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Working Capital Management

A Project Report Submitted in partial fulfillment of The requirements for the Master of Business Administration

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PREFACE

Dissertation report for an M.B.A student is an important part of competition of the particular topic. Hence every student undergoes this training at various place having different topics. The main objective of the actual environment that prevails in to today’s organization. In this project on can find that how the theories of book are put into the practice and how much they are suitable and useful As per dissertation is concerned I underwent in NATIONAL ALUMINIUM COMPANY (NALCO) ANGUL. The topic of my dissertation is “WORKING CAPITAL MANAGEMENT”


GUIDE CERTIFICATE

This is to certify that the project entitled “Working Capital Management” is a piece of term project done by XYZ, student of 2 year M.B.A,. To the best of my knowledge and belief the term project report: Embodies the work of the candidate themselves.  Has been duly completed.  Is up to the standard both in respect to contents and language for being referred to the examiner.

Signature


DECLARATION BY THE CANDIDATE I Mr. XYZ a student of 2 year M.B.A INSTITUTE OF BUSINESS AND COMPUTER STUDIES, XYZ UNIVERSITY, , Regd No: -, hereby declare that the project report entitled on “WORKING CAPITAL MANAGEMENT” is the outcome of my own performance and the same has not been submitted to any university/Institute for the award of any degree or any professional diploma/degree.

Date:Place: -

Signature


ACKNOWLEDGEMENT I take this opportunity to place on record my grateful thanks and sincere gratitude to Mr. XYZ, finance Manager, NALCO Finance Dept, ANGUL. Who gave me valuable advice and inputs for my study? My project could not have been completed if I had not been able to get the reference materials from the company. I am immensely grateful to my esteemed guide Ms. XYZ whose continued and invaluable guidance can never be forgotten by me but for whom, this study could not have got present shape. Last but not the least; I would also like to express my thanks to Mr. P.XYZ, S&P dept, who inspired me to put in my best efforts for the inspired me to put in my best efforts for the research/project report.

XYZ


TABLE OF CONTENTS PREFACE..............................................................................................................................II GUIDE CERTIFICATE......................................................................................................III DECLARATION BY THE CANDIDATE.........................................................................IV ACKNOWLEDGEMENT ....................................................................................................V TABLE OF CONTENTS.....................................................................................................VI 1. INTRODUCTION TO NALCO.........................................................................................8

1.1 CORPORATE STRENGTH................................................................................9 1.2 BAUXITE MINE.................................................................................................9 1.3 ALUMINA REFINERY....................................................................................10 1.4 SMELTER PLANT............................................................................................11 1.5 CAPTIVE POWER PLANT:-............................................................................12 1.6 PORT FACILITIES:-.........................................................................................13 1.7 ROLLED PRODUCTS UNIT:-.........................................................................14 1.8 ENVIRONMENT:-............................................................................................14 1.9 COMMUNITY CARE:-.....................................................................................15 1.10 HRM PHILOSOPHY:- ..................................................................................16 1.11 HUMAN RESOURCES(Up to September 2008):-.........................................16 1.12 EXPANSION PROGRAMME:-......................................................................17 1.13 PRODUCTION & SALES:-............................................................................18 1.14 FINANCIAL PERFORMANCE:-...................................................................20 1.15 QUALITY POLICY:-......................................................................................23 Guiding Principles ...............................................................................................23 Commitment.........................................................................................................24 ENVIRONMENT POLICY:-..................................................................................24 1.16 ALUMINIUM PROPERTIES & APPLICATIONS........................................26 Aluminum – the wonder metal has many remarkable features............................26 PRODUCTS.........................................................................................................28 Alumina:-.............................................................................................................28 2. INTRODUCTION TO WORKING CAPITAL MANAGEMENT...............................29

OBJECTIVES OF THE STUDY: -.........................................................................30 3. CASH MANAGEMENT..................................................................................................31

3.1 OBJECTIVES OF CASH MANAGEMENT.....................................................31 3.2 MOTIVES FOR CASH HOLDING..................................................................32 (1). Transaction Motive:-.....................................................................................32 (2).precautionary Motive:-...................................................................................33 (3).Speculative Motive:-.......................................................................................33 3.3 CASH PLANNING: -........................................................................................33 3.4 CASH FORECASTING & BUDGETING........................................................34 Receipts and Payment Method:- ..........................................................................35 Adjusted Net Income Method:-............................................................................36


3. 5 MANAGEMENT OF CASH FLOW: -............................................................36 3.6 DELAYING PAYMENT: -...............................................................................38 4. CASH MANAGEMENT AT NALCO.............................................................................39

