WORKING CAPITAL MANAGEMENT Introduction: Working capital is the life blood and nerve centre of a business. Just as circulation of blood is essential in the human body for maintaining life, working capital is very essential to maintain the smooth running of a business. No business can run successfully with out an adequate amount of working capital. Working capital refers to that part of firm’s capital which is required for financing short term or current assets such as cash, marketable securities, debtors, and inventories. In other words working capital is the amount of funds necessary to cover the cost of operating the enterprise. Meaning: Working capital means the funds (i.e.; capital) available and used for day to day operations (i.e.; working) of an enterprise. It consists broadly of that portion of assets of a business which are used in or related to its current operations. It refers to funds which are used during an accounting period to generate a current income of a type which is consistent with major purpose of a firm existence. Objectives of working capital: Every business needs some amount of working capital. It is needed for following purposes-
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
WORKING CAPITAL MANAGEMENT
Introduction:
Working capital is the life blood and nerve centre of a business. Just as
circulation of blood is essential in the human body for maintaining life,
working capital is very essential to maintain the smooth running of a
business. No business can run successfully with out an adequate amount of
working capital.
Working capital refers to that part of firm’s capital which is required for
financing short term or current assets such as cash, marketable securities,
debtors, and inventories. In other words working capital is the amount of
funds necessary to cover the cost of operating the enterprise.
Meaning:
Working capital means the funds (i.e.; capital) available and used for day
to day operations (i.e.; working) of an enterprise. It consists broadly of
that portion of assets of a business which are used in or related to its
current operations. It refers to funds which are used during an accounting
period to generate a current income of a type which is consistent with
major purpose of a firm existence.
Objectives of working capital:
Every business needs some amount of working capital. It is needed for
following purposes-
• For the purchase of raw materials, components and spares.
• To pay wages and salaries.
• To incur day to day expenses and overhead costs such as fuel, power, and
office expenses etc.
• To provide credit facilities to customers etc.
Factors that determine working capital:
The working capital requirement of a concern depend upon a large number of
factors such as
? Size of business
? Nature of character of business.
? Seasonal variations working capital cycle
? Operating efficiency
? Profit level.
? Other factors.
Sources of working capital:
The working capital requirements should be met both from short term as well
as long term sources of funds.
Financing of working capital through short term sources of funds has the
benefits of lower cost and establishing close relationship with banks.
Financing of working capital through long term sources provides the
benefits of reduces risk and increases liquidity
Types of working capital:
Working capital an be divided into two categories-
Permanent working capital:
It refers to that minimum amount of investment in all current assets which
is required at all times to carry out minimum level of business activities.
Temporary working capital:
The amount of such working capital keeps on fluctuating from time to time
on the basis of business activities.
Advantages of working capital:
• It helps the business concern in maintaining the goodwill.
• It can arrange loans from banks and others on easy and favorable terms.
• It enables a concern to face business crisis in emergencies such as
depression.
• It creates an environment of security, confidence, and over all
efficiency in a business.
• It helps in maintaining solvency of the business.
Disadvantages of working capital:
• Rate of return on investments also fall with the shortage of working
capital.
• Excess working capital may result into over all inefficiency in
organization.
• Excess working capital means idle funds which earn no profits.
• Inadequate working capital can not pay its short term liabilities in
time.
Management of working capital:
A firm must have adequate working capital, i.e.; as much as needed the
firm. It should be neither excessive nor inadequate. Both situations are
dangerous. Excessive working capital means the firm has idle funds which
earn no profits for the firm. Inadequate working capital means the firm
does not have sufficient funds for running its operations. It will be
interesting to understand the relationship between working capital, risk
and return. The basic objective of working capital management is to manage
firms current assets and current liabilities in such a way that the
satisfactory level of working capital is maintained, i.e.; neither
inadequate nor excessive. Working capital some times is referred to as
“circulating capital”. Operating cycle can be said to be t the heart of the
need for working capital. The flow begins with conversion of cash into raw
materials which are, in turn transformed into work-in-progress and then to
finished goods. With the sale finished goods turn into accounts receivable,
presuming goods are sold as credit. Collection of receivables brings back
the cycle to cash.
The company has been effective in carrying working capital cycle with low
working capital limits. It may also be observed that the PBT in absolute
terms has been increasing as a year to year basis as could be seen from the
above table although profit percentage turnover may be lower but in
absolute terms it is increasing. In order to further increase profit
margins, SSL can increase their margins by extending credit to good
customers and also by paying the creditors in advance to get better rates.
