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Introduction:

Working capital management is significant in financial management due to the fact that it

plays a vital role in keeping the wheel of business enterprises running. Working capitalmanagement is concerned with short term financial decision. Shortage of funds for

working capital has caused many businesses to fail and in many cases, as retarded their

growth. Lack of efficient and effective utilization of working capital leads to low rate of

return on capital employed or even compels to sustain losses. The lead for skill working

capital management has thus become greater in recent years. A firm invests a part of its

permananent capital in fixed asset and keeping part of it for working capital i.e. for

meeting a day to day requirement. The management of working capital is no less

important than the management of long term financial investment. Sufficient liquidity is

necessary and must be achieve and maintain to provided funds and pay of the obligation

as they arises or mature.

Each organization is faced with its own limits on the production capacity and technologies

it can employ there are fixed as well as variable costs associated with production goods.

In other words, the markets in which real firm operated are not perfectly competitive.

These real world facts introduce problems and require the necessity of

working capital. The most important areas in the day to day management of the firm, is

the management of working capital. Working capital management is the functional area of

finance that covers all the current accounts of the firm. It is concerned with management

of the level of individual current assets as well as the management of total working capital.

Working capital management involves the relationship between a firm's short-term assets

and its short-term liabilities. The goal of working capital management is to ensure that a

firm is able to continue its operations and that it has sufficient ability to satisfy both

maturing short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable, and

cash. For example, an organization may be faced with an uncertainty regarding availability

of sufficient quantity of crucial inputs in future at reasonable price. This may necessitate

the holding of inventory ie., current assets. Similarly an organization may be faced with an

uncertainty regarding the level of its future cash inflows and insufficient amount of cash

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may incur substantial costs. This may necessitate the holding of a reserve of short term

marketable securities, again a short term capital asset. The unpredictable and uncertain

global market plays a vital role in working capital. Though the globalization of economy

and free trading of products envisages the continuous availability of products but how

much its cost effective and quality based varies concern to concerns.

Working capital refers to the funds invested in current assets, ie., investment in

stocks, sundry debtors, cash and other current assets. Current assets are essential to use

fixed assets profitably. The term current assets refers to those assets which in the

ordinary course of business can be converted into cash within one year without

undergoing diminish in value and without disrupting the operations of the firm. The current

assets are cash, marketable securities, accounts receivable and inventory. Current

liabilities are those which are to be paid within a year out of the current assets or earningsof the concern. The current liabilities are accounts payable, bills payable, bank overdraft

and outstanding expenses.

The financial manager plays a vital role in management of working capital. The

financial management of any business organization involves the three following vital

functions:

1. Management of Long Term Assets

2. Management of Long Term Capital3. Management of Short Term Assets and Liabilities

In most of the organizations the first & second one which refers to Capital Budgeting and

Capital Structure respectively will be maintained and cope up with organization

growth. The third one which refers to Working Capital Management requires more

skills for sustaining and steady growth rate for any organization

The working capital management includes decisions:

i. How much stock/inventory to be hold

ii. How much cash/bank balance should be maintained

iii. How much the firm should provide credit to its customers

iv. How much the firm should enjoy credit from its suppliers

v. What should be the composition of current assets

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Gross working capital

This thought says that total investment in current assets is the working capital of the

company. This concept does not consider current liabilities at all.

Reasons given for the concept:

1) When we consider fixed capital as the amount invested in fixed assets. Then the

amount invested in current assets should be considered as working capital.

2) Current asset whatever my be the sources of acquisition, are used in activities

related to day to day operations and their forms keep on changing. Therefore they

should be considered as working capital.

*Gross Working capital = Total Current Assets

Net working capital

It is narrow concept of working capital and according to this, current assets minus current

liabilities forms working capital. The excess of current assets over current liabilities is

called as working capital. This concept lays emphasis on qualitative aspect which

indicates the liquidity position of the concern/enterprise

*Net Working Capital = Current assets Current Liabilities

4

Types of working capital

On the basis of concept On the basis of time

GrossWorkingCapital

Net WorkingCapital

PermanentWorkingCapital

TemporaryWorkingCapita l

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Fixed or Permanent Working Capital

The volume of investment in current assets changes over a period of time. But always

there is minimum level of current assets that must be kept in order to carry on the

business. This is the irreducible minimum amount needed for maintaining the operating

cycle. It is the investment in current assets which is permanently locked up in the

business, and therefore known as permanent working capital.

Variable or Temporary Working Capital

It is the volume of working capital which is needed over and above the fixed working

capital in order to meet the unforced market changes and contingencies. In other words

any amount over and about the permanent level of working capital is variable or

fluctuating working capital. This type of working capital is generally financed from shortterm sources of finance such as bank credit because this amount is not permanently

required and is usually paid back during off season or after the contingency.

Temporary

Amount of working Permanent

Capital (Rs.)

Time

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Temporary

Amount of working Permanent

Capital (Rs.)

Time

Working Capital Cycle:

Each component of working capital (namely inventory, receivables and payables) has two

dimensions TIME and MONEY. When they comes to managing working capital, then

TIME IS MONEY. If you can get money to move fester around the cycle (collect monies

6

Receivables

SALES

OVERHEADSEtc.

PAYABLES

INVENTORY

CASH

Equity & loan

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due from debtors more quickly) or reduce the amount of money tied up (e., reduce

inventory level relative to sales). The business will generate more cash or it will need to

borrow less money to fund working capital. As consequences, you could reduce the cost

of bank interest or you will have additional freee4 money available to support addition

sales growth or investment. Similarly, if you can negotiate improved terms with suppliers

e.g. get longer credit or an increased credit limit, you festively create freed finance to help

fund future sales

A perusal of operational cycle reveals that the cash invested in operations are recycledback in to cash. However it takes time to reconvert the cash. Cash flows in cycle intoaround and out of a business it the businesss lifeblood and every managers primary taskto help keep it flowing and to use the cash flow to generate profits. The shorter the periodof operating cycle, the larger will be the turnover of the funds invested in variouspurposes.

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Significance and Relevance of Working Capital :

Determinants of Working Capital

Working capital requirements of a concern depends on a number of factors, each of which

should be considered carefully for determining the proper amount of working capital. It

may be however be added that these factors affect differently to the different units and

these keeps varying from time to time. In general, the determinants of working capital

which re common to all organizations can be summarized as under:

1. Nature of business

Need for working capital is highly depends on what type of business, the firm in. there aretrading firms, which needs to invest a lot in stocks, ills receivables, liquid cash etc. public

utilities like railways, electricity, etc., need much less inventories and cash. Manufacturing

concerns stands in between these two extends. Working capital requirement for

manufacturing concerns depends on various factor like the products, technologies,

marketing policies.

2. Production policies

Production policies of the organizations effects working capital requirements very highly.Seasonal industries, which produces only in specific season requires more working

capital. Some industries which produces round the year but sale mainly done in some

special seasons are also need to keep more working capital.

3. Size of business

Size of business is another factor to determines the need for working capital

4. Length of operating cycle

Operating cycle of the firm also influence the working capital. Longer the orating cycle, the

higher will be the working capital requirement of the organization.

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5. Credit policy

Companies; follows liberal credit policy needs to keep more working capital with them.

Efficiency of debt collecting machinery is also relevant in this matter. Credit availability

form suppliers also effects the companys working capital requirements. A company

doesnt enjoy a liberal credit from its suppliers will have to keep more working capital

6. Business fluctuation

Cyclical changes in the economy also influence the level of working capital. During boom

period, the tendency of management is to pile up inventories of raw materials and finished

goods to avail the advantage of rising prove. This creates demand for more capital.

Similarly during depression when the prices and demand for manufactured goods.

Constantly reduce the industrial and trading activities show a downward termed. Hence

the demand for working capital is low.7. Current asset policies

The quantum of working capital of a company is significantly determined by its current

assets policies. A company with conservative assets po licy may operate with relatively high

level of working capital than its sales volume. A company pursuing an aggressive amount assets

policy operates with a relatively lower level of working capital.

