is to help keep it flowing and to use the

cash flow to generate profits. If a business is operating profitably, then it should, in

theory, generate cash surpluses. If it doesn't generate surpluses, the business will

eventually run out of cash and expire.

The faster a business expands the more cash it will need for working capital

and investment. The cheapest and best sources of cash exist as working capital right

within business. Good management of working capital will generate cash will help

improve profits and reduce risks. Bear in mind that the cost of providing credit to

customers and holding stocks can represent a substantial proportion of a firm's total

profits.

There are two elements in the business cycle that absorb cash - Inventory

(stocks and work-in-progress) and Receivables (debtors owing you money). The

main sources of cash are Payables (your creditors) and Equity and Loans.

Each component of working capital (namely inventory, receivables and

payables) has two dimensions TIME and MONEY. When it comes to managing

working capital - TIME IS MONEY. If you can get money to move faster around the

cycle (e.g. collect monies due from debtors more quickly) or reduce the amount of

money tied up (e.g. reduce inventory levels relative to sales), the business will

generate more cash or it will need to borrow less money to fund working capital. As a

consequence, you could reduce the cost of bank interest or you'll have additional free

money available to support additional sales growth or investment. Similarly, if you

can negotiate improved terms with suppliers e.g. get longer credit or an increased

credit limit; you effectively create free finance to help fund future sales.

Sources of additional working capital

Sources of additional working capital include the following:

← Existing cash reserves

← Profits (when you secure it as cash!)

← Payables (credit from suppliers)

← New equity or loans from shareholders

← Bank overdrafts or lines of credit

← Long-term loans

←

If you have insufficient working capital and try to increase sales, you can easily

over-stretch the financial resources of the business. This is called overtrading. Early

warning signs include:

← Pressure on existing cash

← Exceptional cash generating activities e.g. offering high discounts for early

cash payment

← Bank overdraft exceeds authorized limit

← Seeking greater overdrafts or lines of credit

← Part-paying suppliers or other creditors

← Paying bills in cash to secure additional supplies

← Management pre-occupation with surviving rather than managing

← Frequent short-term emergency requests to the bank (to help pay wages,

pending receipt of a cheque).

Handling of Receivables (Debtors)

Slow payment has a crippling effect on business; in particular on small businesses

who can least afford it. If you don't manage debtors, they will begin to manage your

business as you will gradually lose control due to reduced cash flow and, of course,

you could experience an increased incidence of bad debt. The following measures

will help manage your debtors:

1. Have the right mental attitude to the control of credit and make sure that it

gets the priority it deserves.

2. Establish clear credit practices as a matter of company policy.

3. Make sure that these practices are clearly understood by staff, suppliers and

customers.

4. Be professional when accepting new accounts, and especially larger ones.

5. Check out each customer thoroughly before you offer credit. Use credit

agencies, bank references, industry sources etc.

6. Establish credit limits for each customer... and stick to them.

7. Continuously review these limits when you suspect tough times are coming or

if operating in a volatile sector.

8. Keep very close to your larger customers.

9. Invoice promptly and clearly.

10. Consider charging penalties on overdue accounts.

11. Consider accepting credit /debit cards as a payment option.

12. Monitor your debtor balances and ageing schedules, and don't let any debts

get too large or too old.

Recognize that the longer someone owes you, the greater the chance you will

never get paid. If the average age of your debtors is getting longer, or is already very

long, you may need to look for the following possible defects:

← weak credit judgment

← poor collection procedures

← lax enforcement of credit terms

← slow issue of invoices or statements

← errors in invoices or statements

← Customer dissatisfaction.

Debtors due over 90 days (unless within agreed credit terms) should generally

demand immediate attention. Look for the warning signs of a future bad debt.

The act of collecting money is one which most people dislike for many reasons

and therefore put on the long finger because they convince themselves there is

something more urgent or important that demands their attention now. There is

nothing more important than getting paid for your product or service. A customer

who does not pay is not a customer. Here are a few ideas that may help you in

collecting money from debtors:

← Develop appropriate procedures for handling late payments.

← Track and pursue late payers.

← Get external help if your own efforts fail.

← Don't feel guilty asking for money.... its yours and you are entitled to it.

← Make that call now. And keep asking until you get some satisfaction.

← In difficult circumstances, take what you can now and agree terms for the

remainder. It lessens the problem.

← When asking for your money, be hard on the issue - but soft on the person.

Don't give the debtor any excuses for not paying.

← Make it your objective is to get the money - not to score points or get even.

Managing the Payables (Creditors)

Creditors are a vital part of effective cash management and should be

managed carefully to enhance the cash position.

Purchasing initiates cash outflows and an over-zealous purchasing function can create

liquidity problems.

Consider the following:

← Who authorizes purchasing in your company - is it tightly managed or spread

among a number of (junior) people?

← Are purchase quantities geared to demand forecasts?

← Do you use order quantities which take account of stock-holding and

purchasing costs?

← Do you know the cost to the company of carrying stock?

← Do you have alternative sources of supply? If not, get quotes from major

suppliers and shop around for the best discounts, credit terms, and reduce

dependence on a single supplier.

← How many of your suppliers have a returns policy?

← Are you in a position to pass on cost increases quickly through price increases

to your customers?

← If a supplier of goods or services lets you down can you charge back the cost

of the delay?

← Can you arrange (with confidence!) to have delivery of supplies staggered or

on a just-in-time basis?

Inventory Management

Managing inventory is a juggling act. Excessive stocks can place a heavy

burden on the cash resources of a business. Insufficient stocks can result in lost sales,

delays for customers etc.

The key is to know how quickly your overall stock is moving or, put another

way, how long each item of stock sit on shelves before being sold. Obviously,

average stock-holding periods will be influenced by the nature of the business. For

example, a fresh vegetable shop might turn over its entire stock every few days while

a motor factor would be much slower as it may carry a wide range of rarely-used

spare parts in case somebody needs them.

Nowadays, many large manufacturers operate on a just-in-time (JIT) basis

whereby all the components to be assembled on a particular today, arrive at the

factory early that morning, no earlier - no later. This helps to minimize manufacturing

costs as JIT stocks take up little space, minimize stock-holding and virtually eliminate

the risks of obsolete or damaged stock. Because JIT manufacturers hold stock for a

very short time, they are able to conserve substantial cash. JIT is a good model to

strive for as it embraces all the principles of prudent stock management.

The key issue for a business is to identify the fast and slow stock movers with the

objectives of establishing optimum stock levels for each category and, thereby,

minimize the cash tied up in stocks. Factors to be considered when determining

optimum stock levels include:

← What are the projected sales of each product?

← How widely available are raw materials, components etc.?

← How long does it take for delivery by suppliers?

← Can you remove slow movers from your product range without compromising

best sellers?

Remember that stock sitting on shelves for long periods of time ties up money

which is not working for you. For better stock control, try the following:

← Review the effectiveness of existing purchasing and inventory systems.

← Know the stock turn for all major items of inventory.

← Apply tight controls to the significant few items and simplify controls for the

trivial many.

← Sell off outdated or slow moving merchandise - it gets more difficult to sell

the longer you keep it.

← Consider having part of your product outsourced to another manufacturer

rather than make it yourself.

← Review your security procedures to ensure that no stock "is going out the back

door!"

HDFC Bank provides various facilities to its customers and thus the products

undertaken by the customers or facilities provided to its customers are of great use to

the customer.

Business approach towards Working Capital

Working capital is the measurement of the availability of liquid assets a

company has to build its business. Generally, companies that have a lot of working

capital will be more successful since they can expand and improve their operations.

Companies without working capital may lack the funds necessary for growth.

Small businesses often use working capital to pay short-term obligations such

as inventory or advertising but it can also be utilized for long-term projects such as

renovations or expansion. These are elements in the business cycle that can quickly

absorb cash. If working capital dips too low, a business risks running out of cash.

Even very profitable businesses can run into trouble if they lose the ability to meet

their short-term obligations. Business financing or small business loans can be used

as a fast cash option to cushion the periods when the flow is not ideal or readily

available.

