A Project Reporton

ANALYSISOF

WORKING CAPITAL MANAGEMENT

BYBHAWNA KALRA

D.A.V.INSTITUTE OF MANAGEMENTFARIDABAD

Location: M/s. Larsen & Toubro Limited Switchgear Factory, Faridabad

ASUMMER TRAINING

REPORT

ONANALYSIS OF WORKING CAPITAL MANAGEMENT

CONDUCTED ATLARSEN & TOUBRO PVT. LTD.

IN PARTIAL FULFILMENT FOR THE DEGREE OFMASTERS OF BUSINESS ADMINISTRATION (M.B.A.)

(SESSION 2006-2008)

SUBMITTED TO: SUBMITTED BY: Controller of Examination Bhawna Kalra Maharishi Dayanand MBA IIIrd Sem. University, Rohtak Regn. No. 06-DAVM-302

DAV INSTITUTE OF MANAGEMENTFaridabad

CERTIFICATION

This is to certify that the Project Report title Analysis of Working Capital submitted in partial

fulfillment for the award of MBA Degree of University School of Management Studies,

Maharishi Dayanand University, was carried out by Bhawna Kalra under my guidance. This

has not been submitted to any other University or Institution for the award of any

degree/diploma/certificate.

Signature of the Guide

BRIEF HISTORYBRIEF HISTORY

LARSEN & TOUBRO LIMITED was established in 1938, and a today India’s largest multi-

dimensional engineering and construction company involved in manufacturing and supplying

various types of industrial and household equipment.

Two Danish young men, Mr. HOLCK LARSEN & Mr. S. KRISTIAN

TOUBRO attended the same college and passed out as chemical and civil

engineers respectively decided to work in the same company, F.L. Smith

and Co, Copenhagen, Denmark. Mr. Toubro was sent to India in 1934 to

help, erect & commission machinery supplied for a cement plant by F.L.

Smith and Co. Fortunately Mr. Larsen was also sent to India in 1935 to assess the cement

manufacturing capabilities of various manufacturing groups. In 1938, the two Danes decided to

seek their fortunes in postwar India and so came together in that age of entrepreneur to set up

Larsen & Toubro, as a partnership firm by setting up a small office in downtown Mumbai (then

Bombay). Initially they began marketing Danish dairy equipment, which was a great success.

A year later, when World War II broke out, the fledgling Company’s genius for innovation

came to the fore. It began to make the products it used to import. In 1945, L&T was appointed

dealers of Caterpillar, the American earthmoving machinery giant. In 1946, the firm became a

limited company, and soon a nationwide network of offices was set up. L&T had set out a

charter for itself: the company would meet the needs of India’s emerging core sector. ‘In

Service Lies Success’ was enshrined as a corporate motto. Very soon L&T came to be known

for its quality and thus began the creation of one of the largest Indian company. The firm

became a public limited company in 1950. L&T steadily climbed the list of the top 200 Indian

companies - from 72 in 1966 to 25 in 1973. By then, it had developed a vast repertoire of skills

and a reputation for high quality goods and services. Over the next decade, most of L&T’s

activities had crystallized into products and services involving high technology and advanced

product development programmes.

It has now come a long way from its little office in Mumbai of 1938. In India, they are a visible

and vibrant presence. Some of India’s most sophisticated projects and most complex industrial

equipment carry the L&T insignia of excellence.

Mr. TOUBRO passed away in 1982 &. Mr. HOLCK LARSEN the CHAIRMAN EMERITUS

of company, passed away in 2003. He was awarded with Padma Bhushan on 26th Jan 2002.

Mr. A.M.NAIK, Chairman of the company

Company Profile

Larsen & Toubro Limited (L&T) is a technology-driven engineering and construction

organization, and one of the largest companies in India's private sector. It has additional

interests in manufacturing, services and Information Technology.

A strong, customer-focused approach and the constant quest for top-class quality have enabled

the Company to attain and sustain leadership in its major lines of business across seven

decades.

L&T has an international presence, with a global spread of offices. A thrust on international

business over the last few years has seen overseas earnings growing to 18 per cent of total

revenue. With factories and offices located around the country, further supplemented by a wide

marketing and distribution network, L&T's image and equity extends to virtually every district

of India.

Record of Achievements

L&T's signature of excellence is evident on:

India's first indigenous hydrocracker reactor

Oil and gas platform projects executed to global benchmarks

The world's largest continuous catalyst regeneration reactor

The simultaneous execution of clean fuel projects at eight

refineries around India

The world's biggest fluid catalytic cracking regenerator

The world's longest product splitter

Asia's highest viaduct - built for the Konkan Railway

The world's longest LPG pipeline

The world's longest cross country conveyor

Building an international class football stadium in 260 days

MARKET CAPITALISATION OF L&T TILL DATE

EXCHANGEEXCHANGE BSEBSE

OPENOPEN 2600.002600.00

HIGHHIGH 2600.002600.00

LOWLOW 2438.002438.00

TRADED QUATITYTRADED QUATITY 228991228991

CURRENTCURRENT 2450.452450.45

% CHANGE% CHANGE -1.69 -1.69

MARKET CAPITALISATION(in billions)MARKET CAPITALISATION(in billions) 649.91649.91

L&T has been ranked 5th among the Super Ten out of 20 Top admired Corporation in India.

L&T ranks first in the Engineering Business

OPERATING DIVISIONSOPERATING DIVISIONS

LARSEN & TOUBRO LIMITED has four main operating divisions along with Information

Technology.

ENGINEERING & CONSTRUCTION:

L&T’s Engineering & Construction i.e. EPC project business constitutes a critical part of

L&T’s engineering core. L&T has integrated its strengths in process technology, basic and

detailed engineering, equipment fabrication, procurement, project management, erection and

construction, and commissioning to offer single-point responsibility under stringent delivery

schedules. Strategic alliances with world leaders enable L&T to access technical know-how

and execute process intensive large-scale turnkey projects to maintain its leadership position.

ELECTRICAL & ELECTRONICSELECTRICAL & ELECTRONICS :

Electrical & Electronics division (EBG) is organized into two sectors, Electrical & Electronics,

comprising eight Strategic Business Units (SBUs). The Electrical business comprises Electrical

Standard Products, Electrical Systems & Equipment & Petrol Dispensing Pumps & Systems.

The Electronics business comprises Metering & Protection Systems, Control & Automation,

Medical Equipment & Systems, Embedded Software & Systems and Enterprise Networking

business.

L&T’s Electrical Sector has a comprehensive Quality, Environment and Safety management

system. The quality management system for design, development, production, marketing and

servicing has received ISO 9001 certification from BVQI, UK. The environment management

system at its Works has been certified for conformity to ISO 14001 by BVQI. The Division has

implemented Enterprise Resource Planning solution of SAP AG, Germany and went live at 35

locations across the country simultaneously in the ‘Big Bang’ mode in 1999.

HEAVY ENGINEERING:HEAVY ENGINEERING:

L&T’s Heavy Engineering business activities are organized under self-reliant Strategic

Business Units (SBUs), each specializing in different product lines. They meet the needs of

major industries: chemical, petrochemical, refinery, fertilizer, oil & gas, man-made fiber,

power, iron & steel, paper & pulp, minerals & metals, cement, food & dairy, plastic & rubber.

Plant and equipment are designed and manufactured to customer specifications and various

stringent international codes as well as L&T’s own standards. Materials of construction: carbon

steel, low alloy steel, stainless steel, duplex steel, clad steel, nickel, monel, inconel, cupro-

nickel, copper, hastelloy, aluminium, titanium, zirconium, tantalum as well as composites

.L&T has supplied equipment to almost all process industries in India, and has exported

various critical equipment for the hydrocarbon industry abroad.

CONSTRUCTION:CONSTRUCTION:

L&T offers turnkey construction services and engineered turnkey industrial and infrastructure

projects in civil, mechanical, electrical and instrumentation engineering through ECC – its

Engineering, Construction and Contracts Division. The Headquarters of the Division is located

at Chennai. ECC’s track record is built upon timely completion, safety, quality and reliability.

Many of its Business Units, departments and facilities are accredited with ISO certificates.

Well-structured quality assurance systems ensure quality, safety and reliability at every stage

of construction. Regional offices at Ahmedabad, Bangalore, Chennai, Delhi, Hyderabad,

Kolkata, and Mumbai carry out the execution of domestic projects. Area offices at Delhi,

Kolkata, Mumbai and Chennai carry out execution of overseas projects.

INFORMATION TECHNOLOGYINFORMATION TECHNOLOGY:

LARSEN & TOUBRO INFOTECH LIMITED (L&T Infotech) offers comprehensive, end-to-

end software solutions and services. Leveraging the heritage and domain expertise of the

parent company, its services encompass a broad technology spectrum.

SOLUTIONS & SERVICES

• Domain Solutions: Financial services, Telecom, Utilities & Manufacturing.

• Enterprise Application Systems: Enterprise Resource Planning (ERP). Customer

Relationship Management (CRM), e-Procurement & Supply Chain Management (SCM),

Collaborative Product Commerce (CPC) and Enterprise Information Portals (EIP).

• Technology Solutions: Mobile computing, Embedded software and services; Enterprise

Application Integration & Geographic Information Systems Solutions, Web

Electrical & Electronics Division (EBG)

Electrical & Electronics Division (EBG) is one of the core businesses of Larsen & Toubro

Limited (L&T) - India’s largest engineering and construction conglomerate. This division is

engaged in the business of low voltage Switchgear products, Electrical systems, Energy meters,

Medical equipment, Petroleum dispensing pumps and Automation solutions.

This division is the largest manufacturer of low voltage switchgear and controlgear in India

and enjoys market leadership amidst competition from international players. A countrywide

network of Stockists take care of products’ distribution along with a widespread service

network. Offices of the L&T Group companies, located around the world, support the

requirements from export market.

EBG Performance(In Crores)

  2005-2006 2004-2005 2003-2004

Gross Revenue 1582 1220 1019

EBITDA / Revenue % 15.5 12.7 12.9

Export Earnings 173 97 62

The division has a comprehensive Quality, Environment and Safety management system. The

Quality management system for design & development, production, sales, marketing and

servicing has received ISO 9001:2000 certification from BVQI. In addition, its manufacturing

facilities have been certified for conformity to ISO 14001 (Environmental Management

System) & OHSAS 18001 (Occupational Health and Safety Management System) by BVQI.

We have implemented Enterprise Resource Planning (ERP) solution of SAP AG, Germany and

went live at 35 locations across the country simultaneously in the ‘Big Bang’ mode in 1999.

