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History

Mohan T Advani, an entrepreneur of exemplary vision and drive, founded blue Star in 1943. TheCompany began as a modest 3-member team engaged in reconditioning of air conditioners and

refrigerators. Within three years, the Company secured the agency for US-based Melchoir Armstrong Dessau's air-conditioning equipment.

Shortly after, the Company was selected by Worthington, the US leader in air-conditioning, as itsIndia based partner - these were the first of numerous foreign associations to follow. Anexpanding Blue Star then ventured into the manufacture of ice candy machines and bottle coolersand began the design and execution of central air conditioning projects. Then came themanufacture of water coolers. In 1949, the proprietorship company set its sights on bigger expansion, took on shareholders and became Blue Star Engineering Company Private Limited.Ever since, there has been a constant and profitable growth. Blue Star diversified and took upagencies for Material Testing Machines and Business Machines. The export arena beckoned andthe Company began exporting water coolers to Dubai, where in fact, 'Blue Star' soon became the

generic name for water coolers. The sixties and the early seventies witnessed Blue Star continuing to expand and thrive. A team of dedicated professionals aided Mohan T Advani inever furthering his vision of a profitable company dedicated to its ideals of professionalism andsuccess. Employee strength crossed the 1000 mark and the company went public in 1969 to

become Blue Star Limited, as it continues to be called today.

In 1970, the Company took up the all-India distributorship of Hewlett-Packard products, a business relationship which continues today and has grown ever stronger through the years. Asthe Company's reputation for delivering the goods in the most challenging of air conditioning

projects grew steadily, the early seventies saw a series of prestigious projects being entrusted toBlue Star - skyscrapers such as Air India Building, Express Towers, the Oberoi Hotel in Mumbai,

apart from several others. Revenues touched the Rs. 10-crore mark and staff strength doubled toexceed 2000.

As its Indian presence reached greater heights, the Company began building determinedly uponits existing overseas presence, Blue Star set up a joint venture with Al Shirawi in Dubai and wenton to execute some outstanding projects in Syria, Iraq and Saudi Arabia. To complement its air conditioning projects and undertake turnkey industrial projects, an Industrial Division was set upin 1978.

Always moving with the times and ever on the lookout for business possibilities, Blue Star nextset up a software export unit at Seepz, Mumbai in 1983. Then came associations with more global

leaders - a collaboration with York International of USA for central air conditioning equipmentand joint ventures with Motorola and Yokogawa.

In 1984, Ashok M Advani & Suneel M Advani, the sons of Mohan T Advani, took over the reinsof the Company, after spending nearly 15 years within the Company steadily climbing up theladder. A renewed thrust was placed on the company's core business areas - air

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conditioning and refrigeration and the distribution of professional electronics equipment - and thecompany emerged a market leader in these focus areas.

The nineties witnessed India entering an era of economic liberalization and an upsurge incompetition as the dynamic business scenario attracted the world's most forward-lookingcorporations. It was time to re-look at existing business competencies, re-engineer those that wereobsolete and forge ahead in acquiring new business competencies. Blue Star was more than equalto the challenge and expansion continued unabated.

In keeping with this focus, an advanced manufacturing facility was set up at Dadra in 1997, intechnical collaboration with Rheem, USA, to enhance manufacturing competency. Today it bears

the distinction of being regarded as the best such plant India-wide. The dealer network wasstrengthened and expanded to bring products within easy reach of every customer.

With the advent of the much awaited new millennium in 2000, the action continued. The softwareunit was spun off into a separate company, Blue Star InfoTech Ltd., the export of air conditioning

products from the Dadra factory began and contract manufacturing for local and foreign brandscommenced. A new Corporate Vision was developed - "To deliver a world-class customer experience". Every employee is determined to follow this vision and keep their organization acompetitive and forward-looking one.

Blue Star crossed the Rs 500 crore milestone in 2000 and the Rs. 600 crore milestone in 2002-03.

With the boom in construction activity and increased infrastructure investments, the Companyleveraged its leadership position to grow aggressively. In the following three years, the Companynearly doubled its turnover, clocking Rs 1178 crores in 2005-06.

Even more than size, Blue Star enjoys an enviable reputation as an ethical corporation, ever mindful of its obligations towards customers, shareholders, dealers, business partners, employeesand the environment in which it operates .

Milestone of the companyYear Event

1943 Mohan T Advani establishes Blue Star Engineering Company

as a proprietary firm1946 Blue Star secures Melchior Armstrong Dessau agency

1947

Worthington selects Blue Star as Indian Partner.Manufacturing of ice candy machines and bottle coolers

begins. Central airconditioning system design and execution begins

1948 Manufacture of water coolers commences1949 Proprietorship converted to Private Limited Companies1954 Blue Star selected as distributor for Honeywell

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1955 GDR Testing machines distributorship begins

1957 Perkin-Elmer tie-up marks the start of the electronics business. GDR business machines agency commences1960 Total Income crosses the Rs 1 crore mark 1962 GDR Machine Tools distributorship begins1964 Total employment crosses 1,0001965 Techniglas Pvt Ltd set up to manufacture insulation material1969 Factory moves from Colaba in Mumbai to Thane1970 Hewlett- Packard distributorship commences

1972First skyscrapers of Mumbai Air India Building, ExpressTowers and Oberoi Hotel set-up all airconditioned by BlueStar

1972 Total Income crosses Rs 10 crores. Employment crosses 2,000

1974 Water Cooler manufacturing license granted to Yusuf Alghanim, Kuwait

1977 Middle East thrust begins. Joint Venture (JV) with Al Shirawiin Dubai1977 Hitachi Medical Equipment distributorship begins1978 Industrial Division commences activity1980 Bharuch Factory set up1980-86 Major AC and R projects executed in the Middle East1983 International Software Division inaugurated in Seepz1984 York technology collaboration begins

1985 Manufacture of centrifugal packaged chillers commences atThane Plant1986 Total Income crosses Rs 100 crores1987 Yokogawa Blue Star JV formed1987 Gandhinagar factory set up for EPABX systems

1988 Blue Star becomes Indias largest central airconditioningcompany

1988 Manufacturing collaboration with Mitsubishi1988 Assembly of personal computers under the brand nameQuantum begins1989 JV with Hewlett-Packard and Motorola1990 Gandhinagar factory closes1992 Total Income crosses Rs 200 crores1992 Blue Star exits from Motorola JV1993 Formation of Arab Malaysian Blue Star JV in Malaysia1995 Blue Star exits from HP India JV1997 Dadra Plant inaugurated1998 Major thrust on dealerisation and brand building begins1999 Blue Star exits from Industrial Projects business

2000 International Software business spun off to form Blue Star Infotech, listed on stock exchanges

2001 Total Income crosses 500 crores. Export of airconditioning products begins2003 Blue Star exits Yokogawa JV

2005 Blue Star sets up new factory at Kala Amb in HimachalPradesh2006 Total Income crosses the Rs 1000 crores mark 2006 Blue Star opts for a 5 for 1 stock split

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2007 Blue Star sets up its fifth factory at Wada, Thane District

2008 Blue Star powers into Building Electrification. Acquires Naseer Electricals, a leading Electrical Contractor 2008 Total income crosses Rs. 2000 Crores.

Company profileBlue Star is India's largest central air conditioning company with an annual turnover of Rs 2270crores, a network of 24 offices, 5 modern manufacturing facilities, 650 dealers and around 2500employees.

It fulfils the air conditioning needs of a large number of corporate and commercial customers andhas also established leadership in the field of commercial refrigeration equipment ranging fromwater coolers to cold storages. Blue Star's other businesses include marketing and maintenance of hi-tech professional electronic and industrial products.

The Company has manufacturing facilities at Thane, Dadra, Bharuch, Himachal and Wada whichuse state-of-the-art manufacturing equipment to ensure that the products have consistent qualityand reliability.

