A Project on Working Capital Management by Alok, PGDM, IPE, Hyderabad.

Working Capital Management 1

CHAPTER ONE


Introduction

1.1.Working Capital Management

Working capital is the capital available for conducting the day-to-day operations of an

organization; normally the excess of current assets over current liabilities. Working capital

management is the management of all aspects of both current assets and current liabilities, to

minimize the risk of insolvency while maximizing the return on assets.

1.2. Concepts of Working Capital

1. Gross Working Capital (GWC)

GWC refers to the firm’s total investment in current assets.

Current assets (CA) are the assets, which can be converted into cash within an accounting

year (or operating cycle), and include cash, short-term securities, debtors,

(Accounts receivable or book debts) bills receivable and stock (inventory).

Gross working capital focuses on

a. Optimization of investment in current

b. Financing of current assets

2. Net Working Capital (NWC)

Net working capital is the difference between the current assets and current liabilities.

Current liabilities (CL) are those claims of outsiders, which are expected to mature for

payment within an accounting year, and include creditors (accounts payable), bills payable,

and outstanding expenses.

Net working capital can be positive or negative. When current assets exceed current

liabilities net working capital is positive and vice versa.

Positive NWC = CA > CL

Negative NWC = CA < CL


Net working capital focuses on

a. Liquidity position of the firm

b. Judicious mix of short-term and long-term financing

1.3. Operating Cycle

Operating cycle is the time duration required to convert sales after the conversion of

resources into inventories, into cash. The operating cycle of a manufacturing company

involves three phases:

1. Acquisition of resources

2. Manufacture of the product

3. Sale of the product

These phases of operating cycle create cash flows among which cash inflows are mostly

uncertain whereas cash outflows are relatively certain. The firm needs to hold cash to

purchase the raw materials, pay for labour, as these payments involve day-to-day

transactions, real estate firm needs to maintain liquidity. The length of operating cycle for a

real estate firm extends beyond a year.

Gross operating cycle (GOC) = Inventory conversion period (ICP) + Debtors conversion

period (DCP)

ICP= Raw material conversion period (RMCP) + Work-in progress conversion period

(WIPCP) + Finished good conversion period (FGCP)

Fig (i) Operating cycle of a manufacturing firm


1.3.1. Inventory conversion period (ICP)

Inventory conversion period gives the length of time inventory is held between purchase and

sale.

It is calculated as:

In some cases, a more detailed breakdown of inventory may be required. Inventory holding

periods can be calculated for each type of inventory: raw materials, work-in-progress and

finished goods.

1.3.2. Raw Material Conversion Period

It is the average time taken to convert material into work-in progress. It depends on raw

material consumption per day and raw material inventory.

Calculated as:

1.3.3. Work-In-Progress Conversion Period

It is the average time taken to complete semi-finished work or work-in-progress. It is

the length of time goods spend in production.

Calculated as:


1.3.4. Finished Goods Conversion Period

It is the average time taken to sell the finished goods. It is the length of time finished goods

are held between completion or purchase and sale.

Calculated as:

For all inventory period ratios, a low ratio is usually seen as a sign of good working capital

management.

Generally, it is very expensive to hold inventory and thus minimum inventory holding usually

points to good practice.

1.3.5. Debtors (Receivables) Conversion Period

It is the average time taken time to convert debtors into cash.

Calculated as

Generally shorter credit periods are seen as financially sensible but the length will also

depend upon the nature of the business.

1.3.6. Creditors (Payables) Deferral Period (CDP)

CDP is the average time taken by the firm in paying its suppliers.

Calculated as


Generally, increasing payables days suggests advantage is being taken of available credit but

there are risks:

• losing supplier goodwill

• losing prompt payment discounts

• Suppliers increasing the price to compensate

1.4. Working Capital Liquidity Ratios

Two key measures, the current ratio and the quick ratio, are used to assess short-term liquidity.

Generally, a higher ratio indicates better liquidity.

Current Ratio

Measures how much of the total current assets are financed by current liabilities.

A measure of 2:1 means that current liabilities can be paid twice over out of existing current assets.

Quick (Acid Test) Ratio

The quick or acid test ratio measures how well current liabilities are covered by liquid assets.

This ratio is particularly useful where inventory-holding periods are long.

Calculated as

A measure of 1:1 means that the company is able to meet existing liabilities if they all fall due at once.

Working Capital Turnover Ratio

One final ratio that relates to working capital is the working capital turnover ratio

Calculated as


This ratio measures how efficiently management is utilising its investment in working capital

to generate sales and can be useful when assessing whether a company is overtrading.

It must be interpreted in the light of the other ratios used.

Return on Assets (ROA)

Return on Assets is used to analyse the effect of working capital management on profitability.

Calculated as:

Return on Assets = Profit After Tax/Average Total Asset

ROA gives an idea as to how efficient management is at using its assets to generate earnings.

The higher the ROA number, the better, because the company is earning more money on less

investment.

Trend Analysis

In financial analysis, the direction of changes over a period of years is of crucial importance.

Time series or trend analysis of ratios indicates the direction of change.

This kind of analysis is particularly applicable to the items of profit and loss account.

1.5. Working Capital Investment Levels

The level of working capital required (the financial position statement figure) is affected

by the following factors:

• The nature of the business

• Uncertainty in supplier deliveries

• The overall level of activity of the business

• The company's credit policy

• The credit policy of suppliers

• The length of the operating cycle


The working capital ratios can be used to predict the levels of investment required.

This is done by re-arranging the formulas.

Calculated as:

1.6. Cash Conversion/Net Operating Cycle

Net operating cycle is the difference between gross operating cycle and payables deferral

period.

Fig (ii) Cash Conversion Cycle


1.7. Permanent and Variable Working Capital

a) Permanent or fixed capital is the minimum level of required current assets. Depending

on the changes in production and sales, there is need for working capital, over and above the

permanent working capital.

b) Fluctuating or variable working capital is the extra working capital needed, over and

above the permanent working capital to support the changing production and sales activities

of the firm. Variable working capital is required to meet the temporary liquidity needs of the

firm.

Fig (iii) Permanent and Temporary Working Capital


1.7.1. Balanced Working Capital Position

The firm should maintain good working capital, both inadequate and excessive working

capital are dangerous for the firm’s well-being as they could impair the firm’s profitability

due to production interruptions and inefficiencies and sales disruptions.

Fig (iv) Management of Working Capital

Excessive working capital leads to

• It results in unnecessary accumulation of inventories thereby increases the chances

of inventory mishandling, waste, theft and losses

• It is an indication of defective credit policy and slack in collection period.

Consequently, higher incidence of bad debts results, which adversely affects

profits

• Negligent excessive working capital makes management negligent which

degenerates into managerial inefficiency

• Tendencies of accumulating inventories tend to make speculative profits grow.

This may tend to make dividend policy liberal and difficult to cope with in future,

when the firm is unable to make speculative profits


Inadequate working capital leads to

• It stagnates growth. It becomes difficult for the firm to undertake profitable

projects for the firm to undertake profitable projects for non-availability of

working capital funds

• It becomes difficult to implement operating plans and achieve the firm’s profit

target

• Operating inefficiencies creep in when it becomes difficult even to meet day-to-

day commitments

• Fixed assets are not efficiently utilised for the lack of working capital funds. Thus,

the firm’s profitability would deteriorate

• Paucity of working capital funds render the firm unable to avail attractive credit

opportunities etc.

• The firm loses its reputation when it is not in a position to honour its short-term

obligations. As a result, the firm faces tight credit terms

1.8. Determinants of Working Capital

A firm’s working capital can be determined by the following

1. Nature of Business

Working capital requirements of a firm are basically influenced by the nature of its business.

Retail stores have a need for large sum of money to be invested in working capital.

Construction firms need to invest substantially in working capital and a nominal amount in

fixed assets.

2. Market and Demand Conditions

The working capital needs of a firm are related to its sales though it is difficult to determine

the relationship between sales and working capital needs, necessary planning of working

capital has to be done to determine levels of current assets to be employed for future sales.