ERP provides end-to-end integration across all business functions from suppliers to customers

over Internet and it is India’s first installation upgrade to Version 4.6C.

Strategic Business Units

Strategic Business Units (SBUs) of the division have operations at five locations in India –

two in Mumbai and one each in Ahmednagar, Mysore and Faridabad. One of the SBU Of

EBG is operating in Faridabad

Electrical Systems & Equipment (Operations at Faridabad)

L&T Faridabad division manufactures custom-built switchboards with conventional as well as

intelligent protection, control and communication to meet the power distribution and motor

control needs of key industries. L&T FSW continue to be the largest supplier of switchboard

panels in India and these switchboards have been installed at many prestigious plants in India.

The range of custom-built switchboards comprises fully drawout power control centres and

motor control centres, distribution boards and control panels – all conforming to IEC 60439-1

and IS 8623. Its Power Control Centre (PCC) type TF is rated up to 6000A and houses L&T-

made ACBs to take care of power distribution. The L&T-made Motor Control Centre (MCC)

type TQ is rated up to 5000A.

L&T FSW offer fixed distribution boards, Intelligent Relays integrated with the PCCs and

MCCs along with customized Human Machine Interface software and Power Quality

Management Systems from the business associates. Also offered are allied equipment like

busducts, transformers, MV switchgear, industrial batteries and cables, and undertakes turnkey

contracts for comprehensive system engineering, supply, installation, testing and

commissioning of switchboards and allied equipment. L&T offers assistance in product

selection, application engineering and detailed engineering, installation & commissioning,

retrofitting and upgradation of switchboards, after-sales service and training. L&T also designs

and manufactures enclosures in flat pack systems for switchboard assemblers world-wide.

Retrofitting solutions are offered for a wide range of LV & MV switchgear including IMCS.

ORGANIZATIONAL SET-UP Of FARIDABAD UNITORGANIZATIONAL SET-UP Of FARIDABAD UNIT

DEPARTMENTAL STRUCTURE AT FSW

1. Marketing & Sales Department.

2. Design Department.

3. Production, Planning, Control & Materials Department

4. Production Department

Assembly Fabrication Paint Shop Maintenance

5. Switchgear quality & reliability (SQR) Department.

6. Personnel, HR & Administration Department

Personnel & HR Reception Security Computer Communication & canteen facilities

7. Finance and account department

8. IT Service

FLOWCHART SHOWING THE CONNECTIVITYFLOWCHART SHOWING THE CONNECTIVITYBETWEEN ALL THE DEPARTMENTSBETWEEN ALL THE DEPARTMENTS

CUSTOMERSALES & MARKETING

ENGINEERING & DESIGN

SHOP

PURCHASE

ACKNOWLEDGEMENTS

I would like to take this opportunity to thank all the people who helped me in completion of my management training and in the compilation of this report.

I would like to thank Mr. S. M. Saini (Deputy General Manager, L&T-Faridabad Switchgear Works) for providing me with this unique opportunity of undergoing my training at L & T.

I extend sincere thanks to Mr. J. P. Kedia (Manager- Finance and Accounts Department) for providing me guidance at each and every step of the training. I would always be obliged to him because he shared his real-life experiences with me.

I am thankful to the other members of the finance department who explained me finance work, solving queries and being there to help me whenever required.

PLANNING

SQR

STORES

DISPATCH

Table of Contents

i. Abstractii. Introduction

1. Working Capital Management 1.1 Introduction 1.2 The operating Cycle and Working Capital Needs 1.3 Operating Cycle of L&T 1.4 Factors Affecting Working Capital Requirement 1.5 Liquidity Vs. Profitability- A Risk Return Trade Off 1.6 Working Capital Policy

2. Receivables Management 2.1 Need of Receivables 2.2 Objective of Receivable Management

2.3 Cost of Receivables 2.4 Trade off on Receivables 2.5 Determinants of Receivables 2.5.1 Credit Policy 2.5.2 Credit Control 2.6 Channel Financing

3. Payable Management 3.1 Discounting of Bills

4. Inventory Management 4.1 Types of Inventory 4.2 Need for Inventory 4.3 Objectives of Inventory Management 4.4 Cost of holding Inventory 4.5 Techniques for Inventory Management 4.5.1 Perpetual Inventory Verification 4.5.2 ABC Analysis 4.5.3 Economic Order Quantity 4.5.4 Reorder Point 4.5.5 Safety Stock 4.5.6 Lean manufacturing

a. Just In Time (JIT)b. Kanban Systemc. Kaizend. Single Piece Flow Systeme. Gemba Walkingf. Virtual Storage

5. Cash management 5.1 Need of Cash 5.2 Objectives of Cash management 5.3 Cost of Holding Cash 5.5 Benefits of Cash management 5.6 Cash Budget 5.7 Techniques of managing Cash in L&T

6. Conclusion

7. Refrences

ABSTRACT

The project titled ‘Analysis Of Woking Capital Management’ aims at understanding and

analyzing the Working Capital Structure of the plant, Faridabad Switchgear Works

(FSW), a manufacturing unit of Larsen & Toubro Limited (L&T). Working capital

management comprises of four major parts – Inventory management, Receivables

management, Payable Management and Cash management. There are a number of tools

available for a proper working capital management. Most of them are studied as a part of the

project.

As a part of inventory management, various inventory management techniques are studied.

Most of these are being implemented in the plant (like PIV, ABC Analysis, JIT, Single Piece

Flow System etc). Even those tools, which are not practically implemented (like Reorder

Point, Safety Stock etc) are studied. These methods, along with their working and importance,

are studied in detail.

As far as receivables management is concerned, Credit Terms, Credit Policy, and

Collection Policy and Procedure are understood, giving special focus on how they are being

implemented practically. Also, there is an innovative technique being used by L&T for

managing its receivables efficiently. This technique, known as Channel Financing makes sure

that the receivables are collected almost instantly. Just like any other firm, even L&T is trying

to minimize its debtors, as far as possible. Collections are tried to be made as fast as they can,

and all these tools are very much focused and effective in doing so.

Apart from this, I did Discounting of Bills as a part of Payable management technique. It’s

an easy way to check the savings a firm can make by paying its suppliers early.

Another prominent tool being implemented at L&T is Sweeping Facility for Cash

Management . It makes sure that the cash is not lying idle, and is being used efficiently, and

moreover, is invested wisely, in case opportunities are there.

INTRODUCTION

PURPOSE:

The purpose of the report, ‘Analysis of Working Capital Management’, is to understand and

analyze the working capital structure of the manufacturing unit of L&T Limited, that is,

Faridabad Switchgear Works (FSW).

The objective was also to check the the real life situations in an industry as differing from

theories. The project will throw a light on how to link theory with the business world. Working

Capital Management is a part of Corporate Finance, and to understand it, one has to get

involved with it. Working with professionals gives us a feeling of how our future life would be,

and how we are supposed to behave in the business world.

LIMITATIONS:

The report covers the practices followed at one plant of the company, so the study that is being

carried, may be useful for just one factory, and not for others, as there may be difference in the

business module from one factory to another. Therefore, a generalization of this report, to

judge the efficiency of L&T Limited as a whole, cannot be done.

In addition, the project -span of 9-weeks, was insufficient for understanding, and analyzing the

working capital structure of a plant completely. Apart from this, the suggestions being made in

this report may or may not be practically applicable in the all types of industries.

SCOPE:

The report comprises of various suggestions, regarding the proper management of the working

capital, at each and every step of the processes that are taking place at the FSW factory.

Suggestions for improving the overall efficiency of the plant, by improving the working capital

structure of the plant, have been provided. This is be done by suggesting ideas to improve

inventory management, receivables management and cash management processes; separately,

as well as collectively.

METHODS OF COLLECTING DATA AND THEIR SOURCES:

In most of the cases, the data is collected on the spot from the persons involved in the different

processes. As far as possible, I have tried to collect data by myself. I also tried to get involved

with people from various departments, right from Accounts & Finance Department to Planning

& Purchase Department, Stores Department, Marketing Department, Fabrication Department

and Personnel Department.

Apart from self-experimenting and observing, I constantly interacted with various employees

of the Company and gathered useful information on related matters, which were used in the

report as well as for my personal knowledge.

Various books and internet sites, including that of L&T itself, have also helped me a lot in

collecting data and understanding concepts.

Working Capital Management

Every business needs investment to procure fixed assets, which remain in use for a longer

period. Money invested in these assets is called ‘Long term Funds’ or ‘Fixed Capital’. Business

also needs funds for short-term purposes to finance current operations. Investment in short

term assets like cash, inventories, debtors etc., is called ‘Short-term Funds’ or ‘Working

Capital’. The ‘Working Capital’ can be categorized, as funds needed for carrying out day-

to-day operations of the business smoothly. The management of the working capital is

equally important as the management of long-term financial investment.

Every running business needs working capital. Even a business which is fully equipped with all

types of fixed assets required is likely to collapse, if it does not have;

a) Adequate supply of raw materials for processing;

b) Cash to pay for wages, power and other costs;

c) Creating a stock of finished goods to feed the market demand regularly; and,

d) The ability to grant credit to its customers.

Working capital is thus like the lifeblood of a business. The business will not be able to

carry on day-to-day activities without the availability of adequate working capital.

Working Capital management is concerned with the problems that arise in attempting to

manage the current assets, the current liabilities and the relationship that exists between them.

The current assets refers to those assets which in the ordinary course of business can be, or will

be converted into cash within one year without undergoing diminution in the value and without

disrupting the operations of firm. The major current assets are:-

Cash

Marketable Securities

Accounts Receivables

Inventory

The Current Liabilities are those liabilities which are intended, at their inception, to be paid in

the ordinary course of business, within a year, out of current assets or earnings of the concern.

The basic current liabilities are:-

Accounts Payable

Bills Payable

Bank Overdraft

Outstanding Expenses

The term Working Capital may be used in two different ways.

Gross Working Capital (or total Working Capital): The gross working capital refers

to the firm’s investment in all the current assets taken together. For example, if a firm

has a cash balance of Rs. 50000, debtors of Rs. 70000 and inventory of raw material

and finished goods has been assessed at Rs. 100000, then the gross working capital of

the firm is Rs. 220000.

Net Working Capital: The term net working capital may be defined as the excess of

total current assets over total current liabilities. The extent, to which these current

liabilities are delayed, the firm gets availability of funds for that period.

