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A
PROJECT REPORT
ON
WORKING CAPITAL MANAGEMENT
SUBMITTED TO: SUBMITTED BY:
Aditya Sharma
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ACKNOWLEDGEMENT
First and foremost, I would like to express my gratitude to all those
people who helped me in completing my project at Hindustan Zinc Ltd,
debari, Udaipur. My project title is WORKING CAPITAL
MANAGEMENT.
I have tried to give credit all sources from where I have drawn Material
in this project still there may have remained unintended errors. I shall
tell obliged if they are brought to may notice.
I am grateful to may product guide at Hindustan Zinc Ltd. for their kindCooperation, support & guidance without it would not have been
possible for me to complete this project work at time.
I would like to express my gratitude to our respected professor Mitisha
Sharma for the valuable guidance, which helped me through the project.
I would very much appreciate & sincerely acknowledge readers for
improving the quality of this project.
Aditya Sharma
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TOPIC PAGE NO.1. INTRODUCTION 4
2.
OBJECTIVES OF WORKING
CAPITAL MANAGEMENT
6
3. MEANING OF WORKING CAPITAL7
4. Classification of Working Capital 8
5. Principles of Working Capital
Management11
6.
Operating Cycle 12
7. Determinants of Working Capital 14
8. THE NEED FOR THE WORKING
CAPITAL
15
9. IMPORTANCE OF WORKING
CAPITAL
17
10.DANGERS OF EXCESSIVE
WORKING CAPITAL
19
11.ESTIMATION OF CURRENT
ASSETS
21
12.
ESTIMATION OF CURRENT
LIABILITIES
24
13.REFERENCE 27
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INTRODUCTION
Working capital management is an important aspect of financial
management. In business money is required for fixed assets and
working capital. Fixed assets are required to be retained in the
business for the long period and yield return over the life of such
assets. The main objective of working capital management is to
determine the optimum amount of working capital required.
Generally, management of working capital means management of
current assets. Working capital management in an MNE requires
managing the repositioning of cash flows, as well as managing
current assets and liabilities, when faced with political foreign
exchange, tax and liquidity constraints. The overall goal is to reduce
funds tied up in working capital while simultaneously providing
sufficient funding and liquidity for the conduct of global business.
This should enhance return on assets and return on equity. It also
should improve efficiency ratios and other evaluation of performanceparameters. The first section of this chapter describes Tridents
operating cycle. The second section analyzes Tridents fund
repositioning decisions. The third section examines the constraints
That affects the repositioning of Tridents funds. The fourth section
identifies alternative conduits for moving funds. The fifth section
introduces the management of net working capital, including accounts
receivable, inventory, and cash. The sixth and final section examines
how working capital is financed, including the various types ofbanking services available. The chapter concludes with the Mini-
Case, Honeywell and Pakistan International Airways, which
demonstrates the complexity of working capital management for
multinational firms operating in emerging markets.
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Working capital is the life blood and nerve centre of a business. Just as
circulation of blood is essential in the human body for maintaining life,
working capital is very essential to maintain the smooth running of a
business. No business can run successfully without an adequate amount
of working capital.
There is operative aspects of working capital i.e. current assets which is
known as funds also employed to the business process from the gross
working capital Current asset comprises cash receivables, inventories,
marketable securities held as short term investment and other items
nearer to cash or equivalent to cash. Working capital comes into
business operation when actual operation takes place generally the
requirement of quantum of working capital is determined by the level
of production which depends upon the management attitude towards risk
and the factors which influence the amount of cash, inventories,
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receivables and other current assets required to support given volume of
production.
Working capital management as usually concerned with administration
of the current assets as well as current liabilities. The area includes the
requirement of funds from various resources and to utilize them in all
result oriented manner. It can be stated without exaggeration that
effective working capital management is the short requirement of long
term success.
The importance of working capital management is indisputable;
Business liability relies on its ability to effective management of
receivables, inventory, and payables. By minimizing the amount of
funds tied up in current assets. Firms are able to reduce financing costs
or increase the funds available for expansion. Many managerial effortsare put into bringing non-optimal level of current assets and liabilities
back towards their optimal levels.