Sales forecasts determine the level of production, which in turn determines the level of

current assets. Sales forecasts are based on swings in market conditions. An upward swing in

the economy will create demand thereby an increase in sales, which calls for an increased

deployment of funds in current assets. In such a situation, firms resort to substantial

borrowing whereas the scenario for a downward swing in the market is opposite. The demand


for short-term borrowings during the downward swing, to fuel the working capital

requirements goes down.

3. Technology and Manufacturing Policy

The manufacturing cycle comprises the purchase and use of raw materials

and the production of finished goods. Longer the manufacturing cycle, larger will be the

firm’s working capital requirements. An extended manufacturing time span means a larger

tie-up of funds in inventories. Thus, if there are alternative technologies of manufacturing a

product, the technological process with the shortest manufacturing cycle may be chosen.

Once a manufacturing technology has been selected, it should be ensured that manufacturing

cycle is completed within the specified period. This needs proper planning and coordination

at all levels of activity. Any delay in manufacturing process will result in accumulation of

work-in-process and wastage of time. In order to minimise the investment in working capital,

some firms, have a policy of asking for advance payments from their customers.

4. Credit Policy

The credit policy of a firm affects the working capital by influencing the level of debtors. The

credit terms granted to the customers depend upon the norms of the industry to which the

firm belongs.

5. Availability of Credit from Suppliers

The working capital requirements of a firm are also affected by credit terms granted by its

suppliers. A firm will need less working capital, if liberal credit terms are available to it from

the suppliers. Supplier’s credit finances the firm’s inventories and reduces the cash

conversion cycle. In the absence of supplier’s credit, the firm will have to borrow funds from

a bank. Availability of credit at reasonable cost from banks is crucial. It influences the

working capital policy of a firm. A firm without the supplier’s credit, but which can get bank

credit easily on favourable conditions will be able to finance its inventories and debtors

without much difficulty.

6. Operating Efficiency

The operating efficiency of the firm relates to the optimum utilization of all its resources at

minimum costs. Operating efficiency can be achieved by controlling operating costs and


utilization of current and fixed assets thereby improving the use of working capital and

accelerating the pace of cash conversion cycle. Efficient and effective usage of firm’s labour

and other resources decreases the pressure on working capital.

7. Price Level Changes

The increasing shifts in price level make the functions of financial manager

difficult. She should anticipate the effect of price level changes on working capital

requirements of the firm. Generally, rising price levels will require a firm to maintain higher

amount of working capital. Same level of current assets will need increased investment when

price levels are increasing. Companies, which can revise their product prices immediately in

line with increased input costs, will not face a severe working capital problem.

1.9. Issues in Working Capital Management

Working capital management refers to the administration of all components of working

capital – Cash, Marketable securities, Debtors, Stock, and Creditors. The financial manager

must determine the levels and composition of current assets. He must see that right sources

are tapped to finance current assets, and that current liabilities are paid in time. There are

many aspects of working capital management, which make it an important function of a

finance manager:

• Time- Working Capital Management requires much of the financial manager’s time

• Investment- Working capital represents a large portion of the total investment in

assets

• Criticality- Working Capital Management has a great significance for all firms but it

is very critical for small firms

• Growth- The need for working capital is directly related to the firm’s growth

Empirical observations show that financial managers have to spend much of their time to the

daily internal operations, relating to current assets and current liabilities of the firms. As the

largest portion of the financial manager’s valuable time is devoted to working capital

problems, it is necessary to manage working capital in the best possible way to get the

maximum benefit.


Working Capital Management is critical for all firms, especially for small firms. A small firm

may not have much investment in fixed assets, but it has to investment in current assets.

Small firms in India face a severe problem of collecting their debts. Further, the role of

current liabilities in financing current assets is far more significant in case of small firms, as,

unlike large firms they face difficulties in raising finances.

There is a direct relationship between a firm’s growth and its working capital needs. As the

sales grow, the firm needs to invest more in inventories and debtors. These needs become

very frequent and fast when the sales grow continuously. The finance manager should be

aware of such needs and finance them quickly. Continuous growth in sales may also require

additional investment in fixed assets. It may, thus, we concluded that all precautions should

be taken for the effective and efficient management of working capital. The finance manager

should pay particular attention to the levels of current assets and the financing of current

assets. To decide the levels and financing of current assets, the risk return implications must

be evaluated.

1.9.1. Current Assets to Fixed Assets Ratio

A financial manager should determine the optimal level of current assets so that the wealth of

stakeholders is maximized. A firm needs fixed and current assets to support a particular level

of output. However, to support the same level of output, the firm can have different levels of

current assets. As the firms output and sales increase, the need for current assets increases.

Generally, current assets do not increase in direct proportion to output; current assets may

increase at a decreasing rate with output. This relationship is based upon the notion that it

takes a greater proportion of investment in current assets when only a few units of output are

produced, than it does later on, when the firm can use its current assets more efficiently.

The level of current assets can be measured by relating current assets to fixed assets. Dividing

current assets by fixed assets gives CA/FA ratio. Assuming a constant level of fixed assets, a

higher CA/FA ratio indicates a conservative current assets policy and a lower CA/FA ratio

means an aggressive current assets policy, assuming other factors constant. A conservative

policy implies greater liquidity and lower risk while an aggressive policy indicates higher risk

and poor liquidity. Moderate current assets policy falls in the middle of conservative and


aggressive policies. The current assets policy of most firms may fall between these two

extreme policies.

1.9.2. Liquidity vs. Profitability: Risk-Return Trade-Off

Fig (v) The balancing act: Profitability vs. Liquidity

The firm would make just enough investment in current assets if it were possible to estimate

working capital needs exactly. The perfect certainty, current assets holding should be at the

minimum level. A larger investment in current assets under certainty would mean a low rate

of return on investment for the firm, as excess investment in current assets would not earn

enough return. A smaller investment in current assets, on the other hand, would mean

interrupted production and sales, because of frequent stock outa and inability to pay creditors.

As it is not possible to estimate working capital needs accurately, the firm must decide about

levels of current assets to be carried. Given a firm’s technology and production policy, sales

and demand conditions, operating efficiency etc., its capital assets holding will depend upon

its working capital policy. These policies involve risk-return trade-offs. A conservative policy

means lower return and risk, while an aggressive policy produces higher return and risk.


The two important aims of the working capital management are: profitability and solvency.

Solvency, used in the technical sense refers to the firm’s continuous ability to meet maturing

obligations. Lenders and creditors expect prompt settlements of their claims as and when due.

To ensure solvency, the firm should be very liquid, which means larger current assets

holdings. If the firm maintains a relatively large investment in current assets, it will have no

difficulty in paying claims of creditors when they become due and will be able to fill all sales

orders and ensure smooth production. Thus, a liquid firm has less risk of insolvency; that is, it

will hardly experience a cash shortage or a stock out situation. However, there is a cost

associated with maintaining a sound liquidity position. A considerable amount of firm’s

funds will be tied up in current assets, and to the extent, this investment is idle, the firm’s

profitability will suffer.

To have higher profitability, the firm may sacrifice solvency and maintain a relatively low

level of current assets. When the firm does so, its profitability will improve as fewer funds

are tied up in idle current assets, but its solvency would be threatened and would be exposed

to greater risk of cash shortage and stock outs.

1.9.3. The Cost Trade-off

A different way of looking onto the risk-return trade-off is in terms of the cost of maintaining

a particular level of current assets. There are two types of costs involved: cost of liquidity and

cost of illiquidity. If the firm’s level of current assets is very high, it has excessive liquidity.

Its return on assets will be low, as funds tied up in idle cash, stocks earn nothing, and high

levels of debtors reduce profitability. Thus, the cost of liquidity increases with the level of

current assets.

The cost of illiquidity is the cost of holding insufficient current assets. The firm will not be in

a position to honour its obligations if it carries too little cash. This may force the firm to

borrow at high rates of interest. This will also adversely affect the creditworthiness of the

firm and it will face difficulties in obtaining funds in the future. All this may force the firm

into insolvency. Similarly, the low level of stocks will result in loss of sales and customers

may shift to competitors. Also, low level of debtors may be due to tight credit policy, which


would impair sales further. Thus, the low level of current assets involves costs that increase

as this level falls.

In determining the optimum level of current assets, the firm should balance the profitability-

solvency tangle by minimising total costs- cost of liquidity and cost of illiquidity.

