WORKING CAPITAL REQUIREMENTS

OF

DABUR INDIA LIMITED

REPORT

SUBMITTED BY:ANTIMA TYAGI

SUBMITTED IN THE PARTIAL FULFILMENT

OF THE REQUIREMENT FOR THE GRADUATE DIPLOMA IN

INTERNATIONAL BUSSINESS

(2010-2011)

JAGANNATH INSTITUTE OF MANAGEMENT SCIENCEROHINI-3, DELHI

PREFACE

The Concept of Management of Working Capital has been changing at a rapid pace. Earlier it was treated as a mere concept to accomplish the formal requirements, but now a days, it is a mandatory analytical tool on basis of which the organizational liquidity, profitability & sustainability are determined. Working Capital denotes the excess of Current Assets over Current Liabilities. Basically, it is the quantum of money required for the operational activities of any company for a specified period i.e. the Operating Cycle.

The Management of Working Capital is there to ensure that the funds are raised economically & used in most efficient and effective manner so that the firm will not face any awkward position of financial crisis in the future. Thus, the concept of Working Capital is further bifurcated into permanent and temporary working capital.

Each source of finance is associated with a certain proportion of risk and return. Therefore it is very necessary to have an eye over the entire process for maintaining an optimal level. Being an analytical tool, it is used by the management for decision making and further adapting remedial measures for problem solving.

To accomplish this purpose, an attempt has been made to present the recent thinking in most lucid, simple, unambiguous & precise manner. The subject matter of Working Capital has been discussed in a conceptual – cum – analytical manner. It is aim of the study to help the reader develop a skill to understand, analyze and interpret the financial problems & data to make good financial decisions.

ACKNOWLEDGEMENT

With deep sense of pleasure and satisfaction I complete this project on “The Working Capital Management” and take this opportunity to thank Mr. Dinesh Chabbra, Deputy General Manager-Accounts, Dabur India Limited, whose inestimable support rendered it possible.

I also express my deep sense of gratitude to my guide Mr. R Venkatesan, Manager Accounts, Dabur India Limited, under whose guidance I have been able to complete this study.

I would like to place on record my sincere gratitude to my facilitator, Mr. D P Sur Accounts, whose immense support helped me completing this project.

I also wish to thank all the Executives and the staff members of Dabur India Limited, in particular Mr. Atul Bansal and Mr. Rajesh Awal, who were immensely co-operative through out my tenure with them.

I would like to extend my heart felt thanks to Prof. NEHA JAIN, Faculty, and Jagannath institute of management science, Delhi whose invaluable guidance became a tremendous source of inspiration and helped me in completing the project study.

Last but not the least, I would like to thank my parents whose blessings, cooperation and guidance inspired me to complete this task easily.

(ANTIMA TYAGI)JAGANNATH INSTITUTE OF MANGMENT SCIENCE,DELHI

COMPANY PROFILE

HISTORICAL BACKGROUND OF DABUR

Dabur derives its name from Devanagri rendition of Daktar Burman.

In 1884, the Dabur was born in a small Calcutta pharmacy, where Dr. S.K. Burman launches his mission of making health care products.

In 1896, with growing popularity of Dabur products, Dr. Burman expands his operations by setting up a manufacturing plant for mass production of formulations.In early 1900s, Dabur enters the specialized area of nature-based Ayurvedic medicines, for which standardized drugs are not available in the market.

In 1919, the need to develop scientific processes and quality checks for mass production of traditional Ayurvedic medicines leads to establishment of research laboratories.

In 1920, Dabur expands further with new manufacturing units at Narendrapur and Daburgram. The distribution of Dabur products spreads to other states like Bihar and the North-East.

In 1936, Dabur becomes a full-fledged company - Dabur India (Dr. S. K. Burman) Pvt. Ltd.

In 1972, Dabur's operations shift to Delhi. A new manufacturing plant is set up in temporary premises in Faridabad, on the outskirts of Delhi.

In 1979, Commercial production starts in the new Sahibabad factory of Dabur, one of the largest and best equipped production facilities for Ayurvedic medicines and launch of full-fledged research operations in pioneering areas of health care with establishment of the Dabur Research Foundation.

In 1986, Dabur becomes a Public Limited Company. Dabur India Ltd. comes into being after reverse merger with Vidogum Limited.

In 1992, Dabur opens a new chapter of strategic partnerships with international businesses. It enters into a joint venture with Agrolimen of Spain. This new venture is to manufacture and market confectionery items in India.

In 1993, Dabur enters the specialised health care area of cancer treatment with its oncology formulation plant at Baddi in Himachal Pradesh.

In 1994, Dabur India Ltd. raises its first public issue. Due to market confidence in the Company, shares issued at a high premium are oversubscribed 21 times.

In 1995, In order to extend its global partnerships, Dabur enters into joint ventures with Osem of Israel for food and Bongrain of France for cheese and other dairy products.

In 1996, For better operation and management, 3 separate divisions created according to their product mix - Health Care Products Division, Family Products Division and Dabur Ayurvedic Specialties Limited.

In 1997, Dabur enters full-scale in the nascent processed foods market with the creation of the Foods Division and Project STARS (Strive to Achieve Record Successes) is initiated to give a jump-start to the Company and accelerate its growth performance.

In 1998, With changing demands of business and to inculcate a spirit of corporate governance, the Burman family inducts professionals to manage the Company. For the first time in the history of Dabur, a non-family professional CEO sits at the helm of the Company.

In 2000, Dabur establishes its market leadership status with a turnover of Rs.1,000 crores. From a small beginning and upholding the values of its founder, Dabur now enters the august league of large corporate businesses.

2005 - Dabur announces bonus after 12 years

Dabur India announced issue of 1:1 Bonus share to the shareholders of the company, i.e. one share for every one share held. The Board also proposed an increase in the authorized share capital of the company from existing Rs 50 crore to Rs 125 crore.

2009 - Dabur Red Toothpaste joins 'Billion Rupee Brands' club

Dabur Red Toothpaste becomes the Dabur's ninth Billion Rupee brand. Dabur Red Toothpaste crosses the billion rupee turnover mark within five years of its launch.

DABUR AT A GLANCE

Over a period of 125 splendid years of caring, Dabur India Limited had been able to win confidence of the prospective and potential consumers not only in the geographical boundaries of India but the world over. It will not be controversial if we say Dabur as another name of success. Delivering quality automatically follows returns; Dabur presents a live example of the statement.

From a small Calcutta pharmacy, it has extended to various spheres of success and prosperity throughout the world. Dabur India Limited has marked its presence with some very significant achievements and today commands a market leadership status. Its story of success is based on dedication to nature, corporate and process hygiene, dynamic leadership and commitment to its partners and stakeholders.

Dabur India Limited is one of the leading Consumer goods companies in India with interest in natural Health & Beauty Care and Foods. The company commenced operations in 1884 and today has a sales turnover of Rs. 1163.19 crore. An ISO 9002 recognized company Dabur has a strong shareholder fraternity of 30,000 shareholders with a market capitalization of over Rs.1500 crore. The company has over 3000 employees across 11 manufacturing plants in India, Nepal and Egypt and a licensee in the Middle East.

It is the Leading consumer goods company in India with 4th largest turnover of Rs.1163.2 Crore (FY02)

(A) Dabur has been divided into 3 major strategic business units (SBU) on the basis of product categorization – (1) Family Products Division (FPD), (2) Health Care Products Division (HCPD) and (3) Dabur Ayurvedic Specialities (DASL).

(B) There are 6 subsidiary group companies of Dabur India Limited - Dabur Foods Limited, Dabur Nepal Private Limited, Dabur Oncology Plc, Dabur Overseas Limited, Dabur Finance Limited and Dabur Egypt Limited.

(C) 13 ultra-modern manufacturing units spread across 4 countries

(D) Products marketed in over 50 countries

(E) Wide and deep market penetration with 47 C&F agents, more than 5000 distributors and over 1.5 million retail outlets all over India 

STRATEGIC BUSINESS UNITS OF DABUR

FPD, dealing with personal care, the largest SBU contributing to 45% sales of Dabur

Products related to Hair Care, Skin Care, Oral Care and Foods

3 leading brands - Vatika, Amla Hair Oil and Lal Dant Manjan with Rs.100 crore turnover each

Vatika Hair Oil & Shampoo the high growth brand

Strategic positioning of Honey as food product, leading to market leadership (over 40%) in branded honey market 

HCPD, dealing with daily health care, 2nd largest SBU with 28% share in sales 

Products related to Health Supplements, Digestives, Baby Care and Natural Cures

Leadership in Ayurvedic and herbal products market with highly popular brands

Dabur Chyawanprash the largest selling Ayurvedic medicine with 65% (Rs.127 crore) market share.

Charted high growth with 15% in 2001.

Dabur Chyawanprash and Hajmola account for sales of over Rs.100 crore each

Leader in herbal digestives with 90% market share

Hajmola tablets in command with 75% market share of digestive tablets category

Dabur Lal Tail tops baby massage oil market with 35% of total share

DASL, dealing with classical Ayurvedic medicines 

Has more than 250 products sold through prescriptions as well as over the counter

Major categories in traditional formulations include:- Asav Arishtas- Ras Rasayanas- Churnas- Medicated Oils

Proprietary Ayurvedic medicines developed by Dabur include:- Nature Care Isabgol- Madhuvaani- Trifgol

Division also works for promotion of Ayurveda through organised community of traditional practitioners and developing fresh batches of students.

SUBSIDIARIES OF DABUR INDIA LIMITED

Dabur Foods Limited

Dabur Foods Limited markets juices under the brand name- Real, lemon juice under the

brand name Lemoneez, and cooking pastes under Hommade. This is a 100% subsidiary

engazed in marketing of natural fruit juices and ethnic cooking pastes, recorded

impressive sales growth of 44% to reach a turnover of Rs. 53.28 Crore. The company

achieved cash break even during the year. After writing off deferred adpro of Rs. 1.15

Crore, the net loss for the year was Rs. 1.11Crore.

Dabur Oncology Plc

Dabur Oncology Plc is a 100% subsidiary that has been set up modern cytotoxic facilities

for manufacturing and marketing anti-cancer formulations in the international market.

This facility will facilitate Dabur’s entry into developed markets like UK,USA and Europe.

Dabur

Nepal Private Limited

Dabur Nepal Private Limited for providing a manufacturing base for natural health and

personal care products. Nepal is one of the major manufacturing location for Dabur products

sold in India and Nepal. Dabur Nepal Private Limited won the Best Exporter Award in Nepal

for the year 2000. The company has established protocols for successful cultivation of

various medicinal plants through contract farming in Nepal.Dabur Overseas LimitedDabur

Overseas Limited is engaged in trading activities and acted as an investment holding company.Dabur

Finance LimitedDabur Finance Limited is a Non-Banking Financial Company. It generally

deals in Leasing, Hire Purchase and delivering other services in pursuance of the contract.

The parties and employees to whom Loan and advances have been given by the company,

are generally regular in payment of the principal amount as well as interest where applicable.

However, certain non performing loans & advances is taken care of.Dabur Egypt

LimitedDabur Egypt Limited is limited liability company and it started running its operations as of

June 12,1996. The company was formed for the purpose of manufacturing hair care oil, vinegar, rose

water, glucose and other Dabur’s branded consumer products.DABUR WORLD WIDE Treatment of one disease through Allopathic methods might result in serious side effect while this is not so in case of Ayurved as Ayurved treatment runs on natural and herbal products. Dabur's mission of popularizing a natural lifestyle transcends national boundaries. Today there is global awareness of alternative medicine, nature-based and holistic lifestyles and an interest in herbal products. Dabur has been in the forefront of popularizing this alternative way of life, marketing its products in more than 50 countries all over the world. They have spread themselves wide and deep to be in close touch with our overseas consumers. Offices and representatives in Europe, America and Africa;

A special herbal health care and personal care range successfully selling in markets of the Middle East, Far East and several European countries.

Inroads into European and American markets that have good potential due to resurgence of the back-to-nature movement.

Export of Active Pharmaceutical Ingredients (APIs), manufactured under strict international quality benchmarks, to Europe, Latin America, Africa, and other Asian countries. 

Export of food and textile grade natural gums, extracted from traditional plant sources. 

Partnerships and Production

Strategic partnerships with leading multinational food and health care companies to introduce innovations in products and services. 

Manufacturing facilities spread across 3 overseas locations to optimize production by utilizing local resources and the most modern technology available.

