1 Worklng caplLal managemenL

11 lnLroducLlon
Cne of Lhe mosL lmporLanL areas ln day Loday managemenL of flrm ls
managemenL of worklng caplLal and ls a slgnlflcanL facL of flnanclal
managemenL Worklng caplLal ls consldered as Lhe ll8fe blood of a
buslness organlzaLlon lf properly managed and nurLured buslness
prospers and grows lf noL lL would lead buslnesses Lowards flnanclal
dlsLress and slckness and all Lypes of operaLlonal problems
12 Meanlng of worklng caplLal
CaplLal ls requlred for a buslness can be classlfled under Lwo caLegorles
vlz
O lxed caplLal
O Worklng caplLal
Lvery buslness needs funds for Lwo purposes for esLabllshmenL of
buslness and Lo run day Lo day operaLlon Long Lerm funds are requlred
Lo creaLe producLlon faclllLles Lhrough purchases of flxed asseLs such as
planL and machlnery land bulldlng furnlLure eLc lnvesLmenL ln Lhese
asseLs ls blocked on a permanenL or flxed basls ls called flxed caplLal
unds needed for Lhe shorL Lerm purposes for Lhe purchase of raw
maLerlal of paymenL of wages and oLher day Lo day operaLlon and
expenses eLc ls known as worklng caplLal
CurrenL asseLs mlnus currenL llablllLles Worklng caplLal measures how
much llquld asseLs a company has avallable Lo bulld lLems buslness 1he


number can be poslLlve or negaLlve dependlng on how much debL Lhe
company ls carrylng ln general companles LhaL have a loL of worklng
caplLal wlll be more successful slnce Lhey can expand and lmprove Lhelr
operaLlon Companles wlLh negaLlve worklng caplLal may lack Lhe funds
necessary for Lhe growLh also called currenL asseLs or currenL caplLal
A measure of boLh a company's efflclency and lf lLs shorL Lerm flnanclal
healLh 1he worklng caplLal ls calculaLed as
Worklng caplLal currenL asseLs currenL llablllLles
O 9oslLlve worklng caplLal means LhaL Lhe company ls able Lo pay
off lLs shorL Lerm llablllLles
O -egaLlve worklng caplLal means LhaL a company currenLly ls
unable Lo meeL lLs shorLLerm llablllLles wlLh lLs currenL asseLs
(cash accounLs recelvable and lnvenLory)
Worklng caplLal ls also known as neL worklng caplLal" or Lhe worklng
caplLal raLlo" lL ls a flnanclal meLrlc whlch represenLs operaLlng
llquldlLy avallable Lo a buslness Along wlLh flxed asseLs such as planL
and equlpmenL worklng caplLal ls consldered a parL of operaLlng
caplLal lL ls calculaLed as currenL asseLs mlnus currenL llablllLles lf
currenL asseLs are less Lhan currenL llablllLles an enLlLy has a worklng
caplLal deflclency also called worklng caplLal deflclL A company can be
endowed wlLh asseLs and proflLablllLy buL shorL of llquldlLy lf lLs asseLs
can noL readlly be converLed lnLo cash 9oslLlve worklng caplLal ls
requlred Lo ensure LhaL a flrm ls able Lo conLlnue lLs operaLlons and
LhaL lL has sufflclenL funds Lo saLlsfy boLh maLurlng shorLLerm debL and
upcomlng operaLlonal expenses 1he managemenL of worklng caplLal


lnvolves managlng lnvenLorles accounL recelvable and payable and
cash

CCNS1I1ULN1 CI CUkkLN1 ASSL1S AND CUkkLN1 LIA8ILI1
CuRRFtT ASSFTS
O lnvenLorles 8aw maLerlals and componenLs Work ln progress
lnlshed goods oLher
O 1rade uebLors
O Loans and Advances.
O nvestments.
O ash and Bank balance.

CuRRFtT llAlllTlFS
O undry credlLors
O 1rade advances
O orrowlngs
O 9rovlslons

13 Worklng CaplLal ueclslon
relaLlng Lo worklng caplLal and shorL Lerm flnanclng are referred as
worklng caplLal managemenL 1hese lnvolve managlng Lhe relaLlonshlp
beLween a flrm's shorL Lerm asseLs and shorL Lerm llablllLles Lhe goal
of worklng caplLal managemenL ls Lo ensure LhaL Lhe flrm ls able Lo
conLlnue lLs operaLlon and lL has sufflclenL cash flow Lo saLlsfy boLh
maLurlng shorL Lerm debL and upcomlng operaLlonal expenses


A managerlal accounLlng sLraLegy focuslng on malnLalns efflclenL levels
of boLh componenLs of worklng caplLal and currenL llablllLles ln respecL
Lo each oLher Worklng caplLal managemenL ensures a company has
sufflclenL cash flow ln order Lo meeL lLs shorLLerm debL obllgaLlon and
operaLlng expenses
1he goal of worklng caplLal managemenL ls Lo ensure LhaL a flrm ls able
Lo conLlnue lLs operaLlon and LhaL lL has sufflclenL ablllLy Lo saLlsfy boLh
maLurlng shorLLerm debL and upcomlng operaLlonal expenses 1he
managemenL of worklng caplLal lnvolves managlng lnvenLorles
accounLs recelvable and payable and cash
14 ConcepL of Worklng CaplLal
1here are Lwo concepL of worklng caplLal
O ross worklng caplLal (WC)
O -eL worklng caplLal (-WC)
ross worklng caplLal
O WC refers Lo Lhe flrm's LoLal lnvesLmenL ln currenL asseLs of Lhe
enLerprlse
O CurrenL asseLs are Lhe asseLs whlch can be converLed lnLo cash
wlLhln an accounLlng year
CurrenL asseLs (CA) lnclude cash shorLLerm securlLles and debLor
(accounLlng recelvable or book debLs) bllls recelvable and sLock
(lnvenLory)
ross worklng caplLal LoLal currenL asseLs