Blue Star primarily focuses on the corporate and commercial markets. These include institutional,industrial and government organizations as well as commercial establishments such asshowrooms, restaurants, banks, hospitals, theatres, shopping malls and boutiques. In accordancewith the nature of products and markets, business drivers, and competitive positioning, the linesof business of Blue Star can be segmented as follows:

Central and Packaged Air conditioning SystemsCommissioning and support of large central air conditioning plants, packaged air conditionersand ducted split air conditioners. This line of business also promotes after-sales service as a

Lines of business

Central air conditioning system

Cooling products Professional electronics& industrial equipments

Screw Chillers

Scroll Chillers

Double SkinAir HandlingUnits

FanCoil Units

Packaged Acs

Hiper Packaged Acs

HisenPackaged Acs

Ducted Splits

Vrf Systems

Lines of business

Central airconditioningsystem

Cooling products Professional electronics& industrialequipments

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business, by offering several value added services in the areas of upgrades and This involvesdesign, engineering, manufacturing, installation, enhancements, air management, water management and energy management.

Cooling Products :Blue Star offers a wide range of contemporary window and split air conditioners. The Company also manufactures and markets a comprehensive range of commercialrefrigeration products and services that cater to the industrial, commercial and hospitality sectors.These include water coolers, bottled water dispensers, deep freezers, cold storages, bottle coolers,ice cube machines and supermarket refrigeration products.

Professional Electronics and Industrial SystemsFor over five decades, the Electronics Division has been the exclusive distributor in India for many internationally renowned manufacturers of hi-tech professional electronic equipment andservices, as well as industrial products and systems. The Company has carved out profitable

niches for itself in most of the specialized markets it operates in, such as analytical instruments,medical electronics, data communication products, material testing, and test and measuringinstruments.

Senior ManagementAshok M Advani Chairman & Managing Director Suneel M Advani Vice Chairman & Managing Director T. Gouri Sankara Babu Deputy Managing Director Satish Jamdar Deputy Managing Director Arun Khorana Executive Vice PresidentAvinash Pandit Executive Vice PresidentManek Kalyaniwala Executive Vice PresidentB. Thiagarajan Executive Vice PresidentA. S. Dawood Corporate Advisor Electrical Projects DivisionVir S. Advani Vice President - Corporate AffairsR. Aravindan Vice President - Packaged Air conditioning DivisionJ. M. Bhambure Vice President - R & DR. G. Devnani Vice President Dadra PlantMichael Fernandes Vice President - Human Resources and Quality

A. Rakesh RaoVice President - Air conditioning and Projects Division -

Northern Region

P. Venkat Rao Vice President - Room Air conditioner and RefrigerationProducts Division

K. P. SukumarVice President Air conditioning & Refrigeration Service

Division.K. P. T. Kutty Company Secretary

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E x e c u

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INTERNAL CONTROL SYSTEM AND THEIR ADEQUACYIn any industry, the process and internal control system play a critical role in the health of thecompany. Blue star has robust internal process as well as clearly defined roles andresponsibilities at all levels. Frequent internal audits ensure compliance with these processes.Rigorous business planning as well as expense, capital and manpower budgeting processesensure that the progress is monitoring against targets, and control is exercised on all major expenses, so that actual spending is in accordance with the budgets. The managementinformation system provides timely and accurate information for effective control.

ENTERPRISE RISK MANAGEMENTConsidering the risk and challenges being faced by business interprises, companies arerequire to set up a structured procedure for assessment and minimization of business risk as a

part of corporate governance. The company made a detailed study of possible risk in eachdivision/ function through KPMG, a leading management consultancy firm. All major risk were identified and division/ functional heads were made responsible for assessing the risk and adopting measures to minimize the same to report to the board on a periodical basis.

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INTRODUCTION ABOUT HIMACHAL PLANTFactory Facts:

Started in 2005

This factory is 300 kms North West of North Delhi.Area: 14,000 sq.mts

Manpower: 220

This factory has been set-up in the sylvan settings of Kala-amb in Himachal Pradesh. Theindustrial zone of Baddi has seen a proliferation of manufacturing setups in the recent past. BlueStar too has capitalized on this opportunity to augment its manufacturing capacity. With theaddition of Himachal Plant in 2005, which was built with in-house expertise, Blue Star has beenable to meet the increasing market demand. Himachal plant has the advantage of scale of operations and also enjoys tax benefits.

There are different departments in the branch and all the departments handle differently bydifferent persons. All the staff members are well educated and experienced. Different departmentsare

Finance,

HR,

Dispatch,

R & D IT

ProductionPurchase & Sales etc

I have done work with Finance department the HOD of the department is MR Rajesh Madan whois the manager Finance. And the rest is as under. Under him there are three more employees Mr.Susheel Sharma, Mr. Sandeep Garg, Mr. Anil Saini.

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CERTIFICATE

This is to certify that MR. MOHD.ALAM a student of Master of Business Administrationhas successfully completed her one month training on the topic under my guidance. I wishher success in her future accomplishments.

Date: Signature of the GuideMr. Rajesh MadanSr. Manager (Finance)

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Acknowledgement

This training has been made possible through the direct and indirect co-operation of various persons for whom I wish to express my appreciation and gratitude.

The completion of this Training and my success in the same is gratefully credited to my pojectguide and advisor Mr.Rajesh Madan Manager (Finance and Accounts) for providing me all the

possible help and other valuable suggestions.

I am also grateful to Mr. Sushil Sharma Executive (finance) Mr. Sandeep Garg Executive(finance), Mr.Anil Saini Executive (Accounts).Blue Star Ltd, Kala amb road Nahan and all thestaff Members for their support and for providing an opportunity and congenial environment towork with them.I also owe a profound intellectual debt to numerous authors whose ideas and contributions haveshaped my thinking on this subject.

My grateful thanks go to my family for their moral support.

Many who helped me during this endeavor will always be remembered by the gratefully.

Mohd.AlamMBA-II Year

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s

Guiding values And beliefs1. To deliver a World - class customer Experience.2. Focus on Profitable company growth3. Be a company that is a pleasure to do business with.4. Work in a boundary less manner between division to provide the

best solution to the customer.5. Win our peoples heart and mind.6. Place the companys interest above ones own.7. Encourage innovations, creativity and experimentation in what wedo.

8. Build an extended organization of committed business partner.9. Be a good corporate citizen.10. Maintain personal integrity.11. Ensure high standard of corporate governance.12. Honour all personal and corporate commitments.

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WORKING CAPITAL MANAGEMENT

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Cash is the lifeline of a company. If this lifeline deteriorates, so does the company'sability to fund operations, reinvest and meet capital requirements and payments.Understanding a company's cash flow health is essential to making investmentdecisions. A good way to judge a company's cash flow prospects is to look at itsworking capital management (WCM).

Defining Working Capital

Working capital refers to the cash a business requires for day-to-day operations, or, morespecifically, for financing the conversion of raw materials into finished goods,which the company sells for payment. Among the most important items of working capital are levels of inventory, accounts receivable, and accounts

payable. Analysts look at these items for signs of a company's efficiency andfinancial strength.

The term working capital refers to the amount of capital which is readily available to an

organisation. That is, working capital is the difference between resources in cash or readily convertible into cash (Current Assets) and organisational commitments for whichcash will soon be required (Current Liabilities).

Thus:

WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES

In a department's Statement of Financial Position, these components of working capitalare reported under the following headings:

Current Assets Liquid Assets (cash and bank deposits) Inventory Debtors and Receivables

Current Liabilities

Bank Overdraft Creditors and Payables Other Short Term Liabilities

There are basically two concepts of working capital:-1. Gross working capital2. Net working capital

Current assets are those which can be converted into cash within an accounting year andinclude cash,short-term securities,debtors,bills receivables(accounts receivables or book debts) and stock(inventory)

http://www.investopedia.com/terms/c/cashflow.asphttp://www.investopedia.com/terms/c/cashflow.asp

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Current liabilities are those claim of outsiders which are expected to mature for paymentwithin an accounting year and include creditors(accounts payable),bills payable andoutstanding expenses.

Gross working capital:-it refers to the firms investment in current assets.

Net working capital:-it refers to the difference between current assets and currentliabilities.

Net working capital is positiveWhen current assets >current liabilities

Net working capital is negativeWhen current asset

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Sources of working capital1. FIFO2. Sale of non-current assets

a. sale of long term investments(shares,bonds/debentures etc.) b. sale of tangible fixed assets like land,building,plant or equipments.

c. sale of intangible fixed assets like goodwill,patents or copyrights

3. long term financinga. long term borrowings/institutions loans,debentures,bonds etc.

b. issuance of equity and preference shares

4. short term financing such as bank borrowings.