8. Fluctuations of supply and seasonal variations

Some companies need to keep large amount of working capital due to their irregular sales

and intermittent supply. Similarly companies using bulky materials also maintain large

reserves of raw material inventories. This increases the need of working capital. Some

companies manufacture and sell goods only during certain seasons. Working capital

requirements of such industries will be higher during certain season of such industries period.

9. Other factors

Effective co-ordination between production and distribution can reduce the need for

working capital. Transportation and communication means. If developed helps to reduce

the working capital requirement/.

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Operating Cycle

The operating cycle of the company consists of time period between procurement of the

inventory and the collection of the cash from the receivables. The operating cycle is the

length of time between the companys outlay on raw materials, wages, and other

expenses and inflow of cash from sale of goods. Operating cycle is an important concept

in the management of cash and management of working capital. The operating cycles

reveals the time that elapses between outlay of cash and inflow of cash.

The above said periods are ascertained as follow:

(a) Raw material Holding Period =

Average Raw material stock _

Average consumption of Raw material/365

(b) Work-in-Process period =

Average Work-in-Process _

Average cost of goods/365

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(c) Receivable collection period =

Average Receivables _

Average sales/365

(d) Creditors payment period =

Average Work-in-Process _

Average cost of goods/365

(e) Finished Goods Holding period =

Average finished goods stock _

Average cost of goods sold/365

Sources of working capital

The company can choose to finance its current assets by

Long term sources

Short term sources

Long term sources of permanent working capital: - It include equity and preference

shares, retained earning, debentures and other long term debts from public deposits and

financial institution. The long term working capital needs should meet through long termmeans of financing. Financing through long term means provides stability, reduces risk or

payment and increases liquidity of the business concern. Various types of long term

sources of working capital are summarized as follow

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1. Issue of shares

It is the primary and most important sources of regular or permanent working capital.

Issuing equity shares as it does not create and burden on the income of the concern.

Nor the concern is obliged to refund capital should preferably raise permanent working

capital. Issue of preference shares is also a source of creating working capital

2. Retained earnings

Retain earning accumulated profits are a permanent sources of regular working

capital. It is regular and cheapest. It creates not charge on future profits of the

enterprises.

3. Issue of debentures

It crates a fixed charge on future earnings of the company. Company is obliged to pay

interest. Management should make wise choice in procuring funds by issue of debentures.

4. Long term debt

Company can raise fund from accepting public deposits, debts from Financial

Institution like banks, corporations etc. the cost is higher than the other financial tools.

Other sources sale of idle fixed assets, securities received from employees and

customers are examples of other sources of finance.

Short term sources of temporary working capital: - Temporary working capital isrequired to meet the day to day business expenditures. The variable working capital would

finance from short term sources of funds. And only the period needed. It has the benefits

of, low cost and establishes closer relationships with banker. Some sources of temporary

working capital are given below

1. Commercial bank

A commercial bank constitutes a significant source for short term or temporary working

capital. This will be in the form of short term loans, cash credit, and overdraft and

though discounting the bills of exchanges.

2. Public deposits

Most of the companies in recent years depend on these sources to meet their short

term working capital requirements ranging fro six month to three years.

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3.Various credits

Trade credit, business credit papers and customer credit are other sources of short

term working capital. Credit from suppliers, advances from customers, bills of

exchanges, promissory notes, etc. helps to raise temporary working capital

4.Reserves and other funds

Various funds of the company like depreciation fund. Provision for tax and other

provisions kept with the company can be used as temporary working capital.

The company should meet its working capital needs through both long term and short

term funds. It will be appropriate to meet at least 2/3 of the permanent working capital

equipments form long term sources, whereas the variables working capital should be

financed from short term sources. The working capital financing mix should be designed in

such a way that the overall cost of working capital is the lowest, and the funds areavailable on time and for the period they are really required.

SOURCES OF ADDITIONAL WORKING CAPITAL

Sources of additional working capital include the following

Existing cash reserves

Profits (when you secure it as cash)

Payables (credit from suppliers)

New equity or loans from shareholder Bank overdrafts line of credit

Long term loans

If you have insufficient working capital and try to increase sales, you can easily over

stretch the financial resources of the business, this is called overtrading.

Policies for financing Current Assets

Long term financing: The sources of long term financing include Ordinary shares,Preference shares, and debentures, long term borrowings from financial institutions and

reserves and surplus (retained earnings)

Short term borrowing: Short term financing include working capital, funds from banks,

public deposits, commercial paper and factoring of receivables etc.

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Spontaneous financing: Spontaneous financing refers to the automatic sources of short

term funds arising in the normal course of a business. Trade creditors and outstanding

expenses are the example of it. Depending on the mix of short term and long term

financing, the approach followed by a company may be referred to as:

Matching approach

Conservative approach

Aggressive approach

Matching approach:

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

expected life of the source of funds raised to finance assets. When the firms follow thematching approach (known as hedging approach), long term financing will be used to

finance the fixed assets and permanent current assets and short term financing to finance

temporary or variable current assets.

Temporary current assets Short-term Financing

Assets Permanent current assets

Long- term financing

Fixed assets

TIME

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Conservative approach:

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

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

assets and also a part of temporary current assets with long term financing.

Temporary current assets Short-term Financing

(b)

Assets

Permanent current assets Long- term financing

Fixed assets

Aggressive approach:

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

followed by the firm when its uses more short term financing than warranted by the

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

current assets with short term financing.

Temporary current assets Short-term Financing

(b)

Assets

Permanent current assets Long- term financing

Fixed assets

Time

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Working Capital Ratios

Working capital ratios indicate the ability of the business concern in meeting its current

obligation as well as its efficiency in managing the currents assets for generation of the

sales. The ratios are applied to evaluate the efficiency with which the firm manages and

utilizes its current assets. The following three categories of ratios are used for efficient

management of working capital:

(1) Efficiency Ratios:

Working capital to sales ratios = Sales / Working capital

Inventory turnover ratio = sales / Inventory

Current Assets turnover ratio = sales / Current Assets

(2) Liquidity Ratios:

Current ratio = Current Assets / Current Liability

Quick ratio = Current assets Inventory/ Current liability Bank overdraft

Absolute liquid ratio = Absolute liquid Assets / Current Liability

(3) Structural Health Ratios:

Current Assets to Total Net Assets = Total Net Assets / Current Assets

Debtor turnover ratio = Credit Sales / Debtors

Debtor collection periods = Debtors X 365 / Credit sales

Bad debts to sales = Bad Debts / Sales

Creditors Payment Periods = Creditors X 365 / Credit Purchase

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Working capital financing

Tandon Committee: Norms and Recommendations:

In 1974, a study group under the chairmanship of Mr. P. L. Tandon was constituted for

framing guidelines for commercial banks for follow-up & supervision of bank credit for

ensuring proper end-use of funds. The group submitted its report in August 1975, which

came to be popularly known as Tandon Committees Report. Its main recommendations

related to norms for inventory and receivables, the approach to lending, style of credit,

follow ups & information system.

It was a landmark in the history of bank lending in India. With acceptance of major

recommendations by Reserve Bank of India, a new era of lending began in India.

Tandon committees recommendationsBreaking away from traditional methods of security oriented lending, the committee

enjoyed upon the banks to move towards need based lending. The committee pointed out

that the best security of bank loan is a well functioning business enterprise, not the

collateral.

Major recommendations of the committee were as follows:

1. Assessment of need based credit of the borrower on a rational basis on the basis

of their business plans.2. Bank credit would only be supplementary to the borrowers resources and not

replace them, i.e. banks would not finance one hundred percent of borrowers working

capital requirement.

3. Bank should ensure proper end use of bank credit by keeping a closer watch on

the borrowers business, and impose financial discipline on them.

4. Working capital finance would be available to the borrowers on the basis of industry

wise norms (prescribe first by the Tandon Committee and then by Reserve Bank of

India) for holding different current assets, viz.

Raw materials including stores and others items used in manufacturing

process.