Cash flow is the businesses life blood and every owner’s primary task is to

help keep it flowing and to use the cash to generate profits. If a business is operating

profitably, then it should, in theory, generate a cash surplus. If it does not generate a

surplus, the business could eventually run out of cash and expire. The faster a

business expands the more cash it will need for working capital. Proper management

of working capital will generate cash and will help improve profits and reduce risk.

Operating cash flow is generated through revenues, or the cash in, and through

expenditures, or the cash out. But the speed at which sales are converted to cash and

the speed at which your own suppliers are paid, has an important influence on the

health of your operation. So it makes sense to be able to predict how much cash you'll

have on-hand in the future.

Start with a balance sheet

If you're starting a new business, you'll be investing your own money (equity)

and incurring some liabilities (purchasing inventory and or machinery on credit or

borrowing money from a lender). At that point in time, the company's total assets (or

value of goods or infrastructure you've purchased) will be equal to the money you've

invested (the equity) and the money you have borrowed.

The formula looks like this: Total Assets = Liabilities + Equity

The balance sheet however, does not show when you will have to make payments on

purchased equipment or taxes payable such as GST. Those taxes come due in the

future, so it's a good idea to plan or budget for them ahead of time.

Track operating cash flow through income statements

If the balance sheet is a snapshot of your business at a certain point in time,

the income statement shows what really happened with your sales and expenses over

a period of time in the past. If you have monthly income statements, you may be able

to identify patterns in your business cycle and help you make projections for the

future.

Generate a cash flow budget

Using your projected balance sheet and projected income statement, you can

create a projected cash flow budget in order to plan ahead. For a new business, cash

flow projections may be more difficult to set up since there is no previous data, but

data for related businesses can be found through industry groups, from your banker,

your accountant and even over the Internet.

For cash inflows, you need to make sure you account for all possible sources

of income including tax refunds, grants, sales of assets as well as sales of goods and

services. Your cash outflows include operating expenses such as salaries and rent,

debt and tax payments as well as the cost of the goods sold. At the end of every

period, you should have a closing cash balance which then becomes the opening cash

balance for the next period.

The budget should be realistic enough so that you can see whether you need

more working capital financing. It should be detailed enough to indicate those periods

where revenues may be lower than expenditures. Finally, it should prompt you to

create an action plan for dealing with cash flow surpluses as well as cash crunches.

For instance, you can identify periods where your sales are low and plan to bridge the

gap by increasing your line of credit in advance. For a projected large order where

you need to suddenly increase your inventory without getting paid right away, you

may want to arrange for long-term working capital financing. You may also notice

that you are paying suppliers in less time than it takes to get paid by your customers.

If that's the case, you might want to negotiate better terms with those suppliers. And if

it's taking longer to get paid by your customers, it may be time to build some early-

payment inducements into your operation.

Get the whole story

Your success in business will be influenced by sales, control of expenses as

well as by getting the right long-term financing for asset purchases. By comparing

cash flow projections with what actually happened over a period of time, you will

gain insight into your operation that will help you establish strategies for growing the

business.

But while cash flow projections and statements are important tools for

managing your company, they don't necessarily reveal all the important information

that you need. For instance, the income statement won't tell you how long it takes to

make a sale or how many potential customers you had to contact before making that

sale.

Financing Account Payables based on receivables

The ideal, and the most economical, solution is to arrange for accounts receivable

and accounts payable to phase in, in an opportune manner. However, such

arrangements must be made through agreements reached with suppliers at the time of

contract negotiation with the municipality. Many suppliers may consent to such

agreements.

There are also other ways of obtaining temporary financing to increase cash flow

in a business:

1. The company may request the bank to temporarily increase its line of credit to

cover major expenses related to the project

2. The company can also apply for a term loan (to increase its working capital)

with a fixed due date (corresponding to the date set for receipt of final

amounts payable under the contract). This enables the company to comply

with its suppliers' preferred terms of payment, and sometimes even take

advantage of discounts offered for early payments.

3. Shareholders or third parties can inject funds into the business for the duration

of the project, reimbursable upon project completion.

4. When the contract is signed, the company may request the municipality (if

contract conditions permit) to make progressive payments prorated to work

completed, thus enabling more prompt payment of its suppliers.

Obtaining Funds to promote your Business

The first potential source of financing is shareholders, who can be asked to

inject additional funds. This can be done through shareholder advances (loans), or by

issuing new ordinary capital stock. These two options are the least costly methods of

raising extra capital. If shareholders are not in a position to provide additional

funding, the business owner may choose to call upon family members and friends

(commonly called "love money"). In exchange for this type of financing, the business

can issue preferred capital stock, which has a fixed rate of return. It should be noted

that such stock, despite the special rights attached thereto, does not eliminate the risk

associated with investing in a small business. Financial institutions represent the third

possible source of additional financing. If the internally generated funds of a business

are deemed acceptable, a banker is more likely to be willing to consider a request for

financing. Such financing can consist of a term loan or an increase in the current line

of credit. The business owner should prepare a plan (to be presented to the financial

institution) establishing how the business will grow as a result of an injection of

additional funds. A term loan can also be obtained on the "debt-free" portion of the

business' equipment. Lenders (bankers or others) can approve additional financing on

equipment that is not encumbered, and thereby provide the business with new funds

to carry out its advertising/marketing project. Lastly, a number of public

organizations and para-public agencies offer assistance and term financing to enable

businesses to proceed with marketing its product(s) and gaining increased exposure.

This financing can take on various forms, including traditional loans, equity

participation in the business, and financial assistance that need not be repaid.

Working Capital beyond a line of credit

To relieve the strain on your cash flow, you could ask your clients for a

deposit (between 10 and 25 percent). This deposit would help launch the project and

minimize the use of capital acquired from the previous contract. Doing this several

times would enable you to undertake more than one contract at a time. However, this

method may not apply to your situation. It may also be possible to obtain a term loan

on the "debt-free" portion of your company's equipment. Those who lend on

equipment may authorize additional financing on equipment on which there is no

lien. This would enable the business to receive additional funding to undertake a

second contract. Some public and quasi-public organizations have providing financial

aid to small businesses as their mission. In the form of a term loan, such financial aid

can increase working capital and enable a business to undertake more than one

project at a time. Eligibility for such aid usually depends on the company's capacity to

generate enough available funds (profits + amortization) to cover the future

repayment of such a loan. One can also turn to family and friends for new sources of

capital, referred to as "love money." Terms for such loans (repayment, interest rate,

etc.) are usually less stringent than those imposed by traditional lenders.

If you have a good credit rating, nothing prevents you from taking out a

personal (term) loan from your chartered bank or credit union, and subsequently

injecting this amount into your business. The interests on loans of this kind are also

tax deductible.

Your suppliers can also be a source of funding. You could ask them to extend

your payment terms and raise your credit limit. A combination of these two factors

will enhance your potential to undertake more than one project at a time.

Calculation of Cash to Cash ratio

The working capital ratio (W/C) is an indicator that allows for evaluating a

business' ability to meet its short-term obligations. The higher the W/C (or current)

ratio, the greater the "cushion" between a company's financial obligations and its

ability to meet these. Moreover, a higher working capital ratio also means less

pressure on a business' suppliers and line of credit. The working capital ratio should

never be less than 1:1. Excluding inventory from W/C calculations leaves us with

what is known in the industry as the "acid test". While a subtler version of the above

ratio, it is also more realistic, given that it does not consider inventory, an asset that is

not as easily convertible into cash.

Financial Ratio for Assessment of Working Capital Requirements

Most businesses at some point or other face opportunities that require an in

depth look at their financial structure. This may be due to an expansion project or

simply a need for additional financing.

And often the signals are clear:

you may have low cash reserves or your expenses are increasing

you need to extend longer than normal credit terms to a customer for a large

order

You may find yourself borrowing more frequently as your sales are

increasing.