Uses of working capital

1. Adjusted net loss from operations2. Purchase of non-current assetsa) Purchase of long term investments like shares,bonds/debentures etc.

b) Purchase of tangible fixed assets like land,building,plant,machinery,equipmentetc.

c) Purchase of intangible fixed assets like goodwill,patents,copyrights3. Repayment of long-term debt(debentures or bonds)and short-term debts(bank

borrowings)a) Redemption of redeemable preference shares.

b) Payment of cash dividend.

Focusing on liquidity management

Net working capital is a qualitative concept. It indicates the liquidity position of the firmand suggest the extent to which working capital needs may be financed by permanentsources of funds. Current assets should be sufficiently in excess of current liabilities toconstitute a margin or buffer for maturing obligations within the ordinary operating cycleof a business. In order to protect their interests, short-term creditors always like acompany to maintain currnet assets at a higher level than current liabilities. It is aconventional rule to maintain the level of currnet assets twice the level of currentliabilities. However, the quality of current assets should be considered in determining thelevel of current assets vis-a vis current liabilities. A weak liquidity position poses athreat to the solvency of the company and makes it unsafe and unsound. A negativeworking capital means a negative liquidity and may prove to be harmful for thecompanys reputation. Excessive liquidity is also bad. It may be due to mismanagement

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of current assets. Therefore prompt and timely action should be taken by management toimprove and correct imbalances in the liquidity position of the firm.

Net working capital concept also covers the question of judicious mix of long-ter andshort-term funds for financing current assets. For every firm there is a minimum amountof net working capital which is permanent. Therefore a portion of the working capital

should be financed with the permanent sources of funds such as equity, share capital,debentures, long-term debt, preference share capital or retained earnings. Managementmust decide the extent to which current assets should be financed with equity capital or

borrowed capital.

Balanced working capital positionThe firm should maintain a sound working capital position.it should haveadequateworking capital to run its business operations.both excessive and inadequateworking capital positions are dangerous from the firms point of view.excessive workingcapital means holding costs and idle funds which earn no profits for the firm.paucity of working capital not only impairs the firms profitability but also results in productioninterruptions and inefficiencies and sales disruptions.

The dangers of excessive working capital are as follows :1.it results in unnecessary accumulation of inventories.thus chances of inventorymishandling,waste,theft and losses increase.2.it is an indication of defective credit policy and slack collection period. Consequently,higher incidence of bad debts result, which adversely affects profits.3. excessive working capital makes management complacent which degenerates intomanagerial inefficiency.4.tendencies of accumulating inventories tend to make speculative profits grow. This maytend to make dividend policy liberal and difficult to cope with in future when the firm isunable to make speculative profits.

Inadequate working capital is also bad and has the following dangers :1. it stagnates growth. It becomes difficult for the firm to undertake profitable

projets for non-availability of working capital funds.2. it becomes difficult to implement operating plans and achieve the firms profit

target.3. operating inefficiencies creep in when it becomes difficult even to meet day to

day commitments.4. fixed are not efficiently utilized for the lack ofworking capital funds. Thus the

firms profitability would dweteriorate.5. paucity of working capital funds render the firm unable to avail attractive credit

opportunities etc,

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6. the firm loses its reputation when it is not in a position to honour its short termobligations.as a result the firm faces tight credit terms.

An enlightened management should,therefore, maintain the right amount of workingcapital on the continuous basis. Only then a proper functioning of business operationswill be ensured. Sound financial and statistical techniques, supported by

judgement,should beused to predict the quantum of working capital needed at differenttime periods.A firms net working capital position is not only important as an index of liquidity but itis also used as a measure of the firms risk.risk in this regard means chances of the firm

being unable to meet its obligations on due date. The lender considers a positivenetworkingas a measure of safety. All other things being equal, the more the networkingcapital a firm has, the less likely that it will default in meeting its current financialobligations. Lenders such as commercial banks insist that the firm should maintain aminimum net working capital position.

Determinants of working capitalThere are not set rules or formulae to determine the working capital requirements of

firms. A large number of factors, each having a different importance, influence workingcapital needs of firms. The importance of factors also changes for a firm over time.Therefore, an analysis of relevant factors should be made in order to determine totalinvestment in working capital. The following is the description of factors which generallyinfluence the working capital requirements of firms.

Nature of business

Working capital requirements of a firm are basically influenced by the nature of its business. Trading and financial firms have a very small investment in fixed assests,butrequire a large sum of money to be invested in working capital. Retail stores, for

example, must carry large stocks of a variety of goods to satisfy varied and continuousdemands of their customers. A large departmental store like wal-mart maycarry, say, over 20,000 items. Some manufacturing businesses, such as tobacco manufacturers andconstruction firms, also have to invest substantially in working capital and a nominalamount in fixed assests. In contrast, public utilities may have limited need for workingcapital and have to invest abundantly in fixed assests. Their working capital requirementsare normal because they may have only cash sales and supply services, not products.Thus no funds will be tied up in debtors and stock(inventories). For the working capitalrequiorements most of the manufacturing companies will fall between the two extremerequirements of trading firms and public utilities. Such concerns have to make adequateinvestment in current assests depending upon the total assessts structure and other

variables.

Market and demand conditions

The working capital needs of a firm are related to its sales.however,it is difficult to precisely determine the relationship between volumes of sales and working capitalneeds.in practice,current assets will have to be employed before growth takes place.it

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is,therefore,necessary to make advance planning of working capital for a growing firm oncontinous basis.Growing firms may need to invest funds in fixed assests in order to sustain growing

production and sales.this will,in turn, increase investment in current assests to supportenlarged scale of operations.growing firms need funds continuously.they use external

sources as well as internal sources to meet increasing needs of funds.these firms facefurther problems when they retain substantial portion of profits,as they will not be able toPay dividends to shareholders. It is ,therefore,imperative that such firms do proper

planning to finanace their increasing neefws of working capital.Sales depend upon demand conditions. Large number of firms experience seasonal andcyclical fluctuations in the demand for their products and services.these businessvariations affect the working capital requirement,specially the temporary working capitalrequirement of the firm. When there is an upward swing in the economy ,sales willincrease;orrespondingly , the firms investment in inventories and debtors will alsoincrease. Under boom,additional investment in fixed assests may be made by some firmsto increase their productive capacity. This act of firms will require additions of working

capital. To meet their requirements of funds for fixed assests and current assests under bom period,firms generally resort to substantial borrowing. On the other hand ,whenthere is decline in the economy,sales will falll and consequently, levels of inventories anddebtors will also fall.under recession,firm try to reduce their short term borrowings.Seasonal fluctuations not only affect working capital requirement but also create

production problems for the firms. During peak periods of demand,increasing productionmay be expensive for the firm. Similarly,it will be more expensive during the slack

periods when the firm has to sustain its working force and physical facilities withoutadequate production and sales. A firm may thus follow a policy of level productionirrespective of seasonal changes in order to utilize its resources to the fullest extent. Sucha policy will mean accumulation of inventories duing off season and their quick disposalduring the peak season.The increasing level of inventories during the slack season will require increasing fundsto be tied up in the working capital for some months. Unlike cyclical fluctuations,seasonal fluctuations generally conform to a steady pattern. Therefore,financialarrangements for seasonal working capital requirements can be made in advance.

Technology and manufacturing policyThe manufacturing cycle comprise of the purchase and use of raw materials and the

production of finished goods. Longer the manufacturing cycle ,larger will be the firmsworking capital requirements.therefore the technological process with the shortestmanufacturing cycle may be chosen.once a manufacturing technology has been selected,it should be ensured that manufacturing cycle must be completed within the specified

period. This nees proper planning and coordination at all levels of activity.any delay inthe manufacturing process will result in the accumulation of WIP and waste of time. Inorder to minimize their investment in working capital, some firms ,specifically thosemanufacturing industrial products,have a policy of asking for advance payments fromtheir customers. Non manufacturing firms,services and financial enterprises do not have amanufacturing cycle.

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Credit policyThe credit policy of the firm affects the working capital by influencing the level of

debtors. The credit terms to be granted to customers may depend upon the norms of theindustry to which the firm belongs. But a firm has the flexibility of shaping its credit

policy within the constraint of industry norms and practices. The firm should usediscretion in granting credit terms to its customers. Depending upon the individualcase,different terms may be given to different customers. A liberal credit policy,withoutrating the credit worthiness of customers,will be detrimental to the firm and will create a

problem of collection later on. The firm should be prompt in making collections. A highcollection period will mean tie up of large funds in debtors. Slack collection procedurescan increase the chance of bad debts. In order to ensure that unnecessary funds are nottied up in debtors, the firm should follow a rationalized credit policy based on the creditstanding of customers and other relevant factors. The firm should evaluate the creditstanding of new customers and periodically review the credit worthiness of the existingcustomers. The case of delayed payments should be thoroughly investigated.