Stock in Process.

Finished goods.

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Accounts receivables.

5. Credit would be made available to the borrowers in different components like cash

credit; bills purchased and discounted working capital, term loan, etc., depending upon

nature of holding of various current assets.

6. In order to facilitate a close watch under operation of borrowers, bank would

require them to submit at regular intervals, data regarding their business and

financial operations, for both the past and the future periods.

The Norms

Tandon committee had initially suggested norms for holding various current assets for

fifteen different industries. Many of these norms were revised and the least extended to

cover almost all major industries of the country.

Expression of Norms

The norms for holding different current assets were expressed as follows:

(a) Raw materials as so many months consumption. They include stores and other

items used in the process of manufacture.

(b) Stock-in-process, as so many months cost of production.

(c) Finished goods and accounts receivable as so many months cost of sales and sales

respectively. These figures represent only the average levels. Individual items of

finished goods and receivables could be for different periods which could exceed the

indicated norms so long as the overall average level of finished goods and

receivables does not exceed the amounts as determined in terms of the norm.

(d) Stock of spares was not included in the norms. In financial terms, these were

considered to be a small part of total operating expenditure. Banks were expected to

assess the requirement of spares on case-by-case basis. However, they should keep

a watchful eye if spares exceed 5% of total inventories.

Suggested norms for inventory and receivables as suggested by the Tandon Committeeare given in Annexure (I).

The norms were based on average level of holding of a particular current asset, not on the

individual items of a group. For example, if receivables holding norms of an industry was

two months and an unit had satisfied this norm, calculated by dividing annual sales with

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average receivables, then the unit would not be asked to delete some of the accounts

receivable, which were being held for more than two months

The Tandon committee while laying down the norms for holding various current assets

made it very clear that it was against any rigidity and straight jacketing. On one hand, the

committee said that norms were to be regarded as the outer limits for holding different

current assets, but these were not to be considered to be entitlements to hold current

assets upto this level. If a borrower had managed with less in the past, he should continue

to do so. On the other hand, the committee held that allowance must be made for some

flexibility under circumstances justifying a need for re-examination. The committee itself

visualized that there might be deviations of norms in the following circumstances.

(a) Bunched receipt of raw materials including imports.

(b) Interruption of production due to power cuts, strikes or other unavoidablecircumstances.

(c) Transport delays or bottlenecks.

(d) Accumulation of finished goods due to non-availability of shipping space for exports

or other disruption in sales.

(e) Building up of stocks of finished goods, such as machinery, due to failure on the part

of the purchaser for whom these were specifically designed and manufactured.

(f) Need to cover full or substantial requirement of raw materials for specific exportcontract of short duration.

While allowing the above exceptions, the committee observed that the deviations should

be for known and specific circumstances and situation, and allowed only for a limited

period to tide over the temporary difficulty of a borrowing unit. Returns to norms would be

automatic when conditions return to normal.

Methods of Lending

The lending framework proposed by Tandon Committee dominated commercial bank

lending in India for more than 20 years and its continues to do so despite withdrawal of

mandatory provision of Reserve Bank of India in 1997.

As indicated before, the essence of Tandon Committees recommendations was to

finance only portion of borrowers working capital needs not the whole of it. It was thought

that gradually, the borrower should depend less on banks to fund its working capital

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needs. From this point of view the committee three graduated methods of lending, which

came to be known as maximum permissible bank finance system or in short MPBF

system.

For the purpose of calculating MPBF of a borrowing unit, all the three methods adopted

equation:

Working Capital Gap = Gross Current Assets Accounts Payable

. as a basis which is translated arithmetically as follows:

Gross Current Assets Rs.

Less : Current Liabilities

other than bank borrowings Rs. .

Working Capital Gap Rs. .

FIRST METHOD OF LENDING

The contribution by the borrowing unit is fixed at a minimum of 25% working capital gap

from long-term funds. In order to reduce the reliance of the borrowers on bank borrowings

by bringing in more internal cash generation for the purpose, it would be necessary to

raise the share of the contribution from 25% of the working capital gap to a higher level.

The remaining 75% of the working capital gap would be financed by the bank. Thismethod of lending gives a current ratio of only 1:1. This is obviously on the low side.

SECOND METHOD OF LENDING

In order to ensure that the borrowers do enhance their contributions to working capital and

to improve their current ratio, it is necessary to place them under the Second Method of

lending recommended by the Tandon Committee which would give a minimum current

ratio of 1.33:1. The borrower will have to provide a minimum of 25% of total current assets

from long-term funds. However, total liabilities inclusive of bank finance would never

exceed 75% of gross current assets. As many of the borrowers may not be immediately in

a position to work under the Second Method of lending, the excess borrowing should be

segregated and treated as a working capital term loan which should be made repayable in

installments. To induce the borrowers to repay this loan, it should be charged a higher

rate of interest. For the present, the Group recommends that the additional interest may

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be fixed at 2% per annum over the rate applicable on the relative cash credit limits. This

procedure should be made compulsory for all borrowers (except sick units) having

aggregate working capital limits of Rs.10 lakhs and over.

THIRD METHOD OF LENDING

Under the third method, permissible bank finance would be calculated in the same

manner as the second method but only after deducting four current assets from the gross

current assets. The borrowers contribution from long-term funds will be to the extent of

the entire core current assets, as defined, and a minimum of 25% of the balance current

assets, thus strengthening the current ratio further. This method will provide the largest

multiplier of bank finance.

Core portion current assets were presumed to be that permanent level which would generally varywith the level of the operation of the business. For example, in case of stocks of materials the core

line goes horizontally below the ordering level so that when stocks are ordered materials are

consumed down the ordering level during the lead time and touch the core level, but are not

allowed to go down further. This core level provides a safety cushion against any sudden shortage

of materials in the market or lengthening of delivery time. This core level is considered to be

equivalent to fixed assets and hence, was recommended to be financed from long-term sources.

A real time example:

Current liabilities Rs. Rs. Current Assets Rs. Rs.Trade credit 300 Inventories:-Other current liabilities 150 450 Raw materials 600

Work in process 60Bank

Borrowing,

including billdiscounted 600 Finished Goods 270 930

Accounts Receivable

(Bills Discounted) 150Other CA 30

Total 1050 1110

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Third Method

Particulars (Rs.)

Gross current Asset 1110

Less: Core current Assets 285

Real current Asset 825

Less: 25% of the above from

Long-term sources 207

618

Less: Current Liabilities

(Other than bank borrowings) 450

Maximum permissible bank Finance 168

Actual bank borrowing 600Excess borrowing 432

Current Ratio 1.79

It would appear from the above illustration that there is a gradual decrease in MPBF

from one method to the other, which is reflected by the gradual rise of current ratio.

The committee proposed that excess borrowing over the MPBF, shown above should

be placed on a repayment basis to be adjusted over a period of time.

The level of holding under the prescribed three methods of lending should be considered

as minimum threshold level. For units whose existing current ratio is higher than minimum

prescribed, would not be allowed any slip back except under special circumstances.

Reserve Bank of India allowed such slip back for the following purposes only if current

ratio of at least 1.33 was maintained:

(a) For undertaking either an expansion of existing capacity which would also

include setting up of new units.

(b) For fuller utilization of existing capacity, for meeting a substantial increase in the

units working capital requirements on account of abnormal price rise.

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(c) For investment in allied concern with the concurrence of the bank.

(d) For bringing about a reduction in the level of deposit accepted from the public in

order to comply with statutory requirements.

(e) For repayment by installments foreign currency loans and other term loans.

(f) For rehabilitation or reviving weaker units in the group while allowing funds from

cash rich companies, provided that by such transfer the current ratios of the

transferor companies would not fall below 1.33.

Under the liberalized lending regime the RBI has allowed the banks to decide on

permitting slip-back on their own. But the circumstances mentioned above being

exhaustive, continue to act as guidelines.

From an analysis of the operations of cash credit accounts of many non- seasonal

industries, Tandon Committee observed that the outstanding in a cash credit account didnot fall below certain level, which represented the stable fund requirement during the year.