One way to analyze your financial health and identify where you can improve it is

by looking closely at your financial ratios. Ratios are used to make comparisons

between different aspects of a company's performance or within a particular industry

or region. They reveal very basic information such as whether you've accumulated

too much debt, are stockpiling too much inventory or not collecting receivables fast

enough.

Ideally, you should review your ratios on a monthly basis in order to keep abreast

of changing trends in your company. The most common example of the importance of

financial ratios is when a lender determines the stability and health of your business

by looking at your balance sheet. The balance sheet provides a portrait of what your

company owns or is owed (assets) and what you owe (liabilities). Bankers will often

make financial ratios a part of your loan agreement. For instance, you may have to

keep your equity above a certain percentage of your debt, or your current assets above

a certain percentage of your current liabilities. Although you'll find different terms are

available for different ratios, these are the basic 4 categories:

Liquidity ratios

These ratios measure the amount of liquidity (cash and easily converted assets)

that you have to cover your debts and they give a broad overview of your financial

health.

Current ratio

This ratio, also called the working capital ratio measures your company's

ability to generate cash to meet your short-term financial commitments. The current

ratio is calculated by dividing your current assets such as cash, inventory, and

receivables by your current liabilities such as line of credit balance, payables, and

current portion of long term debts.

Quick Ratio

These ratio measures your ability to access cash quickly to support immediate

demands. Also known as the acid test, the quick ratio divides current assets

(excluding inventory) by current liabilities (excluding current portion of long term

debts). A ratio of 1.0 or greater is generally acceptable, but depends on your industry.

A comparatively low ratio can mean that your company might have difficulty

meeting your obligations and may not be able to take advantage of opportunities that

require quick cash. Paying off your liabilities can improve this ratio; you may want to

delay purchases or consider long-term borrowing to repay short-term debt. You may

also want to review your credit policies with clients and possibly adjust them to

improve the time it takes to collect receivables.

A higher ratio may mean that your capital is being underutilized. In this case, you

could invest your capital in projects that drive more growth, such as innovation,

product or service development, R&D or reaching international markets.

Efficiency ratios

Often measured over a 3 to 5 year period, these ratios give additional insight into

areas of your business such as collections, cash flow and operational results.

Inventory turnover looks at how long it takes for inventory to be sold and replaced

during the year. It is calculated by dividing total purchases by average inventory in a

given period. For most inventory-reliant companies, this can be a make or break

factor for success. After all, the longer the inventory sits on your shelves, the more it

costs. Assessing your inventory turnover is important because gross profit is earned

each time inventory is turned over. This ratio can enable you to see where you can

improve your buying practices and inventory management. For example, you could

analyze your purchasing patterns as well as your clients to determine ways to

minimize the amount of inventory on-hand.  You might want to turn some of the

obsolete inventory into cash by selling it off at a discount to specific clients. This

ratio can also help you see if your levels are too low and you're missing out on sales

opportunities.

Inventory to net working capital ratio can determine if you have too much of your

working capital invested in inventory. It is calculated by dividing inventory by total

current assets. In general, the lower the ratio, the better.  Improving this ratio will

allow you to invest more working capital in growth-driven projects such as export

development, R&D or marketing.

Evaluating inventory ratios depends a great deal on your industry and the quality

of your inventory. Ask yourself: are your goods seasonal (ski equipment), perishable

(food), or prone to becoming obsolete (fashion)? Depending on the answer, these

ratios will vary a great deal. Still, regardless of the industry, inventory ratios can you

help you improve your business efficiency.

Average collection period looks at the average number of days customers take to

pay for your products or services.  It is calculated by dividing receivables by total

sales and multiplying by 365. To improve how quickly you collect payments, you

may want to establish clearer credit policies and a set of collection procedures. For

example, to encourage your clients to pay on time, you can give them incentives or

discounts. You should also compare your policies to those of your industry to ensure

you remain competitive.

Profitability ratios

These ratios are used not only to evaluate the financial viability of your business,

but are essential in comparing your business to others in your industry.  You can also

look for trends in your company by comparing the ratios over a certain number of

years.

Net profit margin measures how much a company earns (usually after taxes)

relative to its sales.  In general, a company with a higher profit margin than its

competitor is more efficient, flexible and able to take on new opportunities.

Operating profit margin also known as coverage ratio measures earnings before

interest and taxes. The results can be very different from the net profit margin due to

the impact of interest and tax expenses.  By analyzing this margin, you can better

assess your ability to expand your business through additional debt or other

investments.

Return on assets (ROA) ratio tells how well management is utilizing all the

company's resources (assets). It is calculated by dividing net profit (before taxes) by

total assets.  The number will vary widely across different industries. Capital-

intensive industries such as railways will yield a low return on assets, since they need

expensive assets to do business. Service based operations such as consulting firms

will have a high ROA: they require minimal hard assets to operate.

Return on equity (ROE) measures how well the business is doing in relation to the

investment made by its shareholders. It tells the shareholders how much the company

is earning for each of their invested dollars and is calculated by dividing the equity in

the company by net profits (usually before tax).

A common analysis tool for profitability ratios used today is cross-sectional

analysis, which compares ratios of several companies from the same industry. For

instance, your business may have experienced a downturn in its net profit margin by

10% over the last 3 years, which may seem worrying. However, if your competitors

have experienced an average downturn of 21%, your business is actually performing

better than the industry as a whole. Nonetheless, you will still need to analyze the

underlying data in order to establish the cause of the downturn as well as create

solutions for improvement.

Leverage ratios

These ratios provide an indication of the long-term solvency of a company and to

which extent you are using long-term debt to support your business. Debt-to-equity

and debt-to-asset ratios are used by bankers to see how your assets are financed, for

example, by creditors or through your own investments. In general, a bank will

consider a lower ratio to be a good indicator of your ability to repay your debts or

take on additional debt to support new opportunities.

Accessing and calculating ratios

To calculate your ratios, you can use a variety of online tools such as BDC's ratio

calculators, although your financial advisor, accountant, and banker may already have

the most currently used ratios on hand.

.

Interpreting your ratios

Ratios will vary from industry to industry, and over time, interpreting them

requires knowledge of your business, your industry, and the reasons for fluctuations.

In this light, BDC Consulting offers sound advice, which can help you interpret and

improve your financial performance. To help you understand why ratios can easily

vary from one industry to another, see the examples below.  A current ratio measures

your ability to pay your debts over the next 12 months; a ratio of 1.0 or greater is

generally acceptable.

A clothing story will have goods that quickly lose value because of changing

fashion trends. However, these goods are easily liquidated and have high

turnover.  As a result, small amounts of money continuously come in and go

out, and in a worst-case scenario, liquidation is relatively simple. This

company could easily function with a current ratio close to 1.0

An airplane manufacturer, on the other hand, has high-value,

non-perishable assets such as work-in-progress inventory as well as extended

receivable terms.  Businesses with these characteristics need carefully planned

payment terms with customers; the current ratio should be much higher to

allow for coverage of short-term liabilities.

Beyond the numbers

It's important to keep in mind that ratios are only one way to determine your

financial performance.  Ratios may vary widely depending on your industry category

and location. Regional differences in such factors as labor or shipping costs may also

affect the result and the significance of a ratio. Sound financial analysis always entails

closely examining the data used to establish the ratios as well as assessing the

circumstances that generated the results. Although your financial ratios reveal a lot

about your company's performance, other factors, such as your sales cycle, can also

give you insight into your operational efficiency.

Indian Market Scenario

Successful investors have always given a lot of thrust on working capital

management. A study of top Indian companies with high return on capital employed

(ROCE) shows that many of these companies have operated on negative working

capital management. These companies are known to give good returns to their

shareholders, both in terms of dividends and capital gains. Interestingly, most of these

companies belong to the FMCG or the auto sector.

` Of the 30 stocks in the Sensex, seven stocks have negative working capital

and ROCEs in the range of 20-80%. The total market capitalization of these

companies has moved up by 94% as against the entire Sensex, which moved up by

67% over the last one year.