ANALYSIS..........................................................................................................39 SUMMARY.............................................................................................................44 5. INVENTORY MANAGEMENT.....................................................................................46

5.1 COMPONENTS OF INVENTORY: -...............................................................46 5.2 NEED TO HOLD INVENTORIES: -................................................................47 5.3 OBJECTIVES: -.................................................................................................48 COSTS:-...............................................................................................................48 Ordering cost:-......................................................................................................48 Carrying Cost:-.....................................................................................................49 BENEFITS:-.........................................................................................................49 5.4 TECHNIQUES OF INVENTORY MANAGEMENT......................................49 Classification Problem:-.......................................................................................50 Quantity Problem:-...............................................................................................51 EOQ model:-........................................................................................................51 Approaches:-........................................................................................................52 6. INVENTORY MANAGEMENT AT NALCO................................................................54 7. MANAGEMENT OF ACCOUNTS RECEIVABLES..................................................62

ESTABLISHING OPTIMUM CREDIT POLICY..............................................63 7.1 ACCOUNTS RECEIVABLES MANAGEMENT AT NALCO.......................68 8. FINANCING OF WORKING CAPITAL.......................................................................72

TRADE CREDIT:- ..................................................................................................72 Types of bank finance for working capital...........................................................75 Security Required In Bank Finance.....................................................................77 9. WORKING CAPITAL MANAGEMENT ANALYSIS.................................................79

Current Assets Ratio.............................................................................................80 Liquid Ratio..........................................................................................................80 10. DEHEJA COMMITTEE REPORT..............................................................................84 11. TONDON COMMITTEE REPORT.............................................................................85 12. CONCLUSION ..............................................................................................................86 11. BIBLIOGRAPHY...........................................................................................................87


1. INTRODUCTION TO NALCO National Aluminium Company Limited (NALCO) is considered to be a turning point in the history of Indian Aluminium Industry. In a major leap forward, NALCO has not only addressed the need for self-sufficiency in aluminium but also given the country a technological edge in producing this strategy mental as per world standards. Incorporated in 1981 as a public sector enterprise, NALCO was set up to exploit a part of the large Bauxite deposits discovered in East Cost, in technological collaboration with aluminium pechiney of France (now Alcan).With consistent track record in capacity utilization, technology absorption, quality assurance, export performance and profitability, Nalco is a bright example of India’s industrial capability. Today, as an ISO 9001, ISO 14001 and OHSAS 18001 company, with its product registered in London Metal Exchange, Nalco has emerged as the largest integrated bauxitealumina-aluminium complex in ASIA. Now, Nalco enjoys the status of a Navratna company.

(Figure –1 NALCO Site )

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Working Capital Management

1.1 CORPORATE STRENGTH •

Captive Resources

Advanced Technology

Integrated Operation

World-class Products

Well-Trained Manpower

Sound Financial Management

Care For Ecology And Environment

Self-Funded Expansions

Expertise In Project Management

International Linkages in Technological & Market

1.2 BAUXITE MINE

(Figure –2 Bauxite Mine )


Working Capital Management

A fully mechanized open-cast mine of 4800000 tpa, on panchpatmali hills of Koraput district in Orissa, serves feed-stock to the Alumina Refinery at Damanjodi, located 16km downhill. The transportation is done through a 14.6km long single flight, multicurve, cable belt conveyor of 1800 tph capacity. The mining capacity is being expended to 6300000 tpa. Area of deposits

: 16 sq.km

Resources

: 310 million tonnes

Ore quality

: Alumina 45% Silica 2%

Mineralogy

: Over 90% gibbsitic

Over burden

: 3 mtr(avg.)

Ore thickness

: 14 mtr(avg.)

1.3 ALUMINA REFINERY

(Figure – 3 ALUMINA REFINERY )

The 1575000 tpa energy-efficient Alumina Refinery, having three parallel streams of equal capacity, is located in the picturesque valley of Damanjodi. The Refinery provides alumina to the company’s Smelter at Anugul and exports the balance


Working Capital Management

alumina to overseas markets through Visakhapatnam Port. Presently, it is being expanded to 2100000 tpa capacity.

1.4 SMELTER PLANT

(Figure – 3 SMELTER PLANT)

The 345000 tpa capacity Aluminium Smelter, located at Anugul in Orissa, is based on advanced technology of Smelter and pollution control. Its capacity is being further expanded to 460000 tpa. The Salient features of the plant includes: •

180 KA cell technology

Fume treatment with dry-scrubbing system

Manufacturing of carbon anodes, bus bars, anode stems etc.


Working Capital Management

•

Integrated facilities for manufacturing ingots, sows, billets, wire rods, strips and rolled products.