OBJECTIVES OF WORKING CAPITAL MANAGEMENT
Effective management of working capital is means of accomplishing the
firms goal of adequate liquidity. It is concerned with the administration
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of that portion of assets of a business which are used in or related to its
current operations. It refers to funds which are used during an
accounting period to generate a current income of a type which is
consistent with major purpose of a firm existence.
Classification of Working Capital
The quantitative concept of Working Capital is known as gross working
capital while that under qualitative concept is known as net working
capital.
Working capital can be classified in various ways. The important
classifications are as given below:
Conceptual classification
There are two concept of working
capital viz., quantitative and qualitative. The quantitative concept takes
into account as the current assets while the qualitative concept takes into
account the excess of current assets over current liabilities. Deficit of
working capital exists where the amount of current liabilities exceeds the
amount of current assets. The above can be summarized as follows:(i) Gross Working Capital = Total Current Assets
(ii) Net Working Capital = Excess of Current Assets over
Current Liabilities
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(iii) Working Capital Deficit = Excess of Current Liabilities over
Current Assets.
Classification on the basis of financial reports
The information
of working capital can be collected from Balance Sheet or Profit
and Loss Account; as such the working capital may be classified
as follows:
(i) Cash Working Capital This is calculated from the
information contained in profit and loss account. This
concept of working capital has assumed a greatsignificance in recent years as it shows the adequacy of
cash flow in business. It is based on Operating Cycle
Concepts which is explained later in this chapter.
(iii) Balance Sheet Working Capital The data for Balance
Sheet Working Capital is collected from the balance sheet.
On this basis the Working Capital can also be divided in
three more types, viz., gross Working Capital, net Working
Capital and Working Capital deficit.
Classification on the Basis of Variability Gross Working
Capital can be divided in two categories viz., (I) permanent or
fixed working capital, and (ii) Temporary, Seasonal or
variable working capital. Such type of classification is very
important for hedging decisions.
Temporary Working Capital Temporary Working Capital isalso called as fluctuating or seasonal working capital. This
represents additional investment needed during prosperity and
favorable seasons. It increases with the growth of the business.
Temporary working capital is the additional assets required to
meet the Variations in sales above the permanent level.8
This can
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be calculated as follows: Variations in sales above the permanent
level.8
This can be calculated as follows:
Permanent Working Capital
It is a part of total current assets which
is not changed due to variation in sales. There is always a minimum
level of cash, inventories, and accounts receivables which is always
maintained in the business even if sales are reduced to a minimum.
Amount of such investment is called as permanent working capital.
Permanent Working Capital is the amount of working capital that
persists over time regardless of fluctuations in sales.This is also called
as regular working capital.
Principles of Working Capital Management
Principles of the risk variation:Risk here refers to
the inability of firm to maintain sufficient current assets to pay its
obligations. If working capital is varied relative to sales, the amount of
risk that a firm assumes is also varied and the opportunity for gain or
loss is increased. In other words, there is a definite relationship between
the degree of risk and the rate of return. As a firm assumes more risk, the
opportunity for gain or loss increases. As the level of working capitalrelative to sales decreases, the degree of risk increases. When the degree
of risk increases, the opportunity for gain and loss also increases. Thus,
if the level of working capital goes up, amount of risk goes down, and
vice-versa, the opportunity for gain is like-wise adversely affected.
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Principle of equity position:According to this
principle, the amount of working capital invested in each
component should be adequately justified by a firms equity
position. Every rupee invested in the working capital should
contribute to the net worth of the firm.
Principle of cost of capital:
This principle emphasizesthat different sources of finance have different cost of capital.
It should be remembered that the cost of capital moves
inversely with risk. Thus, additional risk capital results in
decline in the cost of capital.
Principle of maturity of payment:A company should
make every effort to relate maturity of payments to its flowof internally generated funds. There should be the least
disparity between the maturities of a firms short-term debt
instruments and its flow of internally generated funds,
because a greater risk is generated with greater disparity. A
margin of safety should, however, be provided for any short-
term debt payment.
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Operating Cycle
The duration of time required to complete the following
sequence of events, in case of manufacturing firm, is calledthe operating cycle:
1.Conversion of cash into raw materials.
2.Conversion of raw materials into work-in-progress.
3.Conversion of work in process into finished goods.
4. Conversion of finished goods into debtors and bills
receivables through sales.