Gross Working Capital= Sum Total of Current Assets

= RM + WIP + FG + Debtors + Cash and Bank Balance

Net Working Capital= Difference between current assets and current

Liabilities

RM + WIP + FG + Debtors + Cash and Bank Balance

- Creditors – Direct wages - Overheads

The Operating Cycle and Working Capital Needs

The working Capital requirement of firm depends, to a great extent upon the operating cycle of

the firm. The operating cycle may be defined as the time duration starting from the

procurement of goods or raw materials and ending with the sales realization. The length

and nature of the operating cycle may differ from one firm to another depending upon the size

and nature of the firm.

In case of manufacturing concern, this series starts from procurement of raw materials and

ending with the sales realization of finished goods. There is a time gap between happening of

the first event and happening of the last event. This time gap is called the operating cycle.

Thus, the operating cycle of a firm consists of the time required for the completion of the

chronological sequence of some or all of the following:

i. Procurement of raw materials and services.

ii. Conversion of raw materials into work-in-progress.

iii. Conversion of work-in-progress into finished goods.

iv. Sale of finished goods (cash or credit).

v. Conversion of receivables into cash.

Figure:1 – Working capital Cycle

Explanation of diagram

Working capital cycle involves conversions and rotation of various constituents/components of

the working capital. Initially ‘cash’ is converted into raw materials. Subsequently, with the

usage of fixed assets resulting in value additions, the raw materials get converted into work in

process and then into finished goods. When sold on credit, the finished goods assume the form

of debtors who give the business cash on due date. Thus ‘cash’ assumes its original form again

at the end of one such working capital cycle but in the course it passes through various other

forms of current assets too. This is how various components of current assets keep on changing

Finished Goods

Debtors Raw material

Cash

Working Expenses

Creditors

Value Addition

Value Addition

Work in Process

their forms due to value addition. As a result, they rotate and business operations continue.

Thus, the working capital cycle involves rotation of various constituents of the working capital.

L&T’s Operating Cycle

The operating cycle of L&T is as follows:-

Procurement of raw material

The operating cycle for a company primarily begins with the purchase of raw materials, which

are paid for after a delay representing the creditor's payable period. L&T is a capital goods

manufacturer. Some raw materials are procured from outside, some manufactured by its own.

Sometimes it may happen that company needs product in the form of raw material

manufactured by its own SBU’s. In this case stock is transferred within the company but it

won’t be considered as actual sale and no sale tax levied but it is liable to pay excise duty since

excise duty is paid on production and it is the liability of manufacturer.

Conversion of Raw material into finished goods

These purchased raw materials are then converted by the production unit into finished

goods and then sold. The time lag between the purchase of raw materials and the sale of

finished goods is known as the inventory period.

Labor

Labor is vital for conversion of inputs into finished goods.

There are three types of labour here

Skilled Labor

Here a lob our hour rate is fixed and the number of hours required to perform that work

is determined and on the basis of this labor expenses are determined. This is treated as

fixed overheads.

Casual labor

This is not permanent labor. They are paid on daily basis to perform work of a non-

recurrent nature. They are sourced from the Contractors of the Company.

Vendoring

When there is a capacity constraint then a part of the work is done by vendors and the

parts manufactured by these vendors are assembled. This is also called job work

Conversion of Work-in-progress into finished goods

Sale of Finished Goods

Goods are sold either on cash basis or credit basis. Upon sale of finished goods on

credit terms, there exists a time lag between the sale of finished goods and the

collection of cash on sale. This period is known as the accounts receivables period

Conversion of Receivables into Cash

There are basically two ways available to vendors to pay their dues to L&T. These are:-

Cash Payment method

In this a vendor is supposed to clear his dues within a limited amount of time and mode

of payment must be highly liquid. The vendors can pay by demand drafts, pay orders,

or cheques of party which are subject to realization.

Channel Financing

Channel financing is used to receive fast money from debtors. Most of the firms

generally sells goods or services on credit and it takes a little time to realize. Hence,

receivables form an important part of working capital management.

Liquidity versus Profitability- A Risk-Return Trade off

Net Working Capital has bearing on Profitability as well as risk. The term Profitability

used in this context is measured by profits after expenses. The term Risk is defined as the

probability that a firm will become technically insolvent so that it will not be able to meet

its obligations when they become due for payment.

It is said that greater the amount of working capital the less risk prone the firm is

The decision on how much working capital be maintained involves a trade-off because having

a large working capital may reduce the liquidity risk faced by the firm, but it can have a

negative effect on the cash flows. Therefore, the net effect on the value of the firm should be

used to determine the optimal amount of working capital.

The goal of Working Capital Management is to manage current assets and liabilities in

such a way that a satisfactory level of working Capital is maintained.

The assessment of the working capital should be accurate even in the case

of small and micro enterprises where business operation is not very large. We know that

working capital has a very close relationship with day-to-day operations of a business.

Negligence in proper assessment of the working capital, therefore, can affect the day-to-

day operations severely. It may lead to cash crisis and ultimately to liquidation. An

inaccurate assessment of the working capital may cause either under-assessment or over-

assessment of the working capital and both of them are dangerous.

CONSEQUENCES OF UNDER ASSESSMENT OF WORKING CAPITAL

Growth may be stunted. It may become difficult for the enterprise to undertake

profitable projects due to non-availability of working Capital.

Implementation of operating plans may become difficult and consequently the profit

goals may not be achieved.

Cash crisis may emerge due to paucity of working funds.

Optimum capacity utilisation of fixed assets may not be achieved due to non-

availability of the working capital.

The business may fail to honour its commitment in time, thereby adversely affecting its

credibility. This situation may lead to business closure.

The business may be compelled to buy raw materials on credit and sell finished goods

on cash. In the process it may end up with increasing cost of purchases and reducing

selling prices by offering discounts. Both these situations would affect profitability

adversely.

Non-availability of stocks due to non-availability of funds may result in production

stoppage.

While underassessment of working capital has disastrous implications on business, over

assessment of working capital also has its own dangers.

CONSEQUENCES OF OVER ASSESSMENT OF WORKING CAPITAL

Excess of working capital may result in unnecessary accumulation of

inventories.

It may lead to offer too liberal credit terms to buyers and very poor

recovery system and cash management.

It may make management complacent leading to its inefficiency.

Over-investment in working capital makes capital less productive and

may reduce return on investment.

Working Capital: Policy

There is an inevitable relationship, between the sales and current assets. The actual and

forecasted sales have major impact on the amount of current assets which the firm must

maintain. So, depending upon the sales forecast, the financial manager should also estimate the

requirement of current assets.

There are three types of working capital policies which a firm may adopt i.e. moderate working

capital policy, conservative working capital policy, and aggressive working capital policy.

These policies describe the relationship between sales level and the level of current assets.

Current assets

Sales level

Conservative

Moderate

Aggresive

Figure 2 : Different types of working Capital

Policies

In case of moderate working capital policy, the increase in sales level will be

coupled with proportionate increase in level of current assets also e.g. if the sales

increase or expected to increase by 10%, then the level of current assets will also be

increased by 10%.

In case of conservative working capital policy, the firm does not like to take risk. For

every increase in sales, the level of current assets will be increased more than

proportionately. Such a policy tends to

reduce the risk of shortage of working capital by increasing the safety component of

current assets. The conservative working capital policy also reduces the risk of non

payment to liabilities.

In case of aggressive working capital policy the increase in sales does not result in

proportionate increase in current asset. For example, for 10% increase in sales the

level of current asset is increased by 7% only.

This aggressive policy has many implications-

The risk of insolvency of the firm increases as the firm maintains low liquidity.

The firm is exposed to greater risk as it may not be able to face unexpected change, in

the market

Reduced investment in current assets will result in increase in profitability of the firm

L&T and its Working Capital policy

L&T follows conservative working capital policy i.e. for every increase in sales

level the level of current assets will be increased more than proportionately. Such a

policy tends to reduce the risk of shortage of working capital by increasing the safety

component of current assets. This policy also reduces the risk of non payment of

liabilities.

RECEIVABLES MANAGEMENT

The term Receivables is defined as debt owed to the firm by customers arising from the sale of

goods and services in the ordinary course of business. Receivables are a type of loan extended

by the seller to the buyer to facilitate purchase process. When companies sell their products

they sometimes demand cash on delivery, but in most cases they sell goods on credit and allow

a delay in payment. The customers’ promise to pay for their purchases constitutes valuable

assets; therefore accountants enter these promises in their balance sheet as accounts

receivables. Most of the businesses today sell goods and services on credit and it takes times

for the receivables to realize. Hence Receivables management forms an important part of

working capital management.

Need of Receivables

The sale of goods on credit is an essential part of working capital management. Credit sale are

treated as marketing tool to aid sale of goods. As a marketing tool, they are intended to

promote sales and increase profits. Hence Receivables management assumes significance in

the context of overall working capital management.

Objective of Receivables management

In a competitive environment, sometimes the firms are compelled and sometimes the firms

desire to adopt liberal credit policies for pushing up the sales. Higher credit sales at more

liberal terms will no doubt increase the profits of the firm, but simultaneously also increases

the risk of bad debts as well as result in more and more funds blocking in the receivables.

Thus, the objective of receivables management is matching the cost of increasing sales with the

benefits arising out of increases sales with the objective of maximizing the return on

investments of the firm.

Cost of Receivables

i) Cost of Financing: The credit sales delays the time of sales realization and therefore the

time gap between incurring the cost and the sales realization is extended. The firm on the other

hand, has to arrange funds to meet its own obligation towards payment to supplier, employees,

etc. these funds are to be procured at some explicit or implicit cost. This is known as the cost of

financing the receivables.

ii) Administrative Cost: A firm will be required to incur various costs in order to maintain the

record of credit customers before the credit sales as well as after the credit sales.

iii) Delinquency Cost: This is the cost incurred if there is any delay in payment by a customer.

iv) Cost of default by Customers: If there is default by customers and the receivables

becomes, partly or wholly unrealizable, then this amount, known as bad debt also becomes a

cost to the firms.

Trade off on receivables

The trade off on receivables can be applied to find out whether to liberalize credit terms

or not. More liberal credit terms may be expected to generate higher sales revenue and higher

profits; but they increases the potential costs also as the chances of bad debts increases and

there will be decrease in liquidity of firms. On the other hand a stringent credit policy reduces

the profitability but may increase the liquidity of the firms. Thus, a firm should try to frame its

credit policy in such a way as to attain the best possible combination of profitability and

liquidity.

Costs

Administrative Costs

Delinquency costs

Default cost

Total cost of receivables

Cost of financing

Credit period (days)

Normal (20 days) Default (40 days)

Figure 4 : Credit Policy, Profitability and Liquidity of a firm

Determinants of Receivables

In any firm the quantum of receivables is determined by several factors.