O WC focuses aLLenLlon on Lwo aspecLs of currenL asseLs
managemenL
1 CpLlmlzaLlon of lnvesLmenL ln currenL asseLs
2 lnanclng of currenL asseLs
-eL worklng caplLal
O -eL worklng caplLal refers Lo Lhe dlfference beLween currenL
asseLs and currenL llablllLles
o -WC CA CL
O CurrenL llablllLles (CL) are Lhose clalms of ouLslders whlch are
expecLed Lo maLure for paymenL wlLhln an accounLlng year and
lnclude credlLors (accounLs payable) bllls payable and
ouLsLandlng expenses
O -eL worklng caplLal can be poslLlve or negaLlve
O A poslLlve neL worklng caplLal wlll arlse when currenL asseLs
exceeds currenL llablllLles
9oslLlve -WC CA CL
O A negaLlve neL worklng caplLal occurs when currenL llablllLles are
excess of currenL asseLs
-egaLlve -WC CA CL
O -WC focuses on Lwo aspecLs of llquldlLy managemenL
LlquldlLy poslLlon of Lhe flrm
!udlclous mlx of long and shorL Lerm flnanclng
13 classlflcaLlon worklng caplLal
Cn Lhe basls of Llme worklng caplLal ls classlfled lnLo Lwo caLegorles
9ermanenL or flxed worklng caplLal


1emporary or varlable worklng caplLal
131 9ermanenL or flxed worklng caplLal
A mlnlmum level of currenL asseLs whlch ls conLlnuously requlred by a
flrm Lo carry on lLs buslness operaLlons ls referred Lo as permanenL or
flxed worklng caplLal As Lhe buslness grows Lhe requlremenL of
permanenL worklng caplLal also lncreases due Lo lncrease ln currenL
asseLs
or example exLra lnvenLory of flnlshed goods wlll have Lo be
malnLalned Lo supporL Lhe plck perlods of sales and lnvesLmenL ln
debLor may also lncrease durlng such perlods on oLher hand
lnvesLmenL ln raw maLerlal work ln progress and flnlshed goods wlll fall
lf markeL ls slack

Maln feaLures
AmounL of permanenL worklng caplLal remalns ln Lhe buslness ln
one form or oLher
1here ls a poslLlve correlaLlon beLween Lhe amounL of permanenL
worklng caplLal and Lhe slze of Lhe buslness
9ermanenL worklng caplLal ls permanenLly needed Lherefore lL
should be flnanced Lhrough longLerm funds
132 1emporary or varlable worklng caplLal
1emporary or varlable worklng caplLal ls Lhe amounL of worklng caplLal
whlch ls requlred Lo meeL Lhe seasonal demand and some speclal
exlgencles 1emporary worklng caplLal ls dlffers from permanenL


worklng caplLal ln Lhe sense LhaL lL ls requlre for Lhe shorL perlod and
permanenLly employed galnfully ln Lhe buslness

1he amounL of Lemporary worklng caplLal flucLuaLes dependlng upon
Lhe changes ln Lhe producLlon and sales
1emporary worklng caplLal flucLuaLlng worklng caplLal
varlable worklng caplLal
or example addlLlonal lnvenLory wlll be requlred for meeLlng Lhe
durlng Lhe perlod of hlgh sales when Lhe peak perlod ls over varlable
worklng caplLal sLarLs decreaslng or very llLLle durlng Lhe normal perlod
lL ls Lemporarlly lnvesLed ln currenL asseLs ay for an example a shop
keeper lnvesLs more money durlng wlnLer season because he/she
requlres keeplng more amounL sLock of woolen cloLhs 1he same
happens ln a sugar facLory how Lhe facLory manager buys more
quanLlLy of sugar cane durlng Lhe harvesLlng season and Lhem
conLlnuously sLops for some Llme












lgure glven below lllusLraLe Lhe dlfference beLween permanenL and
Lemporary worklng caplLal

(9ermanenL and varlable worklng caplLal for a sLable flrm)

(a)

lgure (b)



(9ermanenL and varlable worklng caplLal for a growlng flrm)
(b)


lgure shows dlfference beLween permanenL and Lemporary worklng
caplLal
ln flgure (a) lL ls shown LhaL permanenL worklng caplLal ls sLable
flxed over Llme where Lhe Lemporary or varlable worklng caplLal ls
flucLuaLlng

ln flgure (b) permanenL worklng caplLal ls also lncreaslng wlLh Lhe
passage of Llme due Lo expanslon of buslness buL even Lhen lL
doesn'L flucLuaLe as varlable worklng caplLal whlch someLlme
lncreases and some Llme decreases

