working capital management
TRANSCRIPT
WORKING CAPITAL MANAGEMENT
OF
STEEL AUTHORITY OF INDIA LIMITED
A
DISSERTATION
SUBMITTED TO THE
DEPARTMENT OF A.B.S.T.
UNIVERSITY OF RAJASTHAN,JAIPUR
FOR THE DEGREE OF
MASTER OF PHILOSPHOY
IN COMMERCE
(ACCOUNTANCY AND BUSINESS STASTICS)
Session 2006-2007
Supervised by Submitted by
Dr.N.K. Sharma, Kshipra Nandwana
Professor, Department of A.B.S.T.
Department of A.B.S.T. University of Rajasthan,
University of Rajasthan, Jaipur
Jaipur
It is certified that the Dissertation entitled “Financial Appraisal of Steel
Authority of India Ltd” described the original work done
by……………………. who worked under my supervision for this
dissertation to be submitted for M.Phil.(Accountancy and Business
Statistic) Examination, 2006-07 in lieu of one of the compulsory papers.
Supervisor:-
Dr.N.K. Sharma,
Professor,
Department of A.B.S.T.
University of Rajasthan,
Jaipur
Chapter -1
Working Capital Management:
A Conceptual Framework
Working Capital Management
Concept of Working Capital
Classification of Working Capital
Determinants of working capital
Principals of working capital management
Operating Cycle Concept of Working Capital
Need for working capital
Goals of working capital management
Structure of working capital
Components of working capital management
Research Methodology
Chapter -1
Working Capital Management:
A Conceptual Framework
Working capital has come to be regarded as the lifeblood of any
concern. Even the sophisticated method of capital budgeting can fall the
organization if proper attention is not devoted to the management of working
capital. The management working capital is complicated due to fluctuating
nature of the amount of working capital and the need to maintain a proper
balance between current assets and the non-current assets to maximize
profitability.
No business firm can progress without adequate working capital
means shortage of input, whereas excess of it leads to extra cost. So, the
quantum of working capital in every business firm should be neither more
nor less than what actually required. This is why the financial managers have
to spend than 90% of their time on this important area of financial
management.
Working Capital Management
Working capital management, which encompasses the short-term
investment and financing decisions of the firm, affects profitability as
well as liquidity of the enterprise. Excessive working capital leads to
unremunerative use of scare funds, inadequate working capital interrupts
the smooth run of business activity and thus both impair profitability.
Effective working capital management of cash, receivable, inventories
and short-term sources of funds. Importance of efficient working capital
management can be judge form the fact that while its effective
management can do much to ensure the success of a business, its
inefficient management can lead not only to loss of profits but also to
ultimate downfall of what otherwise light be considered as a promising
concern.
The present study is based on the premise that skilled working capital
management and satisfactory provision of working capital can lead not
only to material saving in the economical use of capital but can also
assist in furthering the ultimate aim of business, namely of maximizing
financial returns on the minimum amount of capital which need be
employed.
Types of Working Capital
Working capital actually refers to that part of total capital, which is
available and used for carrying out the routine or regular business
operations. Thus the capital required for. Purchasing raw materials payment
of direct and indirect expenses, carrying out production, investment in stocks
and stores, receivables and to be maintained in the from of cash is generally
known as working capital in other words assets engaged in short in other
cycle often accounting year in a business are known as working capital.
Working Capital is defined as the capital required for meeting the
operational needs of a business enterprise. It is the instrument for the
capacity created by fixed capital. It has been named in different ways by
different scholars. It was referred to as ‘circulating capital’ by C.W.
Gerstenberg and short-term funds by Hasting. The most common
nomenclature used for such capital is working capital.
1) Gross Working Capital
The gross working capital simply called as working capital refers to
the firm’s investment incurrent assets. Current assets are the assets, which
can be converted into cash within an accounting year and includes cash,
short-term securities debtors and Bills receivables and stock. Thus the gross
working capital is a quantitative concept. It a firm is to get the highest return
on its investment, it should see that the management at the proper time
provides the correct amount of working capital. According to J.S. Mill
“The sum of current assets is the working capital of business”
2) Net Working Capital
The term net working capital refers to the difference between current
assets and current liabilities are those claims of outsiders, which are
expected to mature for payment within and accounting year and include
creditors, bills payable, bank overdraft and outstanding expenses. Net
working capital will be positive or negative. A positive net working capital
will arise when current assets exceed current liabilities. A negative net
working capital occurs when current liabilities are in excess of current
assets. The net working capital is a quantitative concept.
The important of this concept lies in the fact that the company has to
determine the amount and nature of the current assets to be used in meeting
current when they become due for payment. Further the amount to be used
in the business for operational needs is the amount of current assets left after
payment of liabilities. For the purpose of our study working capital has been
taken net working capital.
“Working capital, according to the honored definition is the excess of
current assets over current liabilities.”
Prof. Harry G. Guthrnann and
Herbert E.
“Any comprehensive discussion on the working capital includes the
excess of current assets over current liabilities.”
Prof. C.W.Gerstenberg
Both these concepts have their own uses and limitations .The gross concept
are a going concern concept because for the productive utilization of fixed
assets, all current assets are necessary. Management is particularly interested
in gross concepts, as it is useful to asses the efficiency with which the
current assets are utilized .The net concepts is useful to judge the current
financial soundness or the shot-term liquidity of concern and is of special
interest to sundry creditors and suppliers of short-term loans and advances.
Gross concepts emphasize the use and the net concept the source. Working
capital in net concepts is qualitative in character as it represents the equity
and long –term financing portion of current assets, which is supposed to
serve as a cushion of safety and security to current liabilities. The gross
concept of working capital is quantitative in character because it represents
the total amount of funds used for current operating purpose.
3) Permanent Working Capital:-
This is the amount required on a continuing basis over the entire year.
It represents the amount of cash receivables and inventory maintained as
a minimum to carry on operates at any time.
These are different from fixed assets which are sunk in the business and
retain their form for a long period but this kind of working capital
constantly changing from the current assets to another. Secondly the
amount of value represented by permanent working capital never leaves
the business process. Thirdly the rise of permanent working capital will
increase so long as their growth in the business.
4) Temporary or Variable Working Capital: -
This represents additional assets required at certain times during the year.
This changes its form cash inventory and from inventory to receivables and
then to cash. Businesses, which are of seasonal nature, require more
temporary working capital. This will increase the turnover of the
investments resulting in efficient use of capital.
5. Balance Sheet working capital : The balance sheet working
capital is one which is calculated from the items appearing in the
balance sheet. Gross working capital, which is represented by
current assets and the working capital which is represented by the
excess of current assets over current liabilities are examples of the
balance sheet working capital.
6. Cash working capital: Cash work gin capital is one which
is calculated from the items appearing in the profit and loss
account. It shows the real flow of money or value at a particular
time and is considered to be the most realistic approach in working
capital management.
7. Negative working capital: Negative working capital
emerges when current liabilities exceed current assets. Such a
situation is not absolutely theoretical and occurs when a firm is
nearing a crisis of some magnitude.
Determinants of working capital
1. Nature of Business: The general nature of business is an
important factor affecting working capital requirement. A
concern's working capital requirements are basically related to the
kind of business it conduits. Public utilities have the lowest
requirement for current assets partly because of their selling a
service instead of a commodity and there is not need of
maintaining big inventories. On the country trading concerns have
to invest proportionately a high amount in current assets as they
have to carry stock in trade, accounts receivable and liquid cash.
The industrial units also require a large amount of working capital.
2. Nature of industry : The composition of an assets is a
function of the size of a business and the industry to which it
belongs. Small companies have smaller proportion of cash,
receivables and inventory than large corporation.
3. Manufacturing Process: If the manufacturing process in an
industry entails a longer period because of its complex character,
more working capital will be required to finance that process. The
longer it takes to make an approach and the greater its cost, the
longer the inventory tied up in its manufacture, the higher the
amount of working capital is required.
4. Turnover of Circulating Capital: The speed with which
the circulating capital competes its round i.e. conversion of cash
into inventory of raw materials and stores, inventory of raw
materials into inventory of finished goods, inventory of finished
goods into book debts or account receivable, and book debts into
cash account, plays an important and decisive role in judging the
adequacy of working capital.
5. Gestation Period : Certain industries have a long gestation
period, with the result that a considerable number of years must
elapse before production, operation can be carried on profitably.
During this period there is either not income or the income is
insufficient. The need of industries with longer gestation period
working capital will be greater.
6. Time lag Between Production and Sales : The smaller the
lag between production and sales, the smaller the requirement for
working capital and vice-versa. The reason is that there will be a
smooth, prompt, regular and timely flow of funds in the business
calling for the smaller amount of working capital.
7. Credit Policy of the Company : The credit which a
company expects to allow and receives will have to be considered.
If the period of credit allowed to customers is larger than the
period allowed to the company, a larger amount of working capital
will be needed. The total amount of credit received and allowed,
besides the period of credit, will also be ascertained by deducting
the total amount of credit allowed from the total amount of credit
received.
8. Growth and Expansion of Business : As a company grows,
it is logical to expect that larger amounts of working capital will
be required though it is difficult to draw up firm rules for the
relationship between the growth in the volume of a company's
business and the growth of its working capital. The composition of
working capital in a going company also shifts with economic
circumstance and corporate practices, Growing industries require
more working capital than those that are static, other things being
equal.
9. Business Cycle Fluctuations : Requirements of working
capital of a concern vary with the business variation. At a time
when the price level comes up and booming conditions prevails,
the psychology of the management is to pile up a big stock of raw
material and other goods likely to be used in the business
operations as there is an expectation to take advantage of the lower
prices. In a period of prosperity to expand the business a larger
amount of working capital is required as compared to the amount
required in a period of depression.