1. The percentage of credit sales to total sales. Higher the sales higher will be the

receivables. But this is not under the control of financial manager.

2. The terms of sale i.e. the credit and collection policies. These also determine the

quantum of receivables. These are under the control of financial manager.

So, the receivable management must be attempted by adopting a systematic approach

and considering the following aspects of receivables management:

The Credit Policy

The Credit Control

Credit Policy

A firm makes significant investment by extending credit to its customers and thus requires a

suitable and effective credit policy to control the level of total investment in the receivables.

The basic decision to be made regarding receivables is to decide how much credit be extended

to a customer and on what terms. This is what is known as credit policy. The credit policy may

be defined as set of parameters and principles that govern the extension of credit to its

customers. This requires the determination of

i) Credit standard

ii) Credit terms

The Credit Standards: when a firm sells on credit, it takes a risk about the paying capacity of

the customers. Therefore to be on safer side, it must set credit standards which should be

applied in selecting customers for credit sales. The following points should be noted while

setting the credit standard for a firm:

Effect of particular standard on sales volume.

Effect of a particular standard on the total bad debts of the firm

Effect of a particular standard on the total collection cost.

Credit Terms: It refers to set of stipulations under which the credit is extended to the

customers. The credit terms specify how the credit will be offered, including the length of

the period for which the credit will be offered, the interest rate on the credit and the cost of

default.

Credit period: It refers to the length of time over which the customers are allowed to delay

payments.

Lengthening the credit period increases the sales by attracting more and more customers,

whereas squeezing the credit period has the distracting effect. The firm must consider the cost

involved in increasing the credit period which will result in increase in the investment in

receivables.

Discount terms: The customers are generally offered cash discount to induce them to make

prompt payments. Different discount rates may be offered for different periods e.g. 3%

discount if payment made within 10 days; 2% discount if payment made within 20 days. Both

the discount rate and the period within which it is available are reflected in the credit terms e.g.

3/10, 2/10, net 30 means

that a 3% cash discount if payment made within 10 days ; 2% discount if payment made within

20 days; otherwise full payment by the end of 30 days from the date of sale.

Practical Implementation

CREDIT TERMS:

Credit Period- The credit period at L&T is not constant. For some vendors, it is 30

days, for others, it may be 45 days or 60 days. This depends entirely on company’s policies. It

can be different for different vendors.

Cash discount- The cash discount offered by L&T is 2% to 1.75%, depending upon

cash discount period.

Cash discount period- The cash discount period allowed by L&T is 1 to 3 days.

This can be summarized as follows:

Credit Discount Period

(days)

Credit Discount

(%)

1 2

3 1.75

30/45/60 0

There are basically two ways available to vendors to pay their dues to L&T. These

are:

Cash:

In cash payment method, a vendor is supposed to clear his dues within a limited

amount of time. And the mode of payment must be highly liquid (Cheque or Demand Draft).

There are three options available with the vendors:

i) Blank Cheque Arrangement: In Blank Cheque arrangement, the vendors provide L&T blank

Cheques drawn on the name of L&T. As soon as the material is received and invoice is

generated, L&T is allowed to fill the relevant amount pertaining to the transaction that took

place between L&T and its vendor. This Cheque can be

cleared on the same day the invoice is generated.

ii) Cheque Arrangement: In simple Cheque arrangement, on

generation of invoice, a cheque is issued by the vendor drawn on

the name of L&T.

iii) Demand Draft (D.D.): Here, a demand draft is drawn on the name

of L&T, by the vendor, as soon as invoice is generated.

Control of Receivables

Once the credit has been extended to a customer as per credit policy, the next important step in

the management of receivables is the control of receivables. The things to be taken into

consideration are:-

1. The collection Procedure: The firm should have a built in system under which customer may

be reminded a few days in advance about the bill becoming due.

The collection procedure of the firm should neither be too lenient nor too strict. A strict

collection policy can affect the goodwill and damage the growth prospects of the sales. If the

firm has a lenient credit policy, the customers with a natural tendency towards slow payment

may become even slower to settle his accounts. Thus, the objective of collection procedure and

policies should be to speed up the slow paying customers and reduce the incidents of bad debts.

2. Monitoring of Receivables:-

The financial mangers should keep a watch on the credit worthiness of all the individual

customers as well as the total credit policy of the firm.

A common method to monitor receivables is the collection Period or number of day’s

outstanding receivables.

Average collection period= Average Receivables

Credit sales per day

Another technique for monitoring the Receivables is known as aging schedule. The quality of

the receivables of a firm can be measured by looking at the age of receivables. The older the

receivables, the lower is the quality and greater the likelihood of a default. In the aging

schedule, the total outstanding receivables on particular days are classified into different age

groups together with percentage of total receivables that fall in each age group.

For example, the receivables of a firm, having a normal credit period of 30 days may be

classified as follows:

Age Group %of total outstanding

(Number of Days) Receivables

Less than 30 days 60%

31-45 days 20%

46-60 days 10%

61 and above 10%

Here the firm has a credit period of 30 days and 60% of the total receivables are less than 30

days old. 20% of the receivables are over due by 15 days, 10% of the receivables are overdue

but 30 days and 10% are over due by more than 30 days.

This type of aging schedule can provide a kind of an early warning suggesting

i) Deterioration of receivables quality

ii) Where to emphasize the appropriate corrective actions

3. Lines of Credit: It is the maximum amount a particular customer may have as due to the

firm at any time. Different lines of credit may be allowed to different customers. As long as the

customer’s unpaid balance remains within this maximum limit, the account may be routinely

handled. However if new order is going to increase the indebtedness of a customer beyond his

line of credit, then the case must be taken for an approval for a temporary increase in the line

of credit.

4.Accounting Ratios: Two accounting ratios may be calculated in particular may be calculated

to find out the changing pattern of receivables. These are

i) Receivables Turnover Ratio

ii) Average collection Period

Both the ratio should be calculated on a continuous basis to monitor the receivables. The ratios

so calculated for the firm must then be compared with the standard for that industry or with

past ratios of the same firm.

Channel Financing

Channel financing is different from the conventional lending since, in conventional

lending, the financing banks are generally not concerned as to how the suppliers of the firm

and dealers of the products of firm, are financing their activity. The weak financials of the

supplier (leading to delay in supply and non-availability of market credit) or the dealers of the

products (delay in receipt in payment leading to higher book debts) could adversely impact the

top-line(sales) as well as bottom-line(profits) of the financed firm. In the channel financing the

financing bank may have to find ways and means as to how the suppliers and buyers (dealers

of the product) can be financed through various instruments/facilities. Hence, the channel

financing adds value to the transaction for all the parties concerned, be it the

manufacturer/trader, the supplier of the inputs or the dealer/buyer or the financing bank.

Through channel financing, the business firms can out-source a major part of their

working capital needs thereby reducing their dependence on bank finance. For instance, it

need not avail of credit from its bank to pay off the supplier if the supplier gets the finance in

his own name from the bank for the raw materials supplied on credit in the form of say, drawee

bills financing. The bank can also allow loan to the dealer for the credit term that has been

fixed between the firm and the dealer in the form of receivable finance or finance against book

debts or factoring of the receivables. This enables the manufacturing firm to get cash

immediately for the finished goods supplied. . Thereafter, the bank makes a due diligence

assessment of the suppliers’/dealers’ standing and credit worthiness and decides to

provide finance on merit.

A simplified channel finance solution is as follows:-

Figure:-5

Step1: Supply of goods from Corporate to Channel Partner.

Step2: Advice to ABN AMRO to make payment for the purchase.

Step3: Payment by ABN AMRO for goods purchased by Channel Partner.

Step4: Repayment by Channel Partner to ABN AMRO Bank as per facility term.

Channel Finance Benefits to Corporate:

Assured availability of finance to their Channel Partner's at lower than current cost.

Corporate can use this as a Marketing tool and strengthen their relationship / reward

loyalty of the Channel Partners

Release of funds from the balance sheet resulting in improvement in financial ratios.

Conversion of balance sheet item to an off balance sheet liability.

Greater efficiencies in the Corporate's receivable management and cash management

process.

Ability to introduce payment discipline with their Channel Partners

Channel Finance Benefits to Channel Partners:

Steady and cheaper source of working capital financing.

Channel Partners can increase sales through higher purchasing power.

Simplicity of documentation and approval procedures.

High service and delivery standards compared to current neighborhood banker.

Channel Partners may be able to increase profitability by availing of Cash discounts

from Corporate.

Channel finance benefits to banks:

Increased customer base

Since, the risk is diversified through finance to supplier, manufacturer and the dealers,

the credit exposure norms are better observe

Practical Implementation

The practice of channel financing is followed in L&T to a great extent and the company is

benefiting a lot through this system of collection of debtors.

The banks which provide Channel Financing facility to L&T are:-

ICICI bank

Deustche bank

Payable Management

As the firm sells goods on credit it may also procure/purchase raw material and finished goods

on credit basis. The payment for these purchases may be postponed for the period of credit

allowed by suppliers. So, the supplier of the firm in fact provides working capital to the

firm for the credit period.

For example, a firm makes a credit purchase of Rs. 60000 per month and the credit allowed by

supplier is two month, then the working capital supplied by creditors is Rs. 120000 (i.e. Rs.

60000*2months). It means the firm would be getting the supplies without however, making the

payment for two months. The postponement of payment to the creditors makes the firm to

utilize this money elsewhere or help the firm to sell on credit without blocking its own funds.

Since, Working Capital is the difference between current assets and current liabilities

and creditors form an important part of current liabilities. So, a firm can save a

considerable amount if these creditors are managed. The extent, to which the payment to

these current liabilities is delayed, the firm gets the availability of funds for that period. So, a

part of the funds required to maintain current assets is provided by current liabilities and the

firm will be required to invest the funds in only those current assets which are not financed by

current liabilities. So, the aim of the firms is to realize its debtors as fast as possible but too pay

its creditors as late as possible.

Creditors can be managed by discounting of bills.

Bill Discounting is a relatively new concept in India. When a firm buys goods on credit the

supplier will state a final payment date . To encourage firm to pay before final payment date ,

the supplier will offer a cash discount for prompt settlement. Now it’s the decision of firm

whether to avail or not that discount facility provided by supplier. For that they should see

whether it is profitable for them or not.

By using discounting of bills technique huge sums of money can be saved, by just paying the

discounted amount in time. Big firms, ( like L&T), which have huge cash reserves, generally,

get into a contract with financial institutuions or banks( like ICICI bank or L&T finance Ltd.).

These financial institutions pay the suppliers the requisite amount on behalf of these firms and

they charge some interest on the amount paid by them to the suppliers from these firms.