C & F AGENTS, DISRIBUTORS & RETAILERS

The objective of appointment of Carrying and Forwarding Agents ('C&FA') is to achieve improved service levels in despatches made, order processing, FMFO issuance of stocks, transportation, efficient and proper maintenance of stocks and sales return recording procedures. The outsourcing of the C&FA function ensures smooth and efficient movement of products from the Company to its dealers, stockists etc. There is a wide market penetration on the part of Dabur through 47 C&F agents, more than 5000 distributors and over 1.5 million retail outlets all over India. The company under restructuring exercise has started focussing on distribution network. The company has shifted to zonal setup for its sales and marketing. The company is planning to shift to C&F agents system and has appointed more than 50 such agents in the market. It has also connected its C&F agents and its key distributors online for better management of its stock. The company has also implemented ERP system to cover all its activities. The company also started its interactive website during the year. It has plans of going for B2B and B2C transactions

CORPORATE GOVERNENCE

Good corporate governance and transparency in actions of the management is key to a strong bond of trust with the Company’s stakeholders. Dabur understands the importance of good governance and has constantly avoided an arbitrary decision-making process. Our initiatives towards this end include:

Professionalization of the board

Lean and active Board(reduced from 16 to 10 members)

Less number of promoters on the Board

More professionals and independent Directors for better management

Governed through Board committees for Audit, Remuneration, Shareholder Grievances, Compensation and Nominations

Meets all Corporate Governance Code requirements of SEBI

CERTIFICATION FOR QUALITY

ISO 9002

Dabur India Limited has been awarded the ISO 9002 certification after the Quality Management Systems of the company were assessed in November 1995. The product areas assessed include Health care Products, Family and Food Products, Bulk Drugs and Chemicals, Ayurvedic specialities and Pharmaceutical products. This implies that for Dabur quality is an attitude that has been translated into action. For the company quality is a culture and not a stop gap arrangement and believe that quality is a corporate responsibility towards its customers, employees and the environment in which it operates. Sustaining consumer confidence for over a century is a true reflection of the quality of the company’s products.

CRISIL GVC Level 2

CRISIL, the leading rating agency in India, has been assigning top credit ratings to Dabur India limited for its institutional borrowings. Recently, CRISIL launched the Governance and Value Creation Rating (GVC) and Dabur India Limited was one of the first companies to volunteer for getting itself rated on GVC. Dabur has been assigned `Crisil GVC Level 2’ rating which is the second highest rating on an 8-point scale. The rating indicates that capability of the Company on wealth creation for all its stakeholders including shareholders, employees, creditors, suppliers, dealers and society, while adopting sound corporate governance practices is `high’. This takes into account past track record as well as future expectations of wealth creation by the company.

Some of the quotes of CRISIL :

(1) The rating reflects Dabur India’s strong wealth management practices, high disclosure standards, and satisfactory track record on creating value for its various stakeholders.

(2) The management’s long experience and good track record coupled with Dabur India’s consistent performance in its existing businesses exemplify its wealth management capabilities.

(3) Dabur India follows good disclosure standards in terms of its financial performance and ownership pattern.

VISION

“Dedicated to the health & well being of every Household”

PRINCIPLES

OwnershipThis is our Company. We accept personal responsibility and accountability to meet business needs.

Passion for WinningWe all are leaders in our area of responsibility, with a deep commitment to deliver results. We are determined to be the best at doing what matters most.

People DevelopmentPeople are our most important asset. We add value through result driven training and we encourage & reward excellence.

Consumer FocusWe have superior understanding of consumer needs and develop products to fulfill them better.

Team WorkWe work together on the principle of mutual trust & transparency in a boundaryless organization.

InnovationContinuous innovation in products & processes is the basis of our success.

PRODUCTS OF DABUR

1 Amla Hair Oil

2 Amla Lite3 Baby Olive Oil4 Back Aid5 Binaca Toothpowder6 Chyawanprash

7 Dabur Balm 8 Glucose D9 Gulabri10 Hajmola11 Hajmola Candy12 Hingoli13 Honey14 Itch Care

15 Jama Ghunti Honey16 Lal Dantmanjan17 Lal Oil18 Nature Care19 Pudin Hara

20 Pudin Hara G21 Ring Ring22 Sarbyna Strong23 Sat Isabgol24 Shilajit25 Shankha Pushpi26 Vatika

- Anti Dandruff Shampoo- Hair oil- Shampoo

Dabur’s Departments1 IT(Information Technology)2 HR(Human Resource)3 Training4 Projects5 Finance6 CSCC(Central Supply Chain Cell)7 CPPD(Central Purchase and Procurement Department)8 Divisions9 DRF(Dabur Research Foundation)10 Operations11 Corporate Communication

FUTURE PLANS OF DABUR INDIA LIMITED

Speaking to Business Line, Mr. Sunil Duggal, Chief Executive Officer, Dabur India, said: "The company's biggest growth areas in the current year will be the personal and healthcare segments. Within the foods segment, the strategy will be to consolidate existing products.''

The company has projected a turnover of Rs 2,000 crore by 2007. Some of the company's slow-moving brands would be either phased out or divested progressively as part of its portfolio rationalization. The company proposes to

enter unexplored areas of haircare, and introduce the brand at lower price points and in sachets. Another category Dabur intends to enter this year is mass skin care.

Dabur India's ad spends (both above-the-line and below-the-line) average Rs 140 crore, and this figure could be ramped up by 10 per cent the following year. They will move toward spending away from non-core to core brands.

Dabur India Ltd announced the "virtual demerger" of its FMCG business from its pharmaceutical business. It has restructured its Rs 162.9-crore pharma business into a separate business unit (SBU). The pharma business would be led by the Pharma Management Committee headed by Dr Anand Burman, Vice-Chairman, Dabur India.

New Delhi Dabur India Ltd. has plans to launch an entire range of Ayurvedic products in the domestic market soon. The company is also focusing on exports of Ayurvedic products into new markets this year.

Successful Implementation of Business Risk Management. “With the Business Risk Management Framework, every employee will now be formally responsible for identifying business risks that surround their functions and make business risk management as part of their normal working practice” said Mr. Rajan Varma, Chief Financial Officer, Dabur India.

Dabur India, the fourth largest FMCG Company in the country, has forged an alliance with FreeMarkets Services, a leading e-procurement consulting company, for adopting the next level of sourcing practice – e-Sourcing, for reducing costs, providing greater transparencies and optimizing procurement efficiencies.

“We will be fully online and conducting the first few set of reverse auctions next month i.e. February. Our association with Free-Markets would give us a head start in terms of market making as they have over 1,50,000 suppliers in their database that will be available to us. Also, Free Markets would vet suppliers from scratch that would cut lead-time’’ added Mr. Jude Magima.

INTRODUCTION

WORKING CAPITAL

Working Capital is the excess of Current Assets over Current Liabilities. It is also called the net Current Assets. It is important from point of view of liquidity and profitability. More precisely, management of Current Assets includes :(1) Cash and Bank Balances(2) Inventories(3) Receivables (including Debtors & Bills)(4) Marketable Securities.Current Assets can be described as those Assets which can be converted into cash / equivalent within a year and which are required to meet day to day operations.

Factors determining Working Capital Requirements :

(1) Basic Nature and Size of BusinessThe quantum of money required for the operations of the business enterprise more or less depends upon its nature and size. Bigger the size more will be the requirement. Similarly, the complex nature of the business demands for large amount of working capital.

(2) Business Cycle FluctuationsThe working capital requirements has also been affected by the fluctuations in the business environment. One of the essentials of any business activity is the element of risk due to unforeseen future and uncertainty. The business should be well equipped against such type of uncertainties.

(3) Seasonal FluctuationsThe liquidity of any business is necessary and can be used as a guard against seasonal fluctuations. Howsoever, it should be remembered that it does not render the undue blockage of the company’s funds. It might be possible that firm will be in acute shortage of flowing funds during the peak season say for wollens in winter and blockage of funds in the off season say wollens in summer. So, here comes the importance of the management of the working capital.

(4) Market CompetitivenessMonopoly situations can be served as an excuse for working capital but in the current scenario of intense competition highly managed working capital is essential to take the advantage of any opportunity while serving as a guard against the possible threats at the same time.

(5) Credit PolicyThe credit policy of the company should be such as to comply all of three mentioned criteria for the optimum results:

(a) Regarding credit extended by supplier of Raw Materials, Goods etc.If the credit time allowed by the supplier is sufficient enough for the company it can relax the operations of the firm as a feasible level and also serve as a shoat term financing for the current assets.

(b) Similarly, credit extended to the customers determine the actual requirement of the working capital funds needed by the company. If the credit allowed by the company is for short period it would result in the early realization of the funds which then be deployed in the other potential areas of interest.

(c) Should take care of the monitoring of own credit policies in the market and it should be in compliance with the prevailing credit policies and trends in the ongoing market scenario so that there is the societal acceptance of the company.

(6) Supply ConditionsAgain to a large extent the determination of the working capital depends upon the flow of trade in the actual encountered situations. Rigidity can be automatically formed just by the insufficient availability of funds. The reason can be understood on the pretext that matching the supply with the demand can only be the optimal solution. It is better to stop production rather than to produce inventory.

Need for Adequate Working Capital :

A firm should maintained Optimum level of Working Capital. There should be neither excessive Working Capital nor inadequate Working Capital.

Excessive Working Capital results in :(1) Unnecessary accumulation of inventories resulting in wastes, thefts, damages etc.(2) Delays in collection of receivables resulting in more liberal credit terms to customers

than warranted by the Market conditions.(3) Adverse influence on the performance of the management.

If there is Inadequate Working Capital, then it means :(1) Fixed Assets may not be optimally used.(2) Firm’s growth may remain stagnant.(3) Interruptions in Production schedule may occur ultimately resulting in lowering of the

profit of the firm.(4) Firm may not be able to take benefit of the opportunity.(5) Goodwill is affected if not meeting liabilities on time.

Therefore, an Optimum quantum of Working Capital should be maintained as it provides :

(1) Solvency of the business : Optimum working capital helps in maintaining solvency of the business concern to make prompt payments and hence helps in creating and maintaining goodwill.

(2) Goodwill : Sufficient working capital enables a business concern to make prompt payments and thus, assist in building goodwill.

(3) Easy Loans : A concern having adequate working capital, high solvency and good credit standing can arrange loans from banks and others on easy and favorable terms.

(4) Cash Discounts : Adequate working capital also enable a concern to avail cash discounts on the purchases and hence reduces the costs of procurement.

(5) Regular Supply of Raw material : Sufficient working capital ensures regular supply of raw materials and uninterrupted production processes.

(6) Regular payment of salaries, wages and other day-to-day commitments : A company which has ample working capital can make regular payment of salaries, wages and day-to-day commitments which raises the morale of the employees & increases their efficiencies.

(7) Exploitation of favorable market conditions : Only concerns with adequate working capital can exploit favorable market conditions such as purchasing its requirements in bulk when the prices are lower.

(8) Ability to face crisis : Optimum working capital enables a concern to face business crisis whether it being financial, behavioral or cultural to certain extent or depression periods in the ongoing business cycle as in these time maximum pressure is on the working capital.

(9) Quick and regular return on the investments : Every individual invest money in the company with a view to earn returns on his investments. Therefore it is an obligation on the part of company to reward its investors from time to time & this regular practice is being facilitated by adequate surplus in the hands of the company.

(10)High Morale : Optimality of working capital creates an environment of security, confidence, high morale and overall efficiency of the business enterprises.

Comparison between Current and Fixed Assets :(1) Funds required for management of Current Assets are determined under Working

Capital techniques and for management of Fixed Assets are determined under Capital Budgeting techniques.

(2) Current Assets generally referred to short term period say for one year while Fixed Assets are concerned with longer tenures say more than one year.

(3) Time Value of money isn’t considered in calculating Working Capital requirements while it is an important part of decision making in any material Capital investment.

(4) Decisions regarding Current Assets affect the short term liquidity position of the firm whereas decisions regarding Fixed Assets affect the long term profitability of the firm.

(5) Lastly, Working Capital Decisions can be modified without much implications whereas Capital budgeting decisions are irreversible.

In Working Capital Management, a Finance Manager is faced with a decision involving some of the considerations as follows :(1) What should be the total investment in Working Capital of the Firm ?(2) What should be the level of individual Current Assets ?(3) What should be the relative proportion of different sources to Finance the Working

Capital requirement ?