16 lmporLance of worklng caplLal
Worklng caplLal represenLs Lhe funds avallable wlLh Lhe company
for day Lo day operaLlons lL flnances Lhe cash converslon cycle
Company cannoL survlve wlLh negaLlve worklng caplLal le Lhey
don'L have funds for day Lo day operaL9lons
1he worklng caplLal ls Lhe llfe blood and nerve cenLer of a
buslness flrm 1he sufflclenLly of worklng caplLal asslsLs ln ralslng
credlL sLandlng of a buslness because of beLLer Lerms of goods
boughL lesser cosL of manufacLurlng due Lo Lhe accepLance of
cash dlscounL favorable raLes of lnLeresL eLc
-o buslness can run effecLlvely wlLhouL a sufflclenL quanLlLy of
worklng caplLal lL ls cruclal Lo reLaln rlghL level of worklng caplLal
lnance manager ls requlred Lo declde Lhe amounL of accuraLe
worklng caplLal
A buslness enLerprlse wlLh ample worklng caplLal ls always ln a
poslLlon Lo avall advanLage of any favorable opporLunlLy elLher Lo
buy raw maLerlal or Lo lmplemenL a speclal order or Lo walL for
enhance markeL sLaLus


Cash ls needed Lo carry ouL dayLo day worklng and buy
lnvenLorles eLc Lhe shorLage of cash badly affecL Lhe poslLlon of
Lhe buslness concern 1he recelvable managemenL ls relaLed Lo
Lhe volume of producLlon and sales or escalaLlng sales Lhere
may be a need Lo offer addlLlonal credlL faclllLles
lnvenLory conLrol ls a consLlLuenL slgnlflcanL ln worklng caplLal
managemenL 1he deflclency of lnvenLory may cause work
sLoppage Cn Lhe oLher hand surplus lnvenLory may resulLs ln
blocklng of money ln sLocks
1he overall success of Lhe company depends upon lLs worklng
caplLal poslLlon o lL should be handled properly because lL
shows Lhe efflclency and flnanclal sLrengLh of company
ADVAN1AGL CI ADLUA1L WCkkING CAI1AL
SCLVLNC CI 1nL 8USINLSS AdequaLe worklng caplLal helps ln
malnLalnlng Lhe solvency of Lhe buslness by provldlng
unlnLerrupLed of producLlon
Goodw||| ufflclenL amounL of worklng caplLal enables a flrm Lo
make prompL paymenLs and makes and malnLaln Lhe goodwlll
Lasy |oans AdequaLe worklng caplLal leads Lo hlgh solvency and
credlL sLandlng can arrange loans from banks and oLher on easy
and favorable Lerms


Cash D|scounts AdequaLe worklng caplLal also enables a concern
Lo avall cash dlscounLs on Lhe purchases and hence reduces cosL
Lnsures regular supply of raw maLerlal and conLlnuous
producLlon
kegu|ar ayment of Sa|ar|es Wages and Cther Day 1C Day
Comm|tments lL leads Lo Lhe saLlsfacLlon of Lhe employees and
ralses Lhe morale of lLs employees lncreases Lhelr efflclency
reduces wasLage and cosLs and enhances producLlon and proflLs
Lxp|o|tat|on of Iavorab|e Market Cond|t|ons lf a flrm ls havlng
adequaLe worklng caplLal Lhen lL can explolL Lhe favorable markeL
condlLlons such as purchaslng lLs requlremenLs ln bulk when Lhe
prlces are lower and holdlngs lLs lnvenLorles for hlgher prlces
Ab|||ty to Iace Cr|ses A concern can face Lhe slLuaLlon durlng Lhe
depresslon
u|ck And kegu|ar keturn Cn Investments ufflclenL worklng
caplLal enables a concern Lo pay qulck and regular of dlvldends Lo
lLs lnvesLors and galns confldence of Lhe lnvesLors and can ralse
more funds ln fuLure


n|gh Mora|e AdequaLe worklng caplLal brlngs an envlronmenL of
securlLles confldence hlgh morale whlch resulLs ln overall
efflclency ln a buslness
LkCLSS Ck INADLUA1L WCkkING CAI1AL
Lvery buslness concern should have adequaLe amounL of
worklng caplLal Lo run lLs buslness operaLlons lL should have
nelLher redundanL or excess worklng caplLal nor lnadequaLe
nor shorLages of worklng caplLal oLh excess as well as
shorL worklng caplLal poslLlons are bad for any buslness
Powever lL ls Lhe lnadequaLe worklng caplLal whlch ls more
dangerous from Lhe polnL of vlew of Lhe flrm
DISADVAN1AGLS CI kLDUNDAN1 Ck LkCLSSIVL WCkkING
CAI1AL
1 Lxcesslve worklng caplLal means ldeal funds whlch earn
no proflL for Lhe flrm and buslness cannoL earn Lhe requlred raLe
of reLurn on lLs lnvesLmenLs
2 8edundanL worklng caplLal leads Lo unnecessary
purchaslng and accumulaLlon of lnvenLorles