1.5 CAPTIVE POWER PLANT:-

(Figure – CAPTIVE POWER PLANT)

Close to the Aluminium Smelter Plant at Anugul, a captive Power Plant of 960 mw capacity has been established for firm supply of power to the Smelter. The coal demand of the plant is met from a dedicated mine of Mahanadi Coalfields Limited. The plant is also connected with the state Grid for sale of surplus power. The ongoing expansion shall raise its capacity to 1200 mw.


Working Capital Management

1.6 PORT FACILITIES:-

(Figure - 8 Ant Wall )

( Figure – PORT FACILITIES)

On the inner harbour of Visakhapatnam Port on the Bay Of Bengal, Nalco has established mechanized storage and ship handling facility for exporting alumina in bulk and importing caustic soda. This facility can handle ships up to 35000 DWT. Ship Loading Rate: 2200 tph Alumina Storage : 3*25000 tonnes Besides, Nalco exports from the ports of Paradeep and Kolkata.


Working Capital Management

1.7 ROLLED PRODUCTS UNIT:-

After acquisition and merger of International Aluminium Products Ltd., Nalco has started production from this 50000 tpa plant. This Rolled products unit is presently producing standard coils and sheets. Besides, it has facilities to produce foil stock, fin stock, cable wrap stock, coil stock and closure stock for a veriety of end uses.

1.8 ENVIRONMENT:-

Nalco assigns high importance to promotion and maintenance of a pollution-free environment in all its activities. The Environment Management Systems in all production/operation units conform to the ISO 14001 norms. Among numerous recognitions, the two highest national awards viz. Indira Gandhi Priyadarshini Vrikshamitra puraskar for plantation & afforestation and Indira Gandhi Paryavaran


Working Capital Management

Puraskar for environment management, conferred on the company by the ministry of Environment & Forests, Government of India, bear further testimony to Nalco’s commitment towards the environment.

1.9 COMMUNITY CARE:The Company has adopted a policy of playing a catalytic role in improving the quality of life of the people living in the peripheral villages, in collaboration with local government authorities.

The activities include: creation of infrastructure for communication, education, health care, water supply, apart from undertaking social forestry, organizing rural sports and supporting cultural activities


Working Capital Management

1.10 HRM PHILOSOPHY:•

To attract competent personnel with growth potential and develop their skills and capabilities in a congenial work and social environment through opportunities for training, recognition, career advancement and other incentives.

To develop and nurture favourable attitudes among the employees and to obtain their best contributions to the organisation by providing stable employment, safe working conditions, job satisfaction, quick redressal of grievances and through good pay and welfare amenities commensurate with the company’s capacity to spend and the Government’s guidelines.

To forest fellowship and sense of belongingness among all sections of employees through closer association of employees with the management and by encouraging healthy trade union practices.

1.11 HUMAN RESOURCES(Up to September 2008):-


Working Capital Management

Total

: 7466

SC/ST Representation

: 2517

Land Displaced Persons

: 1979

Physically Handicapped

: 74

Women Employees

: 320

1.12 EXPANSION PROGRAMME:-

In order to strengthen its business and increase market share, the company has been pursuing expansion programmes on a sustained basis. Soon after the completion of the 1st phase expansion, the company has launched its 2nd phase expansion, commencing


Working Capital Management

in October 2004, which involves fresh investment of more than Rs. 5000 crore. The project is nearing completion. Segment Bauxite Mines Aluminium Refinery Aluminium Smelter Power Point

Present capacity 4800000 tpa 1575000 tpa 345000 tpa 960 MW

Capacity under Expansion 6300000 tpa 2100000 tpa 460000 tpa 1200 MW

The company is now planning 3rd phase expansion with an investment of Rs. 6000 crore, which will increase, aluminium capacity to 5.80 lakhs tonnes and power generation to 1400 MW.

1.13 PRODUCTION & SALES:ALUMINA (IN ‘000 MTs)

1600 1400 1200 1000

P roduc tion

800

E x port

600

C olumn1

400 200 0

2004-2005

2005-2006

2006-2007

2007-2008

Values for the above chart Year 2004-2005

Production 1575

Export 909


Working Capital Management

2005-2006 2006-2007 2007-2008

1590 1475 1576

863 774 860

ALUMINIUM (In ‘000 MTs)

Value for the above chart Year 2004-2005 2005-2006 2006-2007 2007-2008

Production 338 359 359 360

Export sale 133 96 93 101

POWER (In Million Units)