The committee therefore suggested that permissible bank finance be made available to a

borrower in the form of a demand loan for that minimum level which constituted the stable

fund requirement and the fluctuating portion by cash credit. But the concept of core

current asset did not find found favor with banks because of difficulties in calculating them,

and where abandoned by Chore Committee.

Lending Policies of Commercial Banks during Post Liberalization Period

In the credit policy announcements of 1997-98 of RBI give freedom to the banks and the

borrowers in respect of sanction or availability of working capital facilities. Banks would

henceforth make their own assessment of credit requirement of borrowers based on a

total study of the borrowers business operations. RBI would no longer prescribe detailed

industry wise norms for holding of various current assets as in MPBF system, except that

it may provide broad indicative level for the guidance of banks. Accordingly, banks can

decide the levels of holding of each item of current assets, which in their view, would

represent a reasonable build up of current assets for being supported by banks.

Banks are encouraged to evolve suitable internal guidelines for evaluating various

projections made by borrowers including level of trade credits available to them, and also

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to install appropriate risk analysis mechanisms in view of changing risk perceptions under

a liberalized regime.

The Concept of Zero Working Capital

In todays world of intense global competition, working capital management is

receiving increasing attention form managers striving for peak efficiency the goal of

many leading companies today, is zero working capital. Proponent of the zero working

capital concept claims that a movement toward this goal not only generates cash but

also speeds up production and helps business make more timely deliveries and

operate more efficiently. The concept has its own definition of working capital:

inventories+ receivables- payables. The rational here is (i) that inventories andreceivables are the keys to making sales, but (II) that inventories can be financed by

suppliers through account payables.

Companies use about 20% of working capital for each sale. So, on average,

working capital is turned over five times per year. Reducing working capital and thus

increasing turnover has two major financial benefits. First every money freed up by

reducing inventories or receivables, by increasing payables, results in a one time

contribution to cash flow. Second, a movement toward zero working capitalpermanently raises a companys earnings.

The most important factor in moving toward zero working capital is increased speed. If

the production process is fast enough, companies can produce items as they are

ordered rather than having to forecast demand and build up large inventories that are

managed by bureaucracies. The best companies delivery requirements. This system is

known as demand flow or demand based management. And it builds on the just in

time method of inventory control.

Clearly it is not possible for most firm to achieve zero working capital and infinitely

efficient production. Still, a focus on minimizing receivables and inventories while

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maximizing payables will help a firm lower its investment in working capital and

achieve financial and production economies.

Technique for assessment of Working Capital requirement

1. Estimation of Component of working capital Method: Since working capital is

the excess of current assets over current liabilities, an assessment of the working capital

requirements can be made by estimating the amounts of different constituents of working

capital e.g., inventories, accounts receivable, cash, accounts payable, etc.

2. Percent of sales Approach:

This is a traditional and simple method of estimating working capital requirements.

According to this method, on the basis of past experience between sales and working

capital requirements, a ratio can be determined for estimating the working capital

requirements in future.3. Operating Cycle Approach:

According to this approach, the requirements of working capital depend upon the

operating cycle of the business. The operating cycle begins with the acquisition of raw

materials and ends with the collection of receivables

It may be broadly classified into the following four stages viz.

Raw materials and stores storage stage.

Work-in-progress stage. Finished goods inventory stage.

Receivables collection stage.

The duration of the operating cycle for the purpose of estimating working capital

requirements is equivalent to the sum of the durations of each of these stages less the

credit period allowed by the suppliers of the firm.

Symbolically the duration of the working capital cycle can be put as follows: -

O = R + W + F + D - C

Where,

O = Duration of operating cycle;

R = Raw materials and stores storage period;

W = Work-in-progress period;

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F = Finished stock storage period;

D = Debtors collection period;

. C = Creditors payment period

Each of the components of the operating cycle can be calculated as follows:-

R = Average stock of raw materials and stores

Average raw materials and stores consumptions per day

W = Average work-in-progress inventory

Average cost of production per day

D = Average book debts

Average credit sales per day

C = Average trade creditors

Average credit purchases per day

After computing the period of one operating cycle, the total number of operatingcycles that can be computed during a year can be computed by dividing 365 days with

number of operating days in a cycle. The total expenditure in the year when year when

divided by the number of operating cycles in a year will give the average amount of the

working capital requirement.

CASH MANAGEMENT

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It is the duty of the finance manager to provide adequate cash to all segments of the

organization. He also has to ensure that no funds are blocked in idle cash since this will

involve cost in terms of interest to the business. A sound cash management scheme,

therefore, maintains the balance between the twin objectives of liquidity and cost.

Meaning of cash

The term cash with reference to cash management is used in two senses. In a narrower

sense it includes coins, currency notes, cheques, bank drafts held by a firm with it and the

demand deposits held by it in banks. In a broader sense it also includes near-cash

assets such as, marketable securities and time deposits with banks. Such securities or

deposits can immediately be sold or converted into cash if the circumstances require. The

term cash management is generally used for management of both cash and near-cash

assets.

Motives for holding cash

A distinguishing feature of cash as an asset, irrespective of the firm in which it is held, is

that it does not earn any substantial return for the business. In spite of this fact cash is

held by the firm with following motives.

1. Transaction motive

A firm enters into a variety of business transactions resulting in both inflows andoutflows. In order to meet the business obligation in such a situation, it is necessary to

maintain adequate cash balance. Thus, cash balance is kept by the firms with the motive

of meeting routine business payments.

2. Precautionary motive

A firm keeps cash balance to meet unexpected cash needs arising out of

unexpected contingencies such as floods, strikes, presentment of bills for payment earlier

than the expected date, unexpected slowing down of collection of accounts receivable,

sharp increase in prices of raw materials, etc. The more is the possibilit y of such

contingencies more is the cash kept by the firm for meeting them .

3. Speculative motive

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A firm also keeps cash balance to take advantage of unexpected opportunities, typically

outside the normal course of the business. Such motive is, therefore, of purely a

speculative nature.

For example,

A firm may like to take advantage of an opportunity of purchasing raw materials at

the reduced price on payment of immediate cash or delay purchase of raw materials in

anticipation of decline in prices.

4. Compensation motive

Banks provide certain services to their clients free of charge. They, therefore, usually

require clients to keep minimum cash balance with them, which help them to earn interest

and thus compensate them for the free services so provided.Business firms normally do not enter into speculative activities and, therefore, out of

the four motives of holding cash balances, the two most important motives are the

compensation motive.

Objectives of cash management

There are two basic objectives of cash management:

To meet the cash disbursement needs as per the payment schedule; To minimize the amount locked up as cash balances.

1. Meeting cash disbursements

The first basic objective of cash management is to meet the payments Schedule. In

other words, the firm should have sufficient cash to meet the various requirements of the

firm at different periods of times. The business has to make payment for purchase of raw

materials, wages, taxes, purchases of plant, etc. The business activity may come to a

grinding halt if the payment schedule is not maintained. Cash has, therefore, been aptly

described as the oil to lubricate the ever-turning wheels of the business, without it the

process grinds to a stop.

2. Minimizing funds locked up as cash balances

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The second basic objective of cash management is to minimize the amount locked up as

cash balances. In the process of minimizing the cash balances, the finance manager is

confronted with two conflicting aspects. A higher cash balance ensures proper payment

with all its advantages. But this will result in a large balance of cash remaining idle. Low

level of cash balance may result in failure of the firm to meet the payment schedule.

The finance manager should, therefore, try to have an optimum amount of cash

balance keeping the above facts in view.

Cash management - - - - - basic problems

Cash management involves the following four basic problems:

Controlling levels of cash;

Controlling inflows of cash;

Controlling outflows of cash;

Optimum investment of surplus cash.