Fig (iv) Cost Trade-off

It is indicated in the figure that with the level of current assets the cost of liquidity increases

while the cost of illiquidity decreases and vice versa. The firm should maintain the current

assets at the level where the sum of these two costs is minimized. The minimum cost point

indicates the optimum level of current assets.


Inventory

High Levels Low Levels

Benefit:

• Happy customers

• Few production delays (always have

needed parts on hand)

Cost:

• Expensive

• High storage costs

• Risk of obsolescence

Benefit:

• Low storage costs

• Less risk of obsolescence

Cost:

• Shortages

• Dissatisfied customers

Cash


Benefit:

• Reduces risk

Cost:

• Increases financing costs

Benefit:

• Reduces financing costs

Cost:

• Increases risk

Table (i) Inventory and cash


Accounts Receivable

High Levels (favorable credit terms) Low Levels (unfavorable terms)

Benefit:

• Happy customers

• High sales

Cost:

• Expensive

• High collection costs

• Increases financing costs

Cost:

• Dissatisfied customers

• Lower Sales

Benefit:

• Less expensive

Accounts Payable and Accruals


Benefit:

• Reduces need for external finance--

using a spontaneous financing source

Cost:

• Unhappy suppliers

Benefit:

• Happy suppliers/employees

Cost:

• Not using a spontaneous financing

source

Table (ii) Accounts Receivable, Accounts Payable, and Accruals


1.10. Estimating Working Capital Needs

The most appropriate method of calculating the working capital needs of a firm is the concept

of operating cycle. However, a number of other methods may be used to determine working

capital needs in practice.

Three approaches which have been successfully applied in practice:

1. Current assets holding period

To estimate working capital requirements based on average holding period of

current assets and relating them to costs based on the company’s experience in the previous

years. This method is essentially based on the operating cycle concept.

The calculations are based on the following assumptions:

Method 1: Inventory: one month’s supply of each of raw material, semi-finished goods and

finished material.

Debtors: one month’s sales

Operating cash: one month’s total cost

This method gives details of the working capital items. This approach is subject to error if

markets are seasonal.

2. Ratio of sales

To estimate working capital requirements as a ratio of sales based on the assumption

that current assets change with sales.


Method 2: 25-35% of annual sales

This method has a limited reliability. Its accuracy is dependent upon the accuracy of sales

estimates.

3. Ratio of fixed investment

Working capital requirements are estimated as a percentage of fixed investment.


Method 3: 10-20% of fixed capital investment

This method relates working capital to investment. If estimate of investment is inaccurate,

this method is not generally used in practice to estimate working capital needs.


A number of factors will govern the choice of methods of estimating working capital. Factors

such as seasonal variations in operations, accuracy of sales forecasts, investment cost and

variability in sales price would generally be considered. The production cycle and credit and

collection policy of the firm would have an impact on working capital requirements.

Therefore, they should be given due weightage in projecting working capital requirements.

1.11. Policies for Financing Current Assets

A firm can adopt different financing policies vis-à-vis current assets. Three types of financing

may be distinguished as

1. Long Term Financing

The sources of long-term financing include ordinary share capital, preference share

capital, debentures, long-term borrowings from financial institutions and reserves

and surpluses (retained earnings).

2. Short Term Financing

Short-term financing is obtained for a period less than one year. It is arranged in

advance from banks and other suppliers of short term finance in the money market.

Short-term finances include working capital funds from banks, public deposits,

commercial paper, factoring of receivables etc.

3. Spontaneous Financing

Spontaneous financing refers to the automatic sources of short-term funds arising in

the normal course of a business. Trade (suppliers), credit, and outstanding expenses

are examples of spontaneous financing. There is no explicit cost of spontaneous

financing. A firm is expected to utilise these sources of finances fully. The real choice

of financing current assets, once the spontaneous sources of financing have been fully

utilised, is between the long term and short-term sources of finances.

Depending on the long term and short term financing, the approach followed by a company

may be referred to as

• Matching Approach

• Conservative Approach

• Aggressive Approach


1. Matching Approach

The firm can adopt a financial plan, which matches the expected life of assets with the

expected of the source of funds raised to finance assets. Thus, a ten-year loan may be raised

to finance a plant with an expected life of ten years; stock of goods to be sold in thirty days

may be financed with a thirty-day commercial paper or a bank loan. The justification for the

exact matching is that, since the purpose of financing is to pay for assets, the source of

financing and the assets should be relinquished simultaneously. Using long term financing for

short-term assets is expensive, as funds will not be utilised for the full period. Similarly,

financing long-term assets with short-term financing is costly as well as inconvenient, as

arrangements for the new short-term financing will have to be made on a continuing basis.

When the firm follows a matching approach (hedging approach), long-term financing will be

used to finance fixed assets and permanent current assets and short-term financing to finance

temporary or variable current assets are financed with short-term funds and as their level

increases, the level of short-term financing also increases. Under a matching plan, no short-

term financing will be used if the firm has a fixed current assets need only.

2. Conservative Approach

A firm in practice may adopt a conservative approach in financing its current and fixed

assets. The financing policy of the firm is said to be conservative when it depends more on

long-term funds for financing needs. Under a conservative plan, the firm finances its

permanent assets and a part of temporary current assets with long-term financing. In the

Fig (vii) Financing under matching plan


periods when the firm has no need for temporary current assets, the idle long-term funds can

be invested in the tradable securities to conserve liquidity. The conservative plan relies

heavily on long-term financing and, therefore, the firm has less risk of facing the problem of

shortage of funds.

3. Aggressive Approach

A firm may be aggressive in financing its assets. An aggressive policy is said

to be followed by the firm when it uses more short-term financing than warranted by the

matching plan. Under an aggressive policy, the firm finances a part of its permanent current

assets with short-term financing. The relatively large use of short-term financing makes the

firm more risky.


1.12. Short-term financing Vs. Long-term financing

A firm should decide whether it should use short-term financing. If short-term financing has

to be used, the firm must determine its portion in total financing. This decision of the firm

will be guided by the risk return trade-off. Short-term financing may be preferred over long-

term financing for two reasons

i) The cost advantage and

ii) Flexibility

Nevertheless, short-term financing is more risky than long-term financing.

1.12.1. Cost

Short-term financing should generally be less costly than long-term financing. It has been

found in developed countries, like USA, that the rate of interest is related to the maturity of

debt. The relationship between the maturity of debt and its cost is called the term structure

of interest rates. The curve, relating to the maturity of debts and interest rates, is called the

yield curve. The yield curve may assume any shape, but it is generally upward sloping.

Fig (ix) Aggressive financing


Fig (x) Yield Curve

The justification for higher cost of long-term financing can be found in the Liquidity

Preference Theory. This theory says that since lenders are risk averse, and risk generally

increases with the length of lending time, most lenders would prefer to make short-term

loans. The only way to induce these lenders to lend for longer periods is to offer them higher

rates of interests.

The cost of financing has an impact on the firm’s return. Both short-term and long-term

financing have a leveraging effect on stakeholders return. However, the short-term financing

ought to cost less than long-term financing; therefore, it gives relatively higher return to

stakeholders.

1.12.2. Flexibility

It is relatively easy to refund short-term funds when the need for funds diminishes. Long-

term funds such as debenture loan or preference capital cannot be refunded before time. Thus,

if a firm anticipates that its requirements for funds will diminish in near future, it would

choose short-term funds.

1.12.3. Risk

Although short-term financing may involve less cost, it is more risky than long-term

financing. If the firm uses short-term financing to finance its current assets, it runs the risk of

renewing borrowings repeatedly. This is particularly so in the case of permanent current

assets, here permanent current assets refer to minimum level of current assets that a firm

should always maintain. If the firm finances its permanent current assets with short-term

debt, it will have to raise new short-term funds as debt matures. This continued financing


exposes the firm to certain risks. It may be difficult for the firm to borrow during stringent

credit periods. In such times, the firm may be unable to raise any funds. Consequently, its

operating activities may be disrupted. In order to avoid failure, the firm may have to borrow

at most inconvenient terms. These problems are much less when the firm finances with long-

term funds. There is less risk of failure when the long-term financing is used.