WORKING CAPITAL AND RATIO ANALYSIS
Ratio Analysis is one of the important techniques that can be used to check
the efficiency with which working capital is being managed by a firm. The
most important ratios for working capital management are as follows
Net Working Capital:
There are two concepts of working capital namely gross working capital and
net working capital. Net working capital is the difference between current
assets and current liabilities. An analysis of the net working capital will
be very help full for knowing the operational efficiency of the company.
The following table provides the data relating to the net working capital
of SSL.
NET WORKING CAPITAL = CURRENT ASSETS-CURRENT LIABILITIS
YEAR CURRENT ASSETS CURRENT LIABILITIES NET WORKING CAPITAL
2005 246755108 184541063 62214045
2006 289394416 169342603 120051813
2007 337982290 187602877 150379413
2008 36344554 217973661 145471893
Graph
INFERENCE:
From the above table it can be inferred that the proportion of net working
capital had increased from the year 2005 to2007 and decreed in the year
2008 compare with 2007.
Working capital turnover ratio:
This is also known as sales to working capital ratio and usually
represented in times. This establishes the relationship of sales to net
working capital. This ratio indicates -heather or not working capital has
been effectively utilized in making sales. In case if a company can achieve
higher volume of sales with relatively small amount of working capital, it
is an indication of the operating efficiency of the company. It is
calculated as follows-
YEAR NET SALES(RS) WORKING CAPITAL(RS) RATIO
2005 429128296 62214045 6.89
2006 622181610 120051813 5.2
2007 668215791 150379413 4.4
2008 655229319 145471893 4.5
INTERPRETATION:
From the above table we can conclude that working capital ratio is
decreasing. In the year 2005 it is 6.89 times it decreased to 4.4 times in
the year 2007. And it is increasing 4.5 times in the year 2008.
CURRENT ASSETS TO TOTAL ASSETS RATIO:
Current assets play an important role in day-to-day functioning of an
organization. So, every firm should maintain adequate current assets so as
to meet the daily requirements of business. If the proportion of current
assets in total assets exceeds then the required limit, there will be some
idle investments on such assets. At the time, the proportion of current
assets in total should not less than requirements. So, every firm should
maintain the adequate quantity of current assets. But during the situations
of peak demand, should employ more current assets and vice-versa.
Particularly in case of production organizations, there is heavy importance
to the current assets than fixed assets. This kind of analysis will enable
the managers to understand the working capital position of the firm. Data
relating to the proportion of working capital in total assets is depicted
as follows-
This ratio establishes the relationship between the current assets and
total assets.
YEAR CURRENT ASSETS(RS) TOTAL ASSETS(RS) RATIO
%
2005 217973661 390012770 55.88
2006 187602877 327640705 57.25
2007 169342603 475995664 35.57
2008 184541063 491935181 37.51
INFERENCE:
From the above table it can be inferred that the proportion of current
assets to total assets had decreased 55.88 in the year 2005. In the year
2005 it had increased to 57.25, again in the year 2007 it has decreased
35.57%, again in the year 2008 increase in 37.51
Current assets to sales ratio:
The current assets are used for the purpose of generating sales. A ratio of
current assets to sales reveals that how best the assets are applied in
business for turnover. As per the above said ratio, a low proportion of
current assets in relation to sales indicates better turnover of the
company and vice-versa, which will show positive impact on profitability.
The data relating to this aspect is provided as follows and it is
calculated as follows.
YEAR CURRENT ASSETS(RS) NET SALES(RS) RATIO
%
2005 246755108 429128296 57.5
2006 289394416 622181610 46.5
2007 337982290 668215791 50.5
2008 363445554 655229319 55.4
INFERENCE:
From the above table it can be inferred that the proportion of current
assets to sales had increased to 57.5% in the year 2005. In the year 2006
it had decreased 46.5%. In the years 2007 it had increased to 50.5% and in
the year 2008 had increased 55.4%.
Current assets to fixed assets ratio:
Total assets in any business contain both fixed and current assets. For
properly functioning of the organization in terms of production and
marketing it is necessary to maintain a properly balance between them. If
the proportion of fixed assets increases, it will be a negative impact on
the firm’s liquidity and if current assets increase, production increases
and which causes impact on the demand for the product. In view of effective
management of funds and to invest on both fixed and current assets, it is
necessary to take the decision as soon as possible. Data relating to the
ratio between current assets to fixed assets is depicted as follows.