Availability of credit from suppliersThe working capital requirements of a firm are also affected by credit terms granted byits suppliers. A firm will needless working capital if liberal credit terms are available to itfrom suppliers. Suppliers credit finances the firms inventories and reduces the cashconversion cycle. In the absence of suppliers credit the firm will borrow funds for bank.The availability of credit at reasonable cost from banks is crucial. It influences theworking capital policy of the firm. A firm without the suppliers credit, but which can get

bank credit easily on favourable conditions, will be able to finance its inventories anddebtors without much difficulty.

Operating efficiencyThe operating efficiency of the firm relates to the optimum utilization of all its resourcesat minimum costs. The efficiency in controlling operating costs and utilizing fixed andcurrent assests leads to operating efficiency. The use of working capital is improved and

pace of cash conversion cycle is accelerated with operating efficiency. Better utilizationof resources improves profitability and thus,helps in releasing the pressure on workingcapital. Although it may not be possible for a firm to control prices of materials or wagesof labour,it can certainly ensure efficient and effective utilization of materials ,labour and other resources.

Price level changesThe increasing shift in price level make functions of financial manager difficult. Heshould anticipate the effect of price level changes on working capital requirement of thefirm. Generally,rising price levels will require a firm to maintain a higher amount of working capital. Same levels of current assests will need increased investment when

prices are increasing. However, companies that can immediately revise their product prices with rising price levels will not face a severe working capital problem. Further,Firms will feel effects of increasing general price level differently as prices of individual

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Products move differently. Thus,it is possible that some companies may not be affected by rising prices while others may be badly hit.

Working Capital Cycle

Cash flows in a cycle into, around and out of a business. It is the business's life blood andevery manager's primary task is to help keep it flowing and to use the cashflow togenerate profits. If a business is operating profitably, then it should, in theory, generatecash surpluses. If it doesn't generate surpluses, the business will eventually run out of cash and expire. The faster a business expands, the more cash it will need for workingcapital and investment. The cheapest and best sources of cash exist as working capitalright within business. Good management of working capital will generate cash will helpimprove profits and reduce risks. Bear in mind that the cost of providing credit tocustomers and holding stocks can represent a substantial proportion of a firm's total

profits.

There are two elements in the business cycle that absorb cash - Inventory (stocks andwork-in-progress) and Receivables (debtors owing you money). The main sources of cash are Payables (your creditors) and Equity and Loans .

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

dimensions ........ TIME ......... and MONEY. When it comes to managing working capital

- TIME IS MONEY . If you can get money to move faster around the cycle (e.g. collect

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

reduce inventory levels relative to sales), the business will generate more cash or it willneed to borrow less money to fund working capital. As a consequence, you could reduce

the cost of bank interest or you'll have additional free money available to support

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

with suppliers e.g. get longer credit or an increased credit limit, you effectively create

free finance to help fund future sales

It can be tempting to pay cash, if available, for fixed assets e.g.computers, plant, vehicles etc. If you do pay cash, remember that this is now longer available for working capital. Therefore,if cash is tight, consider other ways of financing capital

investment - loans, equity, leasing etc. Similarly, if you paydividends or increase drawings, these are cash outflows and,like water flowing down a plug hole, they remove liquidity fromthe business

More businesses fail for lack of cash than for want of profit.

If you .......Then ......

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BHEL, HEEP HARDWAR BALANCE SHEET

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ra

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I. Cost of liquidityII. cost of illiquidity

--If the firms level of current assets is very high , it has excessive liquidity. Itsreturn on assets will be low, as funds tied up in idle cash and stocks earn

nothing and high level of debtors reduce profitability. Thus, the cost of liquidityincreases with the level of current assets. --the cost of illiquidity is the cost of holding insufficient current assets. The firm

will not be in a position to honour its obligations if it carries to little cash. Thismay force the firm to borrow at high rates of interests. This will also adverselyaffect the credit-worthiness of the firm and it will face difficulties in obtainingfunds in the future. All this may force the firm into insolvency. Similarly, thelow levels of stock will result in loss of sales and customers may shift tocompetitors. Also, low level of debtors may be due to right credit policy whichwould impair sales further. Thus the low level of current assets involves cost thatincrease as this level falls.

Policies for financing current assets

The following policies for financing current assets in HEEP, Haridwar:-LONG TERM FINANCING : The sources of long term financing include ordinaryshares capital, preference share capital debentures, long term borrowings from financialinstitutions and reserves and surplus. The HEEP Haridwar manages its long term

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financing from capital reserve, share premium A/C , foreign project reserve, bondsredemption reserve and general reserve.

SHORT TERM FINANCING : The short term financing is obtained for a period lessthan one year. It is arranged in advance from banks and other suppliers of short term

finance include working capital funds from banks, public deposits, commercial paper,factoring of receivables etc.The HEEP, Haridwar manages secured loans as:-1) Loans and advances from banks2) Other loans and advances:

(i) Debebtures/bonds(ii) Loans from State Govt.(iii) Loans from financial institutions(secured by pledge of PSU

bonds and bills accepted guaranteed by banks)3) Interest accrued and due on loans

(a) from State Govt.

(b) from financial institutions bonds and other (c) packing credit

The HEEP, Haridwar manages unsecured loans as:-1) Public deposits2) Short term loans and advances:

(1) From banks(a) Commercial papers

(2) From others(a) From campanies(b) From financial institutions

3) Other loans and advances(a) From banks(b) From others

(i) from govt. of India(ii) from state govt.(iii) from financial institutions(iv)from foreign financial institution(v) post shipment credit exim bank (vi)credit for assets taken on lease

4) Interest accrued and due on(a) Post shipment credit(b) Govt. credit(c) State Govt. loans(d) Credits for assets taken on lease(e) Financial institutions and others(f) Foreign financial institutions(g) Public deposits

SPONTANEOUS FINANCING :-

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Spontaneous financing refers to the automatic sources of short term funds arising in thenormal course of a business. Trade Credit and outstanding expenses are examples of spontaneous financing.A firm is expected to utilise these sources of finances to the fullest extent. The real choiceof financing current assets, once the spontaneous sources of financing have been fully

utilized, is between the long term and short term sources of finances.

What should be the mix of short and long term sources in financing current assets ?Depending on the mix of short and long term financing, the approach followed by acompany may be referred to as :

1. matching approach2. conservative approach3. aggressive approach

Matching approach

The firm can adopt a financial plan which matches the expected life of assets withthe expected life of the source of funds raised to finance assets. Thus, a ten year loan may be raised to finance a plant with an expected life of ten year; stock of goods to be sold inthirty days may be financed with a thirty day commercial paper or a bank loan. The

justification for the exact matching is that, since the purpose of financing is to pay for assets, the source of financing and the asset should be relinquished simultaneously. Usinglong term financing for short term assets is expensive as funds will not be utilized for thefull period. Similarly, financing long term assets with short term financing is costly aswell as inconvenient as arrangement for the new short term financing will have to bemade on a continuing basis.

When the firm follows matching approach (also known as hedging approach) longterm financing will be used to finance fixed assets and permanent current assets and shortterm financing to finance temporary or variable current assets. How ever, it should berealized that exact matching is not possible because of the uncertainty about the expectedlives of assets.

The firm fixed assets and permanent current assets are financed with long termfunds and as the level of these assets in increases, the long term financing level alsoincreases. The temporary or variable current assets are financed with short term funds andas their level increases, the level of short term financing also increases. Under matching

plan, no short term financing will be used if the firm has a fixed current assets need only.

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Conservative approachA firm in practice may adopt a conservative approach in financing its current and

fixed assets. The financing policy of the firm is said to be conservative when it dependsmore on long term funds for financing needs. Under a conservative plan, the firmfinances its permanent assets and also a part of temporary current assets with long termfinancing. In the period when the firm has no need for temporary current assets, the idle

long term funds can be invested in the tradable securities to conserve liquidity. Theconservative plan relies heavily on long term financing and, therefore, the firm has lessrisk of facing the problem of shortage of funds. The conservative financing policy isshown below. Note that when the firm has no temporary current assets, the long termfunds released can be invested in marketable securities to build up the liquidity positionof the firm.