CHAPTER TWO


DESIGN OF STUDY

2.1. Introduction

Working capital is the capital available to meet the day-to-day operations, and depending on

the industry, it could be a relatively high percentage of the total assets of the organization.

Cash flow is the lifeblood of firms, and efficient working capital management is the key to

achieving healthy cash flow. Firms with weak working capital management strategies give up

flexibility and potentially a competitive advantage.

Efficient utilization of the firm’s resources, as it relates to working capital management,

means that managers should find effective and efficient ways to deal with the cash available

for the day-to-day operations in order to achieve the optimum impact. Good working capital

management leads to increased cash flows, and thus leads to lesser need to depend on

external financing; therefore, the probability of default is minimised. A key factor in the

working capital management is the cash conversion cycle. Cash conversion cycle is defined

as, the time lag between the purchasing of raw materials and the collection of cash from the

sale of goods. The longer the lag, the greater the investment in working capital, and thus the

financing needs of the firm will be greater. Interest expense will be also higher, which leads

to higher default risk and lower profitability.

Working capital fluctuations in a huge multi-national company may not adversely affect its

day to day functioning and funding could be readily available. Whereas for small and

medium enterprises availability of funds could be difficult and even if the funds are available

in the form of debt it could be a burden as the firm has to bear the interest charges. Indian

medium sized firm with its core competence being real estate will have to hold a stringent

policy for working capital management as greater operational efficiency will lead to higher

profits especially when the most important raw materials- steel and cement’s prices are

showing an upward trend in the times of inflation and economic uncertainty.


2.2. Review of Previous Literature

• A study by Melita Stephanou Charitou, Maria Elfani, Petros Lois, University of

Nicosia, Cyprus(Dec 2010) titled “The Effect Of Working Capital Management On

Firm’s Profitability: Empirical Evidence From An Emerging Market” indicated that

the cash conversion cycle and all its major components; namely, days in inventory,

days sales outstanding and creditors payment period, are associated with firm’s

profitability.

• Chatterjee, S. (2012). The impact of working capital on the profitability: Evidence

from the Indian firms. This research has analyzed the impact of working capital on the

profitability for a sample of 100 Indian companies listed in the Bombay Stock

Exchange for a period of 2 years from 2010-2011. The results depict that, there is a

strong negative association between the components of the working capital

management and the profitability ratios of the Indian firms which indicates that, as the

cash conversion cycle increases it would tend to reduce the profitability of the

company, and the managers might increase the shareholder’s value by shortening this

cash conversion cycle to a minimum level. It is also observed that the negative

association also persists between the liquidity and the profitability of the Indian firms.

Nevertheless, there is a positive relationship between the size and the profitability of

the firm. This indicates that, as the size of the firm increases the profitability of the

firm also increases. Finally a negative relationship is observed between the debt and

profitability of the Indian firms.

• Appuhami, B. A. R. (2008). The impact of firms' capital expenditure on working

capital management: An empirical study across industries in Thailand. International

Management Review, 4(1), 8-21. The empirical research found that

firms' capital expenditure has a significant impact on working capital management.

The study also found that the firms' operating cash flow, which was recognized as a

control variable, has a significant relationship with working capital management.

• Mary E. Barth, Donald P. Cram and Karen K. Nelson, Accruals and the Prediction

of Future Cash Flows, The Accounting Review , Vol. 76, No. 1 (Jan., 2001), pp. 27-

58. Separate analysis of the change in accounts receivable, change in accounts

payable, change in inventory, and other cash management related variables increased


the sample firms' ability to predict future cash flows. In fact, these variables were

more successful than several lags of aggregate earnings in predicting future cash

flows.

• Amarjit Gill , Nahum Biger , Neil Mathur (2010), The Relationship Between

Working Capital Management And Profitability: Evidence From The United States.

A sample of 88 American firms listed on New York Stock Exchange for a period of 3

years from 2005 to 2007 was selected. It has found a statistically significant

relationship between the cash conversion cycle and profitability, measured through

gross operating profit. It follows that managers can create profits for their companies

by handling correctly the cash conversion cycle and by keeping accounts receivables

at an optimal level.

2.3. Case for the present study

To analyse the working capital policy of the company over the years to understand the

efficiency of working capital utilization

2.4. Statement of the problem

In order to complete the present and future projects, to streamline cash flows and remain

profitable, Rajapushpa Properties should manage its working capital efficiently.

The raw materials such as steel and cement are extremely important in real estate projects not

to mention, labour’s role, and the costs of these inputs have skyrocketed in the recent times.

Real estate companies need to be thoroughly efficient in project management to stick to the

promised delivery dates by finishing projects on time through proper management of funds

and inventory levels. Buyers play an important role too; there need to be enough cash with

the buyers to invest in home. Real estate sales are dependent on the rates of interest on home

loans. Many such factors affect the sales of a real estate firm.

However, the company can hedge itself against possible price rises or economic slumps

through efficient management of working capital.

The study analyses the working capital management practices of the company over the past

three years.


2.5. The Objectives of the project study

• To analyse various working capital ratios for last three years starting from 2010 to

2013.

• Analysis of Current Asset and Current Liabilities

• To estimate Working Capital requirement

2.6. The Research method followed

The objective of the study is to analyse the Working Capital position of the company

for the past three years from 2010 to 2013.

The major sources of data were secondary data i.e. annual financial reports etc.

• The position of the working capital has been analysed through various Working Capital

ratios with the help of data available in the financial statement of the past three years.

• An analysis of the various items of current asset and current liabilities for past three years

has been done.

2.7. Scope of the study

The study is confined to the organization, to suggest means of improvements in the existing

system.

2.8. Collection of data

Secondary Sources

Balance sheet of Rajapushpa Properties Pvt. Ltd. for the year 2010-11



Primary Source of data includes personal discussion with the finance manager and the

director of the company.

2.9. Tools for Analysis of the data

Microsoft Excel was used all through the project for the financial analysis of data and to

create graphs.


2.10. Geographical Area

The area covered under the study is Hyderabad. All projects of Rajapushpa Properties are

located in and around Hyderabad.

2.11. Period of study or Period covered under study

The period of study was limited to two months during May and June 2013. During this period

all the required data was collected through secondary sources and analysed with the help of

financial tools of analysis.

The data from past three years’ balance sheet has been analysed.

2.12. Limitations of the study

• The period covered under this study is three years.

• This analysis is based on secondary data like annual reports and company’s Balance

Sheet. The scope of the study is limited to that extent.

• The time available to carry out this study was limited to two month


CHAPTER THREE


Industry Overview And Company Profile

3.1. Global Real Estate Industry

The global real estate market continues to move forward, and better-than-expected results in

the final quarter of 2012 demonstrate renewed impetus in the investment market.

Supply is largely under control and, with shortages of high-quality space, rental spikes could

appear in some markets later in the year and into 2014. Greatest upside potential is offered by

U.S. markets, while austerity measures will constrain recovery across parts of Europe.

Many developed economies ended 2012 close to or in recession and a rapid turnaround is not

expected in early 2013. Even if the positive trends are upheld, rates of growth in 2013 as a

whole will remain well below historic norms. The lingering concern for governments in the

developed world will be how to foster a self-sustaining revival. In 2009-2010 these

economies appeared to be emerging from their deep trough and hopes were high of a return to

more normal expansion. However, demand evaporated in 2011 as the crisis in the Eurozone

and tighter policy conditions halted the recovery in its tracks.

3.2. Real Estate in India

Real estate plays a crucial role in the Indian economy. It is the second largest employer after

agriculture and, slated to grow at 30% over the next decade. The Indian real estate market

size is expected to touch $180 billion by 2020.

The housing sector alone contributes to 5-6% of the country’s GDP. Retail, hospitality and

commercial real estate are also growing significantly, providing the much-needed

infrastructure for India’s growing needs.

According to a study by ICRA (Investment Information and Credit Rating Agency of India

Limited), the construction industry ranks 3rd among the 14 major sectors in terms of direct,

indirect and induced effects in all sectors of the economy. A unit increase in construction

expenditure generates five times the income, having a multiplier effect across the board. With

backward and forward linkages to over 250 ancillary industries, the positive effects of real

estate growth spread everywhere. Truly, real estate is a growth engine for India’s economy.