Negative is positive

HLL, Nestle and Godrej Consumers Products Ltd have ROCE in excess of

40%. The same goes for two-wheeler companies like Bajaj Auto, TVS and Hero

Honda, which have given high returns on their investment. The success of this high

return is associated with the way these companies have managed their working capital

management cycles.

These are the companies that first sell their goods and later on pay their raw material

suppliers. This is possible only when the companies are huge in size and account for

the bulk of turnover for their suppliers. In such a situation, they are always in a

position to arm-twist the suppliers by taking more credit.

Leveraging on supply chain

HLL, which had a net negative working capital of Rs 183.3 crore in FY05, has

been able to maintain its creditor days at 64 as compared to receivable days at 16. The

company has generated a ROCE at 44.1%. On the other hand, Godrej Consumer

Products (GCPL) is another company with negative working capital of Rs 45.48 crore

and creditor days at 53, compared to average debtors of six days only. The company

has earned an ROCE at almost 158%.

The strong distribution and dominant position in the FMCG industry has made

these companies to bargain with the debtors and creditors to expand the payment

cycle in favor of the company. The FMCG companies have been able to keep their

creditors almost equal to debtors and inventory, which have resulted in a lot of cash

generation for these companies, which is again invested in the business. These

companies also make investment in short-term papers and call money, which allows

them to earn good returns.

“Traditionally, the FMCG companies are known for maintaining negative

working capital which is leveraged on strong supply chain management. Since this

industry accounts for very negligible amount of debtors, the whole trade is financed

by creditors from the production side and vendors and dealers from the supply side.”

Working Capital is taken to be the life -blood of a business. Lack of working

capital may lead a business to “technical insolvency” and ultimately to liquidation.

That is why, the working capital management of a firm is considered to be one of the

most important tasks of financial managers. Working capital management involves

decisions relating to current assets including decisions about how these assets are to

be financed. Decisions regarding the volume of current assets have its own

importance no doubt, but the question of financing is, in fact, the key area of working

capital management. We have therefore felt it pertinent to estimate the financing

pattern of working capital that prevails at present in the Indian corporate sector. In

particular, the role of borrowings has been dealt with herein, as major share of

working capital finance does come from borrowings.

In the process of the study we have seen that the working capital of each firm

is constituted by several types of sources like bank borrowings, public deposits, trade

credit, long-term borrowings and equity capital. Hence, at the outset, we have tried to

find out the reasons behind utilizing several sources instead of relying upon one or

two best-suited sources. What appears therefrom is that, since working capital needs

are partly fixed and partly fluctuating, the companies cannot but resort to sources of

different types and terms. Moreover, whereas short-term borrowings offer the benefit

of reduced cost due to reduction of idle capital, the use of long-term borrowings has

also the necessity on much ground. Long- term borrowings are less risky than short-

term borrowings and the firms would not have to meet the cash obligations off and

on. Not only the long -term borrowings, but the equity capital has also its role to play

in the financing of working capital in Indian corporate sector. At the initial stage of a

firm, fixed assets as well as current assets have to be financed by this equity capital,

since other sources may not be easily available at that time. Subsequently, when the

firms get momentum, several lenders may stretch their hands for advancing loan, but

the importance of equity capital does not end altogether. On the ground of stability

and security, each firm is to maintain “equity-cushion” throughout its life time. In

view of this, it has been deduced in our study that there is need for financing working

capital from various sources.

Research Methodology:

Research is a systematic, controlled, empirical and critical investigation of

hypothetical propositions about the presumed relationships among natural

phenomenon. It may mean the first small step in an endeavor to better understand the

change occurring and at times forced upon us as individuals or as society.

Research as a process involves – defining and redefining problems, hypothesis

formulation, organizing and evaluating data, deriving deductions, inferences and

conclusions, after careful testing.

Research has its objective, the generalization, extension or verification of

knowledge to aid in formulation of a specific theory or furthers the motives of an art.

It involves critical and exhaustive investigation and experimentation by manipulating

things, concepts or symbols.

Research can be best defined as “the systematic and objective analysis and

recording of controlled observations that may lead to the development of

generalization, principles or theories, resulting in predictions and possibly ultimate

control of events”.

Research method that is usually adapted for projects are of two types:

Primary Data Collection.

The primary method that is used, involves first hand data such as self generation of

facts and figures and other analytical studies.

Secondary Data Collection.

The secondary method of data collection involves data from secondary sources such

as newspaper, magazines, internet, radio or/and television.

The secondary method of data collection is considered in this project as it

includes influences from magazines, journals, interviewing and web surfing. The

method helps in building up the conclusion for the project and even it supports the

analytical study that is conducted in order to specify the objectivity of the project.

Secondary data is data which has been collected by individuals or agencies for

purposes other than those of our particular research study. For example, if a

government department has conducted a survey of, say, family food expenditures,

then a food manufacturer might use this data in the organization’s evaluations of the

total potential market for a new product. Similarly, statistics prepared by a ministry

on agricultural production will prove useful to a whole host of people and

organizations, including those marketing agricultural supplies.

No marketing research study should be undertaken without a prior search of

secondary sources (also termed desk research). There are several grounds for making

such a bold statement.

Secondary data may be available which is entirely appropriate and wholly

adequate to draw conclusions and answer the question or solve the problem.

Sometimes primary data collection simply is not necessary.

It is far cheaper to collect secondary data than to obtain primary data. For the

same level of research budget a thorough examination of secondary sources

can yield a great deal more information than can be had through a primary

data collection exercise.

The time involved in searching secondary sources is much less than that

needed to complete primary data collection.

Secondary sources of information can yield more accurate data than that

obtained through primary research. This is not always true but where a

government or international agency has undertaken a large scale survey, or

even a census, this is likely to yield far more accurate results than custom

designed and executed surveys when these are based on relatively small

sample sizes.

It should not be forgotten that secondary data can play a substantial role in the

exploratory phase of the research when the task at hand is to define the

research problem and to generate hypotheses. The assembly and analysis of

secondary data almost invariably improves the researcher's understanding of

the marketing problem, the various lines of inquiry that could or should be

followed and the alternative courses of action which might be pursued.

Secondary sources help define the population. Secondary data can be

extremely useful both in defining the population and in structuring the sample

to be taken. For instance, government statistics on a country's agriculture will

help decide how to stratify a sample and, once sample estimates have been

calculated, these can be used to project those estimates to the population.

Problems of Secondary Sources

Whilst the benefits of secondary sources are considerable, their shortcomings

have to be acknowledged. There is a need to evaluate the quality of both the source of

the data and the data itself.

The main problems may be categorized as follows:

Definitions

The researcher has to be careful, when making use of secondary data, of the

definitions used by those responsible for its preparation. Suppose, for example,

researchers are interested in rural communities and their average family size. If

published statistics are consulted then a check must be done on how terms such as

"family size" have been defined. They may refer only to the nucleus family or include

the extended family. Even apparently simple terms such as 'farm size' need careful

handling. Such figures may refer to any one of the following: the land an individual

owns the land an individual owns plus any additional land he/she rents, the land an

individual owns minus any land he/she rents out, all of his land or only that part of it

which he actually cultivates. It should be noted that definitions may change over time

and where this is not recognized erroneous conclusions may be drawn. Geographical

areas may have their boundaries redefined, units of measurement and grades may

change and imported goods can be reclassified from time to time for purposes of

levying customs and excise duties.

Measurement Error

When a researcher conducts fieldwork she/he is possibly able to estimate

inaccuracies in measurement through the standard deviation and standard error, but

these are sometimes not published in secondary sources. The only solution is to try to

speak to the individuals involved in the collection of the data to obtain some guidance

on the level of accuracy of the data. The problem is sometimes not so much 'error' but

differences in levels of accuracy required by decision makers. When the research has

to do with large investments in, say, food manufacturing, management will want to

set very tight margins of error in making market demand estimates. In other cases,

having a high level of accuracy is not so critical. For instance, if a food manufacturer

is merely assessing the prospects for one more flavor for a snack food already

produced by the company then there is no need for highly accurate estimates in order

to make the investment decision.