10. Seasonal Variation : The wider the seasonal variation in an
industry, the more additional working capital is temporarily
required in the active season. Thus, almost all of the current assets
of a manufacture of ladies apparel may be temporary in nature. As
the manufacturer prepares for his active season, his inventory may
rise from practically nothing to a peak reached just as volume
deliveries begin. As good are shipped, accounts receivable replace
inventory as the significant element of working capital. Final
conversion from account receivable to cash as customers pay their
bills ushers in the low point in working capital requirement.
11. Inherent Hazards and Contingencies : An enterprise
operating in an industry subject to wide fluctuations in demand
and prices for its products, periodic operating losses, or rapidly
changing technology, requires, additional working capital to cope
with these conditions over and above its permanent and seasonal
requirement.
12. Terms of Purchases and Sales : If the terms of credit on
which purchases are made are favorable less cash will remain
invested in inventory. If payment for purchase is required within a
short time after its delivery, a larger working capital will be
required. Its credits are granted to customers on more liberal terms
a larger amount of working capital will remain in the form of
receivables.
13. Cash Requirement : Cash is one of the current assets which
is essential for the successful operation of the production cycle,
cash should be adequate and properly utilized. A minimum level
of cash is always needed to keep the operating going.
14. Volume of sales : This is the most important factor affecting
the size and components of work gin capital. An enter pries
maintains current assets because they are needed to support the
operational activates which result in sales. The volume of sales
and the sizes of the working capital are directly related to cash
other. As the volume of sales increases, there is an increase in the
investment of working capital in the cost of operations, in
inventors and in receivables.
15. Repayment Ability: An enterprises repayment ability
determines the level of its working capital. The usual practice of
an enterprises is to prepare cash flow statements according to its
plants of repayment and to fix the working capital levels
accordingly.
16. Availability of Credit : the availability of credit from banks
and suppliers also influences the working capital needs of an
enterprise. An enterprise which can get credit from bank and
suppliers easily on favorable conditions, will operate with less
working capital than an enterprise without such a facility.
17. Price level changes : Financial manager anticipates the
effect of price level changes on working capital requirement of the
enterprise. Generally, the rising price level will require an
enterprise to maintain a higher amount of working capital. The
same level of current assets will need an increased investment
when prices are increasing. However, the companies which can
immediately revise their product prices with the rising price level
will not face a severe working capital problem.
18. Liquidity and Profitability : if an enterprise desires to take
a greater risk for bigger rains or losses, it reduces the size of its
working capital in relation to its sales. If it is interested in
improving its liquidity, it will increase the level of its working
capital. However, this policy is likely to result in a reduction of the
sales volume and, therefore, of a profitability. An enterprise, thus,
should choose between liquidity and profitability and decide about
its working capital requirements accordingly.
19. Profit Planning and Control : The level of working capital
is decided by management in accordance with its policy of profit
planning and control. Adequate profit assists in the generation of
cash it makes it possible for management to plough back a part of
earnings into the business and substantially build up internal
financial resources.
20. Activities of the Firm: A firm's stocking of heavy inventory
or selling on easy credit term calls for a higher level of working
capital than for a firm selling service or making cash sales.
21. Operational and Financial Efficiency : Working capital
turnover is improved with a better operational and financial
efficiency of a firm. With a greater working capital turnover, it
may be able to reduce its working capital requirement.
22. Dividend Policy: A desire to maintain an established
dividend policy may affect working capital, often changes in
working capital bring about an adjustment of the dividend policy.
The relationship between dividend policy and working capital is
well established and very few companies dealer a dividend
without giving due consideration to its effects on cash and their
needs for cash. A shortage of working capital often act as a
powerful reason for reducing or shipping a cash dividend.
23. Demand of Creditors: Creditors are interested in the
security of loans. They want their obligations to be sufficiently
covered. They wants the amount security in assets which are
greater than the liquidity.
24. Value of Current Assets : A decrease in the real value of
current assets as compared to their book value reduce the sizes of
the working capital. If the real value of current assets increase,
there will be an increase in working capital.
25. Other Factors : In addition, absence of co-ordination in
production and distribution polices in a company results in a high
demand for working capital. Secondly, the absence of
specialization in the distribution of products may enhance the need
of working capital for a concern as it will have to maintain an
elaborate organization of its own for marketing goods. Thirdly, if
the means of transport and communication in a country like India
are not well developed, the industries may face a great demand for
working capital in order to maintain big inventory of raw materials
and other accessories. Fourthly, the import policy of the
Government may also affect the requirement of working capital
for the companies as they have to arrange for funds for important
the goods as specified times. Lastly, the greater the amount of
working capital, the lower is the risk of liquidity.
Principles of working Capital Management
The four important principles of working capital
management are as shown in the following chart :
1. The Principle of Risk Variation : The world "Risk" here
refers to the inability of an enterprise to maintain sufficient current
assets to pay for its obligation. "If working capital varies relatively
to fixed assets investment or sales, the amount of risk that a firm
assumes is also varied and the opportunity for gain or loss is
increased." This principle assumes that a definite relation exists
between the degree of risk that a firm assumes and the rate of
return. i.e., the more the risk assumed, the greater is the
opportunity for gain or loss. As the level of working capital
relative to sales, decreases, the degree of risk increases, When the
degree of risk increases, the opportunity for gain and loss
increases. Thus, if the level of working capital goes up, the amount
of risk goes up and vice versa. The opportunity for gain or loss is
likewise adversely affected.
2. The Principle of Equity Position : "Capital should be
invested in each component of working capital as long as the
equity position of the firm increases." According to this principle
the amount of working capital invested in each component should
be adequately justified by a firm's equity position. Every rupee
invested in working capital should contribute to the net worth of
the firm.
3. The Principle of cost of Capital: "The type of capital used
to finance working capital directly affects the amount of risk that a
firm assumes as well as the opportunity for gain or loss and cost of
capital." This principle emphasizes that different sources of
finance have different costs of capital. It should be remembered
that the cost of capital moves inversely with risk. Thus, additional
risk capital results in decline in the cost of capital.
4. The Principle of Maturity of Payment : "The greater the
disparity between the maturities of firm's short term debt
instrument and its flow of internally generated funds, the greater
the risk, and vie versa." A Company should make every effort to
related maturity of payment to its flow of internally generated
funds. There should be the least disparity between the maturities
of a firm's short be the least disparity between the maturities of a
firm's short term debt instrument and its flow of internally
generated funds because greater risk is generated with greater
disparity. A margin of safety should however, be provided for any
short term debt payment.
Operating Cycle Concept of Working Capital
Both the concepts, gross and net of working capital, depend on year-end
Balance sheet for their contents. As Balance Sheet merely indicates the
financial status as on the closing date of the firm’s accounting year, these
concepts do not represent the average or representative figure of working
capital requirements for the year in question. The company’s operating
phase can fall anywhere between the top of the highest peak and the bottom
of the lowest trough in the activity cycle of the firm. Therefore, operating
cycle concepts, which is based mainly on the firm’s Profit and Loss Account
including all operational inflows and outflows of values, cash and credit, and
again based to a certain extent on the Balance Sheet of the firm, has been
gaining importance.
Operating Cycle of a Firm
This concept emphasizes functional interpretation of the role of working
capital. According to this concept, working capital is to support all
operational activities of the firm over a period of time and also to pay the
current obligations for materials and expenses. If the firm is to maintain
liquidity and function properly, it has to invest funds in various short-term
assets (working capital) during this cycle. It has to maintain cash balance to
pay the bills as they become due.
The operating cycle relates to a manufacturing firm where cash is
needed to purchase raw materials and convert raw materials into work in
progress and then work in progress is converted into finished goods.
Finished goods will be sold for cash and credit and ultimately debtors
will be realized.
The non-manufacturing firms, such as the wholesalers and retailers,
will not be have the manufacturing phase. Rather they will have the
direct conversion of cash into stock of finished goods into debtors and
then into cash.
Thus, the length of operating cycle, in a manufacturing concern, is the total
of the following periods.
1. Materials in storage period, say, ‘r’, represents the average time of
materials that remain in store prior to the date of issue for
production purposes.
2. Processing period, say, ‘w’, shows the time that may be taken on
an average to convert raw materials into finished goods. It depends
on the state of technological efficiency and supervisory ability of
the firm.
3. Finished goods in storage period, say ‘f’ represents the time for
which finished goods, after completion of production, remain in
warehouse before they are dispatched to customers.
4. Debtor’s collection period, say, ‘d’, represents the time lapse
between sale of goods on credit resulting in debtors and their
conversion into cash.
5. Creditor’s deferral period, say ‘c’, shows the time period the firm is
able to defer payment on its various resource purchases. It will
reduce the length of the operating cycle of the firm.
Thus,
Length of operating cycle =r+w+f+d
Length of cash conversion cycle = r+w+f+(d-c)
Number of cycles in a period
= Number of days in the relevant period
Length of cycle
The computations may be made as under:
R= Average inventory of raw materials and stores
Average consumption of raw materials and stores per day
w = Average inventory of work-in-progress
Average cost of production per day
f = Average inventory of finished goods
Average cost of sale per day
d = Average trade debtors
Average credit sales per day
c = Average trade creditors
Average credit purchases per day
The average inventory, trade creditors and trade debtors can be computed by
dividing, the total of opening and closing balances in respective account of a
particular period by two. The average per day figure can be calculated by
dividing the concerned annual figures by 360 or number of days in the given
period.
The operating cycle concept emphasizes functional interpretation of the role
of working capital. According to this concept, working capital is to support
all operational activities of the firm over a period of time and also to pay the
current obligations for materials and expenses. Ability to pay current
liabilities, as and when these fall due, is only a part of this wider function.
This concept facilitates control of working capital. The operating cycle of
past few years could be studied to determine the improvement in operating
cycle period of the relevant year. Operating cycle concepts helps exerting
greater control on storage (raw materials including stores and finished
goods), conversion process, and debt liquidation and collection policies of a
firm. In other words, management can go deeper into each phase of
operating cycle to look for possible economics in any of all of these phases.