Responding to an increasingly well-informed consumer and keeping in mind the

globalization of the Indian business outlook, real estate developers have also shifted gears

and accepted fresh challenges.

The most marked change has been the shift from family owned businesses to professionally

managed ones. Developers, in meeting the growing need for managing multiple projects

across cities, are investing in centralized processes to source material and organize manpower

and hiring qualified professionals in areas like project management, architecture and

engineering.

The growing flow of foreign direct investment (FDI) into Indian real estate is encouraging

increased transparency. Developers, in order to attract funding, have revamped their

accounting and management systems to meet due diligence standards. Customers have also

benefited from a hassle-free accounting system.

The modern real estate developer is keenly informed about market trends, basing his

information on market research and rich experience. Young business leaders, armed with

management degrees and international exposure, have also added value to this positive trend.

Real estate developers play a leading role in the industry, bridging the gap between

construction ability and the customer’s need. Developers offer value in terms of design, cost,

functionality and location. They work hard to absorb international trends, analyze the

customers’ expectations and deliver quality realty products based on their experience.

In India, real estate developers fulfill a critical need for infrastructure to serve a growing

economy in areas like housing, office space, retail and entertainment, among others.

3.3. Real Estate in Hyderabad

Hyderabad is the capital and largest city of the Indian state of Andhra Pradesh. It occupies

650 square kilometers. The city is located on the banks of the Musi River on the Deccan

Plateau. The population of the city is 6.8 million and that of its metropolitan area is 7.75

million, making it India's fourth most populous city and sixth most populous urban

agglomeration. The Hyderabad Municipal Corporation was expanded in 2007 to form the

Greater Hyderabad Municipal Corporation.


Nehru Outer Ring Road or ORR is a 158 kilometer, 8-lane ring road expressway encircling

the city of Hyderabad. It is being built by HMDA at a cost of INR 6,696 crores with an

assistance of INR 3,123 crores from Japan International Cooperation Agency. The

expressway is designed for speeds up to 120 kmph. A large part, 124 kms of the 158-km was

opened in December 2012. It provides an easy connectivity between NH 9, NH 7, NH 4 and

state highways leading to Vikarabad, Srisailam and Nagarjunasagar. The road aims to

improve connectivity and decongest the traffic flow on the existing major arterials between

the outer suburbs of Greater Hyderabad. The current status of the ORR is as given below:

Completed segments

• Gachibowli to Shamshabad (22 Kilometers)-November 2008

• Shamshabad to Pedda Amberpet (38 kilometers)-2010

• Narsingi to Patancheru (23.7 kilometers)-June 2011

• Patancheru to Shamirpet(38 kilometers)-December 2012

• Shamirpet to Pedda Amberpet (33 kilometers)-June 2013

The realty markets in Hyderabad, which witnessed a prolonged slump due to global recession

coupled with the prevailing political uncertainty, is today in a gradual phase of recovery.

Weak sentiments had dented the markets for over three years, leading to an over-supply

situation across the city. New launches by prominent builders along the IT/ITES corridor,

during the last two-quarters have received a good response, indicating a cautious optimism

prevailing in the markets.

The peripheral regions of Hyderabad contain large chunks of developable land, available at

affordable prices. The development of the Outer Ring Road(ORR), The Metro Rail and the

prevailing MMTS network will help improve connectivity and reduce travel time to various

parts of the city.

The regions surrounding the 158-km Nehru Outer Ring Road is yet to witness inclusive

growth. A healthy mix of commercial and residential development along this region would

aid in the development of this belt as a future growth-corridor. Similarly the presence of land

banks surrounding the International Airport at Shamshabad and along the eastern corridor

indicates the prospects for the growth of the city over the next decade.


3.4. Corporate Profile

Rajapushpa Properties Pvt. Ltd.

Rajapushpa Properties Pvt. Ltd. is an Hyderabad-based real-estate company, founded by Mr.

J.C. Reddy, as an family owned entity in the year 2009. Rajapushpa Properties Pvt. Ltd. has a

turnover of ₹504848000 for the financial year ending 31st March 2013.

Rajapushpa’s first residential project was, a 237 flats gated residential apartments in Attapur,

Hyderabad. Subsequent projects are located in Kokapet and Tellapur.

The corporate office of Rajapushpa Properties is located at

4th Floor, Plot No. 34,

Silicon Valley, Madhapur,

Hyderabad – 500 081

Management

Directors:

P. Jaya Chandra Reddy

P. Mahender Reddy

P. Sreenivas Reddy

Finance Manager:

M. Durga Prasad

Marketing Manager:

Sujith

Projects

Lifestyle City

Lifestyle city is a 150 acre project of 362 villas with areas ranging from 330 sq. yds. to 938

sq. yds. in three independent communities at Tellapur, Hyderabad.

Open Skies

Open Skies is a gated community of forty-eight villas at Kokapet near Financial District.

Cannon Dale

Cannon Dale is a gated community of thirty-seven triplex villas located near financial district

adjacent to Narsingi junction on outer ring road.


The Retreat

Retreat is a gated community of two and three-bedroom luxury apartments laid out in two

blocks and twelve towering floors each. This project is spread in an area of 2 acres and

located adjacent to the outer ring road near Kokapet.

Silicon Ridge

It is Rajapushpa’s first residential real estate project. Silicon Ridge is a gated community of

two and three-bedroom apartments laid out in eleven blocks and has 237 residencies, located

in Attapur, Hyderabad.


CHAPTER FOUR


Analysis of Data

4.1. Current Ratio

The current ratio of a company is a quick way to look at its current assets and current

liabilities.

Current Ratio Year 2010-2011 2011-2012 2012-2013 Current Assets ₹ 180,983,473 ₹ 431,840,922 ₹ 665,071,309 Current Liabilities ₹ 44,790,160 ₹ 146,689,863 ₹ 446,929,793 Current Ratio 4.0 2.9 1.5

Table (iii) Current Ratio

Fig (xi) Current Ratio

Inference

• During the year 2012-2013, the current ratio has gone below the assumed normal

value of 2:1. An exponential increase in current liabilities is the reason for the current

ratio to fall to 1.5.

• The current ratio during the year 2010-11 was 4:1, which is above the assumed value

of 2:1. The following year i.e. 2011-12 the current ratio has decreased to 2.9:1. For

4.0

2.9

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2010-2011 2011-2012 2012-2013

Current Ratio

Current Ratio


the year 2012-13, the value fell to 1.5:1. Current liabilities increased due to the

advances received during the year 2012-13 by the company from customers. As long

as the company can deliver, the product for the advances received there is no need to

worry about the decrease in current ratio during 2012-13.

4.2. Quick Ratio

Quick ratio gives the cash position of the firm more accurately by removing the value of the

inventories from the current assets.

Quick Ratio (Acid Test) Year 2010-2011 2011-2012 2012-2013 Current Assets ₹ 180,983,473 ₹ 431,840,922 ₹ 665,071,309 Current Liabilities ₹ 44,790,160 ₹ 146,689,863 ₹ 446,929,793 Inventories ₹ 142,499,590 ₹ 269,786,686 ₹ 495,410,892 Quick Ratio 0.86 1.10 0.38

Table (iv) Quick Ratio

Fig (xii) Quick ratio

Inference

• The quick ratio has shown a downward trend. It was near the ideal value of 1:1 during

the year 2011-2012.

• During the year 2010-2011, the value of quick ratio was 0.86:1 is fairly near the ideal

value.

0.86

1.10

0.38

0.00

0.20

0.40

0.60

0.80

1.00

1.20

2010-2011 2011-2012 2012-2013

Quick Ratio

Quick Ratio


• As most part of the current assets are inventories, during the year 2012-2013, the

value of quick ratio has fallen to 0.38.

• The company’s quick ratio values have remained fairly above the required levels of

1:1, except for the year 2012-13. Reason being increase in current liabilities due to

advances received from customers at the same time inventories have increased

considerably due to work in progress. It is suggested to keep the quick ratio at an

optimal level of 1:1, as difficulty to meet the short term obligations may affect

solvency of the company.