5. Conversion of debtors and bills receivables into cash.
The length of cycle will depend on the nature of business. Non
manufacturing concerns, service concerns and financial
concerns will not have raw material and work-in-process so
their cycle will be shorter. Financial Concerns have a shortest
operating cycle.
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Operating Cycle of Manufacturing Concerns
Determinants of Working Capital
There are no set rules or formulas to determine the working capitalrequirement of a firm. A number of factors influence the need andquantum of the working capital of a firm. These are discussed below:
Nature of industry: The composition of an asset is relatedto the size of a business and the industry to which it belongs.Small companies have smaller proportion of cash, requirementsand inventory than large corporations. Need of working capitalis thus determined by the nature of an enterprise.
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Demand of creditors: Creditors are interested in thesecurity of loans. They want their advances to be sufficientlycovered. They want the amount of security in assets which aregreater than liabilities.
Cash requirements: Cash is one of the current assetswhich are essential for the successful operations of theproduction cycle. Cash should be adequate and properlyutilized. A minimum level of cash is always needed to keep theoperations going.
General nature of business: The general nature of abusiness is an important determinant of the level of theworking capital. Working capital requirements depends upon
the general nature and its activity on work. They are relativelylow in public utility concerns in which inventories andreceivables are rapidly converted into cash. Manufacturingorganizations, however, face problems of slow turn-over ofinventories and receivables, and invest large amount inworking capital.
Time: - The level of working capital depends upon the timerequired to manufacture goods. If the time is longer, theamount of working capital required is greater and vice-versa.
Moreover, the amount of working capital depends uponinventory turnover and the unit cost of goods that are sold. Thegreater this cost, the larger is the amount of working capital.
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Volume of sales: This is the most important factoraffecting the size and component of working capital. A firmmaintains current assets because they are needed to support theoperational activities which results in sales. The volume of sales
and the size of the working capital are directly related to eachother. As the volume of sales increases, there is an increase inthe investment of working capital in the cost of operations, in
inventories and in receivables.
Terms of purchases and sales: If the credit terms ofpurchases are more favorable and those of sales less liberal, lesscash will be invested in inventory. With more favorable creditterms, working capital requirements can be reduced as a firm
gets time for payment to creditors or suppliers.
Inventory turnover:If the inventory turnover is high, theworking capital requirements will be low. With good andefficient inventory control, a firm is able to reduce its workingcapital requirements.
Receivables turnover: It is necessary to have effectivecontrol over receivables. Prompt collection of receivables andgood facilities for setting payables result into low working
capital requirements.
THE NEED FOR THE WORKING CAPITAL
The need for working capital arises due to the time gap between
production and realization of cash from sales. Working capital
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is must for every business for purchasing raw-materials, semi
finished goods, stores & spares etc and the following purposes.
1.
To purchase raw materials, spare parts and other component.
A manufacturing firm needs raw-materials and other
components parts for the purpose of converting them in to final
products, for this purpose it requires working capital. Trading concern
requires less working capital.
2.
To meet over head expenses.
Working capital is required to meet recurring over head expenses suchas cost of fuel, power, office expenses and other manufacturing
expenses.
3.To hold finished and spare parts etc.
Stock represents current asset. A firm that can afford to maintain stock
of required finished goods, work in progress & spares in required
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quantities can operate successfully. So for that adequate quantity of
working capital is required.
4.Pay selling & distribution expenses.
Working capital is required to pay selling & distribution
expenses. It includes cost of packing, commission etc.
5.Working capital is required for repairs & maintenance both
machinery as well as factory buildings.
6.Working capital is required to pay wages, salaries and other
charges.
7. It is helpful in maintain uncertainties involved in business field.
IMPORTANCE OF WORKING CAPITAL
1.Solvency of the business:Adequate working capital helps in
maintaining the solvency of the business by providing
uninterrupted of production.
2. Goodwil l : Sufficient amount of working capital enables a firm
to make prompt payments and makes and maintain the goodwill.
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conditions such as purchasing its requirements in bulk when the prices
are lower and holdings its inventories for higher prices.
8.Abil i ty to Face Crises: A concern can face the situation during
the depression.
9.Quick and regular return on investments: Sufficient
working capital enables a concern to pay quick and regular of
dividends to its investors and gains confidence of the investors and
can raise more funds in future.