YEAR CURRENT ASSETS(RS) FIXED ASSETS(RS) RATIO
%
2005 246755108 167454219 14.13
2006 289394416 184597059 15.67
2007 337982290 138013376 24.4
2008 363445554 202084725 18.0
INFERENCE:
From the above table it can be inferred that the proportion of current
assets to fixed assets had decreased 14.13% in the year 2005. In the year
2006 it had increased to 15.67%. In the year 2007 it had increased 24.4%it
had decrease in year 2008 in 18.0%.
RATIO ANALYSIS
INTRODUCTION:
Ratio Analysis is a powerful tool o financial analysis. Alexander Hall
first presented it in 1991 in Federal Reserve Bulletin. Ratio Analysis is a
process of comparison of one figure against other, which makes a ratio and
the appraisal of the ratios of the ratios to make proper analysis about the
strengths and weakness of the firm’s operations. The term ratio refers to
the numerical or quantitative relationship between two accounting figures.
Ratio analysis of financial statements stands for the process of
determining and presenting the relationship of items and group of items in
the statements.
Ratio analysis can be used both in trend analysis and static analysis. A
creditor would like to know the ability of the company, to meet its current
obligation and therefore would think of current and liquidity ratio and
trend of receivable.
Major tool of financial are thus ratio analysis and Funds Flow
analysis.Financial analysis is the process of identifying the financial
strength and weakness of the firm by properly establishing relationship
between the items of the balance sheet and the profit account
The financial analyst may use ratio in two ways. First he may compare a
present ratio with the ratio of the past few years and project ratio of the
next year or so. This will indicate the trend in relation that particular
financial aspect of the enterprise. Another method of using ratios for
financial analysis is to compare a financial ratio for the company with for
industry as a whole, or for other, the firm’s ability to meet its current
obligation. It measures the firm’s liquidity. The greater the ratio, the
greater the firms liquidity and vice-versa.
A ratio can be defined as a numerical relationship between two numbers
expressed in terms of (a) proportion (b) rate (c) percentage. It is also
define as a financial tool to determine an interpret numerical relationship
based on financial statement yardstick that provides a measure of relation
ship between two variable or figures.
Meaning and Importance:
Ratio analysis is concerned to be one of the important financial tools for
appraisal of financial condition, efficiency and profitability of business.
Here ratio analysis id useful from following objects.
1. Short term and long term planning
2. Measurement and evaluation of financial performance
3. Stud of financial trends
4. Decision making for investment and operations
5. Diagnosis of financial ills
6. providing valuable insight into firms financial position or picture
ADVANTAGES& DISADVANTAGES OF RATIO ANALYSIS
Advantages:
The following are the main advantages derived of ratio analysis, which are
obtained from the financial statement via Profit & Loss Account and Balance
Sheet.
a) The analysis helps to grasp the relationship between various items in
the financial statements.
b) They are useful in pointing out the trends in important items and thus
help the management to forecast
c) With the help of ratios, inter firm comparison made to evolve future
market strategies.
d) Out of ratio analysis standard ratios are computed and comparison of
actual with standards reveals the variances. This helps the management to
take corrective action.
e) The communication of that has happened between two accounting the dates
are revealed effective action.
f) Simple assessments of liquidity, solvency profitability efficiency of
the firm are indicted by ratio analysis. Ratios meet comparisons much more
valid.
Disadvantages:
Ratio analysis is to calculate and easy to understand and such statistical
calculation stimulation thinking and develop understanding.
But there are certain drawbacks and dangers they are.
i) There is a trendy to use to ratio analysis profusely.
ii) Accumulation of mass data obscured rather than clarifies relationship.
iii) Wrong relationship and calculation can lead to wrong conclusion.
1. In case of inter firm comparison no two firm are similar in size, age
and product unit.(For example :one firm may purchase the asset at lower
price with a higher return and another firm witch purchase the asset at
asset at higher price will have a lower return)
2. Both the inter period and inter firm comparison are affected by price
level changes. A change in price level can affect the validity of ratios
calculated for different time period.
3. Unless varies terms like group profit, operating profit, net profit,
current asset, current liability etc., are properly define, comparison
between two variables become meaningless.
4. Ratios are simple to understand and easy to calculate. The analyst
should not take decision should not take decision on a single ratio. He has
to take several ratios into consideration.
STANDARDS OF COMPARISION:
1. Ratios calculated from the past financial statements of the same firm.
2. Ratio developed using the projected or perform financial statement of
the same firm
3. Ratios of some selected firm especially the most progressive and
successful, at the same point of time.