1. Controlling levels of cash

One of the basic objectives of cash management is to minimize the level of cash balance

with the firm. This objective is sought to be achieved by means of the following: -

(i) Preparing cash budget:

Cash budget or cash forecasting is the most significant device for planning and

controlling the use of cash. It involves a projection of future cash receipts and cash

disbursements of the firm over various intervals of time. It reveals to the finance

manager the timings and amount of expected cash inflows and outflows over a

period studied. With this information, he is better able to determine the future cash

needs of the firm, plan for the financing of these needs and exercise control over

the cash and liquidity of the firm.

Thus in case a cash budget is properly prepared it correctly reveals the timings and

size of net cash flows as well as the periods during which the excess cash may be

available for temporary investment. In a small company, the preparation of cash

budget or a cash forecast does not involve much of complications and, therefore,

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relatively a minor job. However, in case of big companies, it is almost a full time job

handled by a senior person, namely, the budget controller or the treasurer.

(ii) Providing for unpredictable discrepancies:

Cash budget predicts discrepancies between cash inflows and outflows on the

basis of normal business activities. It does not take into account discrepancies

between cash inflows and cash outflows on account of unforeseen circumstances

such as strikes, short-term recession, floods, etc. a certain minimum amount of

cash balance has, therefore, to be kept for meeting such unforeseen

contingencies. Such amount is fixed on the basis of past experience and some

intuition regarding the future.

(iii) Consideration of short costs:

The term short cost refers to the cost incurred as a result of shortage of cash. Such

costs may take any of the following forms:

(a) The failure of the firm to meet its obligations in time may result in legal action by the

firms creditors against the firm. This cost is in terms of fall in the firms reputation

besides financial costs incurred in defending the suit;

(b) Borrowing may have to be resorted to at high rate of interest. The firm may also berequired to pay penalties, etc., to banks for not meeting the obligations in time.

(iv) Availability of other sources of funds:

A firm can avoid holding unnecessary large balance of cash for contingencies in

case it has adequate arrangements with its bankers for borrowing money in times

of emergencies. For such arrangements the firm has to pay a slightly higher rate of

interest than that on a long-term debt. But considerable saving in interest costs will

be effected because such interest will have to be paid only for shorter period.

2. Controlling inflows of cash

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Having prepared the cash budget, the finance manager should also ensure that there is

no significant deviation between the projected cash inflows and the projected cash

outflows. This requires controlling of both inflows as well as outflows of cash.

Speedier collection of cash can be made possible by adoption of the following techniques,

which have been found to be quite useful and effective.

(i) Concentration Banking:

Concentration banking is a system of decentralizing collections of accounts

receivables in case of large firms having their business spread over a large area.

According to this system, a large number of collection centers are established by

the firm in different areas selected on geographical basis. The firm opens its bank

accounts in local banks of different areas where it has its collection centers. The

collection centers are required to collect cheques from their customers anddeposits them in the local bank account. Instructions are given to the local

collection centers to transfer funds over a certain limit daily telegraphically to the

bank at the head office. This facilitates fast movements of funds.

The companys treasurer on the basis of the daily report received from the

head office bank about the collected funds can use them for disbursement

according to needs.

This system of concentration banking results in the following advantages:

(a) The mailing time is reduced since the collection centers themselves collect

cheques from the customers and immediately deposit them in local bank accounts.

Moreover, when the local collection centres are also used to prepare and send bills

to the customers in their areas, the mailing time in sending bills to the customer is

also reduced;

(b) The time required to collect cheques is also reduced since the cheques deposited

in the local bank accounts are usually drawn on banks in that area.This helps in

quicker collection of cash.

(ii) Lock-box system:

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Lock-box system is a further step in speeding up collection of cash. In case of

concentration banking cheques are received by collection centres who, after

processing, deposit them in the local bank accounts. Thus, there is time gap

between actual receipt of cheques by a collection centre and its actual depositing in

the local bank account.

Lock-box system has been devised to eliminate delay on account of this time gap.

According to this system, the firm hires a post-office box and instructs its

customers to mail their remittances to the box. The firms local bank is given the

authority to pick the remittances directly from the post-office box. The bank picks

up the mail several times a day and deposits the cheques in the firms account.

Standing instructions are given to the local bank to transfer funds to the head office

bank when they exceed a particular limit.The Lock-Box system offers the following advantages:

(a) All remittances are handled by the banks even prior to their de3posits

with them at a very low cost;

(b) The cheques are deposited immediately upon receipt of remittances

and the collecting process starts much earlier than that under the system of

concentration banking.

3. Control over cash flows

An effective control over cash outflows or disbursements also helps a firm in

conserving cash and reducing financial requirements. However, there is a basic

difference between the underlying objective of exercising control over cash inflows and

cash outflows. In case of the former, the objective is the maximum acceleration of

collections while in the case of latter, it is to slow down the disbursements as much as

possible. The combination of fast collections and slow disbursements will result in

maximum availability of funds.

A firm can advantageously control outflows of cash if the following considerations are

kept in view:

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(i) Determining of surplus cash

Surplus cash is the cash in excess of the firms normal cash requirements. While

determining the amount of surplus cash, the finance manager has to take into account the

minimum cash balance that the firm must keep to avoid risk or cost of running out of

funds. Such minimum level may be termed a safety level of cash.

Determining safety level for cash

The finance manager determines the safety level of cash separately both for normal

periods and peak periods.

In both the cases, he has to decide about the following two basic factors:

(a) Desired days of cash:

It means the number of days for which cash balance should be sufficient to cover payments.

(b) Average daily cash outflows:

This means the average amount of disbursements, which will have to be made

daily.

The desired days of cash and average daily cash outflows are separately determined

for normal and peak periods. Having determined them, safety level of cash can be

calculated as follows:During normal periods:

Safety level of cash = Desired days of cash x average daily cash outflows

During peak periods:

Safety level of cash = Desired days of cash at the busiest period x

Average of highest daily cash outflows.

(ii) Determining of channels of investments :

The finance manager can determine the amount of surplus cash, by comparing the

actual mount of cash available with the safety or minimum level of cash. Such surplus

may be either of a temporary or a permanent nature.

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Temporary cash surplus consists of funds, which are available for investment on a

short-term basis (maximum 6 months), since they are required to meet regular obligations

such as those of taxes, dividends, etc.

Permanent cash surplus consists of funds, which are kept by the firm to avail of some

unforeseen profitable opportunity of expansion or acquisition of some asset. Such funds

are, therefore, available for investment for a period ranging from six months to a year.

Criteria for investment

In most of the companies there are usually no written instructions for investing the

surplus cash. It is left to the discretion and judgment; It usually takes into consideration

the following factors:

(i) Security:This can be ensured by investing money in securities whose price remain more

or less stable.

(ii) Liquidity:

This can be ensured by investing money in short-term securities including short-

term fixed deposits with bank.

(iii) Yield:

Most corporate managers give less emphasis to yield as compared to securityand liquidity of investment. They, therefore, prefer short-term government securities for

investing surplus cash. However, some corporate managers follow aggressive investment

policies, which maximize the yield on their investments.

(iv) Maturity:

Surplus cash is available not for an indefinite period. Hence, it will be advisable to

select securities according to their maturities keeping in view the period for which surplus

cash is available. If such selection is done carefully, the finance manager can maximize

the yield as well as maintain the liquidity of investments.

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INVENTORY MANAGEMENT

Inventories are good held for eventual sale by a firm. Inventories are thus one of the major

elements, which help the firm in obtaining the desired level of sales

Kinds of inventories

Inventories can be classified into three categories.

(i) Raw materials:

These are goods, which have not yet been committed to production in a manufacturing

firm. They may consist of basic raw materials or finished components.

( ii) Work-in-progress:

This includes those materials, which have been committed to production process but have

not yet been completed.(iii) Finished goods :

These are completed products awaiting sale. They are the final output of the production

process in a manufacturing firm. In case of wholesalers and retailers, they are generally

referred to as merchandise inventory.

The levels of the above three kinds of inventories differ depending upon the nature of the

business.