10. High morale: Adequate working capital brings an
environment of securities, confidence, high morale which results in
overall efficiency in a business.
DANGERS OF EXCESSIVE WORKING CAPITAL
Too much working capital is as dangerous as too little of it. Excessive
working capital raises problems.
1. It results in unnecessary accumulation of inventories. Thus chances
of inventory mishandling, waste, theft and losses increase.
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1.Total costs incurred on material, wages and overheads.
2.The length of time for which raw material are to remain in
stores before they are issued for production.
3.The length of the production cycle or work-in-process, i.e., the
time taken for conversion of raw material into finished goods.
4.The length of sales cycle during which finished goods to be
kept waiting for sales.
5.
The average period of credit allowed to customers.
6.The amount of cash required paying day-today expenses of the
business.
7.The average amount of cash required to make advance
payments.
8.The average credit period expected to be allowed by suppliers.
9.Time lag in the payment of wages and other expenses.
ESTIMATI ON OF CURRENT ASSETS
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1.Raw Material I nventory:
The I nvestment i n Raw Mater ial can be computed with the help
of the following formula:-
Budgeted Cost of Raw Average Inventory
Production x Material(s) x Holding Period
( In units ) per unit (months/days)
12 months / 52 weeks / 365days
2.Work-in-progress (W/P) I nventory:
The relevant cost of determine work in process inventory are the
proportionate share of cost of raw material and conversion costs ( labors
and Manufacturing over Head cost excluding depreciation) In case, full
until of raw material is required in the beginning the unit cost of work is
process would be higher, i.e., cost of full unit + 50% of conversion cost
compared to the raw material requirement. Throughout the production
Cycle, working process is normally equivalent to 50% of total cost of
production. Symbolic
Budgeted Estimated work- Average Time Span
Production x in-progress cost x of work-in-progress
per unit inventory (months/days)
12 months / 52 weeks / 365days
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3.F inished Goods I nventory:
Working capital required to finance the finished goods inventory is
given by factors summed up as follows:-
Budgeted Cost of Goods Produced Finished
Goods
Production x per unit (excluding x Holding
Period
(in units) depreciation)
(months/days)
12
months / 52 weeks / 365days
4. Debtors:
The working capital tied up in debtor should be estimated in relation to
total cost price (excluding depreciation) symbolically,
Budgeted Cost of Sales per Average Debt
Production x unit excluding x Collection Period
( In units ) depreciation (months/days)
12onths / 52 weeks / 365days
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5.Cash and Bank Balances:
Apart from Working Capital needs for Financing Inventories and
Debtors, Firms also find it useful to have such minimum cash Balances
with them. It is difficult to lay down the exact procedure of determining
such an amount. This would primarily be based on the motives of
holding cash balances of the business firm, attitude.
ESTIMATION OF CURRENT LI ABIL I TIES
The Working Capital needs of business firms are lower to the extent that
such needs are met through the Current Liabilities(other than Bank
Credit) arising in the ordinary course of business. The Important Current
Liabilities in this context are Trade-Creditors, Wages and Overheads:-1.
1. Trade Creditors:
The Funding of Working Capital from Trade Creditors can be
computed with the help of the following formula:-
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Budgeted Yearly Raw Material Credit Period
Production x Cost x Allowed by creditors
(In units) per unit (months/days)
12
months / 52 weeks / 365days
2. Di rect Wages:
The Funding of Working Capital from Direct Wages can be
computed with the help of the following formula:-
Budgeted Yearly Direct Labor Average Time-lag in
Production x Cost x Payment of wages
(In units) per unit (months/days)
12
onths / 52 weeks / 365dayss
3. Overheads (other than Depreciation and Amortization):
The Funding of Working Capital from Overheads can be computed with
the help of the following formula:-
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Budgeted Yearly Overhead Average Time-lag in
Production x Cost x Payment of overheads
(In units) per unit (months/days)
12 months / 52 weeks / 365days
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REFERENCE
www.google.com
www.wikipedia.org
www.transtutors.com
www.wikipedia.com
www.slideshare.com
http://www.google.com/http://www.wikipedia.org/http://www.transtutors.com/http://www.transtutors.com/http://www.wikipedia.com/http://www.wikipedia.com/http://www.wikipedia.com/http://www.transtutors.com/http://www.wikipedia.org/http://www.google.com/