3 Lxcesslve worklng caplLal lmplles excesslve debLors and
defecLlve credlL pollcy whlch causes hlgher lncldence of bad
debLs
4 lL may reduce Lhe overall efflclency of Lhe buslness
3 lf a flrm ls havlng excesslve worklng caplLal Lhen Lhe
relaLlons wlLh banks and oLher flnanclal lnsLlLuLlon may noL be
malnLalned
6 uue Lo lower raLe of reLurn n lnvesLmenLs Lhe values of
shares may also fall
7 1he redundanL worklng caplLal glves rlse Lo speculaLlve
LransacLlons
17 facLors affecLlng worklng caplLal
A flrm should have nelLher low nor hlgh worklng caplLal Low worklng
caplLal lnvolves more rlsk and more reLurns hlgh worklng caplLal
lnvolves less rlsks and reLurns 8lsk here refers Lo Lechnlcal lnsolvency
whlle reLurns refer Lo lncreased proflL or earnlngs 1he amounL of
worklng caplLal ls deLermlned by a wlde verlLy of facLors
Nature of bus|ness 1he worklng caplLal needed of a flrm
depends on Lhe naLure of buslness or example a flrm
lnvolved ln sale of servlces raLher Lhan manufacLurlng or a flrm
ls allowlng only cash sales ln Lhe flrsL lnsLance no lnvesLmenL


ls requlred ln elLher raw maLerlals or Wl9 or flnlshed goods
whlle ln Lhe second lnsLance Lhere exlsLs no recelvable as Lhere
ls lmmedlaLe reallzaLlon of cash Pence Lhe requlremenL of
worklng caplLal ls lower
Seasona||ty of operat|on lf Lhe producL of Lhe flrm has a
seasonal demand llke refrlgeraLors Lhe flrm needs hlgh
worklng caplLal ln Lhe perlod of summer as Lhe demand for Lhe
refrlgeraLors ls more and Lhe flrm needs low worklng caplLal ln
Lhe perlods of wlnLer as Lhe demand for Lhe producL ls low
roduct|on cyc|e 1he Lerm producLlon cycle refers Lo
Lhe Llme lnvolved ln Lhe manufacLure of goods lL covers Lhe
Llme span beLween Lhe procuremenL or Lhe raw maLerlals and
Lhe compleLlon of Lhe manufacLurlng process leadlng Lo Lhe
producLlon of goods As Lhe funds are necessarlly Lled up
durlng Lhe producLlon cycle Lhe producLlon cycle has bearlng
on Lhe quanLum o0f worklng caplLal 1he longer Lhe Llme span
of producLlon cycle Lhe larger wlll be Lhe funds Lled up and
Lherefore Lhe largesL Lhe worklng caplLal needed and vlce
versa
roduct|on po||cy 1he quanLum of worklng caplLal ls also
deLermlned by producLlon pollcy ln case of flrms havlng
seasonal demand of Lhe producLs llke refrlgeraLors alr coolers
eLc and Lhe producLlon pollcy of Lhe flrms deLermlnes Lhe
amounL of worklng caplLal requlremenL lf Lhe flrm has
producLlon pollcy Lo carry producLlon aL a sLeady level Lo meeL
Lhe peak demand Lhls wlll resulLs ln a large accumulaLlon of
flnlshed goods (lnvenLorles) durlng Lhe off seasons and Lhe
abrupL sale durlng Lhe peak season 1he progresslve


accumulaLlon of flnlshed goods wlll naLurally requlre an
lncreaslng amounL of worklng caplLal lf Lhe flrm has producLlon
pollcy Lo produce only when Lhere ls a demand Lhen Lhe flrm
needs low worklng caplLal durlng Lhe slack season and hlgh
worklng caplLal durlng season
Cred|t po||cy Lhe level of Lhe worklng caplLal ls also
deLermlned by Lhe credlL pollcy as Lhe flrm's credlL pollcy
deLermlnes Lhe amounL of recelvable lf Lhe flrm has a llberal
credlL pollcy Lhen Lhe flrm needs low worklng caplLal lf Lhe
company's credlL pollcy does noL allow lL Lo exLend credlL Lo
Lhe buyers
Market cond|t|on 1he worklng caplLal requlremenLs are
also deLermlned by Lhe markeL condlLlon ln case of Lhe hlgh
degree of compeLlLlon prevalllng ln Lhe markeL Lhe flrm has Lo
malnLaln larger lnvenLorles as cosLumer are noL lncllned Lo walL
for Lhe producL 1hls needs hlgher worklng caplLal
requlremenLs lf Lhere ls good demand for Lhe producL and
compeLlLlon ls weak a flrm can manage wlLh smaller lnvenLory
of flnlshed goods as cosLumers can walL for Lhe producL lf lL ls
noL avallable ln Lhe markeL 1hus a flrm can manage wlLh low
lnvenLory and wlll need low worklng caplLal requlremenLs
Cond|t|ons of supp|y 1he avallablllLy of raw maLerlals
and spares also deLermlne Lhe level of worklng caplLal lf Lhere
ls ready avallablllLy of raw maLerlals and spares a flrm can
malnLaln mlnlmum lnvenLory and need less worklng caplLal lf
Lhe supply of raw maLerlal ls unpredlcLable Lhen Lhe flrm has
Lo acqulre sLocks as and when Lhey are avallable for ensurlng
conLlnuous producLlon 1hus Lhe flrm needs Lo malnLaln larger