Benefits of holding inventories

Holding of inventories helps a firm in separating the process of purchasing, producing and

selling. In case a firm does not hold sufficient stock of raw materials, finished goods, etc.,

the purchasing would take place only when the firm receives the order from a customer. It

may result in delay in executing the order because of difficulties in obtaining/ procuring

raw materials, finished goods, etc. thus inventories provide cushion so that the

purchasing, production and sales functions can proceed at optimum speed.

The specific benefits of holding inventories can be put as follows:

(i) Avoiding losses of sales

If a firm maintains adequate inventories it can avoid losses on account of losing the

customers for non-supply of goods in time.

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(ii) Reducing ordering cost

The variable cost associated with individual orders, e.g., typing, checking, approving and

mailing the order, etc., can be reduced if a firm places a few large orders than numerous

small orders.

(iii) Achieving efficient production runs

Maintenance of large inventories helps a firm in reducing the set-up cost associated with

each production run.

Risks and costs associated with inventories

Holding of inventories exposes the firm to a number of risks and costs. Risk of holding

inventories can be put as follows:

(i) Price declineThis may be due to increase in the market supply of the product, introduction of a new

competitive product, price cutting by the competitors, etc.

(ii) Product deterioration

This may due to holding a product for too long a period or improper storage conditions.

(iii) Obsolescence

This may be due to change in customers taste, new production technique, improvements

in the product design, specifications, etc.The costs of holding inventories are as follows:

(i) Materials cost

This includes the cost of purchasing the goods, transportation and handling charges less

any discount allowed by the supplier of the goods.

(ii) Ordering cost

This includes the variable cost associated with placing an order for the goods. The fewer

the orders, the lower will be the ordering costs for the firm.

(iii) Carrying cost

This includes the expenses for storing the goods. It comprises storage costs, insurance

costs, spoilage costs, cost of funds tied up in inventories, etc.

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Management of inventory

Inventories often constitute a major element of the total working capital and hence it has

been correctly observed, good inventory management is good financial management.

Inventory management covers a large number of issues including fixation of

minimum and maximum levels; determining the size of the inventory to be carried ;

deciding about the issue price policy; setting up receipt and inspection procedure;

determining the economic order quantity; providing proper storage facilities, keeping

check on obsolescence and setting up effective information system with regard to the

inventories.

However, a management inventory involves two basic problems:

(i) Maintaining a sufficiently large size of inventory for efficient and smooth

production and sales operations;(ii) Maintaining a minimum investment in inventories to minimize the direct-

indirect costs associated with holding inventories to maximize the

profitability.

Inventories should neither be excessive nor inadequate. If inventories are kept at a high

level, higher interest and storage costs would be incurred. On the other hand, a low level

of inventories may result in frequent interruption in the production schedule resulting in

underutilization of capacity and lower sales.The objective of inventory management is, therefore, to determine and maintain the

optimum level of investment in inventories, which help in achieving the following

objectives:

(i) Ensuring a continuous supply of materials to production department

facilitating uninterrupted production.

(ii) Maintaining sufficient stock of raw material in periods of short supply.

(iii) Maintaining sufficient stock of finished goods for smooth sales

operations.

(iv) Minimizing the carrying costs.

(v) Keeping investment in inventories at the optimum level.

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Techniques of inventory management

Effective inventory requires an effective control over inventories.

Inventory control refers to a system which ensures supply of required quantity and quality

of inventories at the required time and the same time prevent unnecessary investment in

inventories.

The techniques of inventory control/ management are as follows:

1. Determination of Economic Order Quantity (EOQ )

Determination of the quantity for which the order should be placed is one of the important

problems concerned with efficient inventory management. Economic Order Quantity refers

to the size of the order, which gives maximum economy in purchasing any item of raw

material or finished product. It is fixed mainly taking into account the following costs.

(i) Ordering costs: It is the cost of placing an order and securing the supplies. It varies

from time to time depending upon the number of orders placed and the number of

items ordered. The more frequently the orders are placed, and fewer the quantities

purchased on each order, the greater will be the ordering costs and vice versa.

(ii) Inventory carry ing cost:

It is the cost of keeping items in stock. It includes interest on

investment, obsolescence losses, store-keeping cost, insurance premium, etc. Thelarger the value of inventory, the higher will be the inventory carrying cost and vice

versa.

The former cost may be referred as the cost of acquiring while the latter as the

cost of holding inventory. The cost of acquiring decreases while the cost of holding

increases with every increase in the quantity of purchase lot. A balance is, therefore,

struck between the two opposing factors and the economic ordering quantity is

determined at a level for which aggregate of two costs is the minimum.

Formula:

Q = 2U x P

S

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Where,

Q = Economic Ordering Quantity

U = Quantity (units) purchased in a year (month)

P = Cost of placing an order

S = Annual (monthly) cost of storage of one unit.

2. Determination of optimum production quantity

The EOQ model can be extended to production runs to determine the optimum production

quantity.

The two costs involved in this process are:

(i) Set up costs;

(ii) Inventory carrying cost.

The set up cost is of the nature of fixed cost and is to be incurred at the time of

commencement of each production run. Larger the size of the production run, lower will

be the set-up cost per unit.

However, the carrying cost will increase with increase in the size of the production run.

Thus, there is an inverse relationship between the set-up cost and inventory carrying cost.The optimum production size is at that level where the total of the set-up cost and the

inventory carrying cost is the minimum.

In other words, at this level the two costs will be equal.

The formula for EOQ can also be used for determining the optimum production

quantity as given below:

E = 2U x P

S

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Where

E = Optimum production quantity

U = Annual (monthly) output

P = Set-up cost for each production run

S = Cost of carrying inventory per annum (per month)

RECEIVABLES MANAGEMENT

Accounts receivables (also properly termed as receivables) constitute a significant portion

of the total currents assets of the business next after inventories. They are a direct

consequences of trade credit which has become an essential marketing tool in modern

business.

When a firm sells goods for cash, payments are received immediately and,therefore, no receivables are credited. However, when a firm sells goods or services on

credit, the payments are postponed to future dates and receivables are created. Usually,

the credit sales are made on open account, which means that, no, formal

acknowledgements of debt obligations are taken from the buyers. The only documents

evidencing the same are a purchase order, shipping invoice or even a billing statement.

The policy of open account sales facilities business transactions and reduces to a great

extent the paper work required in connection with credit sales.

Meaning of receivables

Receivables are assets accounts representing amounts owed to the firm as a result of

sale of goods / services in the ordinary course of business.

They, therefore, represent the claims of a firm against its customers and are carried

to the assets side of the balance sheet under titles such as accounts receivables,

customer receivables or book debts. They are, as stated earlier, the result of extension of

credit facility to then customers a reasonable period of time in which they can pay for the

goods purchased by them.

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Purpose of receivables

Accounts receivables are created because of credited sales. Hence the purpose of

receivables is directly connected with the objectives of making credited sales.

The objectives of credited sales are as follows:

(i) Achieving growth in sales :

If a firm sells goods on credit, it will generally be in a position to sell more goods than if it

insisted on immediate cash payments. This is because many customers are either not

prepared or not in a position to pay cash when they purchase the goods. The firm can sell

goods to such customers, in case it resorts to credit sales.

(ii) Increasing profits:

Increase in sales results in higher profits for the firm not only because of increase in the

volume of sales but also because of the firm charging a higher margin of profit on creditsales as compared to cash sales.

(iii) Meeting competition:

A firm may have to resort to granting of credit facilities to its customers because of similar

facilities being granted by the competing firms to avoid the loss of sales from customers

who would buy elsewhere if they did not receive the expected output.

The overall objective of committing funds to accounts receivables is to generate a

large flow of operating revenue and hence profit than what would be achieved in theabsence of no such commitment.

Costs of maintaining receivables

The costs with respect to maintenance of receivables can be identified as follows:

1. Capital costs:

Maintenance of accounts receivables results in blocking of the firms financial resources in

them. This is because there is a time lag between the sale of goods to customers and the

payments by them. The firm has, therefore, to arrange for additional funds top meet its

own obligations, such as payment to employees, suppliers of raw materials, etc., while

awaiting for payments from its customers. Additional funds may either be raised from

outside or out of profits retained in the business. In both the cases, the firm incurs a cost.