For creditors, attempts may also be made to prolong the repayment period,
of course, without jeopardizing goodwill, with a view to reduce the
operating cycle period further.
Need for working capital
Working capital is must for a business enterprise, though its amount
varies from firm to firm depending on different factors. Working capital
enables a company to make the best use of the productive capacity
established by the expenditure of fixed capital. A firm can work and
survive without making profit but is cannot either survive of work
without working capital funds. If a firm is not earning profit it may be
termed ‘sick’, but if it does not possess working capital, it is likely to be
dead, that is to go bankrupt and close.
Cash is required to purchase raw materials and pay for expenses, as there
may not be prefect matching between cash inflows and outflows.
Adequate stocks of raw materials and supplies are kept to ensure smooth
and uninterrupted flow of production as these generally cannot be
procured immediately whenever needed. Inventory of work-in-process
includes the cost of raw materials transferred to the work-in-process
account plus charges for wages and other direct costs of manufacturing
together with an allocation of overhead costs. It results as the production
process takes time to convert raw materials into finished goods. Finished
goods inventory is kept for timely execution of customer’s orders.
Debtors arise because of credit sales. Which is essential to expand sales
in the today’s competitive world?
Working capital is also required to meet future uncertainties. When the
flow of working capital is smooth and rapid, the amount of working
capital required to produce a given level of output is less than when
interruptions occur which cause the flow to slow down.
Goals of Working Capital Management
(1) Adequate Liquidity:
If a firm lacks sufficient cash to pay its bills when due, it will
experience continuing problems. The most important goal is to achieve
adequate liquidity for the conduct of day-to-day operations.
(2) Minimization of Risks:
In selecting its sources of financing payables and others short-term
liabilities may involve low costs. The firm must ensure that these near
term obligations do not become expensive compared to the current assets
on hand to pay them. The matching of assets and liabilities among
current account is a task of minimizing the risk of being unable to pay
bills and other obligations.
(3) Contribute to Maximizing Firm Value:
The firm holds working capital for the same purpose as it holds any
other assets, that is, to help maximize the present value of common stock
& value of the firm. It should not idle current assets any more than it
should have idle fixed assets.
Working capital may be defined as the difference between current
assets and current liabilities. But this over simplified definitions, instead
of defining working capital tells how working capital is calculated.
One important meaning of working capital is the number of rupees
worth of current assets a not required for paying off current liabilities. At
the date of balance sheet, some part of the current assets is set off by
current debts the remainder available to management to be sued freely.
Structure of working capital
Structure of working capital implies the elements of working capital,
which are inventory, receivables, cash and bank balances and other liquid
resources like short-term of temporary investments.
Inventory:
Inventories occupy the most strategic position in the maximization to profit,
which depends upon the turnover of working capital, which is mostly
determined by the turnover of inventories.
The term inventory includes those items of tangible personal property,
which (a) are held for sale in the ordinary course of business, (b) are in the
process of production for sale and (c) are to be currently consumed in the
production of goods or services to be available for sale. Broadly speaking,
the inventories include raw materials, supplies, and work-in-progress and
finished goods.
Raw materials include the items, which are held in their original form
for processing and production. Supplies are stores and spares and other
goods, which are consumed in the creation and distribution of goods and
services. Work-in-process is raw materials upon which some work have
been performed to change their form, size, physical or chemical properties.
Finished goods include completely manufactured and inspected goods that
are ready for sale.
Holding some inventories of raw materials is essential to ensure
smooth flow of production against the risk of their unavailability. To avail
discount facility, bulk purchase of raw materials also results in stock of raw
materials. Work-in-process inventory results in an attempt to ensure a
completely balanced production flow. Inventory of finished goods is kept to
satisfy the consumer’s demand immediately providing a protective buffer for
economic production lots and for absorption of variation in sales. Inventory
of critical and vital supplies, such as spares and tools, is essential to ensure
against long spell of production held up for want of such components.
Investment in inventory depends on average inventory carried.
Investment in inventories, besides funds tied up in stocks, results in
inventory carrying costs and inventory ordering costs. Inventory carrying
costs include interest on capital locked up, storage and insurance charges,
physical deterioration etc. the costs of ordering include general
administrative overhead costs of processing purchase orders, quality
analysis, written and other forms of communication, transportation etc. the
inventory carrying costs and ordering costs is the ‘total inventory costs’,
where this total inventory cost is the minimum, there is and order quantity
which is referred to as Economic Order Quantity (EOC). This is the point
where investment in inventory is at its optimum.
Receivables:
Receivables occupy an important position in the structure of working capital.
Receivables result from the sale of goods and services in exchange for a
promise for future payment. Receivables should be considered as an
investment rather than the passive consequence of sales. However, the
services the render in increasing profits happen to be only indirect. The
volume of receivables is a function of sales, credit and collection policies.
The greater the volume of sales, the longer the term of credit granted, the
more lenient the collection policies, the more will be the investment in
receivables.
Receivables include book accounts, notes and bills and accrued receivables.
Promissory notes and bills of exchange are self- liquidating instruments of
credit and can be discounted before the date of maturity-usually 3 months to
a year. Receivables arising from period adjustments of sales are designated
as accrued receivables.
Short-term investments/ marketable securities:
In modern times, it has become a practice with business enterprises to avoid
too much redundant cash by investing a portion of their excess cash in
assets, which are susceptible to easy conversion into cash. Such assets may
be in the form of government securities, shares or debentures known as
readily marketable securities.
Cash:
Cash occupies an important place in the structure of working capital. Cash,
even though the rupee investment in cash typically is less than any of the
other assets of the firm, is the most important assets as cash must be
available for paying all suppliers and sources of financing, whether short-
term or long-term.
There is never a time in the life cycle of business enterprises when cash or
ready access to it, is not important. An inadequacy of cash is injurious to the
operative health of an enterprise. Cash is both a means and an end of
business enterprise. Cash is one of the most important tools of day-to-day
operations because it is the most liquid asset, which is available for
assignment to any new use. Return on investment usually takes the form of
payment of cash dividends; and in the event of liquidation cash becomes the
final medium by which claims are discharged.
A business should, in general, keep cash balances (1) that will be sufficient
in relation to other current assets and the current liabilities-to avoid
unfavorable comparisons with similar businesses by creditors, (2) that will
support a satisfactory line of credit with commercial bank, if that is desirable
and (3) that will be enough to prevent trouble in meeting bills and expenses
as they mature.
Structure of working capital shows that different departments like
purchasing, production, marketing, finance departments are involved in the
management of working capital. Hence, working capital effectiveness can be
achieved only through sustained inter-departmental efforts and co-operation.
This is often the difficult phase in the working capital management, since
organizational aspects of conflict come into play, lesser the conflicts; greater
is the effectiveness of working capital management.
Components of working capital:-
According to size & growth of working capital it has two main
components. Thus classification of total assets and current is important from
working capital determination point of view. Fixed assets are held
permanently by a business concern and investment in fixed assets does not
convert into cash in short time. Thus plant and machinery, furniture and
fixture, land and building are fixed assets.
Current assets are those assets which are used for sale thus they are
held by the company for a very short time. Thus raw material, debtors stock
of finished goods is example of current assets.
The second important component of working capital is current
liabilities. Current liabilities are those liabilities, which are to be paid off
with in an year or less. So liabilities are two type i.e. long-term liabilities
and current liabilities. Long time liabilities cosmists of debentures and other
debts payable after a period of one year or more years. Current liabilities
include bills payable sundry creditors provisions etc.
Items including in current assets and current liabilities are given below-
Current assets: -
1. Inventories: -
It is most important part of current assets and its position in the
structure of working capital of an enterprise is very important. Near about
50% of current assets remains as inventories. Other various items of
inventories are given into the following heads.
I Row material
Ii Work-in-progress
Iii Finished goods
Iv Stores and spares
V Loose tools
Vi Miscellaneous goods.
2. Sundry debtors: -
Sundry debtors represents the amount owing from customers for the
sale of goods and services on credit.
Debtors resulting from sale of goods and services in which concern deals,
bills receivable.
3. Cash and Bank Balances: -
Working capital cycle starts from cash and ends with realization of
cash. Cash includes the following items-
I cash in hand
Ii cash with banks in current account
Iii interest accrued on bank balance.
4. Loans and advances: -
Loans and advance includes the following.
i Advance to suppliers
ii Advances to contractors
iii Advances to employees
iv Advances to officers.
5. Miscellaneous current assets:-
I Marketable securities-
(a) Investment in govt. securities.
(b) Investment in shares, debentures or bonds.
II Prepaid expenses
III Dividend receivable
IV Stamps in hand.
Current liabilities
(a)Sundry Creditors
Creditors represent amount owing to outsiders for goals and services
purchased by concern on credit basis. High figure of creditors is in the
advantage of the concern but for sound business practices it is seen with
suspicion and hence avoided. The amount of sundry creditors includes
the following:-
a. Trade creditors
b. Bills payable
c. Liabilities for expenses.
(b)Loans and advances:-
A company arranges short-term loans from banks subsidiary
companies and others. They may be secured or unsecured. The
companies also accept short term deposits from the public loan and
advances includes following items.
1 Sundry loans including loan from subsidiary company.
2 Fixed deposits.
3 Overdrafts, cash credit, loans from bank.
4 Advances and running payments.
5 Security deposits from employees
6 Interest accrued a loans and advances.
3. Provisions:-
A company usually makes provisions for the payments of tax dividend
pension and gratuity etc. they are following-
I Provision for taxation
II Provision for dividends
III Provision for pension and gratuity
IV Provision for contingencies.
4. Miscellaneous current liabilities:-
The liabilities, which are not included in any other head, are included
in miscellaneous head
1 unclaimed dividend
2 Outstanding salaries and wages.
3 Share application money.
4 Employees security deposits.
Research Methdology
Purpose of study
Purpose of study primary objective of this study is to find out how effectively liquidity position maintained by Steel Authority of India limited and study will attempt to answer the following questions:
(a) To find out liquidity condition whether liquid funds are adequate, excessive or inadequate;
(b) To determine better use of available resources;
(c) Identifying area where more attention is needed for better management;
Scope of study
Study consist analysis of working capital condition of Steel Authority of India
Ltd. This study covers the period of five years from –2002-2003 to 2006-2007.