Source Bias

Researchers have to be aware of vested interests when they consult secondary

sources. Those responsible for their compilation may have reasons for wishing to

present a more optimistic or pessimistic set of results for their organization. It is not

unknown, for example, for officials responsible for estimating food shortages to

exaggerate figures before sending aid requests to potential donors. Similarly, and with

equal frequency, commercial organizations have been known to inflate estimates of

their market shares.

Reliability

The reliability of published statistics may vary over time. It is not uncommon, for

example, for the systems of collecting data to have changed over time but without any

indication of this to the reader of published statistics. Geographical or administrative

boundaries may be changed by government, or the basis for stratifying a sample may

have altered. Other aspects of research methodology that affect the reliability of

secondary data is the sample size, response rate, questionnaire design and modes of

analysis.

Time Scale

Most censuses take place at 10 year intervals, so data from this and other

published sources may be out-of-date at the time the researcher wants to make use of

the statistics.

The time period during which secondary data was first compiled may have a

substantial effect upon the nature of the data. For instance, the significant increase in

the price obtained for Ugandan coffee in the mid-90's could be interpreted as

evidence of the effectiveness of the rehabilitation programme that set out to restore

coffee estates which had fallen into a state of disrepair.

Whenever possible, marketing researchers ought to use multiple sources of

secondary data. In this way, these different sources can be cross-checked as

confirmation of one another. Where differences occur an explanation for these must

be found or the data should be set aside.

Sources of Information

1. Internal Sources

2. External Sources

1. Internal Sources:

Sales data: All organizations collect information in the course of their everyday

operations. Orders are received and delivered, costs are recorded, sales personnel

submit visit reports, invoices are sent out, and returned goods are recorded and so on.

Much of this information is of potential use in marketing research but a surprising

amount of it is actually used. Organizations frequently overlook this valuable

resource by not beginning their search of secondary sources with an internal audit of

sales invoices, orders, inquiries about products not stocked, returns from customers

and sales force customer calling sheets. For example, consider how much information

can be obtained from sales orders and invoices:

Sales by territory

Sales by customer type

Prices and discounts

Average size of order by customer, customer type, geographical area

Average sales by sales person and

Sales by pack size and pack type, etc.

This type of data is useful for identifying an organization’s most profitable

product and customers. It can also serve to track trends within the enterprise's existing

customer group.

Financial data: An organization has a great deal of data within its files on the cost of

producing, storing, transporting and marketing each of its products and product lines.

Such data has many uses in marketing research including allowing measurement of

the efficiency of marketing operations. It can also be used to estimate the costs

attached to new products under consideration, of particular utilization (in production,

storage and transportation) at which an organization’s unit costs begin to fall.

Transport data: Companies that keep good records relating to their transport

operations are well placed to establish which are the most profitable routes, and loads,

as well as the most cost effective routing patterns. Good data on transport operations

enables the enterprise to perform trade-off analysis and thereby establish whether it

makes economic sense to own or hire vehicles, or the point at which a balance of the

two gives the best financial outcome.

Storage data: The rate of stock turn, stock handling costs, assessing the efficiency of

certain marketing operations and the efficiency of the marketing system as a whole.

More sophisticated accounting systems assign costs to the cubic space occupied by

individual products and the time period over which the product occupies the space.

These systems can be further refined so that the profitability per unit, and rate of sale,

are added. In this way, the direct product profitability can be calculated.

2. External Sources

The marketing researcher who seriously seeks after useful secondary data is more

often surprised by its abundance than by its scarcity. Too often, the researcher has

secretly (sometimes subconsciously) concluded from the outset that his/her topic of

study is so unique or specialized that a research of secondary sources is futile.

Consequently, only a specified search is made with no real expectation of sources.

Cursory researches become a self-fulfilling prophecy. Dillon et. al3 give the following

advice: "You should never begin a half-hearted search with the assumption that what

is being sought is so unique that no one else has ever bothered to collect it and

publish it. On the contrary, assume there are scrolling secondary data that should help

providing definition and scope for the primary research effort."

The same authors support their advice by citing the large numbers of

organizations that provide marketing information including national and local

government agencies, quasi-government agencies, trade associations, universities,

research institutes, financial institutions, specialist suppliers of secondary marketing

data and professional marketing research enterprises. Dillon et al further advise that

searches of printed sources of secondary data begin with referral texts such as

directories, indexes, handbooks and guides. These sorts of publications rarely provide

the data in which the researcher is interested but serve in helping him/her locate

potentially useful data sources.

The main sources of external secondary sources are

(1) Government (federal, state and local)

These may include all or some of the following:

Population censuses

Social surveys, family expenditure surveys

Import/export statistics

Production statistics

Agricultural statistics.

(2) Trade associations

Trade associations differ widely in the extent of their data collection and

information dissemination activities. However, it is worth checking with them to

determine what they do publish. At the very least one would normally expect that

they would produce a trade directory and, perhaps, a yearbook.

(3) Commercial services

Published market research reports and other publications are available from a

wide range of organizations which charge for their information. Typically, marketing

people are interested in media statistics and consumer information which has been

obtained from large scale consumer or farmer panels. The commercial organization

funds the collection of the data, which is wide ranging in its content, and hopes to

make its money from selling this data to interested parties.

(4) National and international institutions.

Bank economic reviews, university research reports, journals and articles are

all useful sources to contact. International agencies such as World Bank, IMF, IFAD,

UNDP, ITC, FAO and ILO produce a plethora of secondary data which can prove

extremely useful to the marketing researcher.

Summary of Research Methodology

A search of secondary data sources should precede any primary research

activity. Secondary data may be sufficient to solve the problem, or at least it helps the

reader better understand the problem under study. Secondary data is cheaper and

quicker to collect than primary data and can be more accurate.

Before making use of secondary data there is need to evaluate both the data

itself and its source. Particular attention should be paid to definitions used,

measurement error, source bias, reliability and the time span of the secondary data.

Where possible, multiple data sources should be used so that one source can be cross-

checked for consistency with another.

A great deal of potentially useful secondary information already exists within

enterprises. Typically useful information would be that relating to sales, finance,

production, storage and transportation.

Where a serious search of secondary sources is undertaken then the marketing

researcher often finds an abundance of relevant material. Searches of printed

secondary data should begin with a consultation of referral sources such as

directories, handbooks, indexes, and the like.

It will almost certainly become the case, in all parts of the world, that

electronic information sources will eventually supersede traditional printed sources.

With the advent of Internet and CD-ROM, searches of secondary sources are

becoming more efficient and more effective. Computer-based information systems

give access to four different types of database bibliographic, numeric, directories and

full-text.

Analysis and Interpretation

The study analyses the role of public deposit as a source of working capital in

Indian corporate sector. This source emerged in India in 1930s. In 1950s, there

became a downfall in the use of it. In 1970s it again came into prominence. Use of

public deposit may frustrate the Government's policy of channeling the flow of funds

to industrial sector according to planned priorities. Moreover, it is said that the

unwary depositors may come into the trap of unscrupulous depositee- companies, by

lending their hard-earned money as public deposit. But from the standpoint of

depositee companies, public deposit can be said to be a viable source of finance in

many respects.

The most important argument in favor of its use is that it is cheaper than bank

borrowings and many other sources of finances. Now, government has imposed some

regulation and as a result the interest of innocent investors has been protected to an

extent and the flow of public deposit has also been restrained in the interest of

planned economy. It is thus expected that the investors will now accept the offer for

public deposit more freely and the firms, due to its cost advantage, will utilize this

source up to at least the permissible limit. But what we see is that the share of public

deposit to total borrowings is, on an average, only 6% in public limited companies,

and this is as meagre as 0.08% in government companies. Share of public deposit to

current assets is also only 7% in public limited companies and 0.08% in government

companies. The individual results as to the use of public deposit are, however, widely

scattered, and this is substantiated by the high co-efficient of variation (108%) of the

scores. Nevertheless, it is evident from the combined results that the role of public

deposit as a source of working capital is not significant in the decade of eighty,

though in 1970s its role had been better to some extent. Long-term borrowings like

debenture, institutional loan and government loan have also a contribution to working

capital financing, since, a part of current assets is usually covered by long-term funds.