In the former case, the firm has to pay interest to the outsider while in the latter case,

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there is an opportunity cost to the firm, i.e., the money which the firm could have earned

otherwise by investing the funds elsewhere.

2. Administrative costs:

The firm has to incur additional administrative costs for maintaining accounts receivable in

the form of salaries to the staff kept for maintaining accounting records relating to

customers, cost of conducting investigation regarding potential credit customers to

determine their creditworthiness, etc

3. Collection costs:

The firm has to incur costs for collecting the payments from its credit customers.

Sometimes, additional steps may have to be taken to recover money from defaulting

customers.

4. Defaulting costs:Sometimes after making all serious efforts to collect money from defaulting customers, the

firm may not be able to recover the overdues because of the of the inability of the

customers. Such debts are treated as bad debts and have to be written off since they

cannot be realized.

Factors affecting the size of receivables

The size of the receivable is determined by a number of factors.

Some of the important factors are as follows:(1) Level of sales:

This is the most important factor in determining the size of accounts receivable. Generally

in the same industry, a firm having a large volume of sales will be having a larger level of

receivables as compared to a firm with a small volume of sales.

Sales level can also be used for forecasting change in accounts receivable.

(2) Credited policies:

The term credit policy refers to those decision variables that influence the amount of trade

credit, i.e., the investment in receivables. These variables include the quantity of trade

accounts to be accepted, the length of the credit period to be extended, the cash discount

to be given and any special terms to be offered depending upon particular circumstances

of the firm and the customer. A firms credit policy, as a matter of fact, determines the

amount of risk the firm is willing to undertake in its sales activities. If a firm has a lenient or

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a relatively liberal credit policy, it will experience a higher level of receivables as compared

to a firm with a more rigid or stringent credit policy.

This is because of two reasons:

A lenient credit policy encourages even the financially strong customers to make

delays in payments resulting in increasing the size of the accounts receivables;

Lenient credit policy will result in greater defaults in payments by financially weak

customers thus resulting in increasing the size of receivables.

(3) Terms of trade:

The size of the receivables is also affected by terms of trade (or credit terms) offered by

the firm.

The two important components of the credit terms are:

(i) Credit period;

(ii) Cash discount.

(i) Credit period:

The term credit period refers to the time duration for which credit is extended to the

customers. It is generally expressed in terms of net days.

For example,

If a firms credit terms are net 15, it means the customers are expected to pay

within 15 days from the date of credit sale.(ii) Cash discount:

Most firms offer cash discount to their customers for encouraging them to pay their dues

before the expiry of the credit period. The terms of the cash discounts indicate the rate of

discount as well as the period for which the discount has been offered.

PAYABLE MANAGEMENT

Management of accounts payable is as much important as management of accounts

receivable. There is a basic difference between the approach to be adopted by the finance

manager in the two cases. Whereas the underlying objective in case of accounts

receivable is to maximize the acceleration of the collection process, the objective in case

of accounts payable is to slow down the payments process as much as possible. But it

should be noted that the delay in payment of accounts payable may result in saving of

some interest costs but it can prove very costly to the firm in the form of loss credit in the

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market. The finance manager has, therefore, to ensure that the payments after obtaining

the best credit terms possible.

Overtrading and undertrading:

The concepts of overtrading and undertrading are intimately connected with the net

working capable position of the business. To be more precise they are connected with the

cash position of the business.

OVERTRADING:

Overtrading means an attempt to maintain or expand scale of operations of the

business with insufficient cash resources. Normally, concerns having overtrading have a

high turnover ratio and a low current ratio. In a situation like this, the company is not in a

position to maintain proper stocks of materials, finished goods, etc., and has to depend on

the mercy of the suppliers to supply them goods at the right time. It may also not be ableto extend credit to its customers, besides making delay in payment to the creditors.

Overtrading has been amply described as overblowing the balloon. This may, therefore,

prove to be dangerous to the business since disproportionate increase in the operations of

the business without adequate resources may bring its sudden collapse.

Causes of overtrading

The following may be the causes of over-trading:

(i) Depletion of working capital:Depletion of working capital ultimately results in depletion of cash resources. Cash

resources of the company may get depleted by premature repayment of long-term loans,

excessive drawings, dividend payments, purchase of fixed assets and excessive net

trading losses, etc.

(ii) Faulty financial policy:

Faulty financial policy can result in shortage of cash and overtrading in several ways:

(a) Using working capital for purchase of fixed assets.

(b) Attempting to expand the volume of the business without raising the necessary

resources, etc.

(iii) Over-expansion:

In national emergencies like war, natural calamities, etc., a firm may be required to

produce goods on a larger scale. Government may pressurize the manufacturers to

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increase the volume of production without providing for adequate finances. Such pressure

results in over-expansion of the business ignoring the elementary rules of sound finance.

(iv) Inflation and rising prices:

Inflation and rising prices make renewals and replacements of assets costlier. The wages

and material costs also rise. The manufacturer, therefore, needs more money even to

maintain the existing level of activity.

(v) Excessive taxation:

Heavy taxes result in depletion of cash resources at a scale higher than what is justified.

The cash position is further strained on account of efforts of the company to maintain

reasonable dividend rates for their shareholders.

Consequences of overtrading The consequences of over-trading can be summarized as

follows: (i) Difficulty in paying wages and taxes:This is one of the most dangerous consequences of overtrading. Non-payments of

wages in time create a feeling of uncertainty, insecurity and dissatisfaction in all ranks of

the labour. Non-payments of taxes in time may result in bringing down the reputation of

the company considerably in the business and government circles.

(ii) Costly purchases:

The company has to pay more for its purchases on account of its inability to have

proper bargaining, bulk buying and selecting proper source of supplying quality materials.(iii) Reduction in sales:

The company may have to suffer in terms of sales because the pressure for cash

requirements may force it to offer liberal cash discounts to debtors for prompt payments,

as well as selling goods at throwaway prices.

(iv) Difficulties in making payments:

The shortage of cash will force the company to persuade its creditors to extend

credit facilities to it. Worry, anxiety and fear will be the managements constant

companions.

(v) Obsolete plant and machinery:

Shortage of cash will force the company to delay even the necessary repairs

and renewals. Inefficient working, unavoidable breakdowns will have an adverse

effect both on volume of production and rate of profit.

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REVIEW OF LITERATURE:

Bharat Sanchar Nigam Ltd. ( BSNL ) which started its operations in

October, 2000 with Corporate and Registered Office in New Delhi, is the

world's 7th largest Telecommunication Company providing

comprehensive range of telecom services in India i.e. Wireline (Basic

Phone), CDMA mobile, GSM Mobile, Internet, Broadband, Carrier

service, MPLS-VPN, VSAT, VOIP services, etc. Presently, it is one of the

largest & leading public sector unit in India.

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BSNL has installed Quality Telecom Network in the country and is now

focusing on improving / expanding the network, introducing new telecom

services with ICT applications in villages and wining customer's

confidence. Today, it has about 47.3 million lines basic telephone

capacity, 4 million WLL capacity, 48.11 Million GSM Capacity, more

than 37382 fixed exchanges, 44966 BTS, 3140 Node B ( 3G BTS), 287

Satellite Stations, 480196 Rkm of OFC Cable, 63730 Rkm of Microwave

Network connecting 602 Districts, 7330 cities/towns and 5.5 Lakhs

villages. BSNL is the only service provider in the country , making

focused efforts and taking planned initiatives to bridge the Rural-Urban

Digital Divide in ICT sector. In fact, there is no telecom operator in the

country to beat its reach with wide network giving services in every

nook & corner of country and also operate across India (except Delhi &

Mumbai ). Whether it is inaccessible areas of Siachen glacier or North-

eastern region of the country, BSNL serves the customers with its wide

bouquet of telecom services. BSNL is numero-uno operator of India in

all services in its license area. The company offers vide ranging & most

transparent tariff schemes designed to suite every customer.