4.3. Cash ratio

Cash ratio is the ratio of cash and cash equivalents of a company to its current liabilities. It is

an extreme liquidity ratio since only cash and cash equivalents are compared with the current

liabilities. It measures the ability of a business to repay its current liabilities by only using its

cash and cash equivalents and nothing else.

Cash Ratio YEAR 2010-2011 2011-2012 2012-2013

Cash And Cash Equivalents ₹ 8,745,559 ₹ 18,038,813 ₹ 35,232,474 Current Liabilities ₹ 44,790,160 ₹ 146,689,863 ₹ 446,929,793 Cash Ratio 0.195 0.123 0.079 Table (v) Cash Ratio

Fig (xiii) Cash Ratio

0.195

0.123

0.079

0.000

0.050

0.100

0.150

0.200

0.250

2010-2011 2011-2012 2012-2013

Cash Ratio

Cash Ratio


Inference

• The cash ratio for the year 2012-13 was 0.079. It means the company is carrying

small amounts of cash 8% (approximately) for the year 2012-13.

• In the year 2010-11 the ratio was 0.195.

• The cash ratio of the company has been 0.195, 0.063, and 0.079 for the years 2010-

11, 2011-12, 2012-13 respectively. Low values of cash ratio indicate that firm cannot

meet all of its current liabilities with the cash available immediately, but the reserve

borrowing power of the firm may come in handy during such times.

4.4. Return on Assets (ROA)

ROA gives an idea as to how efficiently management is using company assets to generate

profit.

Return on Assets

Year 2010-11 2011-12 2012-13

Net Income ₹ 6,882,000 ₹ 6,927,000 ₹ 21,771,000

Total Assets ₹ 229,150,969 ₹ 494,214,067 ₹ 788,826,884

Return on Assets 0.0300 0.0140 0.0276

Table (vi) Return on Assets

Fig (xiv) Return on assets

0.0300

0.0140

0.0276

0.0000

0.0050

0.0100

0.0150

0.0200

0.0250

0.0300

0.0350

2010-11 2011-12 2012-13

Return on Assets

Return on Assets


Inference

• Return on assets has shown a no consistent trend.

• During the year 2011-12 the increase in total assets lead to decrease in RoA.

• The return on assets ratio shows the relative performance of the company over the

years. Return on assets ratio has shown a downward trend from 0.03 in the year 2010-

11 to 0.014 in the year 2011-12 this can be attributed to the increase in total assets

while the net income has more or less remained at 2010-11 levels. Again, in the year

2012-13 it has shown an upward trend and increased to 0.0276. This positive trend

has to continue for better efficiency.

4.5. Working Capital Turnover Ratio

The ratio measures the effective utilization of working capital. It establishes the relationship

between cost of sales and working capital.

Working Capital Turnover Ratio Year 2010-2011 2011-2012 2012-2013 Sales Revenue ₹ 132,590,997 ₹ 199,217,000 ₹ 500,751,854 Current Assets ₹ 180,983,473 ₹ 431,840,922 ₹ 665,071,309 Current Liabilities ₹ 44,790,160 ₹ 146,689,863 ₹ 446,929,793 Net Working Capital ₹ 136,193,313 ₹ 285,151,059 ₹ 218,141,516 Working Capital Turnover 0.97 0.70 2.30

Table (vii) Working Capital Turnover Ratio

Fig (xv) Working Capital Turnover Ratio

0.97

0.70

2.30

0.00

0.50

1.00

1.50

2.00

2.50

2010-2011 2011-2012 2012-2013

Working Capital Turnover

Working CapitalTurnover


Fig (xvi) Net Working Capital Vs. Sales Revenue

Inference

• The working capital turnover ratio has increased to 2.30 in the year 2012-2013 from

0.70 during the year 2011-2012.

• During the year 2012-13, the working capital turnover ratio has reached its peak value

of 2.30 for the company indicating an improved working capital performance.

• The sudden jump in ratio is due to the increase in sales during 2012-13.

• Net working capital has reduced during the year 2012-13 due to increase in current

liabilities.

• Working capital turnover ratio values say that in the year 2010-11, Rajapushpa

Properties was making only ₹ 0.85 in sales for every ₹ 1 used to fund operations, and

in the year 2011-12 it was, making mere ₹ 0.70 in sales on every ₹ 1 spent on

operations during the year. In the year 2012-13, though the company earned a good ₹

2.30 sales revenue for every ₹ 1 spent on operations.

₹ -

₹ 100,000,000

₹ 200,000,000

₹ 300,000,000

₹ 400,000,000

₹ 500,000,000

₹ 600,000,000

2010-2011 2011-2012 2012-2013

NetWorkingCapital

SalesRevenue


4.6. Inventory Conversion Period

Inventory conversion period

Year 2010-2011 2011-2012 2012-2013

COGS* ₹ 102,975,416 ₹ 165,281,562 ₹ 412,605,311

Inventories ₹ 142,499,590 ₹ 269,768,686 ₹ 495,410,892

Days/year 365 365 365

Inventory conversion period 505 596 438

*COGS – Cost of Goods Sold

Table (viii) Inventory Conversion Period

Fig (xvii) Inventory Conversion Period

Inference

• Inventory conversion period has decreased to 438 days during the year 2012-13.

• The inventory conversion period has decreased due to increase in sales during the

year 2012-13.

• The inventory conversion period (ICP) has touched a peak of 596 days during the year

2011-12 as the work in progress has increased considerably. During the year 2012-13

ICP decreased to 438 days. The downtrend in ICP observed in the year 2012-13 is due

to increased sales during the year.

505 596

438

0100200300400500600700

2010-2011 2011-2012 2012-2013

Inventory conversion period

Inventoryconversionperiod


4.7. Receivables Collection Period

Receivables collection period

Year 2010-2011 2011-2012 2012-2013

Sales ₹ 132,590,997 ₹ 199,217,000 ₹ 500,751,854

Accounts Receivables ₹ 4,008,963 ₹ 83,040,650 ₹ 94,628,622

Days/year 365 365 365

Receivables collection period 11 152 69

Table (ix) Receivables collection period

Fig (xviii) Receivables collection period

Inference

• Receivables collection period has increased to 152 days during the year 2011-12.

• There has been a sudden increase in the trade receivables during the year 2011-12.

• The company could bring down the receivables collection period to 69 days during

2012-13, thanks to the sales revenue during the year.

• Receivables collection period (RCP) has peaked during the year 2011-12 to 152 days

from a mere 11 days during 2010-11. In the following year i.e. 2012-13 RCP came

down to 69 days. This downtrend should be encouraged for higher profitability.

11

152

69

0

50

100

150

200

2010-2011 2011-2012 2012-2013

Receivables collection period

Receivablescollectionperiod


4.8. Payables Deferral Period

Payables deferral period

Year 2010-2011 2011-2012 2012-2013

COGS ₹ 102,975,416 ₹ 165,281,562 ₹ 412,605,311

Accounts Payable ₹ 16,643,581 ₹ 26,177,273 ₹ 60,010,782

Days/year 365 365 365

Payables deferral period 59 58 53

Table (x) Payables Deferral Period

Fig (xix) Payables Deferral Period

Inference

• The payables deferral period has decreased to 53 days in 2012-13 from 59 days in

2010-11.

• The payables deferral period has remained more or less consistent.

• The firm should aim to increase the payables deferral period to the maximum extent

possible.

• Payables deferral period (PDP) has shown a near consistent trend over the past three

years. That said the company should exploit the opportunities to increase the PDP to

permissible extent without losing the credibility with creditors.

59 58

53

50

52

54

56

58

60

2010-2011 2011-2012 2012-2013

Payables Deferral Period

Payables deferral period


4.9. Cash Conversion Cycle

Cash conversion cycle represents the time (in days), a company takes to convert resource

inputs into cash flows.