The extent to which the payments to these Current Liabilities are 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 the Current Liabilities.

THE OPERATING CYCLE AND WORKING CAPITAL NEEDS :

The Operating Cycle may be defined as the time duration starting from the procurement of goods or raw materials and ending with 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.

What is required on the part of a firm is to make adjustments and arrangements so that the uncertainty and non synchronization of these cash flows can be taken care of.

Operating Cycle of a Firm consists of the time required for :(1) Procurement of Raw Materials and Services(2) Conversion of Raw Materials into Work in Progress(3) Conversion of Work in Progress into Finished Goods(4) Sale of Finished Goods (Cash or Credit)(5) Conversion of Receivables into Cash

RMCP WPCP FGCP

ICP RCP---------------------------------------------------------------------------------------------------------

DP NOC______________________________________________________________________

TOCP

Where :RMCP = Raw Material Conversion PeriodWPCP = Work in Progress Conversion PeriodFGCP = Finished Goods Conversion PeriodICP = Inventory Conversion PeriodRCP = Receivable Conversion PeriodTOCP = Total Operating Cycle PeriodDP = Deferral PeriodNOC = Net Operating Cycle

And :ICP = RMCP + WPCP + FGCPTOCP = ICP + RCPNOC = TOCP - DP

For calculation of TOCP & NOC, various Conversion Periods may be calculated as follows :

RMCP = Average Raw Material Stock * 365Total Raw Material Consumption

WPCP = Average Work in Progress * 365Total Cost of Production

FGCP = Average Finished Goods * 365Total Cost of Goods Sold

RCP = Average Receivables * 365Total Credit Sales

DP = Average Creditors * 365Total Credit Purchases

Some Important Reminders :

(1) “Average” Value in Numerator is the average of the Opening & Closing balances. However, if only Closing balance is given, it can be assumed to be average.

(2) No hard and fast rule of 365 days. We can also take 360 days a year.(3) In calculation of RMCP, WPCP, FGCP, the denominator is calculated on cost basis

and the profit margin has to be excluded. The reason being that there is no investment of funds in profits as such.

On the above Basis :

PARTICULARS NO. OF DAYS RMCP

+ WPCP + FGCP = ICP + RCP = TOCP - DP = NOC

Approaches to Working Capital Requirements :

(1) HEDGING APPROACH :

It is also known as Matching Approach. The Hedging Approach guides a firms debt maturity financing decisions. The Hedging principle states that the financing maturity should follow the cash flow characteristics of the assets being financed. For example, an asset that is expected to provide cash flows over a period of say, 5 years, then it should be financed with a debt having similar pattern of cash flow requirements. The Hedging Approach involves matching the cash flows generating characteristics of an asset with the maturity of the source of financing used to finance it.The general rule is that the length of the finance should match with the life duration of the assets. That is why the fixed assets are financed by long term sources only. So, the permanent Working Capital needs are financed by long term sources. On the other hand, the temporary Working Capital needs are financed by short term sources only. In other words, the core or fixed working capital is financed by long term sources of funds while the additional or fluctuating working capital needs are financed by the short term sources.

(2) CONSERVATIVE APROACH :

Under Conservative Approach, the finance manager doesn’t undertake risk. As a result, all the working capital needs are primarily financed by long term sources and the use of short term sources may be restricted to unexpected and emergency situation only. The Working Capital policy of a firm is called a Conservative policy when all or most of the working capital needs are met by the long term sources and thus the firm avoids the risk of insolvency.In case, the firm has no temporary working capital need then the idle long term funds can be invested in marketable securities. This will help the firm to earn some income.

(3) AGGRESSIVE APPROACH :

A working Capital policy is called an Aggressive policy if the firm decides to finance a part of permanent working capital by short term sources. The Aggressive policy seeks to minimize excess liquidity while meeting the short term requirements. The firm may accept even greater risk of insolvency in order to save cost of long term financing and thus in order to earn greater return.

Thus, the Hedging Approach suggests a low cost - high risk situation while the Conservative Approach attempts at high cost - low risk situation. Neither the Hedging Approach nor the Conservative Approach can be used by any firm in the strict sense. Therefore, the financial manager should try to have a trade - off between the Hedging & the Conservative approach.

Liquidity versus Profitability - A Risk-Return Trade off :

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 use to determine the optimal amount of the working capital. The risk return trade off involved in managing the firm’s working capital is a trade off between the firm’s liquidity and its profitability.

The discussion regarding the financing pattern of current assets point out a conflict between the short term and long term sources of finance. This conflict between the two arises because of the fact that these sources have different costs of financing and different risk associated with them. A Financial Manager should therefore strive for a trade-off between the risk and return associated with the financing mix.

One way of achieving a trade-off is to find out, the average working capital required (on the basis of maximum and minimum during the period). Then this average working capital may be financed by long term sources and other requirements, if any, arising from time to time may be met from short term sources. For example, a firm may require a maximum and minimum working capital of Rs. 50000 and Rs. 30000 respectively during a particular year. The firm can have long term sources of Rs. 40000 (i.e. average of Rs. 50000 and Rs. 30000) and any additional requirements above Rs. 40000 may be met out of short term sources as and when the need arises.

BANK CREDIT FOR WORKING CAPITAL

Credit facility provided by commercial banks to meet the working capital requirement has been an important source of short term funds to business firms. In India, bank credit has been the main institutional source of short term financing requirements. This short term financing to business firm is regarded as self-liquidating in the sense that the uses to which the borrowing firm is expected to put the funds are ordinarily expected to generate cash flows adequate to repay the loan within a year. Further, the bank’s motive to provide finance is to meet the seasonal demand. In India, banks may give financial assistance in different shapes and forms. The usual form of bank credit are as follows :

(1) OverdraftIt is the simplest form of bank credit. In this case, the borrowing firm is allowed to withdraw more (up to a specified limit) over and above the balance in the current account. The firm has to pay interest at a predetermined rate only for the period during which the amount was withdrawn.

(2) Cash CreditUnder the Cash Credit, a loan limit is sanctioned by bank and the borrowing firm can withdraw any amount at any time, within that limit. The interest is charged at a specified rate on the amount withdrawn and for the relevant period.

(3) Bills Purchased and Bills DiscountingCommercial banks also provide short term credit by discounting the bill of exchange emerging out of commercial transactions of sale and purchase. However, if the seller wants the money before the maturity date of the bill, he can get the bill discounted by the bank which will pay the amount of the bill to the seller after charging some discount.

(4) Letter of CreditA letter of credit is a guarantee provide by the buyer’s banker to the seller that in the case of default or failure of the buyer, the bank shall make the payment to the seller. So, in fact, the letter of credit becomes a security of the bill and any bank will have no problem in discounting the bill.

(5) Working Capital Term LoansGenerally, the banks while granting working capital facility to a customer stipulates that a margin of 25% would be required to be provide by the customers and hence the bank borrowing remains only limited to 75% of the security offered. The working Capital Term Loan is to be repaid in a phased manner varying between a period of two to five years.

(6) Funded Interest Term LoansSometimes, a company is unable to pay the interest charges on its working capital cash credit facility. Such accumulation of unserviced interest makes the cash credit account irregular and in excess of the sanctioned limit. This unserviced accumulated interest may transfer by the bank from cash credit account to Funded Interest Term Loan (FITL). This will enable the firm to operate its cash credit account. The FITL is considered seprately for repayment.

TRENDS IN FINANCING OF WORKING CAPIATAL BY BANKS

Traditionally, the bank credit has been an easily accessible source of meeting the working capital needs of the borrowing firms. Convenience in getting the bank credit has been an important factor for the growth of bank credit in fulfilling the requirement of industries. However, it also resulted in distortion of allocation of bank resources in favour of industry. Consequently, the bank credit has been subject to various rules, regulations and controls. The reserve Bank of India has appointed different study groups from time to time to suggest ways and means to make the bank credit as an effective instrument of industrialization as well as to ensure equitable distribution of bank resources namely :(1) Dehejia Committee(2) Tandon Committee(3) Chore Committee(4) Marathe Committee(5) Nayak Committee

RATIO ANALYSIS

Ratio measures the relationship between two data expressed in mathematical terms in some logical manner; Male-Female Ratio of the population of a country, Ratio of students passed among those appeared in an examination a re the two examples. Absolute comparison between two figures does not carry much sense. When spoken in terms of ratio, it becomes much more penetrating and meaningful. Not for comparison only, ratios convert the data in precise form for easy understanding. Ratios can be expressed as proportion or percentage. The Ratio Analysis has emerged as a principal technique for analysis of the Financial Statements.

Steps in Ratio Analysis : The Ratio Analysis requires two steps as follows :

(1). Calculation of a ratio and

(2). Comparing the ratio with some predetermined standard. The standard ratio may be the past ratio of the same firm or industry’s average ratio or a projected ratio or the ratio of the most successful firm in the industry. In interpreting the ratio of a particular firm, the analyst could not reach any fruitful conclusion unless the calculated ratio is compared with the standard one. The importance of a correct standard is obvious as the conclusion is going to be based on the standard itself.

Types of comparisons : The ratios can be compared in three different ways :

(1). Cross Section Analysis : One way of comparing the ratio or ratios of a firm is to compare them with the ratio or ratios of some other selected firm in the same industry at the same point of time. The cross section analysis helps the analyst to find out as to how particular firm has performed in relation to its competitors. It is easy to be undertaken as most of the data is freely available in the financial statements of the firms.

(2). Time Series Analysis : The analysis is called Time Series Analysis when the performance of the firm is evaluated over a period of time. By comparing the present performance of a firm with the performance of the same firm over last few years, an assessment can be made about the trend and the direction of the progress of the firm. The information generated by the Time Series Analysis can be of immense help to the firm to make planning for future operations.

(3). Combined Analysis : If the Cross Section and Time Series Analyses, both are combined together to study the behavior and pattern of the ratios, then meaningful and comprehensive evaluation of the performance of the firm can definitely be made.

Pre requisite to Ratio Analysis :

(1). The dates of different financial statements from where data is taken must be same.

(2). If possible, only audited financial statements should be considered. Otherwise there must be sufficient evidence that the data is correct.

(3). Accounting Policies followed by the different firms should be same otherwise the results will get distorted.

(4). One ratio may not throw light on any area of performance of the firm. Therefore, a group of ratios must be preferred. This will also be conductive to counter checks.

(5). Last, but not the least, the analyst must find out that the two figures being used to calculate a ratio must be related to each other, otherwise, there is no purpose of calculating a ratio.

Categorization of Ratios :

The ratios can be categorized under different names and different groups depending upon the purpose they ought to be served. There is no hard and fast rule regarding this matter. Therefore, it might be possible that a ratio serving a particular purpose in a company falls under a separate category in comparison to another company or a ratio of utmost importance for a company comes out to be a wastage for another. Howsoever, with due respect to all the possible sayings, here the ratios are divided under six sub-heads namely:

(1). Cash Position Ratios

(2). Short Term Solvency Ratios / Liquidity Ratios

(3). Long Term Solvency Ratios / Capital Structure Ratios

(4). Profitability Ratios

(5). Activity Ratios (6). Capital Market Ratios

(1). CASH POSITION RATIO :

Cash position ratio show the cash reservoir of the business. Cash is the most liquid asset; Cash reservoir is constituted of cash in hand and cash in bank (which can be freely used for the day to day operations) and marketable securities (which can be disposed of readily). Marketable Securities may also be part of trade investments, which the business would not dispose of, although readily marketable. So, it is better to take marketable securities from non-trade investment categories.

(1). Absolute Cash Ratio : The purpose of this ratio is to show how far cash reservoir is sufficient to meet the current liabilities. Although Provisions do not represent current liabilities, some provisions have the characteristics of current liabilities. Examples are tax provision and proposed dividend. It is almost certain that some liabilities will arise in the near future.

(2). Cash Interval Ratio : Interval Measure indicates the ability of the cash reservoir to meet cash expenses. The businessman is interested to know how many days he can run the business using his cash reservoir if there is no further cash inflow. Higher reserve gives better protection against unforeseen events for which the business may have to depend exclusively on its cash reservoir. Average daily cash expenditure is determined by taking away depreciation and similar other non-cash expenditure from the total expenses charged to the profit and loss account and dividing the total net expenses by 365 days.