4. Ratios of the industry to which the firm belongs.
IMPORTANCE OF RATIO ANALYSIS
In the preceding discussion in the form, we have illustrated the compulsion
and implication of important ratios that can be calculated from the Balance
Sheet and Profit & Loss account of a firm. As a tool of financial
management, they are of crucial significance. The importance of ratio
analysis lies in the fact and enables the drawing of inferences regarding
the performance of a firm. Ration analysis is a relevant in assessing the
performance of a firm in respect of the following aspect.
CAUSTION IN USING RATIOS:
1. It is difficult to decide on the proper bases of comparison.
2. The comparison rendered difficult because of difference in situation of
two companies or of one-company for different years.
3. The price level change make the interpretation of ratios invalid
4. The difference in the definition of items in the balance sheet and
Profit & Loss statement make the interpretation of ratios difficult.
5. The ratios calculated at a point of time are less informative and
defective as they suffer from sort term changes.
6. The ratios are generally calculated from the past financial statement
and thus are no indicators of future.
LIQUTDITY Vs PROFITABILITY
INTRODUCTION
Financial analysis is the process of identifying the financial strengths
and weakness of the firm by properly establishing relationship between the
items of the balance sheet and profit loss account. Management should
particularly interest in knowing financial strengths and weakness of the
firm to make their best use and to be able to spot out financial weakness
of the firm to take a suitable corrective actions.
Financial analysis is the starting point of making plans, before using any
sophisticated forecasting and planning procedures.
Major tools of financial analysis are ratio analysis and funds flow
analysis. Financial analysis is the process of identifying the financial
strengths and weakness of the firm by properly establishing relationship
between the items of the balance sheet and the profit and loss account.
Meaning and importance
Ratio analysis is concerned to be one of the important financial tools for
appraisal of financial condition, efficiency and profitability of business.
Here ratio analysis is useful from following objectives.
1. Short term and long term planning.
2. Measurement and evaluation of financial performance.
3. Study of financial trends.
4. Decision making for investment and operations.
5. Diagnosis of financial ills.
6. Providing valuable insight into firm’s financial position or picture.
Ratio’s
1. Current Ratio
2. Quick Ratio
3. Absolute Quick Ratio
4. Net Profit Ratio
5. Debtors Turnover Ratio
6. Inventory Turnover Ratio
CURRENT RATIO
The current ratio is calculated by dividing current assets by current
liabilities.
Current ratio = current assets/current liabilities
The current ratio is a measure of the firm’s short-term solvency. It
indicates the availability of current assets in rupees for every one rupee
of current liabilities. A ratio of greater than one means that the firm has
more current assets than current liabilities claims against them. A
standard ratio between them is 2:1. The data relationship the current ratio
of ANNAPURNA EARCANAL LIMITED is depicted as follows:
YEAR CURRENT ASSETS CURRENT LIABILITIES Current Ratio (%)
2005 246755108 184541063 1.34
2006 289394416 169342603 1.71
2007 337982290 187602877 1.8
2008 363445554 217973661 1.67
Graph
Inference:
The standard norm for this ratio is 2:1 the empirical analysis of the data
relating to the current ratio of Annapurna Ear canal Ltd. Has decreased
from 1.71 in the year 2006 to 1.8 in the year 2007
QUICK RATIO:
This ratio establishes a relationship between quick of liquid assets and
current liabilities. It is an absolute measure of liquidity management of
the concern. An asset is liquid if it can be converted in to cash
immediately or reasonably soon without a loss of value, if ignores totally
the stocks. Because inventories normally require some time for realizing
into cash: their value also has a tendency to fluctuate. The standard quick
ratio is 1:1.
Quick Ratio = Quick Assets/Current Liabilities
YEAR QUICK ASSETS CURRENT LIABILITIES QUICK RATIO(%)
2005 203744623 184541063 1.1
2006 243039010 169342603 1.4
2007 296815785 187602877 1.58
2008 323437711 217973661 1.48
QUICK RATIO GRAPH
Inference:
The standard norm for this ratio is 1:1, means for every 1 rupee of current
liability, company must have 1 rupee of quick assets.
The quick ratio of Annapurna earcanal ltd.1.1in 2005, 1.4 in 2006 and1.58
in 2007. It have more than 1 rupee of quick assets for all 4years.
Absolute quick ratio:
Since cash is the most liquid assets necessary to examine the ratio of cash
and its equivalent to current liabilities. Trade investment or marketable
securities are equivalent of cash. Therefore, they may be included in the
consumption of absolute quick ratio.