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

be followed by the firm when it uses more short term financing than warranted by thematching plan. Under an aggressive policy, the firm finances a part of its permanentcurrent assets with short term financing. Some extremely aggressive firms may even

finance a part of their fixed assets with short term financing. The relatively more use of short term financing makes the firm more risky. The aggressive financing is Illustrated infig below.

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Short term vs long term financing: A Risk Return Trade off A firm should decide whether or not it should use short term financing. If short termfinancing has to be used, the firm must determine its position in total financing. Thisdecision of the firm will be guided by the risk return trade off. Short term financing may

be preferred over long term financing. For two reasons: 1. the cost advantage 2.flexibility. But short term financing is more risky than long term financing.Cost: short term financing should generally be less costly than long term financing. It has

been found in developed countries like usa, the rate of interest is related to the thematurity of debt. The relationship between the maturity of debt and its cost is called theterm structure of interest rates. The curve, relating to maturity of debt and interest rates, iscalled the yield curve. The yield curve may assume any shape, but it is generally upwardsloping. Fig below shows the yield curve. The fig indicates that more the maturity greater the interest rate.

The justification for the higher cost of long term financing can be found in theliquidity preference theory. This theory says that since lenders are risk averse, and risk generally increases with the length of lending time (because it is more difficult to forecastthe more distant future), most lenders would prefer to make short term loans. The only

way to induce these lenders to lend for longer periods is to offer them higher rates of interest.The cost of financing has an impact on the firms return. Both short and long termfinancing have a leveraging effect on shareholders return. But the short term financingought to cost less than the long term financing; therefore, it gives relatively higher returnto shareholders.

It is noticeable that in India short term loans cost more than the long term loans.Banks are the major suppliers of the working capital finance in India. Their rates of

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interest on working capital finance are quite high. The main source of long term loans arefinancial institutions which till recently were not charging interest at differential rates.The prime rate of interest rate charged by financial institutions is lower than the ratecharged by banks.Flexibility : it is relatively easy to refund short term funds when the need for funds

diminishes. Long term funds such as debenture loan or preference capital cannot berefunded before time. Thus, if a firm anticipates that its requirement for funds willdiminish in near future, it would choose short term funds.Risk : although short term financing may involve less cost, it is more risky than long termfinancing. If the firm uses short term financing to finance its current assets, it runs therisk of renewing borrowing again and again. This is particularly so in the case of

permanent assets. As discussed earlier, permanent current assets refer to the minimumlevel of current assets which a firm should always maintain. If the firm finances it

permanent current assets with short term debt, it will have to raise new short term fundsas debt matures. This continued financing exposes the firm to certain risks. It may bedifficult for the firm to borrow during stringent credit periods. At times, the firm may be

unable to raise any funds and consequently, it operating activities may be disrupted. Inorder to avoid failure, the firm may have to borrow at most inconvenient terms. These problems are much less when the firm finances with long term funds. There is less risk of failure when the long term financing is used.

Risk returned trade-off: Thus, there is conflict between long term and short termfinancing. Short term financing is less expensive than long term financing, but, at thesame time, short term financing involves greater risk than long term financing. Thechoice between long term and short term financing involves a trade-off between risk andreturn.

1. HANDLING RECEIVABLES(DEBTORS)

2. MANAGING PAYABLES(CREDITORS)3. INVENTORY MANAGEMENT4. KEY WORKING CAPITAL RATIOS

HANDLING RECEIVABLES(DEBTORS )

Cashflow can be significantly enhanced if the amounts owing to a business are collectedfaster. Every business needs to know who owes them money.... how much is owed....how long it is owing.... for what it is owed.

Late payments erode profits and can lead to bad debts.Slow payment has a crippling effect on business, in particular on small businesses who

can least afford it. If you don't manage debtors, they will begin to manage yourbusiness as you will gradually lose control due to reduced cashflow and, of course, you

could experience an increased incidence of bad debt.

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It is very difficult for the organization to sell always on cash basis in todays competitivemarket. In almost every business, we have to sell on credit basis.The basic objective of management of sundry debtors is to optimize the return oninvestment on this asset. It is obvious that if there are large amounts tied up in sundrydebtors, working capital requirement would be high and consequently interest charges

will be high. In such cases, the bad debts and cost of collection of debts would be high.On the other hand if the credit policy is very tight, investment in sundry debtors is lowbut the sale may be restricted, since the competitors may offer more liberal credit

term.We have limited resources and therefore every resource has its own opportunity cost.Therefore the management of sundry debtors is an important issue and requires proper

policies and efficient execution of such policies.Debtors and cost of debtors have direct relation,cost will increase due to increase indebtors and vice-versa. It depend on the credit sale of concern and credit period(collection period) allowed to customer. It is interest of customer to pay as late as

possible and company who made sales, would like to collect their debtor as early as

possible. There is a conflict between the two aspects.Debtor management is the process of finding the balance at which company agree toreceive its payment without hampering or having any adverse effect on its sales andcustomer agree to pay at their economical buying concept.Sundry debtor level depends on two measure issues:

Volume of Credit sales Credit period allowed to customers.

Following factors may be considered before allowing credit period to the customer:-1. Nature of product2. Credit worthiness of the customer, which varies from customer to

customer

3. Quantum of advance received from customers4. Credit policy of company, say number of days allowed to customer for payment to the customers

5. Cost of debtors6. Manufacturing cycle time of the product etc.

Credit policy:The term credit policy is used to refer to the combination of three decision variables:Credit standard are criteria to decide the types of customers to whom goods could be soldon credit. If a firm has more slow paying customers, its investment in accounts receivablewill increase. The firm will also be exposed to higher risk of default.

Credit terms specify duration of credit and terms of payment by customers. Investment inaccounts receivables will be high if customers are allowed extended time period for making payments.Collection efforts determine the actual collection period. The lower the collection period,the lower the investment in accounts receivable and vice-versa.Credit Policy VariablesThese are:

1. Credit standars and analysis

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2. Credit terms3. Collection policy and procedures

The financial manager or the credit manager may administer the credit policy of a firm.Credit policy has important implications for the firms production,marketing and financefunctions.the impact of changes in the major decision variables of credit policy are:

Credit standardsThese are the criteria which a firm follows in selecting customers for the purpose of credit extensions. The firm may have tight credit standards;that is , it may sell mostly oncash basis and may extend credit only to the most reliable and financially strongcustomers. Such standards will result in no bad debt losses and less cost of creditadministration. But the firm may not be able to expand sales. The profit sacrificed on lostsales may be more than the costs saved by the firm. On the contrary, if credit standardsare loose, the firm may have larger sales. But the firm will have to carry largereceivables. The cost of administrating credit and bad debt losses will also increase.Thus, the choice of optimum credit standards involves a trade-off between incrementalreturn and incremental costs.

Credit analysis : credit standards influence the quality of the firms customers. There aretwo aspects of the quality of customers;(I) the time taken by customers to repay creditobligation and(II)the default rate. The average collection period determines the speed of

payment by customers. It measures the number of days for which credit sales remainoutstanding. The longer the average collectionperiod, the higher the firms investment inaccounts receivables. Default rate can be measured in terms of bad debt losses ratio.-the

proportion of uncontrolled receivable. Bad debt losses ratio indicates default risk. Defaultrisk is the likelihood that a customer will fail to repay the credit obligation. On the basisof past practice and experience ; the finance manager should be able to form a reasonable

judgement regarding the chance of default. To estimate the probability of default, thefinancial or credit manager should consider:Character refers to the customers willingness to pay. The financial or credit manager should judge whether the customers will make honest efforts to honour their creditobligations. The moral factor is of considerable importance in credit evaluation in

practice.Capacity refers to the customers ability to pay. Ability to pay can be judged by assessingthe customers capital and assets which he may offer as security. Capacity is evaluated

by the financial position of the firm as indicated by analysis of ratios and trends in firmscash and working capital position. The financial or credit manager should determine thereal worth of assets offered as security.Condition refers to the prevailing economic and other conditions which may affect thecustomers ability to pay. Adverse economic conditions can affect the ability or willingness of a customer to pay. The firm may categorise its customers at least in thefollowing three categories:

1. Good accounts; financially strong customers2. Bad accounts; financially very weak, high risk customers.3. Marginal accounts; customers with moderate financial health and risk.