(3). Cash Position to Total Assets Ratio : This ratio is a measure of liquid layer of the assets deployed by business. It has been discussed earlier that cash is the most liquid business asset. How much cash is maintained by others who are in the same business or how much was maintained in the business earlier may give some idea about the ideal cash position to total assets ratio.

(2). SHORT TERM SOLVENCY RATIO / LIQUIDITY RATIO :The Terms liquidity and short term solvency are used synonymously. Liquidity means ability of the business to pay-off its short term liabilities. Inability to pay short term liabilities affect the credibility of the business. It also lowers its credit rating. A continuos default on the part of the business to pay-off its liability may even create hindrance to its day to day operations.

(1). Current Ratio : Current Ratio is given by current assets as a ratio of current liabilities. Higher the current ratio better is the liquidity position. The traditional belief is that 2:1 current ratio is an indicator of good liquidity position. The Chore Committee recommended that 1.33:1 current ratio should be attained by an enterprise for a good liquidity position.

(2). Quick Ratio : Very often presence of slow moving inventories make some portion of current assets illiquid even at a higher degree. Also there are current liabilities like bank overdraft, cash credit and short term borrowings which are used as a means of financing

current assets. So, these short term liabilities (if any) are excluded from current liabilities while quantifying liquidity.

Thus, if quick ratio is more than current ratio, this is caused by(a). Low proportion of non-liquid current assets (like inventory).(b). Low proportion of quick liabilities.If quick ratio is less than current ratio, this is due to(a). High proportion of non-liquid current assets.(b). High proportion of quick liabilities.Quick Ratio is taken as ultimate test of liquidity.

(3). LONG TERM SOLVENCY RATIO / CAPITAL STRUCTURE RATIO :

Capital Structure of a business consists of long term funds, which are not repayable in the short run and short term funds, which are repayable in the short run. Here the short run can be taken as a period of one year or so. Long Term funds are :(a). Shareholder’s Funds(b). Loan Funds excluding cash credit, bank overdraft and other short term loans.

(1). Debt Equity Ratio : Debt Equity ratio is popularly used as Capital Structure Ratio. It is also called Leverage Ratio. Debt means long term loan funds and Equity means shareholder’s funds. It shows the long term solvency of the business. Higher the debt fund used in the capital structure, greater is the risk. The risk is technically called financial risk. Debt-equity ratio is also called leverage ratio. This lever operates favourable if rate of interest is lower than return on capital employed.

(2). Proprietary ratio : Proprietary Ratio is calculated to judge the owner’s contribution to total fund applications. This ratio indicates share of proprietary fund against each rupee of investment. It can be calculated by dividing the Proprietor’s funds from the Total Assets

(3). Capital Gearing Ratio : It gives the proportion of interest bearing fund to non-interest bearing fund. It is different from debt-equity ratio. Preference Share capital is fixed dividend bearing fund. Likewise, other long term and short term borrowed funds carry fixed interest. Equity share capital and reserves and surplus do not carry fixed dividend. The word “gear” is used to indicate the proportion of fixed interest / dividend bearing fund. Higher the proportion of fixed interest / dividend bearing fund to non interest / dividend bearing fund, higher is the gearing and as a consequence commitment to pay fixed interest / dividend out of profit is higher. This ratio seems to be better than the debt equity ratio as debt does not include all interest bearing fund. Also equity includes redeemable preference shares which carry fixed dividend. There are two further

ways to highlight the respective positions via Financial Leverage and Operating Leverage.

(4). PROFITABILITY RATIO :

A business is run primarily for profit. So its performance has been measured in terms of profit. Profitability ratios give some yardsticks to measure profit in relative terms, either with reference to sales or assets or capital employed.

(1). Gross Profit Ratio : This ratio provides us the proportion of gross profit incurred with respect to sales. Moreover the percentage of this ratio for any specified industry remain more or less same as this profit takes into account the direct cost of production which are in contrast to all the firms in the same industry.

(2). Net Profit Ratio : This ratio reflects the net profit earned by a firm after taking into consideration all the cash and non cash expenditure for a specified period of time. Generally this work as a yardstick to measure and compare the respective position of the firms on the basis of the profitability.

(3). Return on Capital Employed : A popularly used measure of profitability based on capital employed is Return on Capital Employed. It can be worked out by dividing the net profit before interest and tax by average capital employed during the year. Through this ratio, one is in a position to know the results reaping out from the respective quantum of the capital employed.

(4). Return on Shareholder’s fund : This ratio reflects the proportion of profit which is left out with the firm, after payment of interest, tax and preference dividend to the shareholder’s fund. Shareholders want the maximum possible dividend while the management wants to withhold with the entire lot of funds and earnings. Therefore, an eye should be regularly kept on the prevailing proportion.

(5). Operating Ratio : This ratio is a good indicator of the operational efficiency of the firm. It takes into account the operating cost which is sum total of Cost of goods sold and Selling & Administration costs; and not the total cost. The ratio of this operating cost with the net sales gives a fair view of the operational efficiency of the firm.

(6). Operating Profit Ratio : This ratio takes into consideration operating profit which is the difference between the sales figure and operating costs. This provides the Firm, an idea about how efficiently and effectively, its resources are being used in the respective areas over a specified period of time.

(5). ACTIVITY RATIO :Activity Turnover Ratios generally indicate relationship between sales and assets and these are indicators of efficiency of asset use. However, sometimes, turnover ratios are expressed in relation to cost of goods sold. Current Liabilities are also often linked with turnover or cost of goods sold.

(1).Working Capital Turnover Ratio : Working Capital Turnover Ratio can be provided by dividing Sales from the average working capital employed by the firm during a specified period of time. Thus, a relative status can be judged for the working capital employed in order to achieve the respective sales figure. The higher the ratio, the lower is the investment in the working capital and higher would be the profitability.

(2).Capital Turnover Ratio : Capital Turnover Ratio reflects the relationship of Sales with the average capital employed by the firm. It can be helpful in determining the excessive or inadequate amount of capital employed as far as sales are concerned. The higher the ratio, the greater is the sales made per rupee of capital employed.

(3).Fixed Assets Turnover Ratio : Again the sales figure achieved by the respective average fixed assets employed by the firm is being reflected by this ratio. The contribution of fixed assets can be judged in respect of the sales figure achieved by the firm.

(4).Total Assets Turnover Ratio : The proportion of quantum of Sales with respect to average total assets i.e. sum of fixed and current assets is being called as Total Assets turnover Ratio.

(5).Inventory Turnover Ratio : Inventory Turnover Ratio reflects the proportion of total sales with the average inventory maintained by the firm during a specified time period. Difference in the inventory ratios of the different industries may result from the different characteristics of various industries. Since this ratio is a test of efficient inventory management, the higher the ratio, the better it is.

(6).Debtors Turnover Ratio : Debtors turnover ratio is calculated to judge the credit policy of the firm. Higher is the Debtor Turnover, lower is the credit period offered to customers. It can be calculated by dividing annual net credit sales with the average debtors.

(7).Average Collection Period : This ratio provides the number of days in which the debtors of the company are expected to be realized. In other words, a high receivable turnover ratio or a low average collection period depicts highly liquid position on one hand and a very restrictive credit policy on the other.

(8).Creditors Turnover Ratio : Like Debtors turnover ratio, this ratio indicates the credit period enjoyed by the firm from its suppliers. Since trade credit is a popularly used financing source of working capital, it is important to look at this ratio. It shows the velocity of debt payment by a firm.

(9).Average Payment Period : This ratio reflects the period in which the company ought to pay its creditors during a specified period of time. To the extent possible, a firm should try to maintain the average payment period which is approximately equal to the credit terms of the supplier.

(6). CAPITAL MARKET RATIO :

Capital Market Ratios are used to reflect the market position of the company. It works as a yardstick for the company to compare its various aspects with the prevailing market trends, competitor’s share and also with its own previous performance.

(1). Earning Per Share : Earning Per Share can be calculated by dividing the net profit after interest, tax and preference dividend with the number of equity shares. It measures the profitability in terms of the total funds and explain the return as a percentage of the funds.

(2). Earning Yield Ratio : This ratio reflects the proportion of the earnings of a shareholder in respect of the prevailing market price. The Yield is defined as the rate of return on the amount invested. It can be observed that Earning Yield is the inverse of the Price Earning ratio.

(3). Price Earning Ratio : Price earning ratio can be obtained by dividing the market price with the earning per share. The PE Ratio indicates the expectations of the equity investors about the earnings of the firm. The investor’s expectations are reflected in the market price of the share and therefore the PE Ratio gives an idea of investor’s perception of the EPS.

(4). Dividend Pay-Out Ratio : This ratio provides the proportion of Dividend per share with respect to Earning per share in the prevailing market trends. It refers to the proportion of the Earning Per Share which has been distributed by the company as dividends.

(5). Dividend Yield Ratio : This ratio can be obtained by dividing the Dividend per share with the prevailing market price per share for a specified period of time. Both the Earning Yield and the Dividend Yield evaluate the profitability of the firm in terms of the market price of the share and hence are useful measures from the point of view of a prospective investor who is evaluating a share worth to take a buy or not to buy decision.

RECEIVABLE MANAGEMENT

Receivables are almost certain and inevitable to arise in the ordinary course of business. They represent extension of credit and investment of funds and must be carefully managed. Every firm must develop a credit policy that includes setting credit standards, defining credit terms and employing methods for timely collection of receivables. The Receivables (including the debtors and the bills) constitute a significant portion of the working capital and is an important element of it. Since credit sales assumes a sizeable proportion of total sales in any firm, the receivable management becomes an area of attention. Higher credit sales at more liberal terms will no doubt increase the profit of the firm, but simultaneously also increases the risk of bad debts as well as results in more and more funds blocking in the receivables. The term RM may be defined as collection of steps and procedure required to properly weigh the costs and benefits attached with the credit policies. The RM consists of matching the costs of increasing sales (particularly credit sales) with the benefits arising out of increased sales with the objective of maximizing the return on investment of the firm.

COSTS OF RECEIVABLES :

(1). Cost of Financing : The credit sales delays the time of sales realization and therefore the time gap between the cost and the sales realization is extended. This results in the blocking of the funds for a longer period. The firm on the other hand, has to arrange funds to meets its own obligation at some explicit or implicit costs. This is known as the cost of financing the Receivables.

(2). Administrative Costs : A firm will also be required to incur various costs in order to maintain the record of credit customers both before the credit sales as well as after the credit sales.

(3). Delinquency Costs : Over and above the normal administrative cost of maintaining and collection of receivables, the firm may have to incur the additional delinquency costs, if there is delay in payment by a customer; in the form of reminders, phone calls, postage, legal notices etc. Moreover, there is always an opportunity cost of the funds tied up in the receivables due to delay in the payment.

(4). Cost of Default by Customers : If there is a default by a customer and the receivable becomes, partly or wholly, unrealizable, then this amount, known as bad debt, also becomes a cost to the firms. This cost does not appear in the case of cash sales.

BENEFITS OF RECEIVABLES :

(1). Increase in Sales : Almost all the firms are required to sell goods on credit, either because of trade customs or other conditions. The sales can further be increased by liberalizing the credit terms. This will attract more customers to the firm resulting in higher sales and growth of the firm.

(2). Increase in Profits : Increase in sales will help the firm to easily recover the fixed expenses & attaining the break even level, and increase the operating profit of the firm.

(3). Extra Profits : Sometimes, the firms make the credit sales at a price which is higher than the usual cash selling price. This brings an opportunity to the firm to make extra profit over and above the normal profit.

TRADE-OFF ON RECEIVABLES :

Firms offer credit to customer for a number of reasons, but the ultimate objective is to generate sales that would not have occurred otherwise. The costs associated with offering credit are twofold: Firstly, granting credit exposes the firm to the possibility that the customer will default. Secondly, the foregone interest between the time of sales and the sales realization. This cost can however be partially or wholly set off by charging customers interest cost for buying goods on credit. In fact, in cases where the firm can charge higher interest rate from the customer, such interest income becomes a profit instead of a cost to the firm.

The trade-off on receivables can be applied to find out whether to liberalize the credit terms or not. When a firm adopts more liberal credit policies, the sales increase resulting in higher profits. However, the chances of bad debts will also increase and there will be a decrease in liquidity of the firm. On the other hand, a stringent credit policy reduces the profitability but increases the liquidity of the firm. The opposite forces of profitability and liquidity have an inverse relationship. 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.