Absolute quick ratio = Absolute Quick Assets/Current Liabilities
YEAR CASH&EQUIVLENT CURRENT LIABILITIES ABSOLUTE QUICK RATIO
2005 4548328 184541063 0.024
2006 9272929 169342603 0.055
2007 16297869 187602877 0.087
2008 24336946 217973661 0.111
Absolute quick ratio graph
Inference:
The standard norms of absolute quick ratio is 0.5:1.From the above table
the firm not maintain the sufficient level of quick assets because of the
day-to-day expenses .It is fluctuating between
The standard norm for this ratio is 1:2 means for every 2 rupees of current
Liabilities, Company must have 1 rupee of cash and bank balance and
marketable securities.
Net Profit Ratio:
As every business is to earn profit, this ratio is very important because
it measures the profitability of sales. A business may yield high gross
income but low net income because of increasing operating and non-operating
expenses. This situation can easily be detected by calculating this ratio.
The profits used for this purpose may be profits after/before tax. To
obtain this ratio, the figure of net profits after tax is divided by the
figure of net profits after tax is divided by the figure of sales the ratio
is also known as sales margin as we can ascertain with its help the margin
which the sales leave later deducting all the expenses. The unit of
expression is percentage, as is the case with profitability ratios.
YEARS NET PROFIT NET SALES RATIO %
2005 70557286 429128286 1.64
2006 24851266 622181610 3.99
2007 22072724 668215791 3.31
2008 14235566 655229319 2.17
Graph
Inference:
Higher the ratio better is the profitability. From the table the ratio is
declining from 2005 to 2006 is increase. Again decrease in the year 2008
Net Profit Ratio is not effective over the period of study. Company has not
control over the cost of goods sold, selling, administrative and
distribution expenses.
So, effective steps are to be taken to increase the profits.
CASH MANAGEMENT
Introduction:
Cash management is one of the key areas of working capital management. Cash
is the liquid current asset. The main duty of the finance manager is to
provide adequate cash to all segments of the organization. The important
reason for maintaining cash balances is the transaction motive. A firm
enters into variety of transactions to accomplish its objectives which have
to be paid for in the form of cash.
Meaning of cash:
The term “cash” with reference to cash management used in two senses. In a
narrower sense it includes coins, currency notes, cheques, bank drafts held
by a firm. n a broader sense it also includes “near-cash assets” such as
marketable securities and time deposits with banks.
Objectives of cash management:
There are two basic objectives of cash management. They are-
? To meet the cash disbursement needs as per the payment schedule.
? To minimize the amount locked up as cash balances.
Basic problems in Cash Management:
Cash management involves the following four basic problems.
? Controlling level of cash
? Controlling inflows of cash
? Controlling outflows of cash and
? Optimum investment of surplus cash.
Determining safety level for cash:
The finance manager has to take into account the minimum cash balance that
the firm must keep to avoid risk or cost of running out of funds. Such
minimum level may be termed as “safety level of cash”. The finance manager
determines the safety level of cash separately both for normal periods and
peak periods. Under both cases he decides about two basic factors. They
are-
Desired days of cash:
It means the number of days for which cash balance should be sufficient to
cover payments.
Average daily cash flows:
This means average amount of disbursements which will have to be made
daily.
Criteria for investment of surplus cash:
In most of the companies there are usually no formal written instructions
for investing the surplus cash. It is left to the discretion and judgment
of the finance manager. While exercising such judgment, he usually takes
into consideration the following factors-
Security:
This can be ensured by investing money in securities whose price remains
more or less stable.
Liquidity:
This can be ensured by investing money in short term securities including
sha\ort term fixed deposits with banks.
Yield:
Most corporate managers give less emphasis to yield as compared to security
and liquidity of investment. So they prefer short term government
securities for investing surplus cash.
Maturity:
It will be advisable to select securities according to their maturities so
the finance manager can maximize the yield as well as maintain the
liquidity of investments.
Cash Management in SSL:
The cash management is carried out in seaways by CTM (Corporate Treasury
Management). CTM is a commonly followed procedure in most of the companies.
Ratio Analysis is one of the important techniques that can be used to check
the efficiency with which cash management is being managed by a firm. The
most important ratios for cash management are as follows-
Cash to current assets ratio:
This ratio establishes the relationship between the cash and the current
assets. It is calculated as follows
YEAR CASH (RS) CURRENT ASSETS(RS) RATIO
2005 3460206 246755108 1.4
2006 8184807 289394416 2.82
2007 15209747 337982290 4.5
2008 23476324 363445554 6.45
Graph
INFERENCE:
From the above table it can be inferred that the cash to current assets
Ratio is shown it is 1.4% in the year 2005 and increased till 2008.