Benefits of Discounting of Bills

Discounting of Bills make it easy to decide whether the discount being allowed by the

supplier is worth taking or not.

Also, it make possible to calculate savings being received on account of availing

discount, in monetary terms

It also helps in improving relationship between vendors/suppliers.

It’s an indirect cash inflow , because the company is going to pay less than what it was

supposed to pay initially

The cash thus saved can be invested elsewhere.

It’s a win-win situation for both-the company as well as suppliers as the suppliers will

be getting money much before the stipulated time and the company is able to enjoy the

benefits of discount offered by the suppliers.

PRACTICAL IMPLEMENTATION

L&T uses bill discounting technique with all its major suppliers. For this L&T has arrangement

with L&T finance, which pays its suppliers on behalf of l&T within the time stipulated ( that is,

the time period for which the discount is allowed)

Here, is the cost benefit analysis ‘for discounting of bills’ done by Faridabad Switchgear

(FSW) with its various supplier. This is discounting for the bills whose due date was july

2007

Name of the party Gross amt(Rs)

Tenor(days) Rate of int. .

Int for 90 days

Discount amt 60/75 days

Interest for 60/75 days Savings

Credit period

Sangeeta Industries

555,066.33 90 10.50% p.a.

14,211.22 10081.71 9474.15 607.56

60 days

M/S. U.K.Industries

367,656.75 90 10.50% p.a.

9,413.02 6519.15

6,275.35 243.8033

60 days

Manju Plastics 82,813.95 90 10.50% p.a.

2,120.26 1695.74

1,413.51 282.2307

60 days

Ace Cable Industries Pvt. Ltd.

475,909.53 90 10.50% p.a.

12,184.59 10916.59

10,158.82 757.77

75 days

M/s Dishant Impex Pvt. Ltd.

200,227.98 90 10.50% p.a.

5,126.38 4089.59

3,417.59 672.0001

60 days

M/s Rakesh Steels

115,901.18 90 10.50% p.a.

2,967.39 2365.33

1,978.26 387.0715

60 days

Sangeeta Industries

894,013.51 90 10.50% p.a.

22,374.83 16238.07

14,916.55 1321.516

60 days

Manju Plastics 30,721.41 90 10.50% p.a.

768.88 629.35

512.58 116.7654

60 days

Sangeeta Industries

866,733.70 90 10.50% p.a.

22,190.76 15742.65

14,793.84 948.8118

60 days

Sangeeta Industries

968,843.17 90 10.50% p.a.

24,805.04 17592.36

16,536.69 1055.667

60 days

Dhiman Industries

319,278.99 90 10.50% p.a.

8,174.42 6545.41

5,449.61 1095.799

60 days

Ace Cable Industries Pvt. Ltd.

894,587.45 90 10.50% p.a.

22,903.89 20492.24

19,086.57 1405.67

75 days

Dhiman Industries

319,278.99 90 10.50% p.a.

8,082.57 6545.41

5,388.38 1157.03

60 days

M/S. U.K.Industries

306,004.77 90 10.50% p.a.

7,834.56 5418.49

5,223.04 195.4497

60 days

Sangeeta Industries

566,092.83 90 10.50% p.a.

14,493.53 10272.3

9,662.35 609.9484

60 days

Dhiman Industries

524,373.81 90 10.50% p.a.

13,425.41 10735.5

8,950.27 1785.229

60 days

Ace Cable Industries Pvt. Ltd.

418,254.89 90 10.50% p.a.

10,347.51 9508.92

8,622.92 886

75 days

Sangeeta Industries

668,889.28 90 10.50% p.a.

17,125.40 12149.09

11,416.93 732.1579

60 days

Sangeeta Industries

1,447,999.81 90 10.50% p.a.

37,072.76 26264.94

24,715.17 1549.767

60 days

M/S. U.K.Industries

99,693.51 90 10.50% p.a.

2,466.39 1765.31

1,644.26 121.0499

60 days

Sangeeta Industries

558,812.70 90 10.50% p.a.

13,824.87 10148.69

9,216.58 932.1079

60 days

Ace Cable Industries Pvt. Ltd.

351,855.38 90 10.50% p.a.

8,806.02 8059.91

7,338.75 721.16

75 days

Sangeeta 90 10.50% p.a. 12809.29 704.8593 60

Industries 717,226.82 18,156.65 12,104.43 daysDhiman Industries

447,326.18 90 10.50% p.a.

11,324.09 9157.84

7,549.40 1608.445

60 days

Ace Cable Industries Pvt. Ltd.

321,701.05 90 10.50% p.a.

8,143.88 7369.17

6,786.56 582.61

75 days

Dhiman Industries

826,501.04 90 10.50% p.a.

21,160.69 16920.49

14,107.13 2813.363

60 days

M/S. U.K.Industries

347,748.30 90 10.50% p.a.

8,903.31 6157.62

5,935.54 222.0805

60 days

Sangeeta Industries

1,760,117.86 90 10.50% p.a.

45,063.84 32925.46

30,042.56 2882.9

60 days

Sangeeta Industries

1,135,943.94 90 10.50% p.a.

29,083.28 20609.65

19,388.85 1220.799

60 days

M/s Dishant Impex Pvt. Ltd.

56,664.74 90 10.50% p.a.

1,450.77 1157.36

967.18 190.1783

60 days

Ace Cable Industries Pvt. Ltd.

226,255.76 90 10.50% p.a.

5,792.77 5182.81

4,827.30 355.51

75 days

Ace Cable Industries Pvt. Ltd.

214,031.75 90 10.50% p.a.

5,295.09 4902.81

4,412.58 490.23

75 days

Sangeeta Industries

917,123.21 90 10.50% p.a.

22,689.38 16637.54

15,126.25 1511.289

60 days

Manju Plastics 30,660.32 90.00 10.50% p.a.

758.53 627.66

505.69 121.9747

60 days

Net Savings 30288.8

Table:- Discounting of Bill

We can see that discount be availed is more than interest being paid. Therefore, it is beneficial for the company to convert their suppliers through bill discounting route.

This table is just a part of whole document which clearly signifies the importance of discounting of bills. We can observe that just for the bills whose due date is on july we can have a savings of Rs. 30288.8.

A table depicting summary of savings which L&T was able to make, using bill discounting, for the year ended 31 st

March 2007 is given below:-

S.No. Drawer No. Of Bills Savings1 Ace cables Industries Ltd. 63 73562.792 Bestech Electricals 4 1993.933 Dhiman Industries 9 -1063.324 Dishant Impex Pvt. Ltd 31 -11882.605 Manju Plastic 26 1283.786 Rakesh steels 17 -28211.217 Sangeeta Industries 82 67963.598 Trident Switchgears Pvt. Ltd. 8 2426.449 U.K. Industries 37 -12168.9910 Wheels Polymers Pvt. Ltd. 8 33685.33Total 285 127589.74

Table – Discounting of Bills – Overall Savings

Inventory Management

The Dictionary meaning of Inventory is 'a list of goods'. In a wider sense, inventory can be defined as an idle resource which has an economic value. It is however, commonly used to indicate various items of stores kept in stock in order to meet future demands.

Inventory is assets to the firm and requires investment and hence involves the

commitment of firm’s resources. The inventories need not be viewed as an idle asset

rather these are an integral part of firm’s operations.

Inventory refers to stockpile of products that a firm is offering for sale and the

component that makes up the product. We can also say that inventory is composed of

assets that will be sold in the future in the normal course of business. But the question

arises how much inventory be maintained? If the inventories are too big, they become

strain on the resources; however, if they are too small, the firm may loose sales.

In any organization, there may be following four types of inventory:

(a) Raw materials & parts-- These may include all raw materials,

components and assemblies used in the manufacture of a product;

(b) Consumables & Spares -- These may include materials required

for maintenance and day-to-day operation;

(c) Work in progress -- These are items under various stages of

production not yet converted as finished goods;

(d) Finished Products -- Finished goods not yet sold or put into use.

Need For Inventory

Every organization needs to maintain a minimum amount of inventory so as to fulfill its

customer’s demands. Also, the organizations foresee future demand and they plan their

inventory levels accordingly. These reasons can be classified as:

Transactionary motive: to meet the day to day requirements of sales, production

process, customer demand etc.

Precautionary motive: A firm should keep some inventory for unforeseen circumstances

also.

Speculative Motive: The firm keep some inventory in order to capitalize opportunity to

make profit.

Objectives of Inventory management

a. To ensure a continuous supply of raw materials to facilitate uninterrupted

production.

b. To maintain sufficient stock of raw materials in periods of short supply and

anticipate price changes.

c. To control inventory investment by maintaining optimum Inventory.

d. To minimize investment in inventory and to ensure maximum turnover of

inventory in an accounting period.

e. To ensure stocking of relevant materials in adequate quantities and to ensure that

unwanted or slow- moving items and/or non-moving items do not pile up.

f. To minimize inventory carrying costs in business- both ordering cost and carrying

cost.

g. To eliminate waste and delays in the process of manufacturing at all stages so as

to reduce inventory pile up.

h. To ensure adequate and timely supply of finished goods to the market through

proper distribution.

Cost of holding Inventory

Every firm maintains some stock of raw materials, work-in-progress and finished goods

depending upon the requirement and other features of the firm. It is benefited, by holding

inventory but there is cost involved with it. had these cost not there, there would not have

been any problem of inventory management and every firm would have maintained

higher and higher level of inventories. The cost of holding inventory includes the

following:-

Ordering Cost- The cost associated with the acquisition or ordering of inventory

is known as ordering cost. Firms have to place order with suppliers to replenish

inventory of raw materials. Such expenses involved are referred to as ordering

cost. The ordering cost may have fixed component which is not affected by the

order size; and a variable component which changes with the order size. It

includes:

o Carriage Inward

o Insurance Inward

o Communication cost

o Stationary Cost

o Demurrage Charges

Ordering Cost= (A*O)/Q

where, A= Annual Requirement of a particular material in units or numbers

or kgs.

O= Ordering cost per order

Q= Lot size, in units

Carrying Cost:

The very fact that the items are required to be kept in stock means additional expenditure

to the organization. The different elements of costs involved in holding inventory are as

follows:

(a) Interest on capital / cost of capital / opportunity costs

(b) Obsolescence and depreciation

(c) The cost of storage, handling and stock verification

(d) Insurance Costs

The average inventory carrying costs can, therefore, be as follows:

Interest/costs of capital/opportunity cost 15 to 25%

Obsolescence and depreciation cost          2 to 5%

Storage, handling etc.                      3 to 5%

Insurance costs                             1 to 2%

Total                                        21 to 37%

Carrying Cost is calculated by:

Carrying Cost= ( C*O)/Q

where, C is carrying cost

Stock-out Cost (A Hidden Cost):

A stock out is a situation when the firm is not having units of an item in store but there is

demand for that either from the customers or production department. There is always a

cost of stock out in the sense that the firm faces a situation of lost sales or back orders.