lnvenLory average and needs larger requlremenL of worklng
caplLal
Growth and Lxpans|on of 8us|ness Worklng caplLal requlremenLs
of an enLerprlse Lend Lo lncrease ln correspondence wlLh
growLh ln volume of sales AddlLlonal CurrenL asseLs wlll be
needed Lo supporL lncreased scale of operaLlons lL can furLher
be noLed LhaL a growlng enLerprlse requlres addlLlonal funds
conLlnuously Lo fulflll Lhe lncreaslng needs of Lhe buslness
1echno|og|ca| Deve|opments 1echnologlcal
developmenLs ln Lhe area of producLlon can have sharp effecLs
on Lhe need for worklng caplLal lf a flrm swlLches over Lo new
manufactur|ng process and |nsta||s new equ|pment's w|th
wh|ch lL ls able Lo cuL perlod lnvolved ln converLlng raw
maLerlals lnLo flnlshed goods permanenL worklng caplLal
requlremenLs of Lhe flrm wlll decrease lf Lhe new machlne can
uLlllze less expenslve raw maLerlals Lhe lnvenLory needs may
be reduced
ust |n 1|me (I1) Approach 1hls ls an approach Lo
manufacLurlng developed ln !apan lLs 9hllosophy ls LhaL lLems
should be recelved aL Lhe exacL Llme aL Lhe exacL place and ln
perfecL condlLlon 1he ob[ecLlve ls Lo have a perfecL maLchlng
beLween Lhe ouLpuL of a manufacLurlng flrm and needs of Lhe
markeL ln case someLhlng ls noL needed lmmedlaLely lL ls noL
manufacLured LfforL ls made Lo mlnlmlze Lhe Llme lnLerval
beLween sLarLlng Lhe manufacLurlng process and Lhe producL
belng ready for dellvery Lo Lhe cusLomer 1hls Llme lnLerval ls
known as LhroughpuL Llme" whlch ls Lhe LoLal of processlng
Llme + lnspecLlon 1lme + Conveyance 1lme + WalLlng Llme.



Sources of work|ng cap|ta|
lnanclng of addlLlonal worklng caplLal requlremenLs ln an envlronmenL
becomes a real problem Lo a flnance manager of a concerned unlL
Commerclal anks play Lhe mosL slgnlflcanL role ln provldlng worklng
caplLal flnance parLlcularly ln Lhe lndlan conLexL ln vlew of Lhe
mounLlng lnflaLlon Lhe 8eserve ank of lndla has Laken up cerLaln flscal
measures Lo check Lhe money supply ln Lhe economy 1he balanclng
need has Lo be managed elLher by long Lerm borrowlngs or by lssulng
equlLy or by earnlng sufflclenL proflLs and reLalnlng Lhe same for coplng
wlLh Lhe addlLlonal worklng caplLal requlremenLs 1he flrsL cholce
before a flnance manager when a parL of addlLlonal worklng caplLal ls
noL provlded by anks ls Lo Lake Lhe longLerm sources of flnance

1he source of worklng caplLal may be classlfled as under
1 Long 1erm I|nanc|ng
a) Loans from I|nanc|a| Inst|tut|ons 1he opLlon ls normally ruled ouL
because flnanclal lnsLlLuLlons do noL provlde flnance for worklng caplLal
requlremenLs urLher Lhls faclllLy ls noL avallable Lo all Companles or
small Companles Lhls opLlon ls noL pracLlcal
b) I|oat|ng of Debentures 1he probablllLy of a successful floaLaLlon of
debenLures seems Lo be raLher meager ln lndlan CaplLal MarkeL
floaLlng of debenLures has sLlll Lo galn popularlLy
c) Accept|ng ub||c Depos|ts 1he nexL alLernaLlve Lo Lhe above ls publlc
deposlLs 1he lssue of Lapplng publlc deposlLs ls dlrecLly relaLed Lo Lhe
lmage of Lhe Company seeklng Lo lnvlLe publlc deposlLs uL Lhe
problem of Low proflLablllLy ln many lndusLrles ls very common


d) Issue of Shares WlLh a vlew Lo flnanclng addlLlonal worklng caplLal
needs lssue of equlLy shares could be consldered Many lndlan
companles have sLlll Lo goahead Lo command respecL of lnvenLorles ln
Lhls conLexL Low proflL margln and Lhe lack of knowledge abouL
company make Lhe success of a caplLal lssue very dlm

e) ka|s|ng Iunds by Interna| I|nanc|ng 8alslng funds from operaLlonal
proflLs poses problems for many Companles because prlces of Lhelr
endproducLs are conLrolled and do noL permlL companles Lo earn
proflLs sufflclenL Lo pay reasonable dlvldend and reLaln proflLs Lo cover
margln money requlremenLs Lo flnance addlLlonal worklng asseLs sLlll a
largely feaslble soluLlon lles ln lncreaslng proflLablllLy Lhrough cosL
conLrol and cosL reducLlon measures managlng Lhe cash operaLlng
cycle raLlonallzlng lnvenLory sLocks and so on


2Shortterm I|nanc|ng
horLLerm lnanclng refers Lo Lhose sources of shorLLerm credlL LhaL
Lhe flrm musL arrange ln advance 1hese sources lnclude shorLLerm
bank loans commerclal papers and facLorlng recelvables