Research Hypothesis
A hypothesis is a tentative generalization about the subject of inquiry,
the validity of which is to be tested by undertaking research. The hypothesis
is based on existing knowledge of the subject.
It may be a generally accepted view , on idea or a mere guess, on the
basis of above mentioned the following hypothesis are assumed to be tested
in the present study :-
The substantive hypotheses underlying the empirical study are
given as follows :
(a) Mismanagement of working capital has been at the root of
industrial sickness prevailing in steel authority of India
Limited.
(b) The industry faced a plethora of problems during the study
period and still it has been facing many a problems. If these
problems were tackled property, the performance of the
industry in working capital management would improve to a
satisfactory extent.
(c) There are areas where the performance of working capital
management can be improved by effective management of
cash, receivables and inventories.
(d) There have been certain uncontrollable and controllable
factors affecting the working capital of the industry. It is
hypothesized that even by controlling the controllable factors, the
industry can improve its working capital management.
Database and research methodology
Both primary and secondary data have been made use of in carrying
out of present research work. Whereas primary data are obtained through
interviews executives of steel authority of India limited. And secondary data
are obtained from the annual reports of steel authority of India limited.
Limitations of study
The present study has been taken as a partial fulfillment for the degree of M.Phil
(ABST), so the time factor has been limitation but exhaustive analysis of working
capital condition of Steel Authority of India Ltd concern requires a wide canvas.
1. Only five years data of Steel authority of India ltd have been analysed
and interpreted in this study.
2. All the limitations that are applied in all accounting and statistical
techniques are limitations of the study.
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Chapter: Size and Adequacy of Working Capital
Size of working capital
Investment in current assets
Investment in current assets as percentage of total net assets
Investment in current assets relative to fixed assets
Adequacy of working capital
Chapter: Size and Adequacy of Working Capital
Working capital represents that portion of total capital of an enterprise,
which is employed in short-term operations. It consists of current assets. The
management of current assets assumes greater importance because the sum
total of investment in different current assets represents a very large portion
of the total investment of a firm. The level of current assets of an enterprise
has an important effect on its risk. As the size of current assets decreases, the
enterprise’s risk would increase and vice-versa.
Size of working capital
The size of working capital in food- processing industry can be studied by
examining (a) investment in working capita/current assets, (b) investment in
current assets as percentage of total assets and (c) investment in current
assets relative to fixed assets.
(a) Investment in current assets as percentage of total net assets:
another measure to gauge the importance of working capital is the ratio of
current assets to total net assets steel Industry in India.
(b) Investment in current assets relative to fixed assets: Capital of an
enterprise consists of fixed capital and working capital. In earning maximum
return on total capital employed, working capital plays a great role in the
utilization of facilities created by fixed capital. Ceteris paribus, a firm’s
profitability may be increased as working capital is added to fixed capital
provided the firm does not exceed 100% capacity. A fully equipped
industrial enterprise without the supply of materials to process or without
cash to pay off workmen’s wages and other current expenses or a store
without merchandise to sell is virtually useless. However, more working
capital in excess of the amount required, would reduce the profits since the
excess is idle. Hence, an attempt is made to compare the investment in
current assets with investment in fixed assets by calculating the ratio of
current assets to net fixed assets.
Adequacy of working capital
Working capital management is often referred to as liquidity management.
Liquidity plays a significant role in the successful functioning of a business
firm. The business should have enough cash to meet its currently maturing
obligations. If sufficient liquidity is not maintained the enterprise is
technically insolvent or at least faces the financial embarrassment of
renegotiating its obligations to creditors. In the absence of adequate amount
of working capital, fixed assets cannot be gainfully employed. It adversely
affects growth and hampers the reputation of business. Many a time business
failure takes place due to lack of working capital. To avoid interruptions in
the production schedule and to maintain sales, a firm requires enough funds
to finance inventories and receivables. Our data also substantiates this
argument because high positive relationship between working capital and
sales was observed.
Like inadequate working capital, excess working capital also brings many
disadvantages to the firm. It no doubt improves liquidity but reduces
profitability. Besides the cost f holding it, which may depend on the sources
of financing working capital, excess working capital causes inefficiency in
the management. It induced the managements enter into speculative
activities in securities and raw materials. Sometimes, directors exploit the
situation of excess working capital for their personal benefit by giving
liberal dividends which otherwise are not justifiable. Unwarranted expansion
may be made.
Thus, if a firm fails to plan working capital requirements properly, it may
have at one time inadequate working capital and at another time excess
working capital. The basic objective of working capital management is to
ensure that working capital is available inadequate quantity. Adequate
working capital implies providing an ample but reasonable excess of current
assets over current liabilities.
Need for Adequate Working Capital
A concern should have sufficient working capital because it is needed
for not only to keep the operating cycle going on and improve the credit
standing but also to provide against the danger from shrinkage in the
value of the current assets particularly the inventories.
An enlightened management should, therefore, maintain a right
amount of working capital on a continuous basis. Only then a proper
functioning of the business operations will be ensured. Sound financial
and statistical techniques, supported by judgment should be used to
predict the quantum of working capital needed at different time period.
The fund flow statement is derived from analysis of changes that take
place in assets and equity items, between two dates. The change in the
amount of working capital is the net effect of various transactions. A
study is desirable of the transaction that mayor may not effect the
working capital.
Chapter :Financing of Working Capital
Dehejia Study Group
Tendon Study Group
Chore Committee Group
Chapter:Financing of Working Capital
In recent years, the availability of bank credit to industry has been the
subject matter of regulation and control, the idea being to secure alignment
of bank credit with planning priorities and ensures its equitable distribution
to various sectors of the Indian economy. Five reports are of special
significance in this respect:
A. Dehejia Committee Report, 1969.
B. Tendon Committee Report, 1975.and
C. Chore Committee Report, 1979.
Dehejia Study Group
The national credit council (now defunct) constituted in October, 1968, a
study group under the chairmanship of V.T. Dehejia to examine “the extent
to which credit needs of industry and trade are likely to be inflated and how
such trends could be checked.” The submitted its report in September 1969.
Since the bulk of bank credit was short-term the group’s enquiry was
primarily concerned with the ‘Inflation’ of short-term bank credit. The term
‘Inflation’ with reference to the use of bank credit means that borrowers
have received have received credit in excess of their genuine requirements.
Major finding of the Dehejia study group
(1) Inflation of bank credit
The aforesaid group found that the bank credit during the period from 1960-
60 to 1966-67 expanded at a higher rate than the rise in industrial output.
During this period, the rise in the value of inventories with industry was so
percent while the rise in short-term bank credit was as much as 130 percent.
The ration of short-term bank borrowings to inventories went up from
40percent in 1961-62 to 52 percent in 1966-67.The group, therefore, came to
the conclusion that in the absence of specific restraints, there was a tendency
on the part of the industry generally to avail of short-term credit from banks
in excess of the amount justified by growth in production and or inventories
in value terms. However, there was no evidence of ‘excess’ bank credit to
trade or commerce.
(2) Diversion of Short term Credit
A study of 255 companies over the period 1961 to 62 to 1966-67 shoed
deterioration in their current ratio and the increase in short term liabilities
was utilized for financing the gap between long term assets and long-
term of these companies was financed by expansion in short term
liabilities including bank loans. This diversion, in the opinion of the
group, was due to three factors; namely (1) generally sluggish conditions
in the capital market since 1962;(2) the limited appraisal of application
for short term loans compared to medium or long-term loans: and (3)
stipulation of repayment schedules for medium-term loans.
(3) Present Lending System
The group believed that the present lending system also assisted certain
units for the diversion of short-term bank credit to finance non-current
investment in Indian industry. The working capital advances of banks
were granted by way of cash credit limits, which were only technically
repayable on demand. The system was found convenient in view of the
emphasis placed by banks on the security aspect. These short-term
advances were note necessity used for short-term purpose. The possibility
of heavy reliance on bank credit by industry arose mainly from the way
in which the system of cash credit, accounting for about 70 percent of
total bank credit, had been operated. The double or multiple financing of
stocks through credit facilities, too, helped excess bank credit.
Finally, the undue stretch of the period of trade credit was also
responsible for the inflation of bank credit to industry.
Suggestions
The group made the following suggestions for checking the tendency
towards the diversion of bank credit: -
i. The appraisal of credit applications should be made with reference to the
total financial situation, analysis and forecast submitted by the borrowers.
The would help in estimate of the extent to which current liabilities have
been put to non-current use and the manner in which liabilities and assets of
borrowers are likely to move over a period of time.
ii. The outstanding in the existing as well as future cash credit accounts
should be distinguished as between the hardcore and the strictly short-term
component, the latter would be the fluctuating part of the account. The group
has hard-core element in the cash credit borrowings should be segregated
and put on a formal term-loan basis, subject to a repayment schedule. The
study group has opined that the Indian banks association and the Reserve
Bank of India should make a study of industry-wise norms for minimum
inventory levels.
Iii As regard the problem of double or multiple financing, the group has
urged hat a customer should generally be required to confine has dealing to
on bank only, the group has recommended the adoption of a ‘consortium’
arrangement.
Iv With a view to preventing undue elongation of the period of trade credit
and tapping up the resources of banks for unproductive purpose, the group is
of the opinion that the period of trade credit should not exceed 60 days
normally and in special circumstances 90 days. The undue delay in the
settlement of bills by government departments could be discouraged by
stipulating that the departments should pay interest on bills if they are not
paid within 90 days of their receipt.