CASH TO CURRENT LIABILITIES RATIO:
This ratio establishes the relationship between the cash and current
liabilities. It is calculated as follows.
YEAR Cash (Rs) CURRENT LIABILITIES(RS) Ratio
2005 3460206 184541063 1.87
2006 8184807 169342603 4.83
2007 15209747 187602877 8.1
2008 23476324 217973661 10.77
Graph
INTERPRETATION:
From the above table it can be inferred that the proportion cash to current
liabilities ratio is shown decreasing trend. It is 13.40% in the year 2000-
01 & decreased to 0.74% in the year 2005-06.
RECEIVABLES MANAGEMENT
Introduction:
Receivables constitute a significant portion of the total assets of the
business. When a firm seller goods or services on credit, the payments are
postponed to future dates and receivables are created. If they sell for
cash no receivables created.
Meaning:
Receivable are asset accounts representing amounts owed to the firm as a
result of sale of goods or services in the ordinary course of business.
Purpose of receivables:
Accounts receivables are created because of credit sales. The purpose of
receivables is directly connected with the objectives of making credit
sales. The objectives of credit sales are as follows-
? Achieving growth in sales.
? Increasing profits.
? Meeting competition.
Factors affecting the size of Receivables:
The main factors that affect the size of the receivables are-
? Level of sales.
? Credit period.
? Cash discount.
Costs of maintaining receivables:
The costs with respect to maintenance of receivables are as follows-
Capital costs:
This is because there is a time lag between the sale of goods to customers
and the payment by them. The firm has, therefore to arrange for additional
funds to meet its obligations.
Administrative costs:
Firm incur this cost for manufacturing accounts receivables in the form of
salaries to the staff kept for maintaining accounting records relating to
customers.
Collection costs:
The firm has to incur costs for collecting the payments from its credit
customers.
Defaulting costs:
The firm may not able to recover the over dues because of the inability of
customers. Such debts treated as bad debts.
Receivables management:
Receivables are direct result of credit sale. The main objective of
receivables management is to promote sales and profits until that point is
reached where the ROI in further funding of receivables is less than the
cost of funds raised to finance that additional credit (i.e.; cost of
capital). Increase in receivables also increases chances of bad debts.
Thus, creation of receivables is beneficial as well as dangerous. Finally
management of accounts receivable means as the process of making decisions
relating to investment of funds in this asset which result in maximizing
the over all return on the investment of the firm.
Receivables management and Ratio Analysis:
Ratio Analysis is one of the important techniques that can be used to check
the efficiency with which receivables management is being managed by a
firm. The most important ratios for receivables management are as follows-
DEBTORS TURNOVER RATIO: -
Debtors constitute an important constituent of current assets and therefore
the quality of the debtors to a great extent determines a firm’s liquidity.
It shows how quickly receivables or debtors are converted into cash. In
other words, the DTR is a test of the liquidity of the debtors of a firm.
The liquidity of firm’s receivables can be examined in two ways they are
DTR and Average Collection Period.
YEAR CREDIT SALES (RS) AVG DEBTORS (RS) RATIO
2005 429128286 69433936 6.18
2006 622181610 77624616 8.01
2007 668215791 87464986 7.63
2008 655229319 115088536 5.69
INTERPRETATION:
From the above table it can be inferred that the proportion sales to
average debtors is showing fluctuating trend in the year 2005 is 6.18. It
increased to 1.83 times in 2006 and increases remaining two years decries.
DEBTORS COLLECTION PERIOD:
Data collection period is nothing but the period required to collect the
money from the customers after the credit sales. A speed collection reduces
the length of operating cycle and vice versa
YEARS AVG Debtors(in Rs) Net credit sales (in Rs) Debtors collection period
(in days)
2005 69433936 429128286 59
2006 77624616 622181610 46
2007 87464986 668215791 48
2008 11508856 655229319 64
Source: data compiled from the annual reports of Annapurna earcanal ltd.
INFERENCES:
From the above table it can be inferred that the debtors turn over ratios
showing fluctuating trend. In the year 2005 it is debtors collection period
is 59 days and reduced in the year 2006 to 46 days then increased slightly
up to 2008.