Cash Conversion Cycle

|Year 2010-2011 2011-2012 2012-2013

Sales ₹ 132,590,997 ₹ 199,217,000 ₹ 500,751,854

COGS ₹ 102,975,416 ₹ 165,281,562 ₹ 412,605,311

Inventories ₹ 142,499,590 ₹ 269,768,686 ₹ 495,410,892

Accounts Receivables ₹ 4,008,963 ₹ 83,040,650 ₹ 94,628,622

Accounts Payable ₹ 16,643,581 ₹ 26,177,273 ₹ 60,010,782

Days/year 365 365 365

Inventory conversion period 505 596 438

Receivables collection period 11 152 69

Payables deferral period 59 58 53

Cash conversion cycle (CCC) 457 690 454

Table (xi) Cash Conversion Cycle

Fig (xx) Cash Conversion Cycle

457

690

454

0

100

200

300

400

500

600

700

800

2010-2011 2011-2012 2012-2013

Cash Conversion Cycle (CCC)

Cash conversion cycle (CCC)


Inference

• The length of the time to convert resources into cash flows has been more or less

consistent except during the year 2011-12.

• The spike in the cash conversion cycle during the year 2011-12, can be attributed to

an increase in receivables collection period and inventory conversion period.

• Payables deferral period has been more or less consistent over the years.

• Receivables collection period has spiked to 152 days in the year 2011-12.

• Empirical studies show that Cash conversion cycle (CCC) is inversely related to

profitability. In the year 2011-12, the CCC was 690 days in the previous year and in

the following year, it has remained more or less same at 457 and 454 respectively.

Rajapushpa properties can improve profitability by further decreasing the length of

CCC.

4.10. Sales

It indicates the amount realized from product or service sold through the normal operations of

the company during the year.

Sales

Year 2010-2011 2011-2012 2012-2013

Sales ₹ 132,590,997 ₹ 199,217,000 ₹ 500,751,854

Table (xii) Sales


Fig (xxi) Sales

Inference

• A consistent increase in the sales over past three years has been witnessed.

• A remarkable sales growth of about 151.36% has been observed in the sales during

the year 2012-13 over the year 2011-12.

• The increase in sales revenue can be attributed to completion of projects.

• The sales revenue of Rajapushpa Properties has shown a consistent increasing trend

all through 2010 to 2013. This upward trend is a positive sign to sustain this in the

long run and to improve on it the company can adopt better working capital

management practices.

₹ 132,590,997

₹ 199,217,000

₹ 500,751,854

₹ 0

₹ 100,000,000

₹ 200,000,000

₹ 300,000,000

₹ 400,000,000

₹ 500,000,000

₹ 600,000,000

2010-2011 2011-2012 2012-2013

Sales

Sales


4.11. Changes in Working Capital

Changes In Working Capital

2010-11 2011-12 Increase Decrease

Current Assets (a)Current investments (b)Inventories ₹142,499,590 ₹269,768,686 ₹127,269,096

(c )Trade receivables ₹ 4,008,963 ₹ 83,040,650 ₹79,031,687 (d)cash and cash equivalents ₹ 8,745,559 ₹ 18,038,813 ₹ 9,293,254 (e )Short-term loans and

advances ₹ 25,729,361 ₹ 60,992,773 ₹35,263,412 (f)Other current assets

Total ₹180,983,473 ₹431,840,922 ₹ 250,857,449 Current Liabilities

(a)Short-term borrowings ₹ 0 (b)Trade payables ₹ 16,643,581 ₹ 26,177,273 ₹ 9,533,692

(c )Other current liabilities ₹ 24,591,894 ₹117,818,746 ₹ 93,226,852 (d)Short-term provisions ₹ 3,554,685 ₹ 2,693,843

₹ 860,842

Total ₹ 44,790,160 ₹ 146,689,863 ₹ 102,760,544 ₹ 860,842

Working Capital(WC) ₹136,148,313 ₹285,151,059 Change in WC

₹ 149,002,746

2011-12 2012-13 Increase Decrease Current Assets (a)Current investments

(b)Inventories ₹269,768,686 ₹495,410,892 ₹ 225,642,206

(c )Trade receivables ₹ 83,040,650 ₹ 94,628,622 ₹ 11,587,972 (d)cash and cash equivalents ₹ 18,038,813 ₹ 35,232,474 ₹ 17,193,661 (e )Short-term loans and advances ₹ 60,992,773 ₹ 39,799,321 ₹ 21,193,452 (f)Other current assets

₹431,840,922

₹665,071,309 ₹ 254,423,839 ₹ 21,193,452

Current Liabilities (a)Short-term borrowings ₹ 52,536,248 ₹ 52,536,248 (b)Trade payables ₹ 26,177,273 ₹ 60,010,782 ₹ 33,833,509

(c )Other current liabilities ₹117,818,746 ₹323,790,449 ₹ 205,971,703

(d)Short-term provisions ₹ 2,693,843 ₹ 10,592,313 ₹ 7,898,470

Total ₹146,689,863

₹446,929,793 ₹ 247,703,682 ₹ 52,536,248

Working Capital(WC) ₹285,151,059 ₹218,141,516

Change in WC ₹ 67,009,543 Table (xiii) Changes in Working Capital


Inference

• Working capital has increased considerably during the year 2011-12, the result of

which can be seen from the sales during next year.

• During the year, 2012-13 current liabilities have increased drastically leading to an

decrease in working capital over the previous year (2011-12).

4.12. Trend Analysis

Time series or trend analysis of ratios indicates the direction of change.

The procedure followed is to assign the number 100 to items of the base year and to calculate

the percentage changes in each item of other years in relation to base year. This procedure

may be called as trend percentage method.

Table (xiv) Trend Analysis

Trend Analysis

YEAR 2010-2011 2011-2012 2012-2013

Sales ₹ 132,590,997 ₹ 199,217,000 ₹ 500,751,854

EBITDA ₹ 15,042,000 ₹ 16,367,000 ₹ 56,800,000

PAT ₹ 6,992,000 ₹ 6,927,000 ₹ 21,771,000

Current Assets ₹ 180,983,473 ₹ 431,840,922 ₹ 665,071,309

Current Liabilities ₹ 44,790,160 ₹ 146,689,863 ₹ 446,929,793

Gross fixed Assets ₹ 29,908,029 ₹ 33,388,506 ₹ 49,564,354

Net Fixed Assets ₹ 26,327,829 ₹ 32,452,869 ₹ 48,145,444

Total assets ₹ 229,150,969 ₹ 494,214,067 ₹ 788,826,884

Net Worth ₹ 38,113,251 ₹ 41,215,242 ₹ 100,601,010


Trend Analysis: Trend-Percentage Method YEAR 2010-2011 2011-2012 2012-2013 Sales 100% 150% 378% EBITDA 100% 109% 378% PAT 100% 99% 311% Current Assets 100% 239% 367% Current Liabilities 100% 328% 998% Gross fixed Assets 100% 112% 166% Net Fixed Assets 100% 123% 183% Total assets 100% 216% 344% Net Worth 100% 108% 264%

Table (xv) Trend Analysis: Trend-Percentage Method

Inference

• Trend analysis has shown that the total assets have grown faster than the net worth, it

is an indication that the company has been relying on outsider’s money. The growth

in sales and EBITDA has come to same level by year 2012-13. The growth in PAT

has not kept up with the growth in sales from the base year 2010-11. Currents assets

and current liabilities have not moved together. The exponential growth in the current

liabilities is attributed to increase in advances from customers, which is likely to be

converted into sales in the coming year.