The corporate practices as to these of different types of long-term sources reveal that

the position of debenture in corporate finance is almost equal to that of institutional

loan. In RBI sample, both hold individually 14% of total borrowings. In case of ten

selected public limited companies their individual scores are 7% and in case of

government companies their scores are only 0.1% - 0.3%. Government loan, on the

other hand, occupies as much as 66% share of total borrowings in government

companies, though its position in public limited companies is really insignificant.

Sometimes long-term borrowings may occupy important role in total

borrowings, but that does not mean that contribution of long-term borrowings to

working capital will also be significant. If current liabilities cover the current assets in

full, the long-term sources, whatever may be their position to total borrowings, will

have to be presumed to be used for financing the fixed assets only. From this view

point, we have computed the extent of gap between current assets and current

liabilities of the selected companies, and have presumed that the gap has been

financed by long-term sources as a whole. Multiplying the gap with the ratio of each

long-term source to total long-term funds, we have estimated the share of different

companies of long-term borrowings, viz, debenture, institutional loan and government

loan, in the context of working capital. The results so obtained reveal that the

individual share of institutional loan and debentures towards financing working

capital is 2%-5% in case of public limited companies and 0.05% - 0.16% in case of

government companies. Thus, it appears that the role of debenture and institutional

loan in working capital finance is almost an exercise of paper only. Position of

government loan is also disappointing in public limited companies. But in

government companies its contribution is remarkable. This is quite expected as

government companies have developed a practice of banking upon ‘easily-available’

government loans. However, the position of government loan as a source of finance is

gradually decreasing even in government companies. On the other hand the position

of debenture is gradually improving both in private as well as in public sector.

Institutional loan exhibits a fluctuating trend during the decade of eighty, although

ultimately its position has improved to an extent. Another viable source of working

capital is trade credit, which is considered to be a formality-free, security-free and

interest-free source of finance. Due to the above advantages, trade credit has been

practically a common source of working capital to almost all enterprises;

notwithstanding the fact that there is some implicit cost associated with trade credit

and the explicit cost is also originated when cash discount offered is foregone. During

1980s, 30% of current assets and 25% of total borrowings of public limited

companies have come from trade credit and in case of government companies the

scores have respectively been 8. 3% and 8.8%. As such, it may be stated that the role

of trade credit is equally important during the period under study. However, its

contribution in public limited companies is higher in comparison with that in

government companies.

One of the important factors determining the feasibility or otherwise of a

particular source of finance is stated to be the cost. Hence, we have attempted to see

thereafter how far the cost actually plays the decisive role in the selection of sources.

With an attempt to estimate the effect of cost on their selection, we have computed

the specific costs of some sources. Trade credit has been taken to be less costly source

of finance, although there are some implicit costs of trade credit over and above the

cost of foregoing cash discount. Bank borrowings, on the other hand, appear to be

costliest of the three sources. Thus, on cost consideration, it is natural that share of

bank borrowing in working capital finance will be much lower than that of trade

credit. But the corporate practices reveal that ratio of bank borrowings, to trade credit

is, on an average, 88%, that is, bank borrowings do not lag as much behind the trade

credit as it should be from the view point of cost of finance. Then, coming to the

comparative position of bank borrowings and public deposit we find that, throughout

the decade of eighty, the cost of public deposit had always been lower than that of

bank borrowings. But during the period, the use of bank borrowings was

approximately four times of public deposit. Moreover, it has been revealed that the

cost of public deposit, contrary to general expectation, has gradually come down. Had

the cost been a factor for the use of public deposit, its share to current assets would

have been higher over time due to gradual reduction in cost. Reversely, we see a

decreasing trend in the use of this source. In view of all these, we have come to the

conclusion that effect of cost on the selection of sources of working capital is not at

all significant. Finally, we have observed that in public limited companies in India the

current ratio is only 1.38:1. From this, it appears that they have adopted aggressive

policy for working capital finance. This policy has its merits no doubt, but for the

purpose, Settlement Earning Capacity (SEC) of the firms should have been adequate.

Our study reveals that SEC of Indian public limited companies is 688 days in the year

1988, 629 days in 1989 and 505 days in 1990. This indicated that existing earning

capacity of the companies is not sufficient to settle net current liabilities within one

year (i. e. 365 days). Hence, we have suggested discouraging the aggressive policy.

Rather, it will be better if the companies resort to medium and long-term loan instead

of banking upon current liabilities. This practice will not be harmful as the debt-

equity ratio of the firms is now very low (only 0.56:1). Position of government

companies is completely reverse. Current ratio there is 4. 32:1. such a conservative

policy may be desirable from liquidity point of view. But this risk-aversion may result

in higher cost. They resort to long-term borrowings like government loan, and hence

their debt -equity ratio has been higher (1. 11:1) to an extent. As such, problem of idle

capital may crop up there. This may be one of the reasons due to which most of the

government companies have been showing minus figures in profit and loss account

year after year. It has been suggested therefore that the government companies should

resort more to short-term and less costly sources like public deposit. Government

being the guarantor, the availability of public deposit may also be sufficient there.

The customers of HDFC Bank utilizes the Working Capital provided by the

bank and bank charges interest rates at such facilities that are payable on monthly

basis by the customers. The interest is charged on the Limit or the credit facility used

by the customer.

The limit is set up by the bank on the basis of current operations and working

of the business and thus the interest is charged only on the amount of limit or credit

that is used and not on the total limit setup by the bank. For e.g. The limit setup by the

bank is 10 Lacs at 10.5% and the credit facility utilized by the customer in a month is

just 2 lacs then interest rate for 1 month is calculated as 2, 00,000 X 10.5/100 X 1/12

Conclusion

One of the most important areas of finance to monitor is your company’s

working capital, which is the difference between current assets and current liabilities.

As a small business owner, you must constantly be alert to changes in working capital

and their implications; otherwise, you may miss some warning signs that can lead to

business failure. The most important component of working capital is cash, far the

most important asset of any business, particularly a small business. Without it, the

business will fail. So it is of paramount importance for you as the business owner to

control all cash transactions. It is helpful for us, as a business owner, to think of

working capital in terms of five components:

1. Cash and equivalents.

This most liquid form of working capital requires constant supervision. A

good cash budgeting and forecasting system provides answers to key questions such

as: Is the cash level adequate to meet current expenses as they come due? What is the

timing relationship between cash inflow and outflow? When will peak cash needs

occur? When and how much bank borrowing will be needed to meet any cash

shortfalls? When will repayment be expected and will the cash flow cover it?

2. Accounts receivable.

Many businesses extend credit to their customers. If you do, is the amount of

accounts receivable reasonable relative to sales? How rapidly are receivables being

collected? Which customers are slow to pay and what should be done about them?

3. Inventory.

Inventory is often as much as 50 percent of a firm’s current assets, so

naturally it requires continual scrutiny. Is the inventory level reasonable compared

with sales and the nature of your business? What’s the rate of inventory turnover

compared with other companies in your type of business?

4. Accounts payable.

Financing by suppliers is common in small business; it is one of the major

sources of funds for entrepreneurs. Is the amount of money owed suppliers reasonable

relative to what you purchase? What is your firm’s payment policy doing to enhance

or detract from your credit rating?

5. Accrued expenses and taxes payable.

These are obligations of your company at any given time and represent a

future outflow of cash.

Factors determining working capital requirements

• Nature of business

• Size of business

• Production policy

• Manufacturing process

• Seasonal variations

• Working capital cycle

• Rate of stock turn over

• Credit policy

• Business cycles

• Rate of growth of business

• Price level changes

• Earning capacity & dividend policy

• Other factors.