Credit terms: the stipulations under which the firm sells on credit to customers arecalled credit terms. These stipulations include(A) credit period (b) cash discount.

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Credit period: the length of time for which credit is exyended to customers is called thecredit period. It is generally stated in term of a net date. A firms credit period may begoverned by the industry norms. But depending on its objectives the firm can lengthenthe credit period. On the other hand, the firm may tighten its credit period if customersare defaulting too frequently and bad debts losses are building up.

Cash discount: it is a reduction in payment offered to customers to induce them to repaycredit obligations within a specified period of time, which will be less than the normalcredit period. It is usually expressed as a percentage of sales. Cash discount termsindicate the rate of discount and the period for which it is available. If the customer doesnot avail the offer, he must make payment within the normal credit period. A firm usescash discount as a tool to increase sales and accelerate collections from customers.Thus,the level of receivables and associated costs may be reduced. The cost involved isthe discounts taken by customers.

Collection policy and proceduresA collection policy is needed because all customers do not pay the firms bill in time.

Some customers are slow payers while some are non-payers. The collection effortsshould, therefore, aim at accelerating collections from slow-payers and reducing bad-debtlosses. A collection policy should ensure prompt and regular collection. Promptcollection is needed for fast turnover of working capital, keeping collection costs and baddebts within limits and maintaining collection efficiency. The collection policy should laydown clear cut collection procedures. The collection procedures for past dues or delinquent accounts should also be established in unambiguous terms. The slow payingcustomers should be handled very tactfully. Some of them may not be permanentcustomers.The firm should decide about offering cash discount for prompt payments. Cash discountis a cost to the firm for ensuring faster recovery of cash. Some customers fail to paywithin the specified discount period, yet they may make payment after deducting theamount of cash discount. Such cases must be promptly identified and necessary actionshould be initiated against them to recover the full amount.

BHEL HARIDWAR The unit is engaged in the manufacturing business of heavy electrical equipments, wherecycle time of the product is 18-24 months and most of the contracts take approximately3-5 years to complete. Customers of BHEL Hardwar are broadly divided into followingcategories:-

State electricity boards Power project Public sector undertakings Railways Government departments Private sectors Exports

In most of the contracts, payments of BHEL Hardwar are made in following stages:- Payment terms Advance from customers

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At the time of dispatch of goods At the time of MRC deferred payment after commissioning of project with certain

test.However the above mentioned terms may vary from contract to contract.

SUNDRY DEBTORS2001-02 2002-03 2003-04 2004-05

state electrici ty boards 1259143255.49 670091788.52 -2670304680.00 1616690094.36other power projects 1035318043.01 1042764240.52 934197751.18 1157194105.64P.S.U 180542662.66 228930513.34 201983241.94 151128737.86Govt. department 11175988.00 724340.00 57617382.00 20449755.00private parties 188357195.89 188255827.57 69380789.09 48427786.63carriage/other charges recoverable 2856365.32 3347890.44 3191152.00 701823.00from customersdeferred debts 2194589493.16 -1837247743.00 1477584726.00 1672307544.00debtors for scrap & surplus material 308081.43 308081.43 308081.00 -308081.43others 1615611.00 21546476.00 34991783.91 35271132.74

SUNDRY DEBTORS,HEEP-HARDWAR

Rs. In thousand2001-02 2002-03 2003-04 2004-05

a)debts outstanding for period exceeding 6 months 2463754 1851466 1541165 1882662b)other debts 2626655 2290246 4045449 2972563c)sub total 5090409 4141712 5586614 4855225less:provision for bad and doubtful debts 494547 464758 517386 760930 TOTAL 4595862 3676954 5069228 4094295SALES 6670210 8195014 9501446 9091295DEBTORS TURNOVER 1.45 2.2 1.87 2.22AVERAGE COLLECTION PERIOD(DAYS) 251 165 195 165

The following measures will help manage your debtors:

1. Have the right mental attitude to the control of credit and make sure that it getsthe priority it deserves.

2. Establish clear credit practices as a matter of company policy.3. Make sure that these practices are clearly understood by staff, suppliers and

customers.4. Be professional when accepting new accounts, and especially larger ones.5. Check out each customer thoroughly before you offer credit. Use credit agencies,

bank references, industry sources etc.

6. Establish credit limits for each customer... and stick to them.7. Continuously review these limits when you suspect tough times are coming or if operating in a volatile sector.

8. Keep very close to your larger customers.9. Invoice promptly and clearly.10. Consider charging penalties on overdue accounts.11. Consider accepting credit /debit cards as a payment option.

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12. Monitor your debtor balances and ageing schedules, and don't let any debts gettoo large or too old.

Recognize that the longer someone owes you, the greater the chance you will never get paid. If the average age of your debtors is getting longer, or is already very long, you may

need to look for the following possible defects:

1. Weak Credit Judgement2. Poor Collection Procedures3. Lax Enforcement Of Credit Terms4. Slow Issue Of Invoices Or Statements5. Errors In Invoices Or Statements6. Customer Dissatisfaction.

Debtors due over 90 days (unless within agreed credit terms) should generally demandimmediate attention. Look for the warning signs of a future bad debt. For example.........

longer credit terms taken with approval, particularly for smaller orders use of post-dated checks by debtors who normally settle within agreed terms evidence of customers switching to additional suppliers for the same goods new customers who are reluctant to give credit references receiving part payments from debtors.

Profits only come from paid sales. The act of collecting money is onewhich most people dislike for many reasons and therefore put on the long finger becausethey convince themselves there is something more urgent or important that demand their attention now. There is nothing more important than getting paid for your productor service. A customer who does not pay is not a customer. Here are a few ideas that

may help you in collecting money from debtors:

1. Develop appropriate procedures for handling late payments.2. Track and pursue late payers.3. Get external help if your own efforts fail.4. Don't feel guilty asking for money.... its yours and you are entitled to it.5. Make that call now. And keep asking until you get some satisfaction.6. In difficult circumstances, take what you can now and agree terms for the

remainder. It lessens the problem.7. When asking for your money, be hard on the issue - but soft on the person . Don't

give the debtor any excuses for not paying.8. Make it your objective is to get the money - not to score points or get even .

MANAGING PAYABLES(CREDITORS)

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Creditors are the businesses or people who provide goods and services in credit terms.That is, they allow us time to pay rather than paying in cash.

There are good reasons why we allow people to pay on credit even though literally itdoesn't make sense! If we allow people time to pay their bills, they are more likely to buy

from your business than from another business that doesn't give credit. The length of credit period allowed is also a factor that can help a potential customer decide whether to buy from your business or not: the longer the better, of course.

In spite of what we have just said, creditors will need to optimise their credit control policies in exactly the same way that we did when we were assessing our debtors'turnover ratio - after all, if you are my debtor I am your creditor!

We give credit but we need to control how much we give, how often and for how long.The formula for this ratio is:

Creditors' Turnover = Average Creditors(Cost of Sales/365)

Creditors are a vital part of effective cash management and should be managed carefullyto enhance the cash position.

Purchasing initiates cash outflows and an over-zealous purchasing function can createliquidity problems. Consider the following:

1. Who authorizes purchasing in your company - is it tightly managed or spreadamong a number of (junior) people?

2. Are purchase quantities geared to demand forecasts?3. Do you use order quantities which take account of stock-holding and purchasing

costs?4. Do you know the cost to the company of carrying stock ?5. Do you have alternative sources of supply ? If not, get quotes from major

suppliers and shop around for the best discounts, credit terms, and reducedependence on a single supplier.

6. How many of your suppliers have a returns policy ?7. Are you in a position to pass on cost increases quickly through price increases to

your customers ?8. If a supplier of goods or services lets you down can you charge back the cost of

the delay ?9. Can you arrange (with confidence !) to have delivery of supplies staggered or on a

just-in-time basis ?

There is an old adage in business that if you can buy well then you can sell well .Management of your creditors and suppliers is just as important as the management of

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your debtors. It is important to look after your creditors - slow payment by you maycreate ill-feeling and can signal that your company is inefficient (or in trouble!).