Therefore, the receivables management must be attempted by adopting a systematic approach and considering the following aspects of the receivable management :(1). The Credit Policy.(2). The Credit Evaluation.(3). 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 to be extended to a customer and on what terms. This is what is known as credit policy. The credit policy may be defined as the set of parameters and principles that govern the extension of credit to the customers. This requires the determination of the credit standard i.e. the conditions that the customer must meet before being granted credit, and the credit terms i.e. the terms and conditions on which the credit is extended to the customers.

(1). Credit Standards : When a firm sells on credit, it takes a risk about the paying capacity of the customers. Therefore, the problem is to balance the benefits of additional sales against the cost of increasing bad debts. Effect of the credit standard on the sales volume, total bad debts of the firm and on the total collection costs are worth noting. The credit standard will help setting the level which must be satisfied by a customer before being selected for making credit sales. However, even after selecting the customers, all of them need not necessarily be offered the same terms and conditions.

(2). Credit Terms : The credit terms refer to the 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. The credit terms may relate to the following :

Credit Period : It refers to the length of the time over which the customers are allowed to delay the payment. There is no hard and fast rule regarding the credit period and it may differ from one market to another. Customary practices are important factor in deciding the credit period.

Discount Terms : The customers are generally offered cash discount to induce them to make prompt payments. Different discount rates are offered for different periods e.g. 5% discount if payment made within 10 days; 3% discount if payment made within 20 days etc.

When a firm offers a cash discount, its intention is to accelerate the flow of cash into the firm to improve its cash position. The length of cash discount affects the collection period. Some customers, who were not paying promptly, may be tempted to avail the discount and may pay earlier. This will result in shortening of the average collection period.

However, there is always a cost of cash discount. If a firm has an average collection period of 40 days, and in order to reduce the average collection period, it offers a cash discount of 3% if payment is made in 10 days. A customer having a balance of Rs.100,

who was paying in 40 days, now avails the discount of 3% and pays Rs.97 on the 10 th

day.

So, firm will be having Rs.97 for a period of 30 days (40-10), and the cost is Rs.3. The annual cost of this discount can be calculated as follows :

Annual financing cost = Rs. 3 * 365 * 100 = 37.6% Rs. 97 30

So, the annual cost of offering cash discount is 37.6%. This may be compared with the cost of financing from other sources to decide whether to offer discount to customers or not. The annual financing cost may be ascertained as follows :

Annual financing cost = % Discount * 365 * 100 100-% Discount Credit Period - Discount Period

Increase in discount rate will tantamount to reducing the ultimate selling price resulting in increase in sales. Increasing the collection period results in increasing the amount of receivables and hence the higher cost of receivables. Therefore, any change in the discount terms should be evaluated in terms of costs and benefits of such change. The competition requires that the credit terms should match the credit terms of other firms.

CREDIT EVALUATION :

The receivables are generally considered a relatively low risk asset. Under normal circumstances, the total bad debts losses a firm will experience can be forecast with reasonable accuracy, especially if the firm sells to a large number of customers and does not change its credit policies. These normal losses can be considered purely a cost of extending credit.

Credit Evaluation involves determination of the type of the customers who are going to qualify for the trade credit. Several costs are associated with extending credit to less credit-worthy customers. When more time is spent investigating the less credit-worthy customers, the cost of credit investigation increases. As the customer’s credit rating declines, the chance that the amount will not be paid on time increases. Collection costs also increase as the quality of the customer declines.

There are three basic factor of credit worthiness of a customer. First, the character i.e. the willingness and the practice of the customer to honor his obligations by paying as agreed. Second, the capacity i.e. the financial ability of the customer to pay as agreed, and third, the collateral i.e. the security offered by the customer against the credit. Evaluation of credit worthiness of a customer is a two step procedure (1). collection of information, and (2). analysis of information.

(1). Collection of Information :

In order to make better decisions, the firm may collect information from various sources on the prospective credit customers. Some of the sources are listed below :(a). Bank Reference(b). Credit Agency Report(c). Published Information(d). Credit ScoringInformation collection is often costly and therefore, the firms also weigh the benefits of gathering information against its costs.

(2). Analysis of Information :

The five well known C’s of credit : Character, Capacity, Capital, Collateral and Conditions provide a framework for the evaluation of a customer. These characteristics can throw light on the credit worthiness or default-risk of the customer. The difficulty arises in case of those customer who are marginally credit worthy. In such a situation, the financial manager must attempt to balance the potential profitability against the potential loss from the default.

CONTROLS OF RECEIVABLES :

Since the credit has been extended to a customer as per the credit policy, the next important step in the management of receivables is the control of these receivables. In this reference, the efforts may be required in the following directions :

(1). The Collection Procedure :Once a firm decides to extend credit and defines the terms of credit sales; it must develop a policy for dealing with delinquent or slow paying customers. There is a cost of both : Delinquent customers create bad debts and other costs associated with repossession of goods, whereas the slow paying customer cause more cash being tied up in receivables and the increased interest costs. A strict collection policy can affect the goodwill and damage the growth prospects of the sales. If a firm has a lenient credit policy, the customers with a natural tendency towards slow payments, may become even slower to settle his accounts. Overly aggressive collection policy may offend good customers who inadvertently have failed to pay in time. One possible way of ensuring early payments from customers may be to charge interest on over due balances. But this penal interest and the rate thereof must be agreed in advance and better written in sales document. Thus, the objective of collection procedure and

policies should be to speed up the slow paying customer and reduce the incidence of bad debts.

(2). Monitoring of Receivables :In order to control the level of receivables, the firm should apply regular checks and there should be a continuous monitoring system. For the purpose, number of measures are available as follows :

(a). A common method to monitor the receivables is the collection period or number of day’s outstanding receivables. The average collection period may be found by dividing the average receivables by the amount of credit sales per day i.e.,Average collection period = Average Receivables

Credit Sales per day

(b). Another technique available 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 receivable, the lower is the quality and higher or greater the likelihood of a default.

(3). Lines of Credit :Another control measure for receivables management is the line of credit which refers to the maximum amount a particular customer may have as due to the firm at any time. However, if a 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 :Accounting information may be of good help in order to control the receivables. Though, several ratios may be calculated in this regard, two accounting ratios, in particular may be calculated to find out the changing patterns of receivables. These are (a). Receivables Turnover Ratio, and (b). Average Collection Period.

FACORING AND RECEIVABLES MANAGEMENT :

Factoring may be defined as the relationship between the seller of goods and a financial firm, the factor, whereby the latter purchases the receivables of the former and also administer the receivables of the former. Factoring involves sale of receivables of a firm to another firm under an already existing agreement between the firm and the factor. So, the factoring is a tool to release the working capital tied up in credit extended to the customers, for more profitable uses and thereby relieving the management from sales collection chores so that they can concentrate on other important activities. There are two types of Factoring : (1). Non-recourse factoring (Full Factoring) where factor firm purchases the receivables from the selling firm and (2). Recourse Factoring (Pure

Factoring) where factor firm does only collection work of receivables & thus does not bear any risk of default by the receivable

INVENTORY MANAGEMENT

The Inventory absorbs a major part of Working Capital funds; the key of efficient working capital management lies in inventory management. Inventories are assets of the firm and require investment and hence involve the commitment of firm’s resources. If the inventories are too big, they become a strain on the resources, however if they are too small, the firm may loose the sales. Therefore, the firm must have an optimum level of inventories. Managing the level of inventories is like maintaining the level of water in a bath tub with an open drain. The water is flowing out continuously. If water is let in too slowly, the tub is soon empty. If water is let in too fast, the tub over flows. Like the water in the tub, the particular item in the inventory keeps changing, but level may remain the same.

TYPES OF INVENTORIES :

(1). RAW MATERIAL : This consists of basic materials that have been committed to the production in a manufacturing concern. The purposes of maintaining raw material inventory is to uncouple the purchase function from the production so that delays in the shipment of raw material do not cause production delays. Carrying extra inventory means tying up money in the resources. When money is converted into inventories, it leads to additional costs in the form of storage, security, supervision, insurance, obsolescence etc. in addition to loss of an opportunity to earn a return on money.

(2). WORK IN PROGRESS : This Category includes those materials, which have been committed to the production process but have not been completed. The more complex and lengthy production process the larger will be the investment in the work in process inventory. Work in Progress refers to the raw materials engaged in various phases of production schedule. The degree of completion may be varying for different units. The value of Work in Progress includes the raw material costs, the direct wages and expenses already incurred and the overheads, if any. So, the Work in Progress inventory consists of partially produced / completed goods.

(3). FINISHED GOODS : These are the goods which are either being purchased by the firm or are being produced or processed in the firm. These are completed products awaiting sales. The purpose of finished goods inventory is to uncouple the production and the sale function so that it is not necessary to produce the goods before the sales can occur and therefore sales can be made directly out of inventory. It is necessary to decide on the safety stock of finished goods to be carried to meet the fluctuations in the demand as well as other uncertainties that are present in the nature of business.

PURPOSE OF MAINTAINING INVENTORY :

We have seen that the purpose of carrying inventory is to uncouple the operations of the firm i.e. to make each function of the firm independent of other functions so that delays in one area do not affect the production and sales activities. Any firm will like hold higher levels of inventory. This will enable the firm to be more flexible in supplying to the customers and will find ease in its production schedule. Given the benefits of holding inventories and costs of stock-outs, a firm will be tempted to hold maximum possible inventories. But this is costly too, because the funds blocked in inventory always have an opportunity costs. Thus, the objective of inventory management is to determine the optimal level of inventory i.e. the level at which the interest of all the departments are taken care of. The motives for holding inventory may be enumerated as follows :

(1). Transactionary Motive :

Every firm has to maintain some level of inventory to meet the day to day requirements of sales, production process, customer demand etc. This motive makes the firm to keep the inventory of finished goods as well as raw materials.

(2). Precautionary Motive :

A firm should keep some inventory for unforeseen circumstances also. For example the fresh supply of the raw material may not reach the factory due to strike by the transporters or due to natural calamities in a particular area. There may be labor problem in the factory and the production process may halt. So, the firm must have inventory of raw materials as well as finished goods for meeting such emergencies.

(3). Speculative Motive :

The firm may be tempted to keep some inventory in order to capitalize an opportunity to make profit e.g. sufficient level of inventory may help the firm to earn extra profit in case of expected shortage in the market.

COSTS OF INVENTORY :

(1). Carrying Costs :

This is the cost incurred in keeping or maintaining an inventory of one unit of raw material or work in progress or finished goods. Two costs associated with it are: (a). Cost of storage: This means and includes the cost of storing one unit of raw material by the firm. This cost may be in relation to rent of space occupied by stock, the cost of people employed for safety of stock, cost of infrastructure required e.g. air conditioning etc. cost of insurance, cost of pilferage, warehousing costs, handling costs etc. (b). Cost of financing: This costs includes the costs of funds invested in the inventories. The funds used in the purchase / production of the inventories have an opportunity costs i.e. the income which could have been earned by investing these funds elsewhere. It may be noted that the, total carrying cost is entirely variable and rise in the direct proportion to the level of the inventories carried. The total carrying cost move in the same direction as the annual average inventory.

(2). Cost of Ordering :

The cost of ordering includes the cost of acquisition of inventories. It is the cost of preparation and execution of an order, including cost of paper work and communicating with the supplier. The total annual cost of ordering is equal to the cost per order multiplied by number of orders placed in a year. The number of orders determines the average inventory being held by the firm. The carrying costs and the costs of ordering are the opposite forces and collectively they determine the level of inventories in any firm.

(3). Cost of stock-outs :

A stock-out is a situation when the firm is not having units of an item in store but there is a demand for that either from the customers or the production department. The stock out refers to the demand for an item whose inventory level has already reduced to zero or insufficient level. There is always a cost of stock outs in the sense that the firm faces a situation of lost sales or back orders. Stock-outs are quite often expensive.

So, the trade off on inventory is fairly clear. On the one hand, having too high an investment in inventory results in large carrying costs which, will drag down the value of the firm. On the other hand, having too small an inventory either result in lost sales or higher ordering costs. On this basis, the whole theory of inventory management can be summarized as follows :

(1). Maintaining sufficient stock of raw material to continuous supply for uninterrupted production schedule.(2). Maintaining sufficient stock of finished goods for smooth sales operations.(3). Minimizing the total annual cost of maintaining inventories.