INVENTORY MANAGEMENT
Introduction:
Inventories are stock of the product a company is manufacturing for sale
and components. That makeup the products. The various forms in which
inventories exist in a manufacturing company are: Raw-materials, work-in-
process, finished goods.
? Raw-Materials: - Are those basic inputs that are converted into finished
products through the manufacturing process. Raw-materials inventories are
those units, which have been purchased and stored for future production.
? Work-In-Process inventories are semi-manufactured products. The represent
products that need more work before they become finished products for sale.
? Finished Goods inventories are those completely manufactured products,
which are ready for sale. Stocks of raw-materials and work-in-process
facilitate production which stock of finished goods is required for smooth
marketing operations. These inventories serve as a link between production
and consumption of goods.
? Stores and spares are also maintained by some firms. This includes office
and plant cleaning materials like soaps, brooms, oil, fuel, light, bulbs
etc. These materials do not directly enter in production. But are necessary
for production process.
Need to holding inventory
The question of managing inventories arises only when the company holds
inventories. Maintaining inventories involves tying up of the company's
funds and incurrence of storage and handling cost. It is expensive to
maintain inventories, why does company hold inventories? There are three
general motives for holding inventories.
1.Transaction Motive: - Emphasizes the need to maintain inventories to
facilitate smooth production and sales operations.
2.Precautionary motive: - Necessitates holding of inventories to guard
against the risk of unpredictable changes in demand and supply forces and
other factors.
3.Speculative motive: - Influences the decision to increase or reduce
inventory levels to take advantages of price influences.
A company should maintain adequate stock of materials for a continuous
supply to the factory for the uninterrupted production. It is not possible
for a company to procure raw materials whenever it is needed. A time lag
exists between demand for materials and its supply. Also there exists
uncertainty in procuring raw materials in time on many occasions. The
procurement of materials may be delayed because of such factors as strike,
transport disruption or short supply. Therefore, the firm should maintain
sufficient stock of raw materials at a given time to stream line
production.
Objective of Inventory Management
In the context of inventory management the firm is faced with the problem
of meeting two conflicting needs
? To maintain a large size of inventory for sufficient and smooth
production and sales operations.
? To maintain a minimum investment in inventories to maximize
profitability.
Both excessive and inadequate inventories are not desirable. These are two
dangerous points within which the firm should operate. The objective of
inventory management should be to determine and maintain optimum level of
inventory investment. The optimum level of inventory will lie between the
two danger points of excessive and inadequate inventories.
The firm should always avoid a situation of over investment or under
investment in inventories. The major dangerous of over investment are
? Unnecessary tie-up of the firms funds losses of profit
? Excessive carrying cost
? Risk of quality
The aim of inventory management thus should be to avoid excessive and
inadequate levels of inventories and to maintain sufficient inventory for
smooth production and sales operations. Efforts should be made to place an
order at the right time with the right source to acquire the right quantity
at the right price and quality. An effective inventory management should
? Ensure a continuous supply of raw materials to facilitate uninterrupted
production.
? Maintain sufficient stock of raw materials in periods of short supply and
anticipate price changes.
? Maintain sufficient finished goods inventory for smooth sales operations
and efficient customer service.
? Minimize the carrying cost and time.
? Control investment in inventories and keep it at an optimum level.
Inventory management techniques
In managing inventories the firm objective should be in consonance with the
shareholders' wealth maximization principle. To achieve this firm should
determine the optimum level of inventory. Efficiently controlled
inventories make the firm flexible. Inefficient inventory control results
in unbalanced inventory and inflexibility-the firm ma sometimes run out of
stock and sometimes may pileup unnecessary stocks. This increases level of
investment and makes the firm unprofitable.
To manage inventories efficiency, answers should be sought to the following
two questions.
1)How much should be ordered?
2)When should it be ordered?
The first question how much to order, relates to the problem of determining
economic order quantity (EOQ), and is answered with an analysis of costs of
manufacturing certain level of inventories. The second question when to
order arise because of determining the reorder point.
EOQ
One of the major inventory problems to be resolved is how many inventories
should be added when inventory is replenished. If the firm is buying raw
materials it has to decide lots in which it has to be purchased on each
replenishment. If the firm is planning a production run, the issue is how
much production to schedule or how much to make. These problems are called
order quantity problems and the task of the firm is to determine the
optimum or economic order quantity (or economic lot size) determining an
optimum inventory level involves two types of costs.
1)Ordering cost
2) Carrying cost
The economic order quantity is that inventory level which minimizes the
total of ordering and carrying costs.