V To check the extension of extra bank credit, the group has pt fourth a
suggestion that a levy of a commitment charge on unutilized limits, coupled
with a minimum interest charge if necessary, could be considered. From the
point of view of administrative convenience, at the initial stages, limits
sanctioned up to Rs.10 lacks might be exempted. The commitment levy
might be progressively raised with the size of unutilized limits.
Vi The group has emphasized greater recourse to bill finance; such a
practice would not only impose financial discipline on the purchaser but also
help the supplier or producer to plan his financial commitments in a realistic
manner. It would also help the development of genuine bill market in India.
The group for consideration has stressed a reduction in stamp duty on usance
bills by the government.
Tendon Study Group
The reserve bank of India set up a study group to frame guidelines
follow-up bank credit in July, 1974 under the chairmanship of Shri
Prakash Tondon , the chairman of Punjab national bank. The terms of
reference to the group were to:
(a) Suggest guidelines for commercial banks to follow up and supervise
credit from the point of view of ensuring proper end-use of funds and
keeping a watch on the safety of the advances and to suggest, the type of
operational data and other information that may be obtained by banks
periodically from such borrowers and by the reserve bank of India from
the lending banks;
(b) Make recommendations for obtaining periodical forecasts from
borrowers of :(a) business/production plan;(b) credit needs;
(C) Make a suggestion from for prescribing inventory norms for different
industries both in the private and public sectors and indicate the broad
criteria for deviating from these norms.
(d) Suggest criteria regarding satisfactory capital structure and sound
financial basis in relation to borrowings
(e) Make recommendations regarding the sources for financing the
minimum working capital requirement.
(f) Make recommendations as to whether the existing pattern of
financing working capital requirement by cash credit/overdraft system
etc. requires to be modified ,if so to suggest suitable modifications.
(g) Make recommendations of any other related matter, as the group may
consider necessary to the subject of enquiry or any other allied matter, which
may be specifically referred to it by the reserve bank of India.
Major findings and suggestion of the Tendons Group
The study Group submitted its report to RBI in August 1975. A resume
of the group’s main observation and recommendations is given below.
Cash Credit System and Financial Indiscipline
The problem of potential imbalance in demand for and supply of funds is
accentuated by the manner in which banks extend credit under the
present cash credit system of lending. Under this system, the level of
advances in a bank is determined not by how much a banker can lend at a
particular point of time but by a borrower’s decision to borrow at the
time. This makes credit planning difficult in banks. Also, cash credit
advances are repayable on demand only in name. To the extent that out
standings in the cash credit accounts never fall below a certain level
during the course of a year, there is an element of what is called a ‘hard-
core’ borrowing which is in reality a quasi-permanent lock –up of banks
funds in the borrowers business. Under the new system, the borrower
would plan his credit needs and the banker also would be able to plan,
having known the borrower’s credit requirements.
Norms for Inventories and accounts receivables
Inventory and receivables comprise the bulk of the current assets. There
is no uniformity in approach among banks in assessing working capital
requirements, especially with regard to inventories, if bank credit is to be
viewed as a tool of resource allocation in the economy, one cannot get
away from the problem of defining reasonable levels of inventories
(including safety stocks) and receivables in each industry; hence, the
need for norms for these current assets. Norms have been suggested for
15 major industries, taking into account, inter alias, company finance
studies made by the reserve bank, process period in different industries,
discussions with industry experts and feed-back received on the interim
report.
The norms proposed represent the maximum levels for holding inventory
and receivables in each industry. If, however, a borrower has managed
with less in the past, he should continue to do so. Norms cannot be
absolute or rigid. From norms may be visualized under certain
circumstances, e.g., bunched receipt of raw materials, power cuts, strikes,
transport delays, etc. All credit limits, no matter whether enhancement
there in is sought for or not, should be considered in the light of the
norms and where the levels of inventory and receivables are excessive,
those should be reduced, along with dues to the bank and/or other
creditors.
Working Capital Gap and Bank Credit
The working capital gap, viz., a borrower’s requirement of finance to
carry current assets (based on norms) other than those financed out of his
other current liabilities, could be bridged partly his owned funds and
long–term borrowings and partly by bank borrowings. The maximum
permissible level of bank borrowings could be worked out in three ways.
In the first method, the borrower has to contribute a minimum of 25
percent of the working capital gap from long-term funds, i.e., owned
funds and term borrowings; this will give a minimum current ratio of
1:1.In the second method, the borrower is to provide, a minimum of 25
percent of total current ratio of at least1.3:1. In the third method, the
borrower’s contribution from long-term funds is to the extent of the
entire core current assets as defined, plus a minimum of 25 percent of the
balance current assets, thus strengthening the current ratio further.
The classification of current assets and current liabilities for computing
the permissible level of bank finance should be made with the first
method, covering all borrowers by this method within a period of about
one year, and the ideal of the third method may be reached in stages. The
aim should be to move forward and the borrowers in the third or the
second category should not revert to the second or the first category
respectively by increasing their dependence on bank borrowings.
Style of lending
The annual credit limit may be bifurcated into a loan, which would
comprise the minimum level of borrowing throughout the year, and a
demand cash credit, which would take care of the fluctuation
requirements cash credit, which would take care of the fluctuation
requirements, both to be reviewed annually. There should, however, be
no rigidity in the matter of bifurcation of the overall credit limit between
loan and cash credit. In the cash of industries with a very high degree of
seasonality, assessment of bank finance may have to be done on the basis
of monthly cash budgets.
The demand cash credit should be charged at slightly higher interest rate
than the loan components. This approach will give the borrower an
incentive for good planning. In order to ensure that customers do not use
the new cash credit facility in an unplanned manner, the financing should
be placed on a quarterly reporting system for operational purpose, on the
standard form.
Bill Limits
A part from loan and cash credit, a part of the total credit requirement,
with the overall eligibility, could also be provided by way of bill limits to
finance a seller’s receivables. It is desirable that as far as possible,
receivable should be financed by way of bills, rather than cash credit
against bank debts.
As regards the question whether purchased may be financed by way of
cash credit of bills, each bank may take its own decision in consultation
with the borrower, keeping in view the size of his operations, the
individual transaction and administrative set-up obtaining in the bank.
Coverage of Proposed System
The proposed system of lending and style of credit may be extent to all
borrowers having credit limits in excess of Rs.10 lacks from the banking
system, while the information system may be introduced, to start with, in
respect of borrows with limits of Rs. 1 crore and above from the entire
banking system and then extended progressively to others.
Information System
The mechanics of lending suggested cove examination of the borrower’s
total operation plan, also his past and current financial position. The
borrower should, therefore, furnish to the banker an operating statement
and funds flow statement for the whole year, i.e. the next year and the
projected balance sheet as at the end of the year, along with application
for advance or renewal for the purpose of fixation of overall credit limit.
Follow up-system
A bank has to follow up and supervise the use of credit to verify, first,
whether the assumptions of lending in regard to the borrower’s operation
continue to hold good; and, whether the end –use is according to the
purpose for which the credit was given.
From the quarterly forms, the banker will verify whether the operational
results conform to earlier expectations and whether there is any
divergence regarded as red signals; however, variance up to 10 percent
may be treated as normal.
In addition to the quarterly data, the larger borrowers should submit a
half-yearly Performa balance sheet along with a profit and loss account,
with two months of the end of the half –year.
Managerial Competence
Managerial Competence is an important factor in the efficiency of
operations, reflected in profitability and working capital and financial
management. A banker should keep in mind that appraisal of essential,
particularly because the new emphasis is laid on viability particularly and
development rather than on security alone.
Bank Credit for Trade
While financing trade, banks should keep in view, inter alias, the extent
of owned funds of the borrower in relation to the credit limits granted, the
annual turnover, possible diversion to other units or uses and amounts
being ploughed back from profits into the business. They should avoid
financing of goods, which have already been obtained on credit.
Norms for Capital Structure
In discussing the norms for capital structure, the relationship of long-term
debt to enquiry and have total outside liabilities to equity have to be kept
in mind. Where a company’s long-term debt/net worth and outside
liabilities/net worth ratios are worse than the medians, the bake should try
to persuade the borrower to strengthen his equity base as early as
possible, The would be a comparatively practical approach.
Chore Committee Group
The changeover recommended should be affected with a minimum of in
convenience to the banker and the customer. RBI constituted in March,
1979 a six members working group under the chairmanship of K.B.
Chore, Additional Chief Officer, Department of Banking Operations and
Development, RBI, to review mainly the systemic cash credit and credit
management policy for banks.
The term of reference were:
To review the operation of the cash credit system in recent ears,
particularly with reference to the gap between sanctioned credit limits
and the extent of their utilization;
In the light of the review, to suggest:
i. Modification in the system with a view to making the system more
amenable to rational management of funds by commercial banks, and
ii. Alternative type of credit facilities, which would ensure greater credit
discipline and also enable banks to relate credit limits to make increase in
output or other productive activities; and
iii. to make recommendations on any other related matters as the group
may consider germane to the subject.
The group submitted its interim report in the middle of May, 1979 and
the final report by the end of August, 1979.
Recommendations of the Group
The highlights of the Chore Committee Report are as follows:
1. Lending System
The existing system of three types of lending, viz., cash credit, loans, and
bills should be retained but whenever loans and bills should supplement
possible, the use of cash credit. However, there should be security of the
operation of the cash credit accounts by reviewing large working capital
limits at least once in a year.
The discipline relation to the submission of quarterly statements from the
borrowers under the information system is also to be strictly enforced in
respect of borrowers with working capital limits of R. 50 Lacks and over
under the baking system.
2. Withdraw of Bifurcation of Credit Limits
Bifurcation of cash credit limits as recommended by Tondon committee,
into a demand loan portion and fluctuating cash credit component, and to
maintain a differential interest rate between the 2 components, should be
withdrawn. Such bifurcation might not serve the purpose of better credit
planning by narrowing the gap between sectioned limits and the extent of
utilization thereof. In cases where cash credit accounts had already been
bifurcation, step should be taken to abolish the differential interest rates
with immediate effect.