Importance of Working Capital Ratios

Ratio analysis can be used by financial executives to check upon the

efficiency with which working capital is being used in the enterprise. The following

are the important ratios to measure the efficiency of working capital. The following,

easily calculated, ratios are important measures of working capital utilization.

Ratio Formulae Result Interpretation

Stock Turnover (in days) Average Stock * 365/ Cost of Goods Sold = x days

On average, you turn over the value of your entire stock every x days. You may need

to break this down into product groups for effective stock management.

Obsolete stock, slow moving lines will extend overall stock turnover days. Faster

production, fewer product lines, just in time ordering will reduce average days.

Receivables Ratio (in days) Debtors * 365/ Sales = x days It take you on average x

days to collect monies due to you. If you’re official credit terms are 45 day and it

takes you 65 days... why? One or more large or slow debts can drag out the average

days. Effective debtor management will minimize the days.

Payables Ratio (in days) Creditors * 365/ Cost of Sales (or Purchases) = x days

On average, you pay your suppliers every x days. If you negotiate better credit

terms this will increase. If you pay earlier, say, to get a discount this will decline. If

you simply defer paying your suppliers (without agreement) this will also increase -

but your reputation, the quality of service and any flexibility provided by your

suppliers may suffer.

Current Ratio Total Current Assets/ Total Current Liabilities = x times

Current Assets are assets that you can readily turn in to cash or will do so within 12

months in the course of business. Current Liabilities are amount you are due to pay

within the coming 12 months. For example, 1.5 times means that you should be able

to lay your hands on $1.50 for every $1.00 you owe. Less than 1 times e.g. 0.75

means that you could have liquidity problems and be under pressure to generate

sufficient cash to meet oncoming demands.

Quick Ratio (Total Current Assets - Inventory)/ Total Current Liabilities = x

times Similar to the Current Ratio but takes account of the fact that it may take time

to convert inventory into cash. Working Capital Ratio (Inventory + Receivables -

Payables)/ Sales As % Sales A high percentage means that working capital needs are

high relative to your sales. Other working capital measures include the following:

Bad debts expressed as a percentage of sales. Cost of bank loans, lines of credit,

invoice discounting etc.

Debtor concentration - degree of dependency on a limited number of

customers. Once ratios have been established for our business, it is important to track

them over time and to compare them with ratios for other comparable businesses or

industry sectors.

A measure of both a company's efficiency and its short-term financial health.

The working capital ratio is calculated as: Positive working capital means that the

company is able to pay off its short-term liabilities. Negative working capital means

that a company currently is unable to meet its short-term liabilities with its current

assets (cash, accounts receivable, inventory). Also known as "net working capital". If

a company's current assets do not exceed its current liabilities, then it may run into

trouble paying back creditors in the short term. The worst-case scenario is

bankruptcy. A declining working capital ratio over a longer time period could also be

a red flag that warrants further analysis. For example, it could be that the company's

sales volumes are decreasing, and as a result, its accounts receivables number

continues to get smaller and smaller.

Working capital also gives investors an idea of the company's underlying

operational efficiency. Money that is tied up in inventory or money that customers

still owe to the company cannot be used to pay off any of the company's obligations.

So, if a company is not operating in the most efficient manner (slow collection), it

will show up as an increase in the working capital. This can be seen by comparing the

working capital from one period to another; slow collection may signal an underlying

problem in the company's operations.

Working Capital Cycle

Cash flows in a cycle into, around and out of a business. It is the business's

life blood and every manager's primary task is to help keep it flowing and to use the

cashflow to generate profits. If a business is operating profitably, then it should, in

theory, generate cash surpluses. If it doesn't generate surpluses, the business will

eventually run out of cash and expire. The faster a business expands the more cash it

will need for working capital and investment. The cheapest and best sources of cash

exist as working capital right within business. Good management of working capital

will generate cash will help improve profits and reduce risks. Bear in mind that the

cost of providing credit to customers and holding stocks can represent a substantial

proportion of a firm's total profits.

There are two elements in the business cycle that absorb cash - Inventory

(stocks and work-in-progress) and Receivables (debtors owing you money). The main

sources of cash are Payables (your creditors) and Equity and Loans.

Each component of working capital (namely inventory, receivables and

payables) has two dimensions ........TIME ......... and MONEY. When it comes to

managing working capital - TIME IS MONEY. If you can get money to move faster

around the cycle (e.g. collect monies due from debtors more quickly) or reduce the

amount of money tied up (e.g. reduce inventory levels relative to sales), the business

will generate more cash or it will need to borrow less money to fund working capital.

As a consequence, you could reduce the cost of bank interest or you'll have additional

free money available to support additional sales growth or investment. Similarly, if

you can negotiate improved terms with suppliers e.g. get longer credit or an increased

credit limit; you effectively create free finance to help fund future sales.

Any change in the working capital will have an effect on a business's cash

flows. A positive change in working capital indicates that the business has paid out

cash, for example in purchasing or converting inventory, paying creditors etc. Hence,

an increase in working capital will have a negative effect on the business's cash

holding. However, a negative change in working capital indicates lower funds to pay

off short term liabilities (current liabilities), which may have bad repercussions to the

future of the company.

Suggestion

When it comes to managing working capital, the first piece of advice “don't be

reactive. Be proactive." Entrepreneurs experiencing rapid growth are often confronted

with the challenge of not having enough cash on hand to operate their businesses. "Be

sure you're ready for growth and that you don't find yourself in the red without cash

resources. It's a question of planning ahead. You don't want it to become a crisis

before you go to your bank,”

Although working capital is seemingly a simple calculation of current assets

minus current liabilities, business owners can easily lose sight of how much they need

to keep their businesses operating smoothly. "In the daily grind, you may be more

focused on making sales. But of course, it's not because you have revenues that you

have money to spend,” For many entrepreneurs, for example, working capital can be

tied up in delinquent client payments or overstocking inventory.

Get external help

A good example would be to ensure that you are eliminating work processes

that add no value to the product or service and simplifying those processes that do.

Lean manufacturing, for example, targets a number of sources of waste, including

overproduction, defects, delivery delays, unnecessary inventory and the movement of

goods, people or information. Ultimately, if you can find ways to run your company

more efficiently, you can also make more profits and increase cash flow.

Know Your Sales Cycle

Keeping a vigilant eye on your sales cycle is another way to help manage your

working capital. "You need to know if your sales cycle is similar from year-to-year

and identify its highs and lows. If you know that you will be facing financial

difficulties during certain periods, you may need to adjust your working capital

accordingly,” "You need to know your main expenditures during a low season, and

then try and keep your expenses down during that period." Fixed expenditures for

most businesses include labor and equipment. "There are certain areas of your

business where you'll always need an influx of cash."

Know the “quality of your receivables”

"Getting paid is not a sure bet today even though you may have outstanding

payments from clients,". "You want to ensure that your customers have a good credit

history and that they will respect your payment terms. Otherwise you may find

yourself without cash when you need it,” It’s recommended that entrepreneurs clearly

communicate their credit policy up front. "It's basically a set of rules to help you get

paid as quickly as possible. Your clients need to know the maximum amount of credit

you will grant them, payment terms (30, 45, 60 or 90 days) and deposit requirements.

"Ask yourself: how much can I afford to lend my customers without draining my

working capital?"

Collect payments faster

Collecting payments from customers faster is an obvious route to keeping

more working capital in your company. Still, it is believed that it's important not to

put your client rapport in jeopardy. "You need to keep your clients happy and attract

sales, but at the same time, ensure that you're not footing the client bill too long,". To

help protect you from late payments, it’s always recommended that billing as early as

possible and making sure payment terms are clear. "You don't have to wait until the

end of the month. That's a common fallacy. You need to generate an invoice as soon

as the goods or services are delivered." For clients making large purchases, it is

suggested for progressive invoicing.

Negotiate the best supplier terms

"Be sure that your suppliers are giving you the best possible deal and don't be

afraid to negotiate,” It's important to shop around to get quotes from several suppliers.