TECHNIQUES OF INVENTORY MANAGEMENT :

ABC Analysis :

ABC Analysis is a basic analytical management tool, which enables top management to place the effort where the results will be greatest. This technique, popularly known as Always Better Control or Alphabetical Approach, has universal application in many areas of human endeavor. The ABC analysis is based on the propositions that (i). Managerial time and efforts are scare and limited and (ii). Some items of inventory are more important then others. In material management, this technique has been applied in areas needing selective control, such as inventory, criticality of item, obsolete stocks, purchasing orders, receipt of materials, inspection, store-keeping, and verification of bills.

Under ABC analysis, the different items may be placed in different groups as follows :

(1). Different items are given priority on the basis of total value of annual consumption. Item with highest value is given top priority and so on. The annual consumption value of all the items, already arranged in the priority order, are then shown in cumulative terms for each and every item.

(2). Thereafter, the running cumulative totals of annual value of consumption are expressed as a percentage of total value of consumption.

(3). These cumulative percentage of consumption values are divided into three categories i.e. A, B and C. Usually, group A is consisting of items having cumulative percentage value of 60% to 70%, group B is consisting of next 20% to 25% and the remaining items are placed in the group C.

ECONOMIC ORDER QUANTITY (EOQ) :

The Economic Order Quantity (EOQ) model attempts to determine the orders size that will minimize the total inventory costs. It assumes that total inventory costs is the sum total of inventory carrying costs and inventory ordering costs. The EOQ model as a technique of inventory management defines three parameters for any inventory item.

(1). Minimum level of inventory of that item depending upon the usage rate of that item, time lag in procuring that item and unforeseen circumstances, if any.

(2). The reorder level of that item, at which next order for that item must be placed to avoid any chance of a stock out, and

(3). The re-order quantity for which each order must be placed.

The exact quantity of an item to be purchased at one time, i.e. how much to buy, is one of the fundamental problems faced by the Purchase Manager. If the materials are purchased in bulk quantities the inventory carrying cost will go up, consequently there may be chances of over stocking. On the other hand, if the materials are purchased on small quantities the ordering cost will go up. Consequently the buyer fail to get additional benefit from the supplier such as discount, credit benefit etc. It is therefore, necessary to strike a balance between these two extremes and maintain optimum level of investment in inventory. The Purchase Manager has also to decide as to when should procure the desired material. The EOQ model is based on the following assumptions :

(a). The total usage of a particular item for a given period (usually a year) is known with certainty and the usage rate is even through out the period.

(b). That there is no time gap between placing an order and getting its supply.

(c). 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, and lastly;

(d). That there are only two costs associated with the inventory, and these are the costs of ordering and costs of carrying of the inventory.

Given the above assumption, the EOQ model may be presented as follows : 1/ 2

EOQ = [(2AO)/C]

Where EOQ = Economic quantity per order A = Total annual requirement for the item O = Ordering Cost per order of that item C = Carrying cost per unit per annum.

Assuming that inventory is allowed to fall to zero and then is immediately replenished, the average inventory becomes EOQ / 2.

However, the EOQ model suffers from various shortcomings, particularly the unrealistic assumptions.

(1). The total usage of an item during a particular period is difficult to be known with certainty. In most of the cases the actual demand of an item during the year is fluctuating.

(2). The assumption of no time gap between placing an order and getting its supply is also not realistic. The supply of an item may not immediately reach the firm as soon as the inventory level reaches zero and the order is placed.

(3). Another shortcoming of the EOQ model is that the quantity given by the EOQ model may be hypothetical. For example, the order can not be placed for fractional units say 150.45 units. Quite often, the orders are placed in a particular multiple size, e.g. in multiple of dozens, or 10’s or 100’s.

(4). The EOQ model also assumes that the ordering cost is fixed and is not a function of the size of the order. This is unlikely to be true when there are economies of scale or quantity discounts associated with larger orders.

(5). The carrying cost may also vary substantially as the size of the inventory rises because of economies of scale or the storage efficiency. If it is so, then the EOQ model may not give the desired results.

THE RE-ORDER LEVEL :

The re-order level is the level of inventory at which the fresh order for that item must be placed to procure fresh supply. The re-order level depends on: (a). The length of time between placing an order and receiving the supply, and (b). The usage rate of the item. The re-order level can be determined as follows :

R = M + T.U

Where R = Re-order LevelM = Minimum level of inventoryT = Time gap / delivery time, and U = Usage rate

SAFETY STOCK OR MINIMUM INVENTORY LEVEL :

Safety stock is the minimum level of inventory desired for an item given the expected usage rate and the expected time to receive an order. If any order is placed when the inventory reaches 150 units instead of 100 units, the additional 50 units constitute the safety stock. The firm expects to have 50 units in stock when the new order arrives. The safety stock protects the firm from slow deliveries, stock outs and unanticipated demand to a large extent.

The minimum level or the safety level of an item is maintained by the variability in demand for the item and the risk, the firm is willing to take of stock-outs. Usually, the smaller the safety level the greater will be the risk of stock-outs. A firm can reduce the costs and risk of stock-outs by increasing the safety level. If the stock movement is highly predictable then there is very less chance of a stock-out. However, if the stock inflows and outflows are highly unpredictable, then it becomes necessary to carry additional safety stock to prevent unexpected stock-outs.

CASH MANAGEMENT

Cash Management refers to the management of cash balance and the bank balance and also includes the short term deposits. The cash is obviously the most important current asset, as it is the most liquid and can be used to make the immediate payments. Insufficiency of cash at any stage may prevent a firm from discharging its liabilities or force it to sell its other assets immediately. On the other hand, extreme liquidity may take the firm to make uneconomic investments. This underlines the significance of the cash management. A financial manager is required to manage the cash flows (both inflows and outflows) arising out of the operations of the firm. Cash management does not end here and the financial manager may also be required to identify the sources from where cash may be procured on a short term basis or the outlets where excess cash may be invested for a short term.

Cash management is an important and integral part of working capital management. While there is need to have certain amount of cash in order to have the ability to settle transactions promptly on the due dates, keeping more cash than what is required would mean loss of opportunities to earn a return.

MOTIVES OF HOLDING CASH :

(1) Transaction motive : Business firms as well as individuals keep cash because they require it for meeting demand for cash flow arising out of day to day transactions. The necessity of keeping a minimum cash balance to meet payment obligations arising out of expected transactions, is known as transactions motive for holding cash.

(2) Precautionary motive : The precautionary motive for holding cash is based on the need to maintain sufficient cash to act as a cushion or buffer against unexpected events. Therefore, a firm should maintain larger cash balance than required for day to day transactions in order to avoid any unforeseen situation arising because of insufficient cash.

(3) Speculative motive : Cash may be held for speculative purposes in order to take advantage of potential profit making situations. Some cash balance may be kept to take advantage of these windfalls e.g. an opportunity to purchase raw materials at a heavy discount, if paid in cash. The speculative motive provides a firm with sufficient liquidity to take advantage of unexpected profitable opportunities that may suddenly appear (and just as suddenly disappear if not capitalized immediately).

(4) Compensation motive : In order to avail the convenience of the current account, the minimum cash balance must be maintained by the firm and this provides the compensation motive for holding cash.

OBJECTIVE OF CASH MANAGEMENT :

The cash management strategies are generally built around two goals: (a). To provide cash needed to meet the obligations, and (b). To minimize the idle cash held by the firm. The primary objective of cash management is to ensure the cash outflows as and when required. Investment in the idle cash balance must be reduced to a minimum. The funds locked up in cash balance is a dead investment and has no earnings. The finance manager has to ensure that the minimum cash balance being maintained by the firm is not affecting the payment schedule and meeting all disbursement needs. Cash being a sensitive asset, has to be regulated according to needs. Any deficits or inadequacies should be rectified and any excess amount should be gainfully invested.

FACTORS AFFECTING THE CASH NEEDS :

(1). Cash Cycle : The term cash cycle refers to the length of the time between the payment for the purchase of raw material and the receipt of sales revenue. So, the cash cycle refers to the time that elapses from the point when the firm makes an outlay for purchase raw materials to the point when cash is collected from the sale of finished goods produced using that raw material. Different patterns of cash cycles and cash flows may be there depending upon the nature of the business.

(2). Cash Inflows and Cash Outflows : Every firm has to maintain cash balance because its expected inflows and outflows are not always synchronized. The timing of the cash inflows will not always match with the timing of the outflows. Therefore, a cash balance is required to fill up the gap arising out of difference in timings and quantum of inflows and outflows.

(3). Cost of Cash Balance : There is always an opportunity cost of maintaining excessive cash balance. If a firm is maintaining excess cash then it is missing the opportunities of investing these funds in a profitable way. Similarly, if the firm is maintaining inadequate cash balance than it may be required to arrange funds and there will always be a cost (may be more than normal cost) of raising fund.

(4). Other considerations : In addition to the above factors, there may be some other considerations also affecting the need for cash balance. There may be several subjective considerations such as uncertainties of a particular trade, staff requirements etc. which will have a bearing on determining the cash balance by a firm.

RECIPTS AND PAYMENTS METHOD OF CASH BUDGET :

For each period, the expected inflows are put against the expected outflows to find out if there is going to be any surplus or deficiency in a particular period. Surplus, if any, during a particular period may be carried forward to the next period or steps may be taken to make short term investments of this surplus. Deficiencies, if any must be arranged for within the same period from some short term sources of finance such as bank credit etc. Cash budget is an effective tool of cash management and it may help the management in the following ways :

(a). Identification of the period of cash storage so that the financial manager may plan well in advance about arranging the funds at an appropriate time.

(b). Identification of cash surplus position and duration for which surplus would be available so that alternative investment of this excess liquidity may be considered in advance.

(c). Better coordination of the timing of cash inflows and outflows in order to avoid chances of shortages or surplus of cash etc.

CONTROL ASPECTS :

The financial manager should take appropriate steps for preventing any unexpected deviation in both the inflows as well as the outflows. These include decisions that answer the following questions: (i). What can be done to speed up cash collections and slow down or better control cash outflows? (ii). What should be the composition of the marketable securities portfolio?

CONTROLLING INFLOWS AND OUTFLOWS :

A firm may open collection centers (banks) in different parts of the country to save the postal delays. This is known as concentration banking. Under the lock box system, the customers mail their payments to a post office box near their workplace. The firm arranges with a local bank or some other agency to collect the payments and credit to the firm’s account as quickly as possible.

A financial manager should try to slow down the payments as much as possible. However, care must be taken that the goodwill and credit rating of the firm is not affected. The discount offered by creditors for prompt payment must be evaluated properly in terms of costs and benefits of the discounts. There may not be a balance in the bank account when a cheque is issued but there must be sufficient balance when the cheque is expected to be presented for payment. For example, if tax is to be deposited within 7 days of the expiry of a month, then tax must be paid only on the 7th day and not before.

PLAYING THE FLOAT :

When a firm receives or makes payments in the form of cheques etc., there is usually a time gap between the time the cheque is written and when it is cleared. This time gap is known as float. The float for paying firm refers to the time that elapses between the point when it issues a cheque and the time at which the funds underlying the cheque are actually debited in the bank account. Float has three components :

(i). Mail Time : It is the time between the issue of a cheque and its receipt by the payee.

(ii). Processing Time : It is the time between the cheque received by the payee and the deposit of the cheque in the bank account of the payee, and

(iii). Collection Time : It is the amount of time for transferring funds, through banking system, from the payer’s account to that of the payee. In India, this collection time is generally three days, including the day of depositing a cheque.

Float reduction can yield considerable benefits in terms of usable funds that are released for firm’s use and returns produced on such freed up balances. When the firm makes the payments, it receives the benefits of the payment float i.e. it gets to use the money for the period between when the cheque is written and when it clears. When the firm receives a cheque as payment for goods and services, it is at the receiving end of the processing float and cannot use the funds until the cheques clears. The difference between the two is the net float i.e. the net benefit or costs to the firm on account of the float.

The amount of cheques issued but not presented is known as payment float. The amount of cheques deposited in the banks, but not yet cleared, is known as the receipt float. The difference between the payment float and the receipt float is known as the net float. Float management helps avoiding stagnation of funds.