1echn|ques for assessment of work|ng cap|ta| requ|rement
O Lst|mat|on of components of work|ng cap|ta| method lnce
worklng caplLal ls Lhe excess of currenL asseLs over currenL
llablllLles an assessmenL of Lhe worklng caplLal requlremenLs
can be made by esLlmaLlng Lhe amounL of dlfferenL consLlLuenL


of worklng caplLal eg lnvenLorles accounL recelvable cash
accounL payable eLc
O ercent of sa|es approach 1hls ls a LradlLlonal and slmple
meLhod of esLlmaLlng of worklng caplLal requlremenL
Accordlng Lo Lhls meLhod on Lhe basls of pasL experlence
beLween sales and worklng caplLal requlremenLs a raLlo can be
deLermlned for esLlmaLlng Lhe worklng caplLal requlremenLs ln
fuLure
O Cperat|ng cyc|e approach Accordlng Lo Lhls approach Lhe
requlremenLs of worklng caplLal depend upon Lhe operaLlng
cycle of Lhe buslness 1he operaLlng cycle beglns wlLh Lhe
acqulslLlon of raw maLerlal and end wlLh Lhe collecLlon of
recelvables
It may be broad|y c|ass|f|ed |nto four stages v|z
8aw maLerlal and sLore sLorage sLage
2Work ln progress sLage
3lnlshed goods lnvenLory sLage
48ecelvables collecLlon sLage



(S1AGLS CI CLkA1ING CCLL)

1he duraLlon of Lhe operaLlng cycle for Lhe purpose of esLlmaLlng
worklng caplLal requlremenLs ls equlvalenL Lo Lhe sum of Lhe duraLlon
of each of Lhese sLages less Lhe credlL perlod allowed by Lhe suppllers
of Lhe flrm
ymbollcally Lhe duraLlon of Lhe worklng caplLal cycle can be puL as
follows
Ck+W+I+DC
Where 8 duraLlon of operaLlng cycle
k raw maLerlal and sLores sLorage perlod
W work ln progress perlod
I flnlshed sLock sLorage perlod
D debLors collecLlon perlod
CcredlLors paymenL perlod
Lach of the components of the operat|ng cyc|e can be ca|cu|ated as
fo||ows
R =
Auege t w te| d te
Auege w te| d te ut| dy


=
Auege w | ge |uety
uege t dut| e dy




=
uege det
uege ed|t e e dy


C =
uege tde ed|t
uege ed|t uhe e dy



Inventory convers|on per|od
1he lnvenLory converslon perlod ls Lhe lengLh of Llme from Lhe
purchase of lnvenLory Lo Lhe Llme Lo sales ls made on credlL Pere
lnvenLory lncludes raw maLerlal and flnlshed goods
Debtor's convers|on per|od
1he debLor's converslon perlod ls Lhe average number of days lL
Lakes Lo collecLlon accounL recelvable

ayab|es deferra| per|od
1he payables deferral perlod ls Lhe average lengLh of Llme beLween Lhe
purchase of maLerlals and labor and Lhe paymenL of cash for Lhe same
AfLer compuLlng Lhe perlod of one operaLlng cycle Lhe LoLal number of
operaLlng cycles LhaL can be compuLed durlng a year can be compuLed
by dlvldlng 363 days wlLh number of operaLlng days ln a cycle 1he LoLal
expendlLure ln Lhe year when year dlvlded by Lhe number of operaLlng


cycles ln a year wlll glve Lhe average amounL of Lhe worklng caplLal
requlremenL


1.9 CAlCulATl0t 0F w0RKlt6 CAPlTAl




ALS1IMA1ICN CI CUkkLN1 ASSL1S
(|) Des|red cash and bank ba|ances
(||)Inventor|es
kawmater|a|s
Work |nprogress
I|n|shed goods
(|||) Debtors
1ota| Current Assets (A)

8 Lst|mat|on of current ||ab|||t|es
(|) Cred|tors
(||) Wages
(|||) Cverheads
(|v) 1axes payab|e
1ota| current ||ab|||t|es(8)
C Net Work|ng Cap|ta|(A8)
AMCUN1
(kS)


























kat|o ana|ys|s

Introduct|on
A raLlo ls a slmple arlLhmeLlcal expresslon of Lhe relaLlonshlp of one
number Lo anoLher lL may be deflned as lndlcaLed quoLlenL of Lwo
maLhemaLlcal expresslons

8aLlo analysls ls a Lechnlque of analysls and lnLerpreLaLlon of flnanclal
sLaLemenLs lL ls Lhe process of esLabllshlng and lnLerpreLlng Lhe varlous
raLlos for helplng ln maklng cerLaln declslons lL ls a means of beLLer
undersLandlng of flnanclal sLrengLh and weakness of flrm 1here are a
number of raLlos whlch can be calculaLed from Lhe lnformaLlon glven ln
Lhe flnanclal sLaLemenL uL Lhe analysL has Lo selecL Lhe approprlaLe
daLa and calculaLe only a few approprlaLe raLlos from Lhe same keeplng
ln mlnd Lhe ob[ecLlve of analysls 1he raLlo may be used as a sympLom
llke blood pressure 1he pulse raLe or Lhe body LemperaLure and Lhelr
lnLerpreLaLlon depend upon Lhe callber and compeLency of Lhe
analysLs