"Even if you're unable to get a better price, you can at least negotiate better payment

terms so you're not draining your cash flow." It is also recommended that making

payments to suppliers on time. "If you respect their terms, you're more likely to get

their cooperation if you need to renegotiate payments when things are tougher.

Watch your inventory closely

It's also a good idea to assess your inventory turnover to determine which

items are selling and which may be using up your working capital. "If you've got too

much tied up in inventory, then you may be vulnerable. Be sure that, you can liquefy

your inventory for cash when you need it." A rule of thumb is that once you see a

trend or pattern in client orders, you can begin to stock inventory according to your

needs. Does this just before you sell the inventory, so that the money you've invested

comes back into the business as quickly as possible?

How to increase your Working Capital

Working capital is the backbone of any business, so learning how to maintain

or generate more cash in your company is vital to succeed today. "It's basically the

cash you need to operate, or your current assets minus your current liabilities.

Without enough working capital, you could lose your flexibility and credibility with

financial institutions, suppliers and customers”. Depleting your working capital can

also diminish your capacity to exploit new business opportunities, "For instance, if

your competition suddenly closes up shop and you need more inventory to service

their customers, you would need working capital to buy that additional inventory.

Without it, you're unable to react quickly,” Ultimately, keeping sufficient working

capital on hand can be a major challenge for cash-strapped entrepreneurs. However, it

is recommended that a few tried-and-tested ways of increasing your operating cash.

Avoid financing fixed assets with working capital

Experts highly recommend that entrepreneurs avoid depleting their working

capital to finance fixed assets such as equipment. "A lot of small businesses tend to

use cash to pay their debts. It's an old mentality. In the end, you would be better off

using long-term loans to pay for fixed assets,” When business owners use up all of

their cash, they also look more risky to financial institutions. "You may lose their

confidence that you're running a healthy company." As an alternative, a long-term

loan enables SME’s to breathe easily and pay for assets systematically at a set pace.

"You can also easily recuperate the costs of interest on a long-term loan. For

example, if you keep a good cash flow and are able to pay your suppliers quickly,

you're more likely to be able to secure discounts. In turn, these discounts can partially

pay the interest on your loan. Eventually, you'll get the cost of the loan back."

Borrow to increase your working capital

Experts always contend that taking on long-term debt for working capital also

pays off. "You can't grow your business and increase your profits if you're not

investing in your company,” "For instance, if you have a list of clients, you can only

change them into real accounts receivables if you can afford the inventory to sell to

them,". "It's basic business know-how." Entrepreneurs can also recuperate the costs of

loans, for example, through increased revenues.  Thus, HDFC Bank can provide long-

term financing for increased inventory or other fixed assets, market development or e-

business initiatives, just to name a few. In addition, HDFC Bank can arrange

repayment schedules to help entrepreneurs keep as much working capital available as

possible.

Refinance your fixed assets

Entrepreneurs can also consider refinancing their fixed assets such as

equipment in order to generate working capital. "Basically, you're leveraging your

assets and turning them into the cash that you need." Once again, business owners can

benefit from the extra working capital to improve their plant layout, pursue new

export markets or align their HR strategies.

Make a personal investment

Another option for small and medium sized businesses is to make personal

investments in order to increase working capital. "You'll first need to do a cost and

benefits analysis to see what return you will get on your investment,” "This is a viable

strategy if you see that the pay-off in your business outweighs personal losses.

Managing your working capital

Your level of working capital is intimately related to the flow of cash into and

out of your business. Simply stated, you need enough working capital to setup the

business, pay operating costs, and continue to operate until payment arrives 30, 60 or

maybe even 90 days later.

But if you've used a lot of that working capital to pay for fixed assets, you

may come up against a crash crunch that prevents you from paying suppliers, buying

materials and even paying yourself a salary. It's a good idea then, to maintain a level

of working capital that allows you to make it through those crunch times and continue

to operate the business.

Short-term financing such as a line of credit (LOC) can be used to make

emergency purchases or to bridge the gap between month's-end payables and

receivables. An LOC can be negotiated with your financial institution, and this should

be done before any need actually arises. It's usually easier to negotiate an LOC when

you don't really need one. A good time to go to your financial institution is

immediately after the end of a good year or quarter. Bring your financial statements.

In growth situations where you have to suddenly increase inventory that will

be sold on credit, you may need to increase your working capital. Shareholders and

other investors can sometimes provide this cash injection and HDFC Bank can also

provide long-term financing for working capital.

Large asset purchases such as equipment and real estate should be financed

long-term which allows you to spread the payments over the average life of the

assets. Yes, you'll be paying interest but, you'll still have a big portion of your capital

on-hand for business operations.

The federal and provincial governments provide loan-guarantee services for

the purchase of operating equipment and fixed assets, making it much easier for small

businesses to obtain loans from financial institutions. Under programs such as the

Canada Small Business Financing Program, the government agrees to pay up to 85%

of the value of the loan, back to the financial institution if you the borrower default on

that loan.

And it's always a good idea to make a cash flow budget. Your bookkeeper,

accountant, accounting software and even spreadsheets downloadable from the

Internet can help you anticipate inflows and outflows of money over a period of time.

Budgeting allows you to see when a cash crunch is likely to occur.

Manage the business risks

There are many risks involved in running a business, and serious challenges

should be expected at some time in the future. You need to consider a number of

scenarios such as "What if that big order suddenly comes in?", "What if that big order

is cancelled?" or "What if that important client under owes me money?" This kind of

risk analysis can become part of your cash-flow budgeting process. For instance, if

you're using a spreadsheet to enter cash inflows, simply reflect that situation by

adding or deleting. The repercussions in the weeks and months to come should be

immediately visible, so that you can consider what you would do if that occurred.

You can reduce the risk of cash-crunch due to this type of situation, by

planning ahead and having a more diversified client base. If you're not dependent on

one large order or client, your livelihood doesn't hinge on the health of someone else's

business. Finding new clients will increase revenue, improve your cash flow situation

and make you less susceptible to marketplace adversity.

Another risk associated with running a business, especially among startups, is

mix-ups between business and personal bank accounts and credit cards. Since initial

financing often comes from the owner's personal savings it's easy to see how that can

happen. This situation has a simple remedy which consists of opening a separate bank

account and credit card for the business. Your business account should be where you

deposit customer cheques, draw your salary, and pay your employees and suppliers.

Similarly, get a separate credit card for the business, make business-related purchases

on that card, and pay for that card using your company cheques. Some credit cards

provide management reports that detail the types of purchases made over the month

and over the past year, and this type of information can then be used in your cash

flow budget for next year.

Collect quickly

To guard against late payments, bill as early as possible and make those

invoices as clear and as detailed as possible. It may also be worth changing other

billing practices such as invoice frequency: instead of waiting until the end of the

month, generate an invoice as soon as the goods or services are delivered. Make sure

those invoices are addressed to the right person in the right department.

For those big orders, you may want to consider progressive invoicing while

you manufacture the goods or deliver the service. For example you can ask for a

deposit with the order and then a percentage of the payment at various agreed upon

milestones.

Keep track of your receivables. It's easy to lose track and then neglect to

follow up on an overdue account. Experience shows that the longer you remain out of

contact with a customer, the less likely you are to recover the full amount owed, so if

you can't take care of it yourself, hire someone to do it for you.

Monitor your costs and your inventory

Make sure you're getting the best possible deal from your suppliers. You can

do this by shopping around and getting quotes from other suppliers. They may not be

able to give a better price, but may be able to offer better payment terms making it

easier on your cash flow situation. Analyze inventory turnover to determine which

items are selling and which are duds that are soaking up your working capital. Try to

keep inventory levels lean so that your working capital isn't tied-up unproductively

and unprofitably.

Bibliography

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2. www.investopedia.com

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4. www.finance.cch.com

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6. Working Capital Management & Control: Principles & Practice By Mr. Satish

B. Mathur

7. www.planware.com/Finance

8. The ICFAI Journals (Finance)

9. www.fxcmttr.com

10. Entreprenuerial Profit & Loss By Murray, RothBards

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