INVENTORY MANAGEMENT

Inventories constitute the most significant part of current assets of a majority of companies in India. On an average, inventories are approximately 60 percent of currentassets in public limited companies in India. Because of the large size of inventoriesmaintained by firms,a considerable amount of funds is required to be committed to them.It is, therefore, absolutely imperative to manage inventories efficiently and effectively inorder to avoid unnecessary investment. A firm neglecting the management of inventories

will be jeopardizing its long run profitability and may fail ultimately. It is possible for acompany to reduce its level of inventories to a considerable degree, e.g.,10 to 20 per cent,without any adverse effect on production and sales, by using simple inventory planningand control techniques. The reduction in excessive inventories carries a favourableimpact on companys profitability.

Nature Of InventoriesInventories are stock of the product a company is manufacturing for sale and componentsthat make up the product. The various forms in which inventories exist in amanufacturing company are:Raw Materials : These are those basic inputs that are converted into finished product

through the manufacturing process. Raw materials inventories are those units which have been purchased and stored for future productions.Work In Process : These inventories are semi-manufactured products. They represent

products that need more work before they become finished for sale.Finished Goods : These inventories are those completely manufactured products whichare ready for sale. Stocks of raw materials and work-in-process facilitate production,while stock of finished goods is required for smooth marketing operations. Thus,inventories serve as a link between the production and consumption of goods.

The levels of three kinds of inventories for a firm depend on the nature of its business. Amanufacturing firm will have substantially high levels of all three kinds of inventories.

Within manufacturing firms, there will be differences. Large heavy engineeringcompanies produce long production cycle products;therefore they carry large inventories.Firms also maintain a fourth kind of inventory, supplies or stores and spares. Suppliesinclude office and plant cleaning materials like soap, brooms, oil, fuel, light bulbs etc.these materials do not directly enter production , but are necessary for production

process. Usually, these supplies are small part of the total inventory and do not involvesignificant investment. Therefore, a sophisticated system of inventory control may not bemaintained for them.

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Need To Hold InventoriesThe question of managing inventories arises only when the company holds inventories.Maintaining inventories involves tying up of the companys funds and incurrence of storage and handling costs. If it is expensive to maintain inventories, why do companies

hold inventories?There are three general motives for holding inventories:-TRANSCATIONS MOTIVE : It emphasizes the need to maintain inventories tofacilitate smooth production and sales operations. PRECAUTIONARY MOTIVE : It necessitates holding of inventories to guard againstthe risk of unpredictable changes in demand and supply forcs and other factors.SPECULATIVE MOTIVE : It influences the decision to increase or reduce inventorylevels to take the advantage of price level fluctuations.

A company should maintain adequate stock of materials for a continuous supply to thefactory for an uninterrupted production. It is not possible for a company to procure raw

materials whenever it is needed. A time lag exists between demand for materials and itssupply. Also, there exists uncertainty in procuring raw materials in time on manyoccasions. The procurement of materials may be delayed because of such factors asstrike, transport disruption or short supply. Therefore, the firm should maintain sufficientstock of raw materials at a given time to stream line production. Other factors which maynecessitate purchasing and holding of raw materials inventories are quantity discountsand anticipated price increase. The firm may purchase large quantities of raw materialsthan needed for the desired production and sales levels to obtain quantity discounts of

bulk purchasing. At times, the firm would like to accumulate raw materials inanticipation of price rise.Work in process inventory builds up because of the production cycle. Production cycle isthe time pan between introduction of raw materials into production and emergence of finished product at the completion of production cycle. Till production cycle completes,stock of WIP has to be maintained.Stock of finished goods has to be held because production and sales are notinstantaneous. A firm cannot produce immediately when customers demand goods.Therefore , to supply finished goods on a regular basis, their stock has to be maintained.

Objective Of Inventory Management

In the context of inventory management, the firm is faced with the problm of meeting twoconflicting needs:

1. To maintain a large size of inventories of raw materials and WIP for efficient andsmooth production and of finished goods for uninterrupted sales operations.

2. To maintain a minimum investment in inventories to maximize profitability.Both excessive and inadequate inventories are not desirable. These are two danger pointswhich the firm should avoid. The objective of inventory management should bedetermine and maintain optimum level of inventory investment. Te optimum level of inventory will lie between the two danger points of excessive and inadequate inventories.

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The firm should always avoid a situation of over investment or under investment ininventories. The major dangers of over investment are:

Unnecessary tie up of the firms funds loss of profit Excessive carrying costs Risk of liquidity

The excessive level of inventories consumes funds of the firm, which cannot be used for any other purpose, and thus, it involves an opportunity cost. The carrying costs such asthe costs of storage, handling, insurance, recording and inspection, also increases in

proportion to the volume of inventory. These costs will impair the firms profitabilityfurther. Excessive inventories carried for long period increases chances of loss of liquidity. It may not be possible to sell inventories in time and at full value. Rawmaterials are generally difficult to sell as the holding period increases. Another danger of carrying excessive inventory is the physical deterioration of inventories while in storage.Maintaining an inadequate level of inventories is also dangerous. The consequences of under investment in inventories are

Production hold-ups Failure to meet delivery commitments Inadequate raw materials and WIP inventories will result in frequent production

interruptions.The aim of inventory management is to avoid excessive and inadequate levels of

inventories and to maintain sufficient inventory for the smooth production and salesoperations. An effective inventory management should:Ensure a continuous supply of raw materials to facilitate uninterrupted productionMaintain sufficient stock of raw materials in periods of short supply and anticipate pricechanges.Maintain sufficient finished goods inventory for smooth sales operation and efficientcustomer service.

Minimize the carrying cost and timeControl investment in inventories and keep it at an optimum level.

HEEP HARIDWAR BHEL produces long production cycle items against the firm orders from customers.Because of this as well as sizeable imported raw materials and compulsory bulk

purchases of items like steel and copper in line with availability from SAIL and MMTC,the company has to carry high level of inventories.

Following steps have been taken to control inventory:

An inventory monitoring cell is constituted at the corporate office. The purchases were controlled by the materials management group reporting to

the Director of Finance. The company provided for weekly meetings between material planning,

production control and purchase departments for better matched materialavailability.

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Monthly review of total inventory at the level of chief executives of plants andcorporate management is introduced.

Inventory control is dovetailed with the budgeting system.Top 100 inventory items are identified for closer scrutiny and control

KEY WORKING CAPITAL RATIOS

The following, easily calculated, ratios are important measures of working capitalutilization.

To comment upon the working capital management in PTL, the technique of ratioanalysis is adopted.

The following ratios have been calculated for the said purpose.

1. Current ratio.

2. Comparative debtors analysis.

3. Working capital turnover ratio.

4. Inventory Turnover analysis.

5. Creditors turnover.

Current Ratio:

The current ratio is an indicator of a firms short term solvency. A firm, to survive on a

continuing basis, should maintain sufficient liquidity. As a rule of thumb, 2:1 is

considered to be an ideal current ratio. The idea of having double the current assets as to

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0

10000

20000

3000040000

50000

60000

70000

80000

2004 2005 2006 2007 2008

Current Assets

Current Liabilities

Debtors/Receivables Turnover Ratio:

Debtors turnover ratio indicates the velocity of debt collection of firm. In simple words,

it indicates the number of times the average debtors are turned over during a year.

Debtors Turnover Ratio = Total sales

Debtors

Avg. collection period = No. of Months

D.T.R

5 Yearly Trend of Debtor Turnover Ratio of BSL

Years Sales Debtors D.T.R Collection Period

(months)2006 181972.06 428632.11 0.422007 201582.12 47235.12 4.27 7.552008 219672.20 48373.98 4.54 6.612009 252317.13 60863.71 4.14 6.322010 253103.36 62821.30 4.03 3.48

Since 1989, the companys main product i.e. tractor which accounted for nearly 95% of

its turnover is being sold against cash only. In fact sales of tractors are executed against

advances from the dealers. Since liquidity position of a company depends upon the

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Provisions 11603.51 10.58

Acceptance & other 4985.12 4.54

Interest Accrued 175.15 0.16

Other Liabilities 13636.89 12.43

TOTAL 109710.30 100

Net Working Capital (C.A. - C.L.) 29569.86

Working Capital Turnover Analysis:

The amount of working capital is sometimes used as a measure of a firms liquidity. It is

considered that between the two firms, the one having the larger amount of working

capital has the greater ability to meet its current obligations. Working capital turnover

analysis is, therefore, used to measure the efficiency with which the firms are using their

working capital. For this purpose, working capital turnover ratio, which indicates the

velocity of the utilization of net working capital, is worked out. A higher ratio indicates

efficient utilization of working capital. In the following lines a comparative statement of

working capital turnover ratio of PTL is produced.