Domestic sale 206 258 263 252


Working Capital Management

6000 5000 4000 G eneration

3000

S ale 2000 1000 0

2004-2005

2005-2006

2006-2007

2007-2008

Values for the above chart Year 2004-2005 2005-2006 2006-2007 2007-2008

Generation 5613 5679 5968 5609

Sale 406 322 421 129

1.14 FINANCIAL PERFORMANCE:TURNOVER & NET PROFIT (Rs. In crore)


Working Capital Management

7000 6000 5000 4000

S ales turnover

3000

Net P rofit

2000 1000 0

2004-2005

2005-2006

2006-2007

2007-2008

Values for the above chart

Year 2004-2005 2005-2006 2006-2007 2007-2008

Sales turnover 4420 5324 6515 5474

SALES TURNOVER (Rs. In crore)

Net Profit 1235 1562 2381 1632


Working Capital Management

4500 4000 3500 3000 2500 E x port

2000

Domes tic

1500 1000 500 0 2004-2005

2005-2006

2006-2007

2007-2008

Values for the above chart

Year 2004-2005 2005-2006 2006-2007 2007-2008

Export 2200 2306 2586 2134

DIVIDEND PAYMENT (Rs. In crore)

Domestic 2200 3018 3929 3340


Working Capital Management

600 500 400 300

A mount P aid % of Dividend

200 100 0 2004-2005

2005-2006

2006-2007

2007-2008

Values for the above chart

Year 2004-2005 2005-2006 2006-2007 2007-2008

Amount Paid 258 322 483 387

Dividend 40 50 75 60

1.15 QUALITY POLICY:Quality will form the core of our business philosophy. Meeting the needs and expectations of the customer and consistently improving our systems and work ethos will be our chosen path achieving excellence in business and fulfilling our social obligations.

Guiding Principles •

To ensure a healthy return on investment by maximising operational efficiency, capacity utilisation and productivity.


Working Capital Management

To continually improve and redesign systems, processes and practices in order to ensure error prevention and improve response time.

To adopt Internal Customer focus as a means to external customer satisfaction.

To treat human resources as the key to quality excellence and ensure development, involvement and satisfaction of employees.

To ensure high quality of inputs through proactive interaction with suppliers.

To meet obligations towards the society as a responsible corporate citizen.

To provide value for money to all stake holders.

To follow ethical business philosophy at all times.

Commitment We dedicate ourselves to the quality policy and objectives of the company in letter and spirit and commit to continuously strive for their fulfillment. ENVIRONMENT POLICY:In recognition of the interests of the society in securing sustainable industrial growth, compatible with a wholesome environment, National Aluminium Company Limited (NALCO) affirms that it assigns high importance to promotion and maintenance of a pollution-free environment in all its activities. •

To use non-pollution and environment – friendly technology.

To monitor regularly air, water land, noise and other environmental parameters.

To constantly improve upon the standards of pollution control and provide a leadership in environment management.

To develop employees’ awareness on environmental responsibilities and encourage adherence to sound environmental practices.


Working Capital Management

•

To work closely with Government & local authorities to prevent or minimise adverse consequences of the industrial activities on the environment.

•

To comply with all applicable laws governing environment protection through appropriate mechanisms.

•

To actively participate in social, welfare and environmental development activities of the locality around its units.


Working Capital Management

1.16 ALUMINIUM PROPERTIES & APPLICATIONS Aluminum – the wonder metal has many remarkable features


Working Capital Management


Working Capital Management

PRODUCTS Alumina:•

Calcined Alumina

Alumina Hydrate

Speciality Aluminas & Hydrates

Detergent Grade Zeolite

Aluminum Metal:(High Purity, CG, EC & LME grades) •

Standard Ingots (each approx. 20/22.5 kgs)

Sow Ingots (each max. 750 kgs)

Wire Rods (in coil form, 9.5/11.95 mm dia, weight approx. 2 mt)

Billets (in four sizes : 127+-1.5 mm / 152+-1.5 mm / 178+-1.5 mm / 203+-1.5 mm dia)

Cast strip (max. width 1600 mm, gauge 6 to 10 mm)

Flat Rolled Products (coils & sheets)


Working Capital Management

2. INTRODUCTION TO WORKING CAPITAL MANAGEMENT Financial management (the effective one) is the outcome or result among other things about proper management and investments of funds in business. Funds can be involved for permanent purposes such as acquisition of fixed assets, diversification of plants and machinery and research & development. Simple working capital returns to a firms investments in short term assets working capital or funds thus refers to the differences between inflow or outflow of funds or excess of current assets over current liabilities working capital management is concerned with the problems assets, the current liabilities and the inter-relationship between them. Working capital is considered as the nerve canter of business. The analysis of working capital as the firm’s main objective is to increase the wealth of shareholder and the wealth depends upon. