CURRENT ASSETS :
Current assets, sometimes called liquid assets, are those resources of a firm
which are either held in the form of cash or expected to be converted in cash within
the accounting period or the operating cycle of the business. The accounting period is
of one-year duration. These assets includes :
Cash:
It is the most liquid current asset. It is the current purchasing power in the
hands of firm and can be used for the purposes of acquiring resources or paying
obligations. Cash includes actual money in hand and cash deposits in bank account.
Marketable securities :
They are the temporary or short-term investments in shares, debentures, bonds
and other securities. These are readily marketable and can be converted into cash
within the accounting period. A firm usually invests in them when it has temporary
surplus cash.
Accounts receivable :
They are the amounts due from debtors (customers) to whom goods or
services have been sold on credit. These are generally realizable in cash within the
accounting period. The firm may not realize all accounts receivable. Some may
remain uncollected and are called bad debts. An estimate or provision is made for
Bills receivable :
These represent the promises made in writing by the debtors to pay definite
sums of money after some specified period of time. Bills are written by the firm and
become effective when accepted by the debtors. These are discounted with bank and
are converted to cash immediately.
Stock (or) Inventory :
This includes raw materials, work-in-process and finished goods in case of
manufacturing firms. This is maintained for smooth production and serving customers
on a continuing basis. They are carried in the balance sheet at the original or market
cost, which ever is less, they are the least liquid current asset.
Prepaid expenses and accrued incomes :
They are the expenses of future period paid in advance. Examples of these are
prepaid insurance, prepaid rent, taxes paid in advance. They are current assets because
their benefits will be received within the accounting period. Accrued incomes are the
benefits, which the firm has earned, but not yet received. They include accrued
dividends, accrued commission or accrued interest.
Loans and Advances :
They include dues from employees or associates advances, advances for
current supplies and advances against acquisition of capital assets. Except for the
advance payment for current supplies, it is not proper to include loans and advances in
CURRENT LIABILITIES :
They are debts payable within an accounting period. Current assets are
converted to cash to pay current liabilities. Some times new current liabilities may be
incurred to liquidate the existing ones. These are mainly classified as :
Sundry Creditors (or) Accounts Payable :
They represent the current liabilities towards suppliers whom the firm has
purchased raw materials on credit.
Bills payable:
They are the promises made in writing by the firm to make payment of a
specified sum toe creditors at some specified date. Bills are written by creditors over
the firm and become bills payable once the firm accepts them. They have a life of less
than a year.
Bank Borrowings :
Commercial banks advance short-term credits to firms for purchasing their
current assets. They may also provide for financing fixed assets. Such loans will be
grouped under long-term liabilities. In India, both long and short-term borrowing is
included under loan funds.
Provisions:
They include provision for taxes or provision for dividends. Every business
has to pay taxes on its income. Usually, it takes some time to finalize the amount of
tax with the tax authorities. Therefore, the amount of tax is estimated and shown as
Outstanding Expenses :
The firm may owe payments to its employees and others at the end of the
accounting period for the services received in the current year. These are payable
within a year short period. Examples are wages payable, rent payable, or commission
payable.
Income received in advance :
A firm can sometimes receive income for goods or services to be supplied in
future. As goods or services have to be provided within the accounting period, they
are treated under current liabilities.
Deposits from Public :
A firm for financing its current assets raises these. These are raised for a
duration of one year through three years.
CONCEPTUAL EXPOSITION:
The concept of working capital has been a matter of greater controversy
among the financial wizards. Broadly speaking, these re divided into a) Gross
working capital and (b) Net working capital.
Gross working capital deals with the problems of managing individual current
assets in day-to-day operations. Current assets are the assets that can be converted into
cash within an accounting year and these include cash, debtors, stock (inventory),
bills receivables, marketable securities etc. Thus, the gross concept is in the nature of
a quantitative definition that focuses attention on the levels of current assets for a
Net working capital refers to the difference between current assets and current
liabilities. Current liabilities are those claims of outsiders that are expected to mature
of payments within an accounting year and include creditors, bills payable and
outstanding expenses.
This net working capital can be either positive or negative. A positive‟ net
working capital will arise when current assets exceeds current liabilities and a
negative working capital when current liabilities are in excess to current assets. Thus,
the Net concept is a qualitative definition, which focuses attention on the character of
the sources from which the funds have been procured to support that portion of
current assets which is in excess of current liabilities.
OBJECTIVES:
Working capital Management is concerned with all the aspects of managing
current assets and current liabilities. The significant objectives, which require
attention of financial executives, are :
a) Managing Investment in Current Assets :
Determination of appropriate level of investment in current assets is the first
and foremost responsibility of working capital manager. Although, the amount of
investment in any current assets ordinarily varies from day-to-day, the average
amount or level over a period of time can be used in determining the fluctuating and
permanent investment in current assets. Besides, the level of investment, the type of
current assets to be held is equally important decision variables. The result is that
there is a very large number of alternative levels of investment in each type of current
asset. Therefore, in principle current asset investment is a problem of evaluating large
a) Financing of Working Capital :
Another important dimension of working capital management is determining the mix of finance for working capital, which may be a combination of spontaneous, short-term and long-term sources. Spontaneous sources of financing consist or trade credit and other account payable that arise spontaneously in the firm‟s day-to-day operations.
b) Inter-relatedness :
The financial manager cannot simply decide that the investment in inventory, for example, will be so much and stop there,. The desired level of inventory is, itself, an changing quantity. For example, the desired level of inventory for a period when its sales are very high would not be the same as the desired level for a period when its sales are very low. Further, no decision regarding inventory and sales could be made without considering the implications for accounts receivables. Moreover, any business decision that results in increased sales and collection for the firm that or I likely to mean that lower average cash balance will be needed a new cash management system will be desirable. Thus, all current assets decisions are inter – related.
POLICIES:
It is clear that the transmission of cash to raw materials, this to work-in-progress then to finished goods and to cash, and all this is a cyclical process. The firm‟s working capital is compared of two components.
1) Permanent Working capital :
The minimum level of investment in current assets regularly employed in business is called Fixed or Permanent working capital. They represent the amount of cash, r eceivable and inventory maintained as minimum to carry on operations at any time.
2) Variable working capital :
The extra working capital needed to support the changing business activities is called Variable or Fluctuating working capital. Additional cash, inventory and receivables may be needed to pay for increased supplies or to support peak selling periods finance after a period of high sales.
LIMITATIONS:
Working capital considers the purpose of current assets as providing adequate cover for current liabilities. This definition suffers from many limitations as stated below :
First, the amount of working capital, viewed in either sense, is obtained from the data contained in the balance sheet, which merely includes the financial position of company as on specific date and is therefore, „static‟ in nature.
Secondly, the balance sheet of a company is prepared and presented in the annual report in accordance with the Schedule VI requirements of the Indian Companies Act. As a result the amount of net working capital obtained by subtracting current liabilities from current assets presented in the balance sheet falls to reflect the true amount of net working capital.
BALANCED WORKING CAPITAL POSITION :
The firm should maintain a sound working capital position. It should have adequate working capital to run its business operation. Both excessive as well as inadequate working capital positions are dangerous from the firm‟s point of view. Excessive working capital means idle funds which earn no profits for the firm. Paucity of working capital not only impairs the firm‟s profitability but also results in production interruptions and inefficiencies.
The dangers of excessive working capital are as follows :
It results in unnecessary accumulation of Inventories. Thus, chances of inventory mishandling, waste, theft and loses increases.
It is an indication of defective credit policy and slack collection period. Consequently, higher incidence of bad debts results, which adversely affects profits.
Excessive working capital makes management co placement, which degenerates into managerial inefficiency.
Tendencies of accumulating inventories tend to make speculative profits grow. This may to make dividends policy liberal and difficult to cope with in future when the firms is unable to make speculative profits.
Inadequate working capital also results in dangers :
It stagnates growth. It becomes difficult for the firm to undertake profitable projects for non-availability of working capital funds.
It becomes difficult to implement operating plans to achieve the firm‟s profit target.
Operating inefficiencies creep in when it becomes difficult even to meet day-to- day commitments.
Fixed assets are not efficiently utilized for the lack of working capital funds. Thus, the firm‟s profitability would deteriorate.
Paucity of working capital render the firm unable to avail attractive credit opportunities etc.
The firm loses its reputation when it is not in position to honor its short term obligations.
GOALS OF WORKING CAPITAL POLICIES :
The firm‟s policy for managing its working capital should be designed to achieve three goals;
1) Adequate liquidity :
If a firm lacks sufficient cash to pay its bills when due, it will experience continuing problems. The most important goal is to achieve adequate liquidity for the conduct of day-to-
day operations.
2)Minimization of risk :
In selecting its sources of financing payables and other short-term liabilities may involve relatively low costs. The firm must ensure that these near current assets on hand to pay them. The matching of assets and liabilities among current accounts is task of minimizing
the risk of being unable to pay bills and other obligations. 3)Contribute to maximizing firm’s value :
The firm holds working capital for the same purpose as it holds any other assets, that is, to maximize the present value of common stock and value of the firm. It should not hold idle current assets any more than it should have idle fixed assets. The investment of excess cash, minimizing of inventories, speedy collection of receivables, and elimination of un- necessary and costly short-term financing all contribute to maximizing the value of the firm.
FACTORS:
A large number of factors affect the working capital of firms. The following are the few factors, which generally, affect the working capital of firms:
1)Nature of business:
Working capital requirements of a firm are basically influenced by the nature of its business. Trading and financial firms have a very small investment is fixed assets, but require a large sum of money to be invested in working capital. Retail stores, for examples, must carry large stock of a variety of goods to satisfy varied and continuous demands of their customers.