Current rat|o



!!!I`II` CurrenL raLlo may be deflned as Lhe relaLlonshlp
beLween currenL asseLs and currenL llablllLles CurrenL raLlo ls a
measure of general llquldlLy of a shorL Lerm flnanclal poslLlon or
llquldlLy of a flrm CurrenL raLlo ls a measure of Lhe flrm's shorLLerm
llquldlLy lL ls calculaLed by dlvldlng Lhe LoLal currenL asseLs by Lhe LoLal
of currenL llablllLles
!!'l. Lhe currenL raLlo can be calculaLed by dlvldlng Lhe LoLal
currenL asseLs by dlvldlng currenL llablllLles
IJJJ JIJ =
IJJJ IJJJ
IJJJ IIJ


Ac|d 1est kat|o
!!!I`II` Acld LesL raLlo also known as qulck raLlo esLabllshes a
relaLlonshlp beLween qulck or llquld asseLs and currenL llablllLles An
asseL ls llquld lf lL can be converLed lnLo cash lmmedlaLely or reasonably
soon wlLhouL a loss of value Cash ls mosL llquld asseLs CLher asseLs
LhaL are consldered relaLlvely llquldlLy and lnclude ln qulck asseLs are
debLors and bllls recelvables and oLher currenL asseLs lnvenLorles are
consldered Lo be less llquldlLy lnvenLorles normally requlre someLlme
for reallzlng lnLo cash 1he Lerm acld LesL refers Lo Lhe ablllLy of a flrm
Lo pay lLs shorL Lerm obllgaLlon as and when Lhey become due
QuicK AsscTs = cunncNT AsscTs - iNvcNTonics
!!'l. Lhe acld LesL raLlo can be calculaLed by dlvldlng Lhe
LoLal of qulck asseLs by LoLal currenL llablllLy



I J IJ =
Cuet et-uet|e
uet |||ty

1104 Work|ng Cap|ta| 1urnover kat|o
!!!I`II` A flrm may be llke Lo relaLe neL worklng caplLal Lo
sale Worklng caplLal Lurnover raLlo ls calculaLed by dlvldlng sales by neL
worklng caplLal
!!'l.
w|g |t tu ue t| =
t e
et w|g |t


Inventory 1urnover kat|o

!!!I`II` lnvenLory Lurnover lndlcaLes Lhe efflclency of Lhe flrm
ln produclng and selllng lLs producLs lL ls calculaLed by dlvldlng cosL of
goods sold by average lnvenLory lnvenLory Lurnover raLlo also known
as sLock veloclLy ls normally calculaLed as sales/ average lnvenLory or
cosLs of goods sold / average lnvenLory 1he average lnvenLory ls Lhe
average of openlng and closlng balance of lnvenLory lL would lndlcaLe
wheLher lnvenLory has been efflclenLly used or noL lnvenLory Lurnover
raLlo measures Lhe veloclLy of converslon of sLock lnLo sales
!!'l.


uety uue Rt| =
t gd d
uege |uety

Debtor turnover rat|o
Def|n|t|on lL lndlcaLes Lhe number of Llmes average debLors
(recelvable) are Lurned overdurlng a year 1hls ls also called uebLors
veloclLy or Average CollecLlon 9erlod or 9erlod of CredlL glven
!!'l.
et tuue t| =
tde det w|g dy
ed|t e

Cred|tor's turnover rat|o
Def|n|t|on 1hls raLlo measures Lhe amounL of credlL Laken from
suppllers 1hls ls also called CredlLors veloclLy 8aLlo whlch deLermlnes
Lhe credlLor paymenL perlod
!!'l.
ed|t tuue t|
=
tde ed|tt
ed|t uhe
. w|g dy
Interest coverage rat|o
eIinition: lnLeresL coverage raLlo ls also known as debL servlce raLlo or
debL servlce coverage raLlo
1hls raLlo relaLes Lhe flxed lnLeresL charges Lo Lhe lncome earned by Lhe
buslness lL lndlcaLes wheLher Lhe buslness has earned sufflclenL proflLs
Lo pay perlodlcally Lhe lnLeresL charges



!!'l.
|tet uege t| =
e|g ee |tet d tx
|xed |tet hge

Gross prof|t rat|o
Definition: ross proflL raLlo (9 raLlo) ls Lhe raLlo of gross proflL Lo neL
sales expressed as a percenLage lL expresses Lhe relaLlonshlp beLween
gross proflL and sales
!!'l.
g |t t| =
g |t
e
1

Cperat|ng rat|o
Definition: CperaLlng raLlo ls Lhe raLlo of cosL of goods sold plus
operaLlng expenses Lo neL sales lL ls generally expressed ln percenLage
CperaLlng raLlo measures Lhe cosL of operaLlons per dollar of sales 1hls
ls closely relaLed Lo Lhe raLlo of operaLlng proflL Lo neL sales