MANAGEMENT OF MARKETABLE SECURITIES

The cash and marketable securities are in fact two sides of the same coin. The two are closely related and therefore, the cash management should take care of the investment in marketable securities. The marketable securities are the short term money market instruments that can easily be converted into cash. The firm can hold a minimum level of cash and can procure additional cash as and when required from the sales of the marketable securities. The cash balance earns no explicit returns and therefore, any cash balance in excess of minimum cash balance may be invested in the marketable securities, and the latter earns some return as well as provide opportunities to be converted easily with virtually no loss of time. Some of the factors determining the selection of marketable securities are as follows :

(1). Maturity : The length of time for which the excess cash is expected to be available should be matched with the maturity of the marketable securities. If the firm invests money for a period longer than the period of the cash availability, then the firm will be running risk of not getting cash when required, though it may be getting higher returns on these securities. In order to avoid any chance of financial distress, the firm should invest excess cash only for a period slightly shorter than the excess cash availability period.

(2). Liquidity and Marketability : Liquidity refers to the ability to transform a security into cash. Should an unforeseen event require that a significant amount of cash be immediately available, then a sizeable portion of the portfolio might have been sold. The marketable securities, though by nature, are all marketable, still care must be taken that the selected investment must be easily, speedily and conveniently marketable. The marketability is an important consideration as sometimes, the cash realization may be required before the maturity date. The marketability feature also includes the time gap required for sale of securities and the transaction costs of sale. The liquidity varies from one type of securities to another. Greater liquidity implies faster speed at which securities can be converted into cash. The speed of convertibility into cash will ensure, first, the prompt cash and second, realization at current market price.

(3). The Default risk : The risk associated with a loss in value of amount (principal) invested in marketable securities is probably the most important aspects of the selection process. The primary motive while selecting a marketable security is that the firm should be able to get back the cash when needed. The firm should select only those securities which have on risk of default of interest or the principal recovery. The financial manager should be ready to sacrifice even the higher returns.

(4). Yield : Another selection criterion for marketable securities is the yield that is available on different assets. This criterion involves an evaluation of the risks and benefits inherent in different securities. If a given risk is assumed, such as lack of liquidity, a higher yield may be expected on the less liquid investments.

TYPES OF MARKETABLE SECURITIES

There are many types of marketable securities available in the financial market. These are all money market instruments and are liquid and can be used by a firm for its better management of excess cash. Some of these are :

(a). Bank Deposits : All the commercial banks are offering short term deposits schemes at varying rate of interest depending upon the deposit period. A firm having excess cash can make a deposit for even a short period of few days only. These deposits provide full safety, facility of pre-mature retirement and a comfortable return.

(b). Inter-corporate Deposits : A firm having excess cash can maker a deposit with other firms also. When a company makes a deposit with another company, such deposit is known as inter-corporate deposit. These deposits are usually for a period of three months to one year. Higher rate of interest is an important characteristic of these deposits. However, these are generally unsecured and the lack of safety is the main deficiency of this type of short term investment.

(c). Bill Discounting : A firm having excess cash can also discount the bills of other firms in the same way as the commercial banks do. On the bill maturity date, the firm will get the money. However, bill discounting as the marketable securities is subject to 2 constraints: (i). The safety of this investment depends upon the credit rating of the acceptor of the bill, and (ii). Usually, the pre-mature retirement of the bill is not available.

(d). Treasury Bills : The treasury bills or T-Bills are the bills issued by the Reserve Bank of India for different maturity periods. These bills are highly safe investment and are easily marketable. These treasury bills usually have a very low level of yield and that too in the form of different purchase price and selling price as there is no interest payable on these bills.

RESEARCH METHODOLOGYPROBLEMOBJECTIVESHYPOTHESES

NOTES AND ASSUMPTIONS TO FINANCIAL HIGHLIGHTS

STORES AND SPARES : There is a wholesome figure of stores and spares consumed which is being charged to the Profit and loss account under “Manufacturing and Operating Expenses” head. As per the reasons offered, being an insignificant part of the total cost of production, it is directly charged as an operating expense. Therefore, in compliance of the policy of Dabur India Ltd., stores and spares are assumed as the direct manufacturing and operating expense rather being treated as a part of Raw Materials. Moreover, the details regarding the opening and closing stock of stores and spares are not available.

ADMINISTRATIVE AND SELLING EXPENSES : In Dabur India Limited, there is a policy of charging all the administrative expenses as well as selling expenses under one common head of “Administrative and Selling Expenses”. Though selling expenses form a part of “Cost of Goods Sold” rather than “Cost of Production” but still they are being treated as a constituent of “Cost of Production” as no further bifurcation is done among them. It is very difficult to locate the exact nature of expenses under the respective head which justify the treatment of the same.

EXCISE DUTY : Theoritical Concept of Finance calls for treating “Excise Duty” as a part of “Cost of Goods Sold” but Liability of Dabur India Limited regarding the same arises as soon as the production takes place. Excise Duty, is a duty levid on the manufacturing of the goods regardless of the fact that those goods have been sold or not. Thus, being an expense purely related to production; “Excise Duty” is treated as a part of Cost of Production rather than the Cost of Goods Sold.

CREDITORS : Here, the basis of calculation of Sundry Creditors is in conformation with the requirements asked by RBI before granting the specified limit / Loan for the purpose of working capital. Creditors under Current Liabilities are further divided under trade creditors (creditors for purchases) and other creditors (creditors for expenses). These Creditors for purchases include Creditors for Goods and Amount due to SSI Units. In addition, Unsecured Short Term Loans i.e. (Book Overdraft of Current Account with Banks and Commercial Papers) also form a part of these creditors for purchases, as per the requirement of RBI. So, it is the sum total of all the above mentioned four.

PROVISIONS : Though Provisions, are submerged with current Liabilities under “Current Liabilities and Provisions” head, they are kept apart while calculating the figure of Current Liabilities during the calculation of working capital. Moreover, Provisions are not the true expenses i.e. they don’t result in the cash outflow but are only the appropriation of profit or surplus left with the company after meeting all its cash and non cash expenditure. So, they are not treated as a part of mandatory short term liability of the company.

DEPRICIATION : As per the company policy, depreciation on the fixed assets is provided on the written down value at the rates specified in schedule XIV of the Companies Act, 1956.

PURCHASES AND SALES : There is neither segregation of Sales into credit sales and cash sales nor Purchases into credit purchases and cash purchases. The justifying reason provided is that the amount of cash sales and cash purchases are very insignificant, so they are not shown separately but form a part of total sales and total purchases respectively. Thus, in the absence of information and immaterial nature of cash sales and cash purchases; Total sales is treated as total credit sales and Total purchases is treated as total credit purchases. The important thing to be noted over here is that the quantum of total credit sales and total credit purchase is same as that of total sales and total purchases respectively.

SAMPLE AND SAMPLE SIZEDATA COLLECTION METHODDATA ANALYSIS PROCEDURE

RESULTS AND DISCUSSION

CONCLUSIONS

LIMITATIONS

RECOMMENDATIONS

BIBLIOGRAPHY

Contact Information

Telephone

+91-120-2777901 to 25

FAX

+91-120-2779074

Postal address

Kaushambi, Sahibabad, Ghaziabad 201010, UP, India.

Electronic mail

Webmaster: gopals@dabur.com

For Details

Corporate Communication

Ph: 95120- 2778501- 25 Extn 2100/1

Fax: 95120- 2777935

email: corporatecommunications@dabur.com

Findings and Recommendations

On the basis of data and information available, we arrived at certain conclusions and suggestions that reflect the working (positive and negative)of Dabur India Limited.

(1) The company has a raw material holding period of more than two months. For the years 2002, 2001 and 2000 the raw material holding period was respectively. The reason being that the production being increasing continuously every year.

It is suggested to the company to reduce its raw materials stock to the minimum level which don’t affect its daily operations. This would help the company of having more of funds in hand which could be invested else where. It would also reduce the interest burden on loans taken from banks and other financial Institutions.

(2) The Stock in Process holding period was for the year 2003 while it was for 2002, 2001 and 2000 respectively.

The company should try to maintain either the same level of stock-in-processor reduce it further but it should not be increased.

(3) It is found that Finished Goods holding period has gone down for the year as compared to

Though aim of increasing the sales would increase the finished goods (for easy availability of goods to the customers) but still it is recommended to the company to further bring down the finished goods holding duration by reducing the finished goods stock.

(4) This implies that the company should try to bring down its debtors collection period without affecting its sales. This can be done by strictly following its credit policy and making changes in it (if required) for the better flow of funds.

(5) Since the credit period given by the suppliers is free from any interest charge so the company can try to improve its relationship with the supplier so that they willingly agree to increase the payment period. Also, the company should try to keep an eye and adopt the credit terms what competitors are following.

(6) The data available for the previous years show that the working capital requirements are rising continuously every year. One of the reasons for this increase is the increase in product line and capacity of Dabur India Limited. Secondly, with the increase in the production every year the inventory are also expected to increase with respect to total current assets so the requirements for the working capital increases. Thirdly, with the increase in sales, the amount of sundry debtors is also expected to increase. It accounts for 45% approximately of the total current assets. Fourthly, the amount of the creditors is reducing which implies requirements of more working capital. Finally, during the process some wastages are due to strict quality control so there is high working capital requirements.

DIFFERENT PRODUCTS OF THE COMPANY

FAMILY PRODUCT DIVISION (FPD ) This division has a turnover of 3986 million and consists of Hair care - Amla Hair Oil & Amla Lite , Vatiaka Hair Oil, Anmol Coconut Oil, Jasmine Hair Oil, Special Hair Oil , Vatika Shampoo & Vatika Anti-Dandruff shampoo..Oral care - Lal Dant Manjan & Dent Care Tooth Paste, Binaca Fresh Toothpowder.Foods - Honey, Sharbat-E-Azam, Gulabari & K.Water

HEALTH CARE PRODUCT DIVISION (HCPD)This division has a turnover of Rs. 2942 million and consists of :-Ayurvedic - Chywanprash, M. Sura, Shilajit & Restora.Digestives - Hajmola Tablets, Hajmola Candy, Pudin Hara & HingoliChild care - Lal Tail, Janma Ghunti, Gripe Water

AYURVEDIC SPECILITIES DIVISIONETHICAL – Medicated Oils, Chunnas, Bati Gutikas, kwaths, Asavas, Ras Rasayan, Bhasma etc.BRANDED - Stresscom, Rhemutail gel & oil, Stimulax etc.

AYURVET DIVSION:Poultry feed supplementAyurvedic Vetenairy Medicines

PHARMACEUTICALS & BULK DRUGSPharmaceuticals comprises :Branded – Strox, Domoxy, Ulgel, New Livfit, Meganeg.Oncology – Adrim Inj., Fytosid Inj., Intaxel Inj.,Generic – Gentamicin Inj., Dexamethanson Tab/Inj.

EXPORT DIVISION:Personal & Health care products to Asia , Middle east, U.K and U.S.A.Merchant Export of Herbal Extract and agri products to Pakistan, Europe and U.S.A.The company is also making its presence felt in the international market by setting Manufacturing facilities abroad.Example – Nepal, Egypt, Middle East.

FOOD DIVISIONReal Fruit Juices, Homemade pastes, Lemoneez .

COSMETIC DIVISION :Samara range.

SWOT ANALYSISSTRENGTHS:-Wide distribution networkAbility to incur huge marketing expendituresNon-Cyclical productsLarge no. of cash rich company’s

WEAKNESSES:-Research & Development efforts to improve product – efficiency is a continuous activity and is extremely time consuming & expensive.Value added food products are expensive for most Pockets, given the high cost of refrigeration, transport etc.

OPPORTUNITES:-Large investment opportunities Change in food consumption patternProposal by the government for making all investment in food related sectors tax free in certain areas.

THREATS:-Change in Government policies & laws related Food Products.Changing excise norms for FMCG's.’Intense competition in marketingFrequently changing customer taste & preferences.

CHANGES -IN-PIPELINEDabur management is going to reduce the existing ten grades to six or seven. In DABUR, employees under the designation of area manager & district manager have similar job description. Therefore, DABUR IS planning to merge these two designation. An increment in salary structure has been proposed because DABUR INDIA LTD, at present, is not paying at par with the other top 5 FMCG COMPANIES.DABUR is heading towards adopting a totally professionalised culture.Integrated information technology system will soon be introduced, where all the working will be done through wide area network (WAN)Stated for launch are some baby care & women health care products.The most important, the 90% stake DABUR INDIA held in finance is being bought over by the Burman’s. As the Burman’s already hold a 10% stake, DABUR FINANCE will become their private company.