Some examples are:

o Non availability/ small amount available with vendors

o Non availability of substitutes

o Quality desired not matching with the supplied ones

o Updated or improved product not available.

Total Cost

The total cost associated with inventory is the sum of ordering and carrying cost i.e.

Total cost= Carrying Cost+ Ordering Cost

= C*O/Q + A*O/Q

One Underlying principle should be kept in time that ordering cost and carrying cost are

inversely related to each other. Suppose the ordering cost increases because more number

of times the order is repeated, a direct consequence would be reduction in inventory held

and hence carrying cost would be less. Conversely, if the number of order is less, this

means that average value of inventory held is higher with the consequence of higher

inventory carrying cost.

Techniques used for inventory management

The finance department of every organization aims at maintaining an optimum level of

inventory on the basis of the trade-off between cost and benefit to maximize the owners

wealth. There are various tools for effective inventory management. The tool depends

upon the type of inventory, namely materials, work-in-progress or finished goods. some

of these tools have an impact not only on inventory but on whole structure of the

organization. They help in reducing cost and improving the efficiency of organization as

a whole.

Perpetual Inventory Verification

This is done to check out actual inventory level and is done on a continuous basis. In

PIV method, the amount of inventory is checked both in documents as well as stores.

Here, some items are checked randomly and while checking those items issues and

receipt of those items is stopped we can say that these items are brought to freezing state.

The database which, ideally, should be refreshed simultaneously whenever there is a

change in inventory and it should match with physical inventory level. Practically, these

two numbers rarely match. This happens because of various reasons, which may or may

not be under the control of management.

Some of the reasons for mismatch are:

Delay in entering data

Technical Errors (intranet or SAP not working)

Documentation Error (document not submitted)

Posting Error

Material issued but document not processed

Document processed but material not issued

Material send for job work but not received effectively

Pilferage

Material waiting for quality check

Benefits Of Perpetual Inventory Verification

a. The exact amount of inventory present in the plant can be checked.

b. Checking it against the database of the stores can give us a fair idea about

how efficiently the system is working

c. Any faults in the system, regarding the errors associated with updating of

database of stores department can be traced.

Practical Implication

At L&T also PIV is done on a continuous basis it may be monthly, quarterly or 6

monthly. Some items are picked randomly and the selection takes into consideration that

an item should be checked at least once in a year. The item selected are counted

physically and, is then, matched against the database of store’s department. In case of any

discrepancies the root cause of mismatch are explored, and is minimized as far as

possible.

L&T maintains a list of ABC items. For PIV some items are randomly selected.

In the picture below these 24 items are selected for PIV and the quantity for each item as

it is in the database is shown.

Figure 6 – Selection of items for PIV

Now the list of items is sent to stores department where they check the database

inventory with physical inventory. Then the stores department sends the list back after

verification and find out the difference it its there.

Recommendations

PIV should be done as frequently as possible.

It should be made sure that data is updated from time to time that is as soon as

material is issued or received, corresponding data should be updated on the plant

database.

Unless or until data is entered no material should be issued or received.

ABC Analysis

This is done to solve classification problem. The most important thing in inventory

control management is classification of different types of inventories to determine the

type and control required for each. The ABC analysis is based on the assumption that

same degree of control should not be exercised on all items of inventory. The ABC

analysis classifies various inventory items into three sets of groups of priority and

allocates managerial efforts in proportion of the priority. The most important items are

classified as class ‘A’ , those of intermediate importance are classified as class ‘B’ and

the remaining items are classified as class ‘C’.

The financial Manager should monitor different items belonging to different groups in

that order of priority. Utmost attention is required for class ‘A’ items, followed by

items in class ‘B’ and then items in class ‘C’.

This is done based on the experience

That 10% of items in the inventory accounts for 70% of consumption in value so they are

classified as ‘A’ class items

20% of items in the inventory account for 20% of consumption in value so they are

classified as ‘B” class items

70% of the items in the inventory accounts for 10% of consumption in value so they are

classified as ‘C’ class items.

Table :- ABC Analysis Benefits Of ABC analysis

It serves as a tool for classification for inventory.

Each item can be given appropriate attention as per classification.

Limitations of ABC analysis

This system suffers from major drawback. An item of inventory may not be very

expensive, but may be very critical to production process and/ or may not be easily

available; still it will be classified under group ‘C’. It would require serious attention but

due to this classification, it will receive less attention. Similarly a not very important

component may receive extra attention then it deserves . In either case it is detrimental to

the growth of the company. This is a serious limitation of ABC analysis.

Practical Implementation

ABC analysis is strictly followed in L&T. It keeps an eye ion those items which are more

crucial for production process than others, such items are given due attention so that there

is neither an excess nor deficit of such materials. On the other hand there is not much to

worry about class B and class C items. There are around 7000 items which are

categorized as A, B, and C items.

Class No Of

Items (%)

Inventory

Value (%)

A 10 70

B 20 20

C 70 10

Total 100 100

Economic Order Quantity Model:

This is to solve order quantity problem.

After ABC analysis we get to know which item deserves how much attention. The next

Problem is to determine the lot size in which a particular item of inventory will be

required. The importance of effective inventory management is directly related to size of

the inventory. A firm should neither place too large or too small orders. The inventory

management basically focuses on maintaining an optimum level of inventory in order to

minimize the cost attached with different inventory levels.

The optimum level of inventory is known as Economic Order Quantity (EOQ) or

Economic lot size. This refers to that quantity per order, which ensures that total of

carrying and ordering cost is minimum.

The approach to determine EOQ is based on the following assumptions:-

The total usage of particular item for a given period (usually a year) is known

with certainty and the usage rate is even throughout the year.

There is no time gap between placing an order and getting its supply

The cost per order of an item is constant and the cost of carrying inventory is also

fixed and is given as a percentage of average value of inventory.

There are only two costs associated with the inventory, and these are the cost of

ordering and the cost of carrying the inventory.

EOQ is generally used to determine the order quantities of class ‘C’ items and

sometimes for class ‘B’ items also. This method is rarely used for class ‘A’ items because

class ‘A’ items are ordered only when requirement arises, there is no need to keep

inventory of class ‘A’ items.

The formula for estimating EOQ is:

EOQ= √ (2A*O)/C

Where, A = annual requirement of a particular material in units or numbers

Or Kgs

O = Ordering cost per order

C = carrying cost per unit

Figure 7 :- Graphical Presentation Of EOQ Model

Explanation

The figure shows that the total ordering cost for any particular item is decreasing as the

size per order is increasing. This will happen because with the increase in the size of

order, the total number of order for a particular item will decrease resulting in decrease in

the order cost. The total annual carrying cost is increasing with the increase in order size.

This will happen because the firm would be keeping more and more items in the stores.

However, the total cost of inventory (i.e. the total carrying cost + the total ordering cost)

initially reduces with the increase in size of order. The trade-off of these two costs is

attained at the level at which the total amount of cost is least. At this particular level the

order size is designated as the economic order quantity. If the firm places the orders for

that item of this economic order quantity, then the total annual cost of inventory of that

item will be minimized.

Benefits of EOQ

It makes sure that there is neither an excess nor deficit of inventory.

It saves cost as it saves carrying and ordering cost.

It also results in strong relationship with vendors.

It results in saving of time.

Practical Implication

EOQ is a relatively old technique for assessing the lot size of the order. Moreover, it

suffers from the disadvantage that the order cost is assumed to be uniform during a

particular period. The main point of problem in calculating EOQ is regarding the

estimation of ordering and carrying costs. Because there are no set rules to find exact

storage cost, maintenance cost etc. Since the production unit of L&T is involved in

manufacturing of tailor-made products, assessment of EOQ is not very relevant for this

kind of business line. However, the general usage items like nuts, bolts, crimps, wires,

batons, nails, lubricants, gaskets etc. are common for all types of items. Hence, it may

have restricted application in the FSW plant.

EOQ is estimated on the basis of prior experience and future requirements. This happens

so because it is very difficult to classify to calculate storage and maintenance costs. They

have to be estimated because there are no provisions available to calculate them. To

prove the usefulness of this method, some arbitrary costs (ordering cost and carrying

cost) are assumed. Accordingly, EOQ is calculated to show how this model works and

how it can be useful in maintaining proper inventory levels.

I

ITEM EOQ

SL98354BOOOS 219

CS94314KOOOS 237

SL97299OMOOS 327

SH97609OOKOS 245

SH97608OOMOS 258

Table – Economic Order Quantity

RECOMMENDATIONS:

Provisions to calculate EOQ must be made because a guess work may

prove to be wrong.

At first, the total cost involved in ordering, transporting, procurement,

storage and maintenance must be calculated. Than, a part of this

(say 20%) should be taken as carrying cost and rest as ordering cost.

Reorder point (under certainty conditions): To solve order point

problem:

Reorder point is that level of inventory at which an order should be placed for

replenishing the current stock of inventory. It may be defined as level of inventory

when fresh order should be placed for procuring additional inventory equal to the

economic order quantity. It is the inventory level which is equal to consumption during

the lead time.

Reorder point is calculated as:

Rρс = L*U

Where, L = Lead time (in days)

U = Average daily usage of inventory

Benefits of reorder point

It makes sure that plant does not run out of stock in any given day.

It makes it easier to keep track of inventory and to know when exactly next lot of

material is needed.

PRACTICAL IMPLEMENTATION:

Practically, reorder point is not calculated at L&T. Trends of requirements of various

items are observed and accordingly order point is estimated for different items. Here the

problem is in estimating exact lead times and average daily usage of inventory. The

difficulty in estimating lead time is that it is never fixed and also, it depends not only on

the material, but also on the supplies and his geographical location. A material which can

be ordered from different suppliers may have different lead times. As far as average daily

usage of inventory is concerned, the fact is that L&T follows engineered-to-order

business, i.e. it manufactures according to immediate demands. So, it becomes difficult to

estimate average daily usage of inventory. The demands keep fluctuating day-by-day.

To emphasize on the importance of reorder point, a calculation based on assumed lead

times and average daily usage of inventory is done. This can prove to be helpful in

implementing reorder point at L&T.