2)Nature of raw materials used :
The nature of major raw material used in the manufacture of finished goods will greatly influence the quantum of raw material inventory. For example, if the raw material is an agricultural product whose availability is pronouncedly seasonal in character the proportion of raw material inventory to total current assets will be quite high. For example, tobacco is the major raw material for cigarette industry whose availability is seasonal in nature and also the tobacco produced requires a reasonably long „curing‟ period. Consequently, the percentage of raw material inventory to total current assets will be quite high compared to other items.
3)Seasonal and cyclical factors :
Most firms experience seasonal fluctuations in the demand for their products and services. These variations in sales affect the level of working capital. Similarly, the overall economy undergoes business and financial cycles. In a recession, a firm‟s sales may temporarily decline, thus reducing the need for inventories and the level of receivables. In a period of high interest rates, customers may be slow in paying their bills, a fact that will cause
4)Process technology used:
Technological developments, particularly related to the production process, can have sharp impacts on the need for working capital. If the firm purchases new equipment that processes raw materials at a faster rate than previously, the permanent need for inventory may be changed. If the faster processing requires more raw materials for efficient production runs, the permanent inventory will increase. If the machine can useless expensive raw materials, the inventory needs may be reduced.
5)Policies of the firm:
Many of the firm‟s policies affect the levels of permanent and variable working capital. If the firm changes its credit policy from 30 to net 60, additional funds may be permanently tied up in receivables. If it changes production policies, inventory requirements
may be permanently or temporarily affected. If it changes it safely level of cash on hand, permanent working capital may increase or decrease. If the level of cash is linked to the level
of sales, variable working capital may be affected. 6)Degree of competition in the market :
When the degree of competition in the market for finished goods in an industry is high, then companies belonging to the industry may have to resort to an increased credit policy to its customers, partially lowering credits standards and similar other practices to push
their products. These practices are likely to result in a high proportion of accounts receivable. Similarly, in a competitive market when the demand for finished product is seasonal the manufacturing company may have to report to increased credit period, special incentives, etc. for achieving off-season sales. All this will result in an accumulation of accounts receivable.
7)Paving habit of customers:
It is a well recognized fact that Government departments and to some extent public sector units are more rule-bound resulting in delayed payments to organizations that have sold products or rendered services to them. Consequently, the organization whose customers
happened to be Government departments will have an accumulation of accounts receivable.
OPERATING CYCLE APPROACH TO WORKING CAPITAL MANAGEMENT : The normal business operations of manufacturing and trading company start with cash, go through the successive segments of the operating cycle, viz., raw material storage period, conversion period, finished goods storage period and average collection period before getting back cash along with profit. The total duration of all the segments mentioned above is known as „Gross operating cycle period‟. This can also be shown in a diagrammatic form:
The above picture depicts the inter-dependence among the components of working Capital. For this purpose the company has to make payments towards wages, salaries and other manufacturing costs. Payments to suppliers have to be made on purchase in the case of cash purchases
Finished Goods
Work-in Process Sundry Debtors or
Accounts Receivable
Selling and Distribution General Administration
and Financial Costs
Wages, Salaries and Manufacturing
Costs
Raw Materials, Components Stores etc.
Sundry Creditors or Accounts Payable Cash
On the expiry of credit period in the case of credit purchases. Further, the company has to meet other operating costs such as selling and distribution costs, general, administrative costs and non-operating costs described as financial costs (interest on borrowed capital). In case the company sells its finished goods on a cash basis it will receive cash along with profit with least delay. When it sells goods on credit basis, it will pass through one more stage, viz., accounts receivable and gets back cash along with profit on the expiry of credit period.
Once again the cash will be used for the purchase of materials and / or payments to suppliers and the whole cycle termed as working capital or operating cycle repeats itself. The process indicates the dependence of each stage or component of working capital on its previous stage or component.
In case the company is placed in an advantageous position of being able to sell its products for cash then the segment of average collection period will disappear from the gross operating cycle period and to that extent the total duration of the cycle gets reduced. In case advance payments are to be made for procuring materials, the operating cycle period increase. The purchase of raw materials, components etc., are usually made on a credit basis, thereby giving rise to the spontaneous current liability, viz. accounts payable. When the average payment period of the company to its suppliers is deducted from the gross operating cycle period the resultant period is called net operating cycle period or simply „operating cycle period‟. It become obvious that the shorter the duration of operating cycle period, the faster will be the transformation of current assets into cash.
The operating cycle approach is quite useful both in controlling and forecasting working capital. It can also be that operating cycle approach proves quite useful as a technique for exercising control-overworking capital.
ANALYSIS
WORKING CAPITAL MANAGEMENT IN SRI VIJAYA VISAKHA MILK