3. Enhancement of Borrower’s Contribution
In order to insure that the borrowers enhance their contributions to
working capital and to improve their current ratio, it is necessary to
bring them under the second method of lending recommended by the
Tondon Committee which would give a minimum current ratio of
1.33:1.As many of the borrows might not immediately be 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, comparatively at a
high rate of interest .This procedure should be made compulsory for
all borrowers (except sick units) having aggregate working capital
limits of Rs. 10 Lacks and over.
4 Encouragement for bill finance
Advances against book debts should be converted into bills wherever
possible and at least 50 percent of the cash credit of cash credit limit
utilized for financing purchase of raw material inventory should also
be changed into this bill system.
5.Separate Limits for Peak Level and Normal Non Peak Level
periods
On the basis of utilization of credit limits by borrower in the past, the
bank should fix separate limits for normal non-peak level, as also far
‘peak level’, credit requirements indicating also the periods during
which the separate limits would be extended to all borrowers having
working capital limits of Rs.10 lacks and above.
6. Adhoc or temporary limits
Borrower should be discouraged from frequently seeking adhoc or
temporary limits in excess of sanctioned limits to meet unforeseen
contingencies. Additional interest of 1 per cent per annum should
normally be charged for such limits.
7.Drawl of Funds to be Regulated Through Quarterly Statements
Before the commencement of a cash quarter, the borrower should be
directed to indicate in advance his quarterly requirement of funds within
the sanctioned limits. Drawing less than or in excess of the operation
limit so fixed, with a tolerance of 10 per cent either way, should be
deemed to be an irregularity and appropriate corrective action should be
taken.
Other recommendation made by the Chore Committee and approved by
RBI are:
(a)Requests for relaxation of inventory norms and for adhoc
increases in limits should be subjected to close scrutiny by banks
and agreed to only in exceptional circumstances; steps to correct
the position should be taken in the shortest possible time.
(b)The bank should devise their own checklist in the light of
the instruction issued by the reserve bank for the scrutiny of date at
the operational level.
(c)Delays on the part of the banks in sanctioning credit
limits could be reduced in the cases where the borrowers co-
operate in giving the necessary information about their past
performance and future projections well in time.
(d)As one of the reasons for the slow growth of the bill
system is the stamp duty on unsance bills, the matter may have to
be taken up with state governments.
(e)Banks should review the system of financing book debts
through cash credit and insists on the conversion of such cash
credit limits into bill limits.
(F)Banks should insist on the public sector undertakings/
large borrowers to maintain control accounts in their books to give
precise data regarding their dues to the small units and furnish such
data regarding their dues to the small units and furnish such data in
their quarterly information system. This would enable the banks to
take suitable measures for ensuring payments of the dues to small
units within a definite period by stipulating, if necessary, that a
portion of limits for bills acceptance (drawn bills) should be
utilized only for drawer bills for small scale units.
(g)To encourage the bill system of financing and to facilitate
call money operation, an autonomous financial institution on the
set up.
(h)A detailed study regarding the relationship between
production and quantum of credit at the industry level should be
made
(i)To be effective credit control measures will have to be
immediately communicated to the operational level and followed
up. There should be a ‘cell’ attached to the chairman’s office at the
central office of each bank to attend to such matters.
(j)Banks should pay particular attentation to monitoring of
key branches and critical accounts.
(k)The communication channels and procedures with in the
banking system should be toned up so as to ensure that minimum
time is taken for collection of instruments.
(l)Although bank usually object to their borrowers dealing
with other banks with out their consent, some of the borrowers
sites maintain current accounts and arrange bills facilities with
other banks, thus vitiating the credit discipline. The reserve bank
should issue suitable instruction in this connection.
Financing of working capital requirements-
A prudent financial manager is always interested to obtain the current
amount of the short-term funds at the right time and the best possible
favorable terms. To take the right sources it is very necessary for him to
have a thorough group of the internal structure of the firm, market for
short term funds and basic policies of the company regarding the aims of
profit maximization needs for liquidity and risk assumption. The extent
of probable variations in the level of operations and their impact on the
various assets, also choice at proper sources. In exercising the choice the
following factors are to be given due weight age.
a) Cost of credit: -
That source of working capital would be selected, which gives a lower
cost per unit of funds. The interest charge alone however does not
measure these cost .A proper consideration like price concession secured
by borrowing to pay cash and the cost of maintain credit relationship etc.
is also required.
b) Dependability: -
An enterprise having a dependable source of credit can afford not to
be carrying with large amount of credit as it can raise the credit when
needed.
This leads to economy in the use of credit and so also in its costs.
A. Flexibility: If the credit are rigid and curtail the freedom, then that
source will not be tapped. The source and method of financing depend
on the nature and classification of the working capital.
c) Flexibility: -
As for as practicable and possible management will like to have
freedom of action. If there is the terms of credit are rigid and curtail the
freedom then that source will not be topped.
Sources of finance of working capital:-
The sources of finance for working capital may be classified broadly into
there categories as follow: -
1. Financing of long term working capital
Normally this will cover the initial working capital and the
regular working capital requirements. A definite volume of current
assets is always needed by the business to carry on its operations. The
amount invested in them is more or less blocked though these assets
change in the form and substance in the process of circulation. This
capital can be conveniently financed by the following sources:-
I Owner’s equity
Ii long-term borrowing
Iii fixed assets reduction.
2. Financing of short term working capital: -
This category covers the funds to be obtained for financing day-to-day
business requirements. Normally the duration of such funds does not extend
beyond a year. The short term working capital can be obtained as below:-
1 Trade creditors – sundry creditors, bills payable
2 Loans form – directors, officers, friends and other enterprises.
3 Advance – on contracts.
4 Factoring
5 Procuring bank assistance.
6 Finance discount and commercial credit companies.
Financing of working capital of Steel Authority of India limited
From long term and short term sources during the period of 2002-03 to
2006-07
Particulars 2002-03 2003-04 2004-05 2005-06 2006-07
Working capital
Short term sources
Percentage (%)
Long term sources
Percentage (%)
Steel Authority of India limited finance their working capital mainly
through external sources as like borrowed funds, these includes loans from
bankers, loans from institutes .For short term finance deposit with
government and public bodies and provisions.
This table shows that in1999-2000 working capital financed by short-
term sources 27.73 and 72.27 financed by long-term sources. From period
1999-2000 to 2003-04 increase in short term, finance. In 2003-04 66.38%
working capital was financed by short-term sources. This show Rajasthan
State Ganganagar Sugar Mills financed their working capital mainly through
short-term sources. This is aggressive approach for financing of working
capital. Under this policy the mill financed a part of is permanent current
assets with short term financing. Increasing part of short term financing may
be risky for mill.
Chapter-
Liquidity Analysis
Meaning and Definition of Liquidity:
Liquidity refers to a firm's continuous ability to meet its short term
maturing obligations. Since cash is used to meet a firm's
obligation, emphasis is given on holding large investment in
current assets which include cash and near cash items like
receivables, short term securities etc. Thus, holding relatively
large investment in current assets will result in no difficulty in
paying the claims of the creditors and others.
Liquidity management, involves the amount of investment in
this group of assets to meet short term maturing obligation
creditors and others. From the point of financing, normally a major
portion of the fund required for financing current assets is obtained
from long term sources, equity and for debt, while the rest is met
from short term source. It goes without saying that if the maturing
obligation are met continuously as and when they become due,
creditors and other will have a feeling of confidence in the
financial strength of the firm and this will sustain the credit
reputation of the firm and an ongoing firm will accordingly face to
difficulty in holding a particular level of current assets. But failure
to meet such obligations on a continuous basis will affect the
reputation, and hence credit worthiness of a firm which will, in
turn, make it more difficult to continue to finance the level of
current assets from short term sources.
Measurement of Liquidity
Generally the following rations are very useful in
ascertaining the short term debt paying ability (liquidity) of a
concern.
1) Current Ratio
2) Quick Ratio
3) Working Capital Turnover Ratio
1) Current Ratio:
Current Ratio, also called working capital ratio, is the most widely
used for all analytical devices based on the balance sheet.
The current ratio is a ratio of the firm’s total current assets to its total
current liabilities; current assets include cash and those assets, which can
be converted into cash with in a year such as marketable securities,
debtors, and stock. Bills receivables, work-in-progress and others short
term investments. Prepaid expenses should also be included in current
assets as they represent the payments that will have not to be made by
firm in the future. All obligations maturing within a year are included in
current liabilities. Thus, a current liabilities includes creditors, bills
payable, accrued expenses, bank overdraft and income tax.
The current ratio is calculated by dividing current assets by current
liabilities.
Current Assets
Current ratio=--------------------------------
Current Liabilities
Current asset ratio of Steel Authority of India limited from 2002-
03 to 2006-07
Table No.1
Rs in Crores
Year Current Assets Current
Liabilities
Ratio
2002-03 6431.23 4475.32 1.437
2003-04 6734.74 4406 1.528
2004-05 12403.44 4778.92 2.595
2005-06 14349.91 5191.70 2.764
2006-07 18728.61 5398.20 3.469
Sources: Annual Report of Steel Authority of India limited
00.5
11.5
2
2.53
3.5
Ratio
2002-03 2003-04 2004-05 2005-06 2006-07
Year
Current Ratio
Ratio
Interpretation
The Current ratio is a measure of the firm’s short-term solvency. A
low ratio is an indicator that a firm may not be able to pay its future bills
on time, particularly if condition changes, causing slowdown in cash
corrections. A high ratio may indicate an excessive amount of current
assets and management’s failure to utilize the firm’s resources properly.
To determine whether the ratio is high, low or just right, the analyst
should consider such factors as the firm past history goals and the current
ratios of similar companies. As a general rule, a 2/1 ratio is considered
acceptable for most firms.
This rule is based on the logic that a worst situation, even if the value
of current assets becomes half. The firm will be able to meet its
obligations liabilities are not subject to any fall in value, they have to be
paid. But current assets can decline in value.
However, an arbitrary standard of 2 to 1 current ratio cannot be
blindly followed. Firms with less than 2 to 1 current ratio may be doing
well, while firms with 2 to 1 even higher current ratios may be finding
difficulties in paying their bills. This is so because the current ratio is a
test of quantity, not quality. The current ratio represents a margin of
safety i.e. a cushion of protection for creditors. Hence, the current ratio is
a ‘crude and quick’ measure of the firm’s liquidity.
Interpretation of current Ratio Steel Authority of India limited
Steel Authority of India limited has current ratios 1.4 in 2002-03, 1.5 in
2003-04. After these year current ratio of sail is always more than 2
which shows a strong liquidity position & short term solvency position of
SAIL.
2) Liquid or Quick Ratio
The word liquidly means conversion assets into cash during the
normal course of business and to have a regular uninterrupted flow of
cash to meet outside current liabilities or current obligations as and
when due. More ever, business also will have to ensure money for
day-to-day operation.
The quick or acid test ratio is a more stringent measure of the
firm’s liquidity. This ratio establishes a relationship between quick or
liquid assets and current liabilities. An asset is liquid, if it can be
converted into cash immediately or reasonably soon without a loss of
value Cash is the most liquid assets. The other assets, which are
considered to be relatively liquid and included in quick assets, are
debtors and bills receivables and marketable securities. Stock and
prepaid expenses are considered to be less liquid. Inventories
normally require some time for realizing into cash. The value of the
stock also has a tendency of fluctuate and there is also uncertainty as
to whether or not the inventories can be said. Prepaid expanses should
also be excluded because they cannot be converted into cash. Thus,
quick assets include cash debtors, bills receivables and marketable
securities.
The quick ratio is so hammed because is shows to ability of a
firm to pay its obligations without relying on the sale and collection of
its inventories. This ratio is also called, liquidity Ratio, Acid Test
Ratio and Quick current ratio or Near Money Ratio.
The quick ratio is fund out by dividing the total of the quick
assets by total current liabilities.
Quick liquid asset
Quick ratio=----------------------------------------------
Current liabilities
Or
Cash + Marketable securities + account receivable
Quick ratio=-----------------------------------------------------------------------
Current liabilities Quick liabilities
Quick ratio of Steel Authority of India limited from 2002-03 to
2006-07
Table No.2
Rs. In Crores
Year Quick Assets Current Ratio
Liabilities
2002-03 2686.86 4475.32 0.60
2003-04 3653.30 4406 0.83
2004-05 8182.75 4778.92 1.71
2005-06 8139.85 5191.70 1.57
2006-07 12077.14 5398.20 2.24
Sources: Annual Report of Steel Authority of India limited
0
0.5
1
1.5
2
2.5
Ratio
2002-03 2003-04 2004-05 2005-06 2006-07
Year
Quick ratio
Ratio
Interpretation
As a guideline, a quick ratio of 1/1 is considered to represent
satisfactory current financial condition. A higher ratio may have several
meanings. It could indicate that the firm has excessive cash or
receivables, both signs of tax, management. It could indicate that the firm
too cautiously ensuring sufficient liquidity. A low ratio usually an in
diction of possible difficulties is the prompt payment of future bills.
A quick ratio of 1/1 or more does not necessarily imply sound
liquidity position. Similarly, low quick ratio does not necessarily imply
bad liquidity position. It should be remembered that all the book debts
may not be liquid and cash may be immediately needed to pay operating
expenses. Ti should also be noted that inventories are not absolutely non-
liquid. To a measurable extent, inventories are available to meet current
obligation. Thus a company with a high value of quick ratio can flounder
if it has slow paying doubtful and stretched out in age receivables (book-
debts). One the other hand, a company with a low value of quick ratio
may really be prospering and paying its current obligation in time, if it
has been managing its inventories very efficiently with a continuous
stability. Nevertheless, the quick ratio remains important index of the
firm’s liquidity. To get an idea regarding the firm’s relative current
financial condition, its current ratio and quick ratio should be compared
with the industry overages.
Interpretation of Quick ratio of Steel Authority of India limited
Steel Authority of India limited has quick ratio 0.60 in 2002-03, 0.83
in 2003-04 which are less than 1/1 guideline. After this year quick ratio is
more than 1/1 guideline on next years of study which indicates that if
creditors press of immediate payment the company has enough liquid
resources to pay them. Quick ratio of the company shows best immediate
liquid position.
3)Working capital turnover Ratio
This ratio is a measure of the efficiency of the employment of the
working capital normally for handling any desirable amount of sales certain
proportion of working capital funds will be indicate to handle that volumes
of sales. In order to affect the desired amount of sales in such a situation
current liabilities will have to be incurred. This may lead to defalcation of
the current ratio. The aim should be to set up an idle ratio showing an
appropriate relationship between the amounts of working capital and sales.
The ratio is calculate by dividing the figure of sales by working capital.
Sales
Working capital turn over ratio=-------------------------------------
Net working capital
Working capital turnover ratio of Steel Authority of India limited
from 2002-03 to 2006-07
Table No.3
(Rs. In Crores)
Year Sales Working capital Ratio in times
2002-03 19207 1955.91 9.82
2003-04 24178 2328.74 10.38
2004-05 31800 7624.52 4.17
2005-06 32280 9158.21 3.53
2006-07 39188 13330.41 2.94
Sources: Annual Report of Steel Authority of India limited
0
2
4
6
8
10
12
Ratio in times
2002-03 2003-04 2004-05 2005-06 2006-07
Year
Working turnover ratio
Ratio in times
Interpretation
This ratio indicates whether or not working capital has been effectively
used in making sales. A high WCT ratio implies a low net working capital in
relation to the sales volume and therefore implies over trading by the firm in
relation to its net working capital this may be risky proposition for the firm.
Interpretation of Ratio of Steel Authority of India limited
Working capital of Steel Authority of India limited turnover ratio is very
high in first two years which show the net working capital in relation to the
sales. In last three years of study company has low working capital ratio
which shows the requirement of effective utilization of working capital.
Meaning and Definition of Inventory Management
Inventory management is concerned with the determination
of the optimal level of investment for each component of
inventory and the inventory as a whole, the efficient use of the
components and the operation of an effective control and review
mechanism.
Inventory management is the vital area of management
covering the sum total of activities needed for the acquisition,
storage an use of materials. It is a technique of controlling the
purchase, use and transformation of material in an optimal
manner. The phrase "optimal' signifies that the productively is not
sacrificed in controlling the volume of inventory. It signifies
minimum waste and the cost of holding inventory. The
management of inventory requires careful planning so that both
the excess and the scarcity of inventory in relation to the
operational requirement of an undertaking may be avoided.
Therefore, it is essential to have a sufficient level of investment in
inventories.
L.R. Howard observes that, "The proper management and
control of inventory not only solves the acute problem of liquidity
but also increases the annual profits and causes substantial
reduction in the working capital of a firm."1
Objectives of Inventory Management
The primary objectives of inventory management are (i) to
minimize the possibilities of disruption in the production schedule
of a firm for want of raw materials, stores and spares and (ii) to
keep down capital investment in inventories. Although, it is
essential to have necessary inventories, excessive inventory is an
idle resource of a concern. The concern should always avoid these
situations. The investment in inventories should be just sufficient
at the optimum level. The major dangers of excessive inventories
are, (a) the unnecessary tie up of the firm's funds and loss of profit,
(b) excessive carrying cost and (c) the risk of liquidity. The
excessive level of inventories consumes the funds of the concern,
which cannot be used for any other purpose and thus involves an
opportunity cost. The carrying costs, such as the cost of storage,
handling insurance, recording and inspection, also increase in
proportion to the volume of inventory. These costs will impair the
concerns profitability further. on the other hand, a law level opf
inventories may result in frequent interruption in the production
schedule resulting in under utilization of capacity and lower sales.
The aim of inventory management, thus should be to avoid
excessive inventory and inadequate inventory and to maintain
adequate inventory for smooth running of the business operations,
Efforts should be made to place orders at the right time with the
right source to purchase the right quantity at the right price and
quality. An effective inventory management should:
Ensure a continuous supply of materials to production
department facilitating uninterrupted production.
Maintain sufficient stock of raw materials in the period of
short supply and anticipate price changes.
Minimize the carrying costs and time.
Maintain sufficient stock of finished goods for smooth sales
operations; and
Control investment in inventories and keep it at the optimum
level.
Inventory Control
Inventory control refers to a system which ensures the supply
of required quantity and quality of inventory at the required time
and at the same time prevent unnecessary investment in
inventories. According to P.K. Ghosh and G.S. Gupta, "Inventory
control is concerned with the acquisition, storage, handling and
use of inventories so as to ensure the availability of inventory
whenever needed, providing adequate cushion for contingencies,
deriving maximum economy and minimizing wastage and losses,"
Control of inventories is one of the most vital phases of
material management. Reducing inventories without impairing
operating efficiency frees working capital that can be effectively
employed elsewhere. Inventory control can make or break a
company. This explains the usual saying that "inventories" are the
"graveyard" of a business.
Designing a sound inventory control system is in a large
measure a balancing operation. It is the focal point of many
seemingly conflicting interests and considerations both short range
and long range.
The aim of a sound inventory control system is to secure the
bet balance between "too much" and "too little". Too much
inventory carries financial risks and to little reacts aversely on
continuity of production and competitive dynamics. the real
problem is not the reduction of the size of the inventory as a whole
but to secure a scientifically determined balance between several
that make up the inventory.
The efficiency of inventory control affects the flexibility of
the firm. Inefficient procedures may result in an unbalanced
inventory, some items out of stock, other overstocked,
necessitating excessive investment. These inefficiencies ultimately
will have an adverse effect upon profits. Turning the situation
around, differences in the efficiency inventory control for a given
level of flexibility affect the level of investment required in
inventories. The less efficient is the inventory control, the greater
is the investment required. Excessive investment in inventories
increases costs and reduces profits. Thus, the effects of inventory
control of flexibility and on level of investment required in
inventories represent two sides of the same coin.