Managing Collections and Disbursements :

The cash cycle in order to deal with the problem of cash management we must have an idea about the flow is known as cash cycle i.e. Cash is used to purchase materials from which goods are produced. Production of these goods involves use of funds for paying wages and meeting other expenses. Goods

produced are sold either on cash or credit. In the later cash the pending bills are received at a later date. The firm thus receives cash immediately or later for goods sold by it. The cycle continues repeating itself.

Speeding up Collections :

In order to minimize the size of cash holding, the time gap between sale of goods and their cash collection should be reduced and the flow controlled. Normally, certain factors creating time lag are beyond the control of management. Yet, In order to improve the efficiency, attention should be paid to the following:All cash should be directly deposited in one account. If there are more than one-collection centers, all cash receipts should be remitted to the main account with top speed. Compared to a single collection courtier, the aggregate requirement for cash will be more when there are several courtiers. Concentration of collections at one place will thus permit the firm to store its cash more efficiently.The time lag between the dispatch of check by the customer and its credit to our account with the bank should be reduced. Some firms with large collection transactions introduced lock box system. In this system the post boxes are hired at different centers where cash/cheques can be dropped in. The local banker can daily collect the same from the lockers. The collecting bank is paid service charges. In order to minimize time, banks may be asked to advise methods for speeding up collection of cash.

Recovering Dues :

After sale of goods on credit, either on account of convention or for promotion sales, receivables are created. It may however be useful to reduce the amount block in receivables by seeing to it that they do not become over due accounts. Incentives in the form of discounts for early payment may be given. More important than anything else is a constant follow up action for recovery of dues. This will improve position of cash balance.

Controlling Disbursements :

Needless to assets that speeding up collections helps conversion of receivable in to cash and thus reduces the financing requirements of the firm. Delaying disbursements can derive similar kind of benefit. Trade credit is a cost less source of fund for it allows us to pay the creditors only after the period of credit agreed upon. The dues can be withheld till the last date. This will reduce the requirement for holding large cash balances. Some firms may like to take advantage of checkbook float, which is the time gap between the date of issue of a check, and actual date when it is presented to payment directly or through the bank.

Investment of idle Cash Balance :

Two other important aspects in cash management are how to determine appropriate cash balance and how invest temporarily idle cash in interest earning assets or securities. Cash by itself yields no income, if we know that some cash will be in excess of our need for a short period of time, we must invest it for earning income without depriving ourselves of the benefits of liquidity if funds. While doing this, we must weigh the advantages of carrying it the carrying extra cash may be necessitated due to its requirement in future, whether predictable or unpredictable. The experience indicates that cash flows cannot be predicted with complete accuracy. Competition, economic conditions make it difficult to predict cash needs accurately.

Investment Criteria :

When it is realized that the excess cash will remain idle, it should be invested in such a way that it would generate income and at the same time ensure quick re-conversion of investment in cash. While choosing the channels for investment of any idle cash balance for short period, it should be seen that,The investment is free from default risk, i.e. the risk involved due to the possibility of default in timely payment of interest and repayment of principal amount The investment shall mature in short span of timeThe investment has adequate marketability. Marketability refers to the ease with which assets can be converted banks into cash. Marketability has two dimensions - price and time-, which are, inter related. If an asset can be sold quickly in large amounts at a price determinable in advance the assets will be regarded as highly marketable and highly liquid.The assets, which largely satisfy the aforesaid criteria, are Government Securities, Bankers Acceptances and Commercial Paper.

SUMMARY :Working capital management is concerned with the problem that arise in attempting to manage the current assets, current liabilities & the interrelationship between them. Their operational goal is to manage the current asset &current liabilities in such a way that a satisfactory level of working capital is maintained. The term working capital refers to net (i.e.) CA-CL with reference to the management of working capital net working capital represent that part of the current assets which are financial with long term fund of the term inventory refers to assets which will be sold in future in the normal course of business operation. The assets which the firm stores as inventory in anticipation of need are raw material, work-in progress/ semi-finished & finished goods.Cash management is one of the key areas of working capital management. These are 4 motives of holding cash;

(1) Transaction motive (2) Precautionary motive(3) Speculative motive(4) Compensating motive

The basic objective of cash management are to reconcile 2 mutually contradictory & conflicting task to meet the payment schedule & to minimize funds committed to cash balances. Receivables defined as debt owned to the firm by us to mere arising from sale of goods as services in the ordinary course of business. The need for working capital arises from the operating cycle of the firm. The operating cycle refers to the length of time to convert the non-current asset into cash.

CONCLUSION :

The need of working capital of Dabur India Limited is increasing day by day this show company gearing up to meet new challenges and competitions.As the company is continuously going on improving its old products and launching its new products like REAL JUICES, VATIKA SHAMPOO etc. so therefore in these circumstance the working capital requirement is continuously increasing on.

The major raw material for Dabur India Ltd. constitutes the following (a) sugar (b) chemicals (c) Oils (d) Herbs (e) Mellasses. The major part of raw materials used by the healthcare products and family products. Healthcare and Family product division constitutes almost 72% of the total sales of the Dabur. Since both divisions involves herbal powder oils and Ayurvedic so there is a constant need of Sugar, Mellasses and Oils herbs by the company.

There was 100% increase in Work in Process inventory from the year 95-96 to 96-97. The main reason for this can be attributed to poor material handling system on the production floor. If the materials can quickly reach the production points the need to store components and partially finished materials at different process on the sheep floor can be greatly reduced and there by release money, that is other wise tied in semi-finished goods. The poor handling of materials leads to increase in the cost of work in progress inventory. Also cycle time the production process involved in the system had risen due to certain bottlenecks in the production process.

In DABUR India Ltd. the proportion of finished goods inventory to total inventory was estimated 53% in 96-97, 55% in 97-98.Thus for effective inventory management a stringent control of assts being produced for the purpose of sale in the normal course of business operation.There are two important aspects of inventory management Viz. Pricing of raw materials and Valuation of inventories. Several methods can be used for pricing of raw materials. These can be broadly classified asFirst In First Out (FIFO)Last In First Out (LIFO)Weighted Average Cost MethodStandard Cost MethodCurrent Price Method However DABUR INDIA LTD. make use of FIFO methods for pricing its raw materials. This means that the order in which materials are received in the stores is the order in which materials issued from the stores. Thus the materials which is issued first is priced on the basis of cost of materials received earliest.This helps in consistent pricing of oldest materials which are issued first but it is very complicated method and proves a bottle neck in the stores accounting as it complicates the over all procedure. Different components of raw materials for the company are purchased from different sources, as there are wide range of suppliers for both sugar & malesses and vegetable oils. This helps the company in purchasing raw materials at the best possible price available in the market and the control its over all cost of producing goods. The company has an effective database system which helps in providing timely

and accurate information regarding the demands and use of raw materials and cost incurred there upon.

This method is also known as selective method of inventory control. It takes the following points into consideration.Different inventory levelsOrder QuantitiesValue of material, andExtent and closeness of the control to be exercised.

It is generally felt in an organization that most inventories have much higher annual usage value as compared to other items. This necessitates the study of the value of materials to be used before deciding upon the extent and closeness of control to be exercised. According to this method of inventory control, inventory items are classified into three classes - A, B & C.If we conduct an analysis of annual consumption of any organization, we can easily come to realize that 75% of total annual consumption value accounts for hardly 10% of the total number of items. These few vital as well as costly items are categorized ‘A’ class item. Similarly a large number of less costly items (70% of the total number of items) accounts for about only 10% of the total amount of consumption value, such items are regarded ‘C’ class items. Thirdly, the items that lie between ‘A’ class and ‘C’ class items are ‘B’ class items. This ‘B’ class item accounts for rest 20% of the total annual consumption.‘X’ items are those inventory value are high. While ‘Z’ items are those whose inventory value is low. Obviously ‘Y’ items are those, which falls between these two categories.Therefore XYZ analysis is helpful in taking stock of those items which are classed as items of highest value, moderate value and low value. Therefore, XYZ and ABC classification are used in organization. Control of items could be done according to their categories such as AX, BY and CZ.

INVENTORY CONTROL OPERATIONS IN DABUR INDIA LIMITED

Dabur India Limited is a leading Ayurvedic and Allopathic Pharmaceutical Company, which produces around 500 products of Health Care, Family Products, Ayurvedic and Allopathic Medicines along with various Asavas and Arishta.In the purchase process for Dabur Products, the major categories are Allopathic Raw materials, which consists of Chemical, Drugs, Colours etc. Ayurvedic Products like Herbs, Dry Fruits, etc. and the third and main category is Packing Materials which plays a major role and maximum cost contribute in total cost of the product. Purchase

Department of Dabur India Limited is involved for the purchasing of various materials which are required for the formulation and packing of a particular product.The inventory control operation in Dabur India Limited starts from the stage of assessment of its requirement of a particular item. First of all the calculation of an item depends upon the sales forecast of the product. When it is decided that so much quantity of the product will be produced to meet out the requirement/demand of the consumers, then we calculate the number of items and their volume in regard to packing materials from the production point of view.Vital items are those, which may cause havoc and may amount to stoppage of work in the Organization if they are not available at the time they are required.However, the Organization may take a reasonable risk in case of those items, which are classed as essential. These items can be sufficiently stocked to ensure a regular flow but care should be taken that if sufficient stocks of Essential items are not available then it may affect the efficiency of the Organization.Desirable items are those, which can be easily bought from the market as and when, required by the Organization.

E.O.Q. is thus the size of the order, which produces the lowest cost of material ordered. It helps in finding appropriate level for holding inventories. It facilitates the fixation of ordering period and the quantity, so as to minimize the total material cost.In order to take a decision on EOQ, the following costs should be considered: -

Ordering Cost: - It refers to the cost of placing the order and securing the supplies. It depends upon the number of orders placed during a specific period and the number of items ordered at a particular time.

Inventory Carrying Cost :- It refers to the cost of keeping the material in the store which includes :-Capital CostCost of storage and handlingCost of deterioration and obsolescenceOther kind of expenses and losses during storage.

Advantage of ABC Analysis: -

It becomes possible to concentrate all efforts in areas, which need genuine efforts. This method produces rewarding results, at the same time it involves minimum control. In respect of ‘A’ category items careful attention is paid at every step, i.e., estimates of requirements, purchasing, safety stock, receipts, inspection, issues, etc. A tight and close control is exercised. A close watch on high consumption items and their progress of replenishment, use, etc. is maintained. But ‘C’ category items, which are numerous and at the same time inexpensive, are comparatively left loosely controlled.

Those items, which fall under ‘C’ category, may be dispensed with in the record-keeping system as well. Physical division of these items into two unequal sections may help in saving time, money and labor without endangering the Production schedule.

It is the most effective and economical method as it is based on selective approach. It helps in placing the orders, deciding the quantity of Purchase, Safety, Stock, etc. thus saving the enterprise from unnecessary stock-outs or surpluses and their resultant consequences. This may be illustrated from the following table where average inventory is one-half of the order quantity.

Advantage of E.O.Q.: -

The advantages of E.O.Q. are as follows: -With the help of EOQ, stock verification and valuation becomes easy.It saves money, financial control becomes easy with the help of EOQ, overstocking and under stocking can be controlled.By adopting EOQ formula total carrying cost and total ordering cost is minimized.EOQ helps in budgeting planning and production planning.

METHODOLOGYWhile critically analyzing the role of Budgetary Control Department in the maximization of the profits of the company, we have deeply analyzing the different parameters of controlling the cash management and inventory management with the help of operating cycle time, ABC & XYZ analysis and other methods of controlling the inventory apart from the determination of Economic order quantity and other factors which can’t be ignored while analysing the cash & inventory management system in the company. For this, we have taken the full advantages of the computerized cash management & material management systems which help us to exactly determined the requirement of the raw & packaging material, stores & spares, according to the production planning for the we take the following data:

i.. Actual requirement as per rolling production programme.

ii. Last year consumption.

iii Cash & credit sales of last year.

iv. Cash & credit purchase of last year.

The duration of the working capital cycle can be put as follows: O = R + W + F + D – CWhereO = Duration of operating cycleR = Raw material and stores periodW = Work in process periodF = Finished stock storage periodD = Debtors’ collection periodC = Creditors payment periodEach of the components of the operating cycle can be calculated as follows:

R = Average stock of raw materials & stores_______Average Raw Material and stores consumption per day

W = Average work-in-process inventory_______Average Cost of production per day

F = Average finished stock inventory______Average Cost of goods sold per day

D = Average book debts_______Average Credit sales per day

C = Average trade creditors_______Average credit purchases per day