ITEM Rc

SL98354BOOOS 100

CS94314KOOOS 180

SL97299OMOOS 150

SH97609OOKOS 144

SH97608OOMOS 120

RECOMMENDATIONS:

Reorder point is a useful tool and hence, should be implemented. It will make sure

that the plant does not run short of inventory for even a single day.

Lead times should be estimated based on both – the type of material and the

supplier.

Safety stock: To overcome unexpected situations

The EOQ and the reorder point have some assumptions, which are not possible

practically. For instance, the demand for inventory is like to fluctuate from time to time.

The demand may exceed the anticipated level.

Similarly, the receipt of inventory from the suppliers may be delayed beyond the

expected lead time. The delay may be due to strikes, floods, transportation, and other

bottlenecks. To avoid such undesirable situations safety stock is maintained.

Safety Stock may be defined as the minimum additional inventory to serve as a

safety margin or buffer or cushion to meet an unexpected increase in usage resulting

from an unusually high demand and/or an uncontrollable late receipt of incoming

inventory.

Benefits of Safety Stock

It is useful as it makes sure that even after reorder point is passed, the plant is able

to maintain its immediate demand.

It acts as a buffer.

It is an effective tool to minimize shortage cost.

PRACTICAL IMPLEMENTATION:

The determination of the optimum safety stock involves dealing with uncertain demand.

The first step, therefore, is to estimate the probability of being out of stock as well as the

size of stock-out in terms of the shortage of inventory at different levels of safety stock.

To give an overview of the whole process, I calculated safety stock of a few items based

on certain assumptions regarding the stock-out acceptance factor, average number of

units per order, average daily usage of inventory and lead time.

ITEM Ss

SL98354BOOOS 156

CS94314KOOOS 256

SL97299OMOOS 213

SH97609OOKOS 187

SH97608OOMOS 209

Table – Safety Stock

Lean Manufacturing

There are many hidden wastes in any organisation . To get rid of these hidden wastes we

need to first unhide them. The best way to do this is to have a VISUAL FACTORY

where there is nothing hidden . Lean Manufacturing is a tool to enable us to achieve this

objective

Fundamentals of Lean Manufacturing :

1. Smooth flow of Material & Information to meet on demand service to customers

but without having to hold high inventories .

2. Elimination of hidden wastes .These wastes fall into seven basic categories :

a. Over Production

b. Defects/Rework

c. Motion

d. Transportation

e. High Inventory

f. Over processing &

g. Waiting

3. To achieve waste elimination , workplace organization using the 5 S System is

necessary:

a. Sort ... Remove unneeded items

b. Set –in – order... A place for everything and everything in its place (PEEP)

c. Shine ... Clean enough to inspect and expose any defect .

d. Standardize.. Create instructions and Standard Operating procedures

e. Sustain... Maintain the above through support and encouragement

4. Reducing Lead Time at every stage of every process through

a. Visual Controls using Kanban cards

b. Receiving material just in time (JIT).

c. Line Balancing to avoid up piling up of material at any stage.

d. Studying the flow of material or Value Stream Mapping.

e. Total Productive Maintenance to improve overall operation of the

equipment.

f. Set up time reduction using SMED (single minute exchange of dies ).

Lean manufacturing is a management philosophy focuses on reduction of the seven

wastes to improve overall customer value. Lean management (also known as Big JIT)

is a philosophy of operations management that seeks to eliminate waste in all aspects of

aspects of firm’s production activities: human relations, vendor relations, technology and

management of materials and inventory.

BY eliminating waste quality is improved, and automatically, production time and cost

are reduced. To solve the problem of waste lean manufacturing has several tools at its

disposal. All of these tools aim at reducing wastes, of one of several types, as far as

possible.

Some of the tools of lean manufacturing which helps in inventory management and

control are:-

Just In time ( right amount in the right place at right time)

Kaizen ( continuous improvement process)

Kanban (pull production)

Single Piece Flow System

Gemba Walking

Virtual Storage

Lean Manufacturing can be achieved by implementing following tools:

Just in Time Concept:

The basic philosophy behind JIT is that the firm should keep minimum level of inventory

on hand relying on suppliers to furnish ‘stock’ ‘just in time’ as and when required. This is

in direct contrast to the traditional inventory philosophy which emphasizes keeping

sufficient levels of safety stocks to ensure that production will not be interrupted.

Thus JIT system benefits in two ways:-

By reducing the ordering cost. This is attempted by locating inventories supplies in

convenient locations.

By reducing the safety stock . This is attempted by developing a strong relationship

with suppliers and setting up restocking strategies that cut time.

Practical Implementation

Just-in-time is implemented, nearly, at each and every stage of manufacturing/production

in the plant. Stores Department and Fabrication Departments are the main users of this

technique.

While manufacturing switchboards, earlier, for an order of say 1000 items in three

months period, one part of the whole manufacturing was done and than other steps took

place. So, inventory of material used to pile up. Also, the different parts used to lie

scattered here and there.

After implementation of JIT, the process is done such that all the steps are taken

simultaneously. So, material keeps moving. Moreover, provisions are made so that all the

parts of a product are kept together.

Procurement of packing cases is another good example of implementation of JIT

concept in L&T. All the finished goods need to be packed in wooden packing cases (also

known as crate packing cases).

There are certain issues related to wooden packing cases:

They are bulky and over-sized.

They have storing constraints.

Dryness of wood up to a specific point is allowed (if the wood gets drier, it

becomes very difficult to pierce nails in it).

So, in order to avoid all these problems, what best can be done is – as soon as the

material is about to complete, the Final Assembly Department informs it to Packing and

Purchase Department. Now, packing and Purchase Department gets ready with their

wooden packing materials, just-in-time as the finished goods are received by them.

RECOMMENDATIONS:

All the workers, especially those who are working in Fabrication

Department, Stores Department and Purchase Department, must be

given proper training regarding the practical implementation of JIT.

Any sort of delay between any two processes should be minimized as far as

possible. Any kind of idle time should not be allowed.

Another point that must be kept in mind is that, right amount of material should

pass from one stage to the other. There is no need to pile-up materials, which are

not going to be used immediately.

Kanban System

The Japanese refer to Kanban as a simple parts-movement system that depends on cards

and boxes/containers to take parts from one work station to another on a production line.

Kanban stands for Kan- card, Ban- signal. The essence of the Kanban concept is that a

supplier or the warehouse should only deliver components to the production line as and

when they are needed, so that there is no storage in the production area. Within this

system, workstations located along production lines only produce/deliver desired

components when they receive a card and an empty container, indicating that more parts

will be needed in production. In case of line interruptions, each work-station will only

produce enough components to fill the container and then stop. In addition, Kanban limits

the amount of inventory in the process by acting as an authorization to produce more

inventory. Since Kanban is a chain process in which orders flow from one process to

another, the production or delivery of components are pulled to the production line. In

contrast to the traditional forecast oriented method where parts are pushed to the line.

The Kanban method described here appears to be very simple. However, this is a "visual

record" procedure.

Figure 8 :- Kanban System

Advantages of Kanban Process

A simple and understandable process

Provides quick and precise information

Low costs associated with the transfer of information

Provides quick response to changes

Limit of over-capacity in processes

Avoids overproduction

Is minimizing waste

Control can be maintained

Delegates responsibility to line workers

"Kanban represents an efficient tool to continuously rationalize the production process

and find the source of problems". Since the circulation of Kanban will stop if there is a

production problem on line, it is easy to both spot and correct the problem

instantaneously.

PRACTICAL IMPLEMENTATION:

Kanban is implemented in Stores Department at L&T Faridabad. For this, a Kanban card

is attached with each and every item present in the Stores Department. Each Kanban

carries all the relevant information about the item, which is useful in estimating its

requirements. A typical Kanban card bears following information:

CAT NO.:.........................................................................................

DESCRIPTION:..............................................................................

INITIATOR:....................................................................................

BUYER:...........................................................................................

CONSUMPTION:...........................................................................

MAXIMUM LEVEL:......................................................................

MINIMUM LEVEL:........................................................................

REORDER LEVEL:........................................................................

Figure 4 – Kanban Card

RECOMMENDATIONS:

CAT numbers should be different, that is no two CAT numbers should be

same.

To make it more effective, no one should be permitted to take material out of or to

put back the material in the bin unless and until he has updated the entries on the

Kanban card.

The data mentioned on the card attached with each bin should be updated as soon

as some material is issued from that bin.

Reorder level should always be kept in mind so that as soon as that point is

reached, the bin should again be filled with the same material up to its optimum

capacity.

KaiZen

KAIZEN: For continuous improvement:

Kaizen literally stands for ‘Kai’-change and ‘Zen’-to become good. The Kaizen

philosophy lies behind many Japanese management concepts such as Total Quality

Control, Quality Control Circles, small group activities, labor relations, etc.

Kaizen is based on a Five-S framework:

a. Seiri - Tidiness

b. Seiton - Orderliness

c. Seiso - Cleanliness

d. Seiketsu - Standardized clean-up

e. Shitsuke - Discipline

Key elements of Kaizen are:

Quality - Quality circles

Effort - Suggestion for improvement

Teamwork - Involvement of all employees

Willingness - To change

Communication

Improved morale

Personal discipline

The Kaizen method of continuous incremental improvements is an originally Japanese

management concept for incremental change.

The Kaizen cycle has four steps:

Establishing a plan to change whatever needs to be improved

Carrying out changes on a small scale

Observing the results

Evaluating both the results and the process and determining what has been learned

BENEFITS OF KAIZEN:

a. It improves safety.

b. It improves efficiency of workers as well as the whole plant.

c. It improves the dedication of the employees as it keeps them safe from any kind of

mishap.

d. It makes the plant well-organized.

PRACTICAL IMPLEMENTATION:

There is a Gang Punching Machine in the fabrication department. Earlier, it had a

manual system for moving the sheet, to be punched, inside the machine and

simultaneously moving a knob. Once, a worker accidentally cut his fingers in the process

of Gang Punching.

To avoid any further mishaps, a wooden block was placed in the machine which could be

pushed to move sheets inside the machine and the need for pushing the sheet inside the

machine by hand was avoided. This ensured the safety of the employees working at the

machine.

Apart from this, there are many big and small changes made, like inclusion of stools to

help workers in cutting sheets, pathways, separate parking bays for keeping trolleys,

posters to provide information to employees regarding their safety, etc.

RECOMMENDATIONS:

It should be checked that all the Kaizen principles followed are being

implemented properly.

Employees should be asked to implement Kaizen principle on their own

and their valuable suggestions should be kept in mind, and as far as

possible, should be implemented.