Control of inventory is exercised by introducing various
measures of inventory control, such as. ABC analysis, fixation of
norms of inventory holdings and reorder point and a close watch
on the movements of inventories.
A. ABC analysis of inventories
B. Fixiation of norms of Inventory
Holdings : (i) Determination of Minimum level of
Inventory.
(ii) Determination of Maximum level of inventory.
C. Ordering system of inventories
(a) Economic order Quantity
(b) Periodic Reordering System
(c) Single Order and Schedule part Delivers system.
Evaluation of Inventory Management
All efforts of company management to control inventory
should aim at keeping various components of inventory at
economical levels and in proper proportions. For a textile
company, work in process is absolutely necessary whereas other
components, viz., raw materials and finished goods only provide
flexibility to its operations. Inventory may be divided into the
following to its operations. Inventory may be divided into the
following categories on the basis of the functions it performs :
Raw materials
Work in process
Finished goods
Stores and spares
Some of the above components are prone to a high degree of
control whereas other may not be controlled easily. The stock of
raw materials and stores and spears can be reduced to a level
where it does not hamper the production process. The amount of
work in process is, generally, determined by the length of the
production cycle. The market forces and the nature of industry
determine the stock of finished goods.
Some of the above components of inventory are fast moving
while others are moving slowly. If unduly large funds are blocked
is slow moving segments, it will not only place a financial burden
but also affect adversely the liquidity of the working capital of a
textile company. therefore, for efficient control of inventory,
company management must try to allocate limited funds to each
component of inventory in an optimal manner.
Size of Inventory :
Inventory to total current asset ratio
Year Inventory Total current
asset
Ratio %
2002-03 3744.37 6431.23 58.22
2003-04 3081.44 6734.74 45.74
2004-05 4220.69 12403.44 34.03
2005-06 6210.06 14349.91 43.28
2006-07 6651.47 18728.61 35.52
Sources: Annual Report of Steel Authority of India limited
Show the size of inventory and percentage of inventory to total
current assets of steel authority of India Limited during the period
under study. Evaluation of inventory management has further
been divided into two parts, the first part discuss the size of
inventory while the second part inventory turnover ratio.
Inventory Turnover Ratio : Inventory turnover ratio
usually establishes relationship between the cost of goods
sold during a given period and the average amount of
inventory. According to Allen R. Drabin and Harold
Bierman Jr. "It is one method of reviewing performance and
controlling inventories periodically to check the inventory
turnover of each type of raw materials, supply and finished
goods." Turnover of inventory directly affects the
profitability of a concern. The higher the turnover, the larger
the profits of the concern. Each turnover added to the volume
of profits.
In the words of James C. Van Horne, "Inventory
turnover ratio acts as an indicator of the liquidity of the
inventory." In other words, the ratio helps in determining the
liquidity of a concern in as much as it gives the rate at which
inventories are converted into sales and then into cash.
Cost of goods sold
Inventory turnover=--------------------------------------------------
Inventory or Average inventory
Or
Sales
Inventory turnover=---------------------------------------------
Inventory or Average inventory
Inventory turnover ratio of Steel Authority of India limited from
2002-03 to 2006-07
Table No.1
(Rs. In Crores)
Year Sales Average
inventory
Raito in times
2002-03 19207 3893.1 4.93
2003-04 24178 3412.91 7.084
2004-05 31800 3651.07 8.71
2005-06 32280 5215.38 6.2
2006-07 39188 6430.77 6.094
Sources: Annual Report of Steel Authority of India limited
0
2
4
6
8
10
Ratio in times
2002-03 2003-04 2004-05 2005-06 2006-07
Year
Inventory turnover ratio
Raito in times
Interpretation:
The inventory turnover shows how rapidly the inventory is turning into
receivable through sales. Generally, a high inventory turnover indicates
inactive stock. And a low inventory turnover implies insufficient inventory
signaling a risk of stock outs. Thus a company must have a sufficient
turnover according to business nature and sales policy.
Interpretation of the Ratio of Steel Authority of India limited
The inventory turnover of the company was 4.93 in 2002-03 and 8.71 in
2004-05 it decreased up to 6.2 in 2005-06. Which shows that inventory
turnover ratio of the firm is not constant. It is better for the company to draw
a range of inventory ratio and try to maintain it.
5
Management of Receivables
Meaning of Management of Receivables
"Receivables Management" also termed as, "credit
management in business enterprises, has gained significance on
account of its positive contribution towards increasing profitability
through increased turnover. Its aim in primarily to seek a rational
balance between the twin objectives of liquidity and profitability
receivables management in an enterprise involve decision relating
to four-policy variables; credit standards, credit period, discounts
given for early payment and the collection policy as measured by
its tightness or laxity. Taken together these four policy variables
determine the magnitude of the investment in account receivable
and the return thereon. Investment in accounts receivables at any
point of time can be determined by the volume of credit sales and
the receivable collection period, which are in turn a function of the
quality of the customers to whom credit is granted. An enterprise
can follow a policy of liberal or restrictive credit granting by
loosening or tightening the credit terms and collection procedures,
each influencing the credit terms and collection producers, each
influencing the size of investment in receivables and the expected
return on that investment, since receivable management comprises
credit and collection policies, in order to maximize the profit
arising from these polices an enterprise should vary them in such a
manner as to achieve the best combination of credit standards,
credit period, cash discount policy and the level of collection
expenditure.
Management of accounts receivables may, therefore, be
defined as the process of making decisions relating to the
investment of funds in the assets which will result in maximizing
the overall return on the investment of the firm
Objective of Receivables Management
The purpose of receivables management is not to maximize
the risk of bad debts. If the objectives were to maximize sales,
then the concern would sell on credit to all on the contrary, if
minimization of bad debts risk were then aim, then the concern
would not sell on credit to any one. In fact, the business enterprise
should manage its credit in such a way that sales are expended to
an extent to which risk remains within an acceptable limit. In
brief, the objectives of receivables management are as follows :
To obtain the optimum (not maximum) volume of sales;
To control the cost of credit and keep it at the minimum;
To maintain the optimum level of investment in receivables;
and
To keep down the average collection period.
The purpose of receivable management is not sales
maximization but an efficient and effective management of
receivables does help to expand sales and can prove to be an
effective tool of marketing. It helps to retain old customers and
win new customers and win new customers. Well administered
receivable management means profitable credit accounts. The
objective of receivable management is, "to promote sale and profit
until that point is reached where the return on investment in future
finding of receivables is less than the cost of funds raised to
finance that additional credit (i.e., cost of capital)"
Performance Evaluation of receivables Management
Receivables management, to be successful must ensure
comparatively slow growth in receivables as against sales,
satisfactory collection period, minimum bad debt losses, and
effective use of the capital invested. For the attainment of these
objectives, concerns formulate sound credit and collection
policies. To what extent concerns have been successful in their
efforts can be judged from their actual performance. The
performance of receivable management in SAIL has been
evaluated by analyzing the size of receivable, Receivable,
Turnover Ratio and Average collection period.
(A) Size of Receivables
The size of receivables is closely linked with a business
enterprise’s trade terms, which include the period of
credit, the rate of discount and collection policies etc. But
the most important factor in determining the size of
receivables is the level of an enterprise’s credit sales.
With an increase in the size of sales, it may decide to
bring about a proportionate increase in the magnitude of
receivables.
The size of receivables (receivables include sundry
debtors and loan advances) in steel authority of India
Limited has been presented in table.
i) The Debtors turnover ratio is calculated as under:
Sales
Debtors turnover=-----------------------------------------------------
Average accounts receivable
Debtors turnover ratio of Steel Authority of India limited from
2002-03 to 2006-07
Table No. 2
(Rs. In Crores)
Year Sales Average
Receivable
Ratio
2002-03 19207 1524.75 12.6
2003-04 24178 1605.025 15.1
2004-05 31800 1729.205 18.4
2005-06 32280 1895.09 17.03
2006-07 39188 2098.24 18.7
Sources: Annual Report of Steel Authority of India limited
0
5
10
15
20
Ratio in times
2002-03 2003-04 2004-05 2005-06 2006-07
Year
Debtors turnover ratio
Ratio
Interpretation
Debtors turnover ratio indicates the efficiency of the staff entrusted
with collection of book debts. The higher the ratio, the better it is, since it
would indicates debts are being collected more promptly by, for
measuring the efficiency, it is necessary to set up a standard figure; a
ratio lower than the standard will indicate inefficiency.
Interpretation of ratio of Report Steel Authority of India limited
In case of Steel Authority of India limited debtors turnover ratio is
increasing. In 2002-03 12.6 and 8.71 in 2004-05 it decreased up to 17.03
in 2005-06 after that it was increased in next years but these ratio not
good such a policy could limit the profits by denying the credit to capital
to potential customer who may then go elsewhere.
ii) Average Collection Period
The ratio indicates the extant to which the debts have been collected in
time. It gives the average debt collection period. The ratio is very useful to
the lenders because it explains to them whether their borrowers are
collecting money within reasonable time. An increase in the period will
result in greater blockage of funds in debtors the ratio may be calculated as
under;
Total or average receivable x No. of days in a year
Average collection period=---------------------------------------------------------
Sales
Average collection period of Steel Authority of India limited from
2002-03 to 2006-07
Table No.3
(Rs. In Crores)
Year Average
receivable
Sales Ratio
2002-03 1524.75 19207 28.98Days approx)
2003-04 1605.025 24178 24.23Days(approx)
2004-05 1729.205 31800 19.85Days approx)
2005-06 1895.09 32280 21.43Days(approx)
2006-07 2098.24 39188 19.54days(approx)
Sources: Annual Report Steel Authority of India limited
0
5
10
15
20
25
30
Ratio in days
2002-03 2003-04 2004-05 2005-06 2006-07
Year
Average collection period
Ratio