4.13. Working Capital Estimation

Estimation Method

Raw Material: One month’s supply (Raw Material consumed/12)

Semi-Finished Material: Raw Material per month + One- half of normal conversion cost

Finished Material: One month’s supply (Total Product Cost/12)

Total Inventory Needs: Raw material + Semi-finished material + finished material

Debtors: One month’s total revenue (Total Revenue/12)

Operating Cash: Total Product Cost/12

Total Working Capital required= Total Inventory Needs + Debtors + Operating Cash


Year 2010-11 2011-12 2012-13

Raw Material

Consumed ₹ 35,588,142 ₹ 121,417,575 ₹ 405,353,782

Operating Expenses ₹ 84,378,110 ₹ 65,611,437 ₹ 42,674,767

Total Expenses ₹ 119,966,252 ₹ 187,029,012 ₹ 448,028,549

Depreciation ₹ 1,915,445 ₹ 886,337 ₹ 1,384,400

Total Product Cost ₹ 121,881,697 ₹ 187,915,349 ₹ 449,412,949

Annual Revenue ₹ 135,122,825 ₹ 203,445,198 ₹ 504,848,388

Table (xvii) Parameters considered for Working Capital Estimation

Estimation of Working Capital using Current Assets Holding Period

Year 2010-11 2011-12 2012-13 2013-14

Raw Material

Consumed ₹ 35,588,142 ₹ 121,417,575 ₹ 405,353,782

RMC/Month ₹ 2,965,679 ₹ 10,118,131 ₹ 33,779,482

Semi-Finished Material ₹ 5,729,176 ₹ 11,686,485 ₹ 38,991,258

Finished Material ₹ 10,156,808 ₹ 15,659,612 ₹ 37,451,079

Total Inventory Needs ₹ 18,851,663 ₹ 37,464,229 ₹ 110,221,819

Debtors ₹ 11,260,235 ₹ 16,953,767 ₹ 42,070,699

Operating Cash ₹ 1,263,048 ₹ 1,368,016 ₹ 4,734,987

Estimated WC ₹ 31,374,946 ₹ 55,786,011

₹157,027,505

Table (xvii) Working Capital (WC) Estimation

Inference

• Estimated working capital needs for the year 2013-14 is ₹ 157,027,505 based on the

current assets holding period method

• The method fairly relies on non-cash items in estimation of working capital


CHAPTER FIVE


CONCLUSION AND RECOMMENDATIONS

Conclusion

The company’s cash flows are positive and the company is making profits. The profitability

and solvency of the company are intact. The firm is in stages of growth where it is going to

witness economies of scale. As the turnover and scales of operations, increase the firm needs

to manage its working capital requirements through a proper policy. The two primary

concerns firms have regarding receivables are the lost cash flows arising from bad debts and

from administrative costs. Standardization of the procedures in debtors and inventory

management to decrease the length of cash conversion cycle will go a long way in increasing

the profitability of the company.

Recommendations

• Improving collection practices, inventory controls, and trade credit practices are

beneficial for the company, the firm's lenders, and their investors.

• The current liabilities have been increasing at an exponential rate during the years

analysed, an effort should be made to keep the current liabilities under check and to

improve the levels of current assets.

• The period between bookings and handing over of homes should be shortest, the

company can use the funds in construction of new projects, and at the same time, cost

of debt too is reduced.

• The working capital estimation method used in this study can be applied with needed

modifications to suite the company’s needs and a mechanism to address the working

capital needs can be put in place.

• The cash conversion cycle and its components can be used as indicators of

performance of the administration.


References 1. The Impact of Working Capital on the Profitability: Evidence from the Indian Firms

Chatterjee, Saswata. SSRN Working Paper Series, Aug 2012.

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and Karen K. Nelson, The Accounting Review , Vol. 76, No. 1 (Jan., 2001), pp. 27-58,

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Practice, Cengage Learning.

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Techniques, PHI Learning Pvt. Ltd.

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Financial Management Association Survey and Synthesis Series, Oxford University

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Annexure

Profit & Loss Statement

Year 2010-11 2011-12 2012-13

Income

Revenue from

Operations ₹ 132,590,997 ₹ 199,217,000 ₹ 500,751,854

Other income ₹ 2,531,828 ₹ 4,228,198 ₹ 4,096,534

Total Revenue (I) ₹ 135,122,825 ₹ 203,445,198 ₹ 504,848,388

Expenses

Raw material

consumed ₹ 35,588,142 ₹ 121,417,575 ₹ 405,353,782

Construction

expenses ₹ 66,323,939 ₹ 37,640,487 ₹ 125,082,630

(Increase)/decrease in

stock ₹ 1,063,335 ₹ 6,241,500 ₹ -117,849,101

Employee benefit

expenses ₹ 4,928,597 ₹ 8,041,945 ₹ 16,907,670

Finance costs ₹ 2,690,511 ₹ 5,420,037 ₹ 22,940,201

Administrative

expenses ₹ 12,062,239 ₹ 13,687,505 ₹ 18,533,568

Depreciation and

amortization ₹ 1,915,445 ₹ 935,637 ₹ 1,418,910


expenses

Provisions and write-

offs

Total Expenses(II) ₹ 124,572,208 ₹ 193,384,686 ₹ 472,387,661

(Loss)/Profit before

tax (III)= (I)-(II) ₹ 10,550,617 ₹ 10,060,512 ₹ 32,460,727

Tax Expenses

Current tax ₹ 3,554,685 ₹ 102,693,843 ₹ 10,592,313

Deferred tax

liability(asset) ₹ 114,390 ₹ 439,364 ₹ 98,376

(Excess)/Short

provision of tax

relating to earlier

years ₹ 6,114,470 ₹ 3,825,314 ₹ 10,000,000

Total Tax

Expense(IV) ₹ 9,783,545 ₹ 6,958,521 ₹ 20,690,689

(Loss)/ Profit for the

year (III)-(IV) ₹ 767,072 ₹ 3,110,991 ₹ 11,770,038

Less/Add: Prior

period expenditure

Balance Carried to

Balance Sheet ₹ 767,072 ₹ 3,110,991 ₹ 11,770,038

Table (xviii) Profit & Loss Statement


Balance Sheet

Year 2010-11 2011-12 2012-13

I EQUITY AND LIABILITIES

(1) Shareholder's funds

(a) Share Capital ₹ 32,384,270 ₹ 32,384,270 ₹ 80,000,000

(b)Reserves and surplus ₹ 5,728,981 ₹ 8,830,972 ₹ 20,601,010

(c )Money received against share warrants

₹ 38,113,251 ₹ 41,215,242 ₹100,601,010

(2) Share application money pending

allotment ₹ 76,003,326 ₹ 94,403,326 ₹107,880,557

(3)Non-current liabilities

(a)Long-term borrowings ₹ 69,397,842 ₹ 68,375,043 ₹132,031,394

(b)Deferred tax liabilities (Net) ₹ 114,390 ₹ 553,754 ₹ 652,130

(c )Other long term liabilities ₹ 732,000 ₹ 732,000 ₹ 732,000

(d)Long term provisions ₹ 3,390,820

₹ 70,244,232 ₹ 73,051,617 ₹133,415,524

(4)Current liabilities

(a)Short-term borrowings ₹ 0 ₹138,854,019 ₹ 52,536,248

(b)Trade payables ₹ 16,643,581 ₹ 26,177,273 ₹ 60,010,782

(c )Other current liabilities ₹ 24,591,894 ₹117,818,746 ₹323,790,449

(d)Short-term provisions ₹ 3,554,685 ₹ 2,693,843 ₹ 10,592,313

₹ 44,790,160 ₹285,543,882 ₹446,929,793

TOTAL ₹229,150,969 ₹494,214,066 ₹788,826,884

II ASSETS

(1)Non-current assets


Table (xix) Balance Sheet

(a)Fixed assets

Tangible assets ₹ 26,327,829 ₹ 32,452,896 ₹ 48,145,444

Capital Work in Progress

Intangible assets under development

(b)Non-current investments ₹ 2,500,000 ₹ 2,500,000 ₹ 2,500,000

(c )Deferred tax assets(net)

(d)Long term loans and advances ₹ 18,945,267 ₹ 27,075,175 ₹ 72,799,540

(e )Other non-current assets ₹ 394,400 ₹ 345,100 ₹ 310,590

₹ 48,167,496 ₹ 62,373,144 ₹123,755,574

(2)Current assets

(a)Current investments

(b)Inventories ₹142,499,590 ₹269,768,686 ₹495,410,892

(c )Trade receivables ₹ 4,008,963 ₹ 83,040,650 ₹ 94,628,622

(d)cash and cash equivalents ₹ 8,745,559 ₹ 18,038,813 ₹ 35,232,474

(e )Short-term loans and advances ₹ 25,729,361 ₹ 60,992,773 ₹ 39,799,321

(f)Other current assets

₹180,983,473 ₹431,840,922 ₹665,071,309

TOTAL ₹229,150,969 ₹494,214,066 ₹788,826,884

Date post:	29-Jan-2015
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A Project on Working Capital Management by Alok, PGDM, IPE, Hyderabad.

Economy & Finance