Ordering cost
The term ordering cost is used in case of raw materials (or supplies) and
includes the entire cost of acquiring raw materials. The include costs
incurred in following activities. Requisitioning purchase ordering,
transporting, receiving, inspecting and storing (store placement).
Carrying cost
Cost incurred for maintaining a given level of inventory is called carrying
cost. They include storage, taxes, insurances, deterioration and
obsolescence.
Economic order quantity (EOQ) =v2AC/c
Where A = annual requirement of raw materials
C=ordering cost
c=carrying cost
EOQ Graphical Approach
The economic ordering quantity can also be found out graphically. The EOQ
figure is as follows:
In the above figure costs-carrying, ordering and total are plotted on
vertical axis is used to represent the order size. We note that total
carrying costs increases as the order size increases, because, on an
average a larger inventory level be maintained, and ordering costs decline
with increase in order size because large order size means less number of
orders. The behavior of total costs line is noticeable since it is a sum of
two types of costs, which behave differently with order size. The total
costs decline in their first instance but they start rising when the
decreases in an average ordering costs is more than offset by the increases
in carrying costs. The economic order quantity occurs at the point Q. Where
the total cost is minimum. Thus the firms operating profit is maximized at
point.
Reorder Point (ROP)
The problem how much to order is solved determining the economic order
quantity yet the answer should the sought to the second problem, when to
order this is a problem of determining the reorder point is that inventory
level at which an order should be placed to replenished the inventory. To
determine the reorder point under certainty, we should know
a) Lead time
b) Average usage
c) Economic order quantity
Lead time is the time normally taken is replenishing inventory after the
order has been placed by certainty we mean the usage and lead time do not
fluctuate under such a situation ROP is simply that inventory level which
will be maintained for consumption during the lead time. i.e,
Reorder point (under certainty) =lead time X Average usage
Re-order Point (under certainty) = Lead time X Average usage.
Inventory management at Annapurna Earcanal Ltd
The Annapurna Ear canal Ltd management all the unit and corporate level
every month reviews inventory. All the functional head are called for
minutes and the inventory holdings are discussed in detail at the meeting
every month .A.E.Ltd purchases the material when the customer places the
order, since the product of are tailor-made to customer’s requirements.
After purchasing the raw materials, which is mostly, still will be stocked
at one place all other procured against production orders are stored.
Depending up on the requirement in various production departments the raw
material is sent to the respective departments or production shops.
When the order is placed for raw material certain raw material is in
transit, such raw material is called as raw material in transit.
Example –Raw material on over seas.
The raw material can be transfer from unit to another unit or from one
department to another is called transfer-in –transist.It is nothing but to
the transfer of raw material among the inter firm units of Annapurna
Earcanal Ltd.
The raw material, which is production process, is called work-in process.
The work in process becomes finished goods inventory. The finished should
not be kept for a longer time. They should be sold off to clear off the
entire inventory. However, finished goods inventory is not there for
Annapurna Earcanal Limited, since production is mainly done on customer
order and specifications. The raw material is purchased and the whole
process is repeated again which we call it as inventory cycle.
Inventory turnover Ratio:-
Inventory turnover ratio indicates the efficiency of the firm in producing
and selling its products. It is calculated by dividing the cost of goods
sold by the average inventory. The average inventory is the average of open
and closing balance of inventory.
Inventory turnover Ratio= Cost of Goods Sold / Average Inventory
Years Cost of goods sold Average inventory ITR( in Times)
2005 307656311 32775024 9.38
2006 606604844 64752367 9.36
2007 399298008 67315972 5.9
2008 390386083 43339215 9
Source:
Data compiled from the annual report of Annapurna Earcanal Ltd.
Inferences:
From the above table it can inferred that the proportion cost of good sold
to average stock it is increased to 9.38times in the year2005 and again
decreased 5.9 times in the year 2007and again increased 9 times in the year
2008.
Inventory holding period:-
Inventory holding period is the reciprocal of inventory turn over ratio.
This can be measure in terms of number of days.
Inventory holding period= Average inventory x365days
Cost of goods of sold
Years AVG INVENTORY CGS (In Rs.) INVENTORY HOLDING PERIOD(In days)
2005 32775024 307656311 39
2006 64752367 606604844 40
2007 67315972 399298008 62
2008 43339215 390386083 41
Graph
Inferences:
From the above table it can infer that the proportion of average inventory
to cost of goods sold had 39 days in 2005. In the year 2007 it can be