Net Working Capital of BLUE STAR LIMITED (Rs. In Lacs)

Year Current Assets Current Liabilities Net Working

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Capital2006 89275.12 13953.99 75321.13

2007 73484.12 39431.92 34052.20

2008 101739.20 87553.20 14186.00

2009 103788.17 86021.11 17767.06

2010 139280.16 109710.30 29569.86

0

10000

20000

30000

40000

50000

60000

70000

2004 2005 2006 2007 2008

Net Working Capital

Working Capital Turnover Ratio of BSL

Years Sales Net W. C. W.C. Turnover Ratio

2006 181972.06 75321.13 0.41:1

2007 201582.12 34052.20 0.16:1

2008 219672.20 14186.00 0.06:1

2009 252317.13 17767.06 0.07:1

2010 253103.36 29569.86 0.12:1

An analysis of this table shows there is slight variation of the ratio from 2004 to 2007.

But it is quite high in 2008 in respect to other years. This no doubt indicates the

maximum use of working capital or quick turnover of current assets due to handsome

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sales of its main products (tractors). To ensure maximum profitability, working capital

has to be managed skillfully to avoid situation of both, under and over trading.

0

0.5

1

1.5

2

2.5

2004 2005 2006 2007 2008

W.C. Turnover Ratio

Inventory Turnover Analysis:

Every firm has to maintain a certain level of inventory of finished products so as to be

able to meet the requirements of the business and ensure an uninterrupted production.

This analysis is done by calculating inventory turnover ratio. Inventory turnover ratio

which is calculated by dividing sales by average inventory indicates the number of times

the stock has been turned over during the year. It also evaluates the efficiency with which

a firm is able to manage its inventory. A lower inventory turnover is an indicator of

higher efficiency in managing the inventory.

Inventory Turnover of BSL in 5 Years

Particulars 2006 2007 2008 2009 2010

Sales 181972.06 201582.12 219672.20 252317.13 253103.36

Inventory 22803.17 23146.11 27349.15 20805.75 25800.84

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I. Turnover Ratio

0.12 0.11 0.12 0.08 0.10

The above table shows PTL has the moderate inventory ratio during this period. Thisindicates that the company has a good inventory management. In FY 2004 there is lowest

inventory turnover. This is due to excessive inventory level than required by its

production and sales activities. The inventory turnover ratio should be moderate because

we cant blindly accept very high inventory turnover ratio as indicative of efficient

inventory management as it may be due to very low levels of inventory which generally

results into frequent stock outs. And frequent stock outs may hamper production

activities and may ultimately affect profits.

Creditors Turnover Analysis:

The analysis of creditors turnover is basically the same as of debtors turnover ratio

except that in place of trade debtors, the trades creditors are taken as one of the

components of the ratio and in place of average daily sales, average daily purchases are

taken as the other component of the ratio. It can be calculated as:

Creditors Turnover Ratio = Net Credit Annual Purchases

Average Trade Creditors

Average Payment Period Ratio = Average Trade Creditors

Average Daily Purchases

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Creditors Turnover Analysis of PTL in 5 Years

Year Purchases SundryCreditors

CreditorsTurnover

Payment Period(months)

2006 160863.79 22563.89 3.93

2007 165711.12 25340.29 2.74

2008 174421.44 28860.20 7.14 1.68

2009 184588.38 38275.54 7.06 1.70

2010 192737.23 55307.83 7.95 1.51

The average payment period ratio represents the avg. number of days taken by the

firm to pay its creditors. Generally lower the ratio better is the liquidity position of the

firm and higher the ratio less liquid is the position of the firm. From the analysis, the

payment period has been reduced from 3.93 in FY 2004 to 1.51 in FY 2008 hence we can

say PTL has better liquidity position.

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Following are some ratios which can also be considered while

analyzing the working capital management:

Equity Ratio -:

Equity Ratio =Shareholders Fund *100

Total Assets (Fixed assets+Current assets+Investments)

Years Shareholders

fund

Total assets Equity Ratio

2006 1798.72 887217.712007 1798.72 971532.662008 1798.72 101739.20 64%2009 1798.72 103788.17 64.2%2010 1798.72 139280.16 78.6%

2001

2002

2003

2004

2005

2006

2007

2008

1 2 3 4 5

0

10000

20000

30000

40000

50000

60000

70000

8000090000

Years

Shareholders fund

Total assets

Equity Ratio

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CURRENT RATIO RS IN THOUSAND

2001-02 2002-03 2003-04 2004-05

CA 9484804 7431039 8915877 9928310

CL 5495805 4690317 6203352 7358624

CA/CL 1.72 1.58 1.437 1.34

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QUICK RATIO RS IN THOUSAND2001-02 2002-03 2003-04 2004-05

CA-INVENTORY 5138694 4194077 4994507 6069775CL 5495805 4690317 6203352 7358624RATIO 0.93 0.89 0.805 0.82

NET WORKING CAPITAL RATIO:

NWC is sometimes used as a measure of firmliquidity. But exactly it is not so. Themeasure of liquidity is a relationship rather than the difference between current assets andcurrent liabilities. NWC measure the firms potential reservoir of funds.

WORKING CAPITAL TURNOVER

A Firm may also like to relate net WC to sales. It may thus compute NWC turnoverby dividing sales by NWC.

NET WORKING CAPITAL RATIORS IN THOUSAND

2001-02 2002-03 2003-04 2004-05NWC 3988999 2740722 2712525 2569686NA 3777407 3442888 3630421 3317746NWC/NA 1.05 0.79 0.747 0.77

WORKING CAPITAL TURNOVERSALES 6670210 8195014 9501446 9091295WC 3988999 2740722 2712525 2569686SALES/WC 1.67 2.99 3.5 3.53

CAPITAL EQUITY RATIO

This helps in calculating how much funds are being contributed together by lender and owner for each one rupes of the owners contribution .

CAPITAL EQUITY RATIORS IN THOUSAND

2001-02 2002-03 2003-04 2004-05NA 4834339 4316856 4495430 4542858

NW 4912745 5783952 6318600 7807402NA/NW 0.98 0.74 0.71 0.58

Other working capital measures include the following :

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1. Bad debts expressed as a percentage of sales.2. Cost of bank loans, lines of credit, invoice discounting etc.3. Debtor concentration - degree of dependency on a limited number of customers.

Once ratios have been established for your business, it is important to track them over

time and to compare them with ratios for other comparable businesses or industry sectors.

SummaryLet us summarise our discussion on the structure and financing of current assets. Therelative liquidity of the firms assets structure is measured by current to fixed assets or current asset to total asset ratio. The greater this ratio , the less risky as well as the less

profitable will be the firm and vice versa. Similarly, the relative liquidity of the firmsfinancial structure can be measured by short-term financing to total financing ratio. Thelower this ratio the less risky as well as profitable will be the firm and vice-versa. Inshaping its working capital policy, the firm should keep in mind these two dimensions :relative asset liquidity (level of current assets) and relative financing liquidity(level of short term financing) of the working capital management. A firm will be following a veryconservative working capital policy if it combines a high level of current assets with ahigh level of long term financing (or low level of short term financing). Such a policywill not be risky at all but would be less profitable. An aggressive firm on the other handwould combine low level of current assets with a low level of long term financing(or high level of short term financing ). This firm will have high profitability and high risk.In fact, the firm the firm may follow a conservative financing policy to counter itsrelatively liquid asset structure in practice. The conclusion of all this is that theconsiderations of assets and financing mix are crucial to the working capitalmanagement.

Recommendations

There is a great need for effective management of working capital in any firm. There isno precise way to determine the exact amount of gross or net working capital for anyfirm. The data and problems of each company should be analysed to determine the

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working capital. There is no specific rule as to how current assets should be financed. It isnot feasible in practice to finance current assets by short-term sources only. Keeping inview the constraints of the company, a judicious mix of short and long term financesshould be invested in current assets. Since current assets involve cost of funds,theyshould be put to productive use.