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BSNL cellular service- CellOne has more than 49.09 million customers,

garnering 16.98 percent of all mobile users in its area of operation as its

subscribers. In basic services, BSNL is miles ahead of its rivals, with 35.1

million Basic Phone subscribers i.e. 85 per cent share of the subscriber

base and 92 percent share in revenue terms. BSNL has more than 2.5

million WLL subscribers and 2.5 million Internet Customers who access

Internet through various modes viz. Dial-up, Leased Line, DIAS,

Account Less Internet(CLI). BSNL has been adjudged as the NUMBER

ONE ISP in the country. BSNL has set up a world class multi-gigabit,

multi-protocol convergent IP infrastructure that provides convergent

services like voice, data and video through the same Backbone and

Broadband Access Network. At present, there are 0.6 million Data One

broadband customers. The company has vast experience in Planning,

Installation, network integration and Maintenance of Switching &

Transmission Networks and also has a world class ISO 9000 certified

Telecom Training Institute.

VISIONBSNL Registered Office

Bharat Sanchar BhavanHarish Chandra Mathur LaneJanpath, New Delhi-110 001

BSNL Corporate Office Bharat Sanchar BhavanHarish Chandra Mathur LaneJanpath, New Delhi-110 00150

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To become the largest telecom Service Provider in Asia.

MISSION

To provide world class State-of-art technology telecom services to its customers on

demand at competitive prices.

To Provide world class telecom infrastructure in its area of operation and to

contribute to the growth of the country's economy.

OBJECTIVES

To be the Lead Telecom Services Provider.

To provide quality and reliable fixed telecom service to our customer and there

by increase customer's confidence.

To provide mobile telephone service of high quality and become no. 1 GSM

operator in its area of operation.

To provide point of interconnection to other service provider as per their

requirement promptly.

To facilitate R & D activity in the country.

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Contribute towards: National Plan Target of 500 million subscriber base for

India by 2010.

Broadband customers base of 20 million by 2010 as per Broadband Policy 2004.

Providing telephone connection in villages as per government policy.

Implementation of Triple play as a regular commercial proposition.

ORGANISATION:

The corporate structure of BSNL Board consists of CMD & five full-time

Directors looking after Human Resource Development (HRD), Planning &

New Services , Operations, Finance and Commercial & Marketing, who

manage the entire gamut of BSNL operations. There are also five other

Govt. Directors in the full Board of BSNL. Shri Kuldeep Goyal took over

as Chairman & Managing Director of BSNL on August 1, 2007. He had

joined the Indian Telecommunication Service of Govt. of India in 1972. He

is an Engineering Graduate from IIT Roorkee. Prior to taking over as

CMD, BSNL, he worked as Director (Planning & New Services) and was

responsible for planning and execution of strategy for expansion of BSNL's

network. He has vast experience in telecom sector viz. planning,

installation, operation and maintenance of wirelines and wireless services,

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data services, computerization of various activities in telecom network and

provision of value added services.

The details of CMD, full-time Directors, Company Secretary andother SeniorOfficers heading various units/sections at BSNL CorporateOffice,New Delhi are as follows:-

-Location: New Delhi, India (+91-11-Tel No.)

Designation-Name-Phone-Fax No-Email--(Office)

CMD-KULDEEP GOYAL -23372424-23372444- cmdbsnl@bsnl.co.inDirector(Enterprise)-RAJENDRA SINGH-23734064-23734166-dir.enterprise@bsnl.co.inDirector(Finance)-GOPAL DAS -23714141-23314141-dirfin@bsnl.co.inDirector(Human Resource)-GOPAL DAS-23734070-23734072-dirhrd@bsnl.co.inDirector(Consumer Fixed Access)-Rajesh Wadhwa -2303714223738999-23734242- diro@bsnl.co.inDirector(Consumer Mobility)-R.K.Aggarwal-23734073-23734075-dirplg@bsnl.co.inCompany Secretary & GM(Legal)-H.C.PANT-23353395-23353389-csgml@bsnl.co.inPrincipal General ManagersArchitect-ASHIS DAY-23738113-23316988-------Building Works-B.K.BINDAL-23711172-23716036 23310195-ddg_bw@bsnl.co.in

Long Term Planning-N.N.GUPTA-23716482-23351291-ddg_ltp@bsnl.co.inElectrical-A.S.CHANDEL-23736527-23322398- srddgelect@bsnl.co.inFinance Personnel-S.R.KAPOOR-23734253-23734252-ddg_fp@bsnl.co.inSPF-Ms. H.T.SANGKHUMI-23734253-23734252- ddg_spf@bsnl.co.in

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mailto:cmdbsnl@bsnl.co.inmailto:dcm@bsnl.co.inmailto:dirfin@bsnl.co.inmailto:dirhrd@bsnl.co.inmailto:diro@bsnl.co.inmailto:dirplg@bsnl.co.inmailto:csgml@bsnl.co.inmailto:ddg_bw@bsnl.co.inmailto:ddg_ltp@bsnl.co.inmailto:srddgelect@bsnl.co.inmailto:ddg_fp@bsnl.co.inmailto:ddg_spf@bsnl.co.inmailto:cmdbsnl@bsnl.co.inmailto:dcm@bsnl.co.inmailto:dirfin@bsnl.co.inmailto:dirhrd@bsnl.co.inmailto:diro@bsnl.co.inmailto:dirplg@bsnl.co.inmailto:csgml@bsnl.co.inmailto:ddg_bw@bsnl.co.inmailto:ddg_ltp@bsnl.co.inmailto:srddgelect@bsnl.co.inmailto:ddg_fp@bsnl.co.inmailto:ddg_spf@bsnl.co.in

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Maintenance Services-RAM KUMAR-23714455-23354549-ddg_ms@bsnl.co.inT&C-S.R.KAPOOR-23718493-23734223-General Managers

Coord & Monitoring-TAJENDER KUMAR-23377861-23377862-ddg_cm@bsnl.co.inAdministration-S.C.AHLUWALIA-23734157-23718288-ddg_admn@bsnl.co.inCorporate Accounts-P.K. PURWAR-23734163-23734164-ddg_accts@bsnl.co.inBroadband-A.K.JAIN-23734057-23734284- ddg_bb@bsnl.co.inEnterprise Business-II-ANOOP KUMAR-23734010-23734012-anoopkumar@bsnl.co.in

Broadband-Operations-ANIL KUMAR- 23766994 - -mailto:ddg_bb@bsnl.co.inBudget & Banking Finance-Smt. YOJANA DAS-23734077-23734033- ddg_bbf@bsnl.co.inCellular Mobile Telecom Service-Core-D.P.SINGH-23710400-23734014- ddg_cmts@bsnl.co.inCMTS (Operations & Mntc)-S.C.SHARMA-23734305-23724304-ddg_cmtsom@bsnl.co.inCMTS-Infra-SUDHIR KUMAR-23319976-23734298-Commercial-S.K.SETH-23734265-23765467- ddg_comml@bsnl.co.inCorporate Task Force-A.N.RAI-23714242-23736752-ddg_ctf@bsnl.co.inCustomer Services-RAKESH BABU-23326255-23327656-ddg_cs@bsnl.co.inEstablishment-D P DE-23734050-23734051- ddg_estt@bsnl.co.inTaxation & EF-Ms ARUNDATI PANDA-23766475-23766476-ddg_taxation@bsnl.co.inInformation Technology-N.K.GUPTA-23714191-23765290-ddg_it@bsnl.co.inInternal Audit- Ms. H.T.SANGKHUMI- 23765252- - ddg_ia@bsnl.co.inInternational Business -M K Jain -23711660- - ddg_ib@bsnl.co.inInternational Relation -R.K.BATRA-23717217-23711516-ddg_ir@bsnl.co.inILD-J.M. SURI-23716060-23715511- ddg_ild@bsnl.co.inMarketing-M.S.S.RAO-23734045-23734046- ddg_mktg@bsnl.co.in

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