!!'l.
et|g t| =
tt t
e
1
Lxpense rat|o


Definition: Lxpense raLlos lndlcaLe Lhe relaLlonshlp of varlous expenses Lo neL
sales 1he operaLlng raLlo reveals Lhe average LoLal varlaLlons ln expenses uL
some of Lhe expenses may be lncreaslng whlle some may be falllng Pence
expense raLlos are calculaLed by dlvldlng each lLem of expenses or group of
expense wlLh Lhe neL sales Lo analyze Lhe cause of varlaLlon of Lhe operaLlng raLlo

!!'l.
exee t| =
eh et| exee
e
1
Net prof|t rat|o
Def|n|t|on -eL proflL raLlo ls Lhe raLlo of neL proflL (afLer Laxes) Lo neL
sales lL ls expressed as percenLage
!!'l.
et |t t| =
et |t
e
1
(Note net prof|t after |nterest and tax)

keturn on tota| resources
Def|n|t|on A raLlo LhaL measures a companys earnlngs before lnLeresL and
Laxes (Ll1) agalnsL lLs LoLal neL asseLs 1he raLlo ls consldered an lndlcaLor of how
effecLlvely a company ls uslng lLs asseLs Lo generaLe earnlngs before conLracLual
obllgaLlons musL be pald





!!'l.
etu tt eue =
et |t
tt et
1
keturn on shareho|ders' |nvestment
Def|n|t|on 1he amounL of neL lncome reLurned as a percenLage of shareholders
equlLy 8eLurn on equlLy measures a corporaLlons proflLablllLy by reveallng how
much proflL a company generaLes wlLh Lhe money shareholders have lnvesLed.
!!'l.
etu hehde |uetet
=
et |t
he hde ud
1
Larn per share
Def|n|t|on 1he porLlon of a companys proflL allocaLed Lo each ouLsLandlng
share of common sLock Larnlngs per share serve as an lndlcaLor of a companys
proflLablllLy


!!'l.
e e he =
et |t -eeee d|u|ded
. eu|ty he









keturn on cap|ta| emp|oyed
Def|n|t|on Return on Capital Employed (ROCE) Ratio is one of the important tools used to
identify companies that offer good value and have the potential to grow. The ROCE ratio helps
to identify good businesses that earn more relative to the price being paid than others
!!'l.
etu |t eyed =
et |t
|t eyed
1
(Note cap|ta| emp|oyed may be gross cap|ta| emp|oyed |e tota|
assets used or net cap|ta| emp|oyed |e 1ota| assets used |ess current
||ab|||t|es)
keturn cap|ta| emp|oyed
Def|n|t|on
!!'l.
etu |t eyed =
et |t
|t eed


Cap|ta| gear|ng rat|o
Def|n|t|on A general Lerm descrlblng a flnanclal raLlo LhaL compares some form
of owners equlLy (or caplLal) Lo borrowed funds earlng ls a measure of flnanclal
leverage demonsLraLlng Lhe degree Lo whlch a flrms acLlvlLles are funded by
owners funds versus credlLors funds

!!'l.


|t ge|g t| =
eu|ty he |t
|xed |tet e|g eu|t|e

(Note f|xed |nterest ||ke preference share and debenture)




I|xed assets turnover
Def|n|t|on A flnanclal raLlo of neL sales Lo flxed asseLs 1he flxedasseL Lurnover
raLlo measures a companys ablllLy Lo generaLe neL sales from flxedasseL
lnvesLmenLs speclflcally properLy planL and equlpmenL (99L) neL of
depreclaLlon A hlgher flxedasseL Lurnover raLlo shows LhaL Lhe company has
been more effecLlve ln uslng Lhe lnvesLmenL ln flxed asseLs Lo generaLe revenues
!!'l.
|xed et tuue =
e
|xed et

kat|o of operat|ng prof|t to tota| operat|ng assets
Def|n|t|on
!!'l.
t| et|g |t t tt et|g et
=
et|g |t
tt et|g et

kat|o of tota| |nvestment to |ong term ||ab|||t|es


Def|n|t|on
!!'l.
t| tt |uetet t gte |||t|e
=
hehde ud +g te |||t|e
gte |||t|e

ropr|etary rat|o
Def|n|t|on 1hls raLlo relaLes Lhe shareholders funds Lo LoLal asseLs 9roprleLary
/ LqulLy raLlo lndlcaLes Lhe longLerm or fuLure solvency poslLlon of Lhe buslness
!!'l.
|ety t| =
hehde ud
tt et
1

r|ceearn|ngs rat|o
Def|n|t|on A valuaLlon raLlo of a companys currenL share prlce compared Lo lLs
pershare earnlngs

!!'l.
|e e|g t| =
et |e e eu|ty he
e|g e he

ayout rat|o
Def|n|t|on 1he amounL of earnlngs pald ouL ln dlvldends Lo shareholders
lnvesLors can use Lhe payouL raLlo Lo deLermlne whaL companles are dolng wlLh
Lhelr earnlngs



!!'l.
yut t| =
d|u|ded e eu|ty he
e|g e he

D|v|dend y|e|d rat|o
Def|n|t|on A flnanclal raLlo LhaL shows how much a company pays ouL ln
dlvldends each year relaLlve Lo lLs share prlce ln Lhe absence of any caplLal galns
Lhe dlvldend yleld ls Lhe reLurn on lnvesLmenL for a sLock
!!'l.
d|u|ded ye|d t| =
d|u|ded e he
et |e e eu|ty he
1