Another point that must be kept in mind is that Kaizen need not be a big change;

it can be as small as keeping a chart of most frequently used telephone numbers

near your desk, to big changes like replacing a number of old machines with a

multi-tasking/many-in-one machine

Single piece flow system

To become lean, companies have to create continuous flow wherever applicable.

Shortening the elapsed time from raw materials to finished goods leads to the best

quality, lowest cost, and shortest delivery time. Creating flow exposes inefficiencies

that demand immediate solutions. Everyone concerned is motivated to fix the problems

and inefficiencies because the plant will shut down if they don't.

Flow means that a customer order triggers the process of obtaining the raw materials

needed just for that customer's order. The raw materials then flow immediately to

supplier plants, where workers immediately fill the order with components, which flow

immediately to a plant, where workers assemble the order, and then the completed order

flows immediately to the customer. The whole process should take a few hours or days,

rather than a few weeks or months.

There are, Various steps involved in production of any item at L&T FSW plant. Every

second step acts as a customer to the previous step. Each step depends on its immediate

predecessor for performing its function.

A problem/delay at any one or more of the steps will lead to a halt in the production

process. So, each and every employee involved at different stages of the production

process is thoroughly trained, and is held responsible for his part in the production

process.

The production process starts with planning, where it is decided what is to be

produced in the next one month or so. After this, a blue-print of the products is made in

the programming stage. A computerized design is made by using various kinds of

programming softwares available with the plant. Now, the punching process on metal

sheets and other items starts followed by bending and drilling/tapping. To make the

product attractive and easy-to-use, powder coating is done. After that, painting of

different parts takes place. Finally, different parts are assembled together to get

theproduct as desired by the customer.

Thus, the layout of company should be such that all these processes should be done in a

continuous manner

Advantages of single piece flow system

Quality. It is much easier to build in quality in one-piece flow. Every operator is an

inspector and works to fix any problems in station before passing them on. But if defects

do get missed and passed on, they will be detected very quickly and the problem can be

immediately diagnosed and corrected.

Higher Productivity. In a one-piece-flow cell, we can quickly see who is too busy and

who is idle. It is easy to calculate the value-added work and then figure out how many

people are needed to reach a certain production rate.

Gemba Walking

Gemba means Actual Place. Instead of relying on reports to run a plant or company, the

manager should put on some walking shoes and "go and see" at the "actual place",

whether its a factory or a store. This Practice is also followed in L&T.

Virtual Storage

This is another technique of effective inventory management. Here the supplier is asked

to open their stores or warehouses within the premises of company and as and when the

material is required an order is placed to the supplier and the suppliers of the godown

deliver the goods to the company with the copy of invoice.

So, virtual storage helps to receive timely delivery of inventory as the goods are lying in

the godown and are issued as and when required.

However, this practice is not followed in L&T.

CASH MANAGEMENT

Cash is the most liquid current asset. It is the common denominator to which all current

assets can be reduced because the other major liquid assets, i.e. inventory and receivables

get eventually converted into cash. This clearly underlines the significance and essence of

cash management.

Cash can be defined in many ways, it’s not only the money in hand or bank, it is much

more than that.

Cash includes:

Currency

Cheques

Drafts

Demand deposits

Marketable securities

Time deposits

NEED OF CASH:

Cash, of all types, acts as a reserve pool of liquidity that provides cash quickly, as and

when needed. They also provide a short-term investment outlet for excess cash and are

also useful for meeting planned outflows of funds.

The major reasons of keeping cash are:

Transaction motive – this refers to the holding of cash to meet routine cash

requirements

Precautionary motive – these refer to the cash balances held in reserve for

random and unforeseen fluctuations in cash flows

Speculative motive – it refers to the desire of a firm to take advantage of

opportunities which present themselves at unexpected moments

Compensating motive – usually banks ask clients to maintain a minimum

balance of cash with them (bank). Since this balance can not be utilized by the

firms for transaction purposes, the banks themselves can use the amount to earn a

return. Such balances are compensating balances.

OBJECTIVES OF CASH MANAGEMENT:

The basic objectives of cash management can be classified majorly in the following three

types:

a. To meet the cash disbursement needs (payment schedule) – these include payments

to vendors as well as salaries to employees etc.

b. To minimize funds committed to cash balances – this is important as cash which is

lying idle is of no use to the firm

c. To synchronize inflows and outflows of cash – an excess of either inflow or outflow

may be detrimental to the growth of the company.

COST OF HOLDING CASH:

Cash management has some costs associated with it.

No earning power - Irrespective of the form in which cash is held as an

asset, it has no earning power. That is, cash does not earn any return.

Depreciation cost - Cash keeps lying idle, without earning anything; in

fact it keeps depreciating with time.

BENEFITS OF CASH MANAGEMENT:

Some of the major benefits of cash management are:

a. To prevent insolvency or bankruptcy arising out of inability of a firm to

meet its obligations.

b. The relationship with bank is not strained.

c. It helps in fostering good relations with trade creditors and suppliers of

raw materials, as prompt payment may help their own cash management.

d. A cash discount can be availed if payment is made within the due date

e. It leads to a strong credit rating

f. To take advantage of favorable business opportunities that may be

available periodically

g. The firm can meet unanticipated cash expenditure within a minimum of

strain during emergencies (strikes, fire, new market strategy by competitor

etc.)

Cash is the most liquid current asset. It is of vital importance to the daily operations of

business. While the proportion of assets held in the form of cash is very small, its

efficient management is crucial to the solvency of the business. Therefore, planning

cash and controlling its use are very important tasks.

Cash budgeting is a useful device for this purpose.

Cash Budget

 Cash budget basically incorporates estimates of future inflows and outflows f cash

over a projected short period of time which may usually be a year ,half or a quarter

year. Effective cash management is facilitated if he cash budget is further broken down

into month, week or even on daily basis.

There are two components of cash budget

(i) cash inflows and

(ii) cash outflows.

The main sources for these flows are given hereunder:

Cash Inflows

(a) Cash sales

(b) Cash received from debtors

(c) Cash received from loans, deposits, etc

(d) Cash receipt of other revenue income

(e) Cash received from sale of investments or assets.

Cash Outflows

(a) Cash purchases

(b) Cash payment to creditors

(c) Cash payment for other revenue expenditure

(d) Cash payment for assets creation

(e) Cash payment for withdrawals, taxes

(f) Repayment of loans, etc.

A suggestive format for ‘Cash Budget’ is given below:

Cash Budget of M/s…

Particulars Months

January Feburary

March

Estimated cash inflows

------------

-----------

I. Total cash inflows

Estimated cash outflows

------------

-----------

II. Total cash outflows

III. Opening cash balance

IV. Add/Deduct surplus/Deficit

during the month (I–II)

V. Closing cash balance (III–IV)

VI. Minimum level of cash

Balance

VII. Estimated excesses or shortfall ofcash (V–VI)

How L&T Manages its cash?

Managing cash is very essential for the business since it is crucial for solvency of

business. L&T uses various techniques to manage its cash operations.

Sweeping Facility

Rather than keeping cash at different locations, the collections and disbursals of all the

locations are recorded and the cash is kept at one central location as it is quite

cumbersome for an organization to maintain records of collection and disbursals of cash

of its different offices. It also involves a number of extra personnel, and is certainly a

waste of work force, time and money. Also, the money lying scattered with various

offices is of no use as such, because it is simply lying idle. A better option will be to

deposit this cash into a bank, having central banking facility, where it can be invested to

earn some profit. For this a suitable multi-locational bank is selected, preferably the one,

which has branches in all the locations where the different offices of the company are

located.

Moreover, if all the money is kept at one place, it will definitely amount to a huge sum.

This huge sum will make it easier for the company to negotiate with the bank regarding

the interest rate which L&T is supposed to pay for availing such facility.

BENEFITS OF SWEEPING FACILITY:

It’s a win-win situation for both – the company and the bank. Both of the parties are

benefited by this technique.

Benefits for the company:

a. Gets a chance to negotiate with the bank over the interest rate which L&T

is supposed to pay to the bank.

b. This huge sum can be invested in business also, which will again prove to

be profitable.

Benefits for the bank:

a. Bank charges the company according to the services rendered by it.

b. Bank can use these funds for its daily business purposes.

PRACTICAL IMPLEMENTATION:

Sweeping Facility service is a prominent tool used for proper cash management at L&T.

For this purpose L&T has selected Standard Chartered Bank because of its intensive

reach in nearly each and every corner of the country, especially in Delhi, Mumbai, Powai

and all other places where L&T offices are located and also because it has the facility of

Central Banking, which is a prerequisite for a bank to offer such service.

What happens is – all the money is deposited in one account. Now, as and when a center

in any particular region requires some money, it withdraws the same with the bank .

Later, the bank receives the same amount from the central account of L&T.

All the financial decisions regarding the selection of bank, its location and interest rate

etc are made at the Head Office of L&T – Treasury Department, L&T Mumbai.

All the offices are allowed to make cash collection and disbursals through a common

bank account of L&T at Standard chartered Bank, Mumbai.

Day Light Limit

Every Branch of L&T maintains two accounts one having the sweeping facility and one

not having. This day light limit is used where sweeping facility is not available. Here,

based on the past experience or on the basis of current business transactions daily cash

flows are estimated i.e. how much cash inflow will be there and how much cash outflow

will be there and based on this estimation that much amount is maintained in the account.

RECOMMENDATIONS:

Now-a-days most of the banks provide central banking facility, so the

main criterion of selection of bank should be the interest rate it is charging

for rendering such services (it should be as low as possible.

Conclusion

The objective of working capital management is to maintain the optimum balance of each

of the working capital components. This includes making sure that funds are held as cash

in bank deposits for as long as and in the largest amounts possible, thereby maximising

the interest earned. However, such cash may more appropriately be "invested" in other

assets or in reducing other liabilities.

When considering these techniques and strategies of Working capital, departments need

to recognise that each department has a unique mix of working capital components. The

emphasis that needs to be placed on each component varies according to department. For

example, some departments have significant inventory levels; others have little if any

inventory.

Furthermore, working capital management is not an end in itself. It is an integral part of

the department's overall management. The needs of efficient working capital

management must be considered in relation to other aspects of the department's financial

and non-financial performance.

Refrences

i. Khan, M. Y., and Jain P. K., ‘Financial Management’, Tata McGraw Hill,

New Delhi, 2004.

ii. Pandey I. M., ‘Financial Management’, Vikas Publishing House Pvt Ltd, New

Delhi, 2005.

iii. Rustogi, R. P. , ‘Financial Management’, Galgotia Publishing House, New

Delhi,2006

iv. www.l&t.com

v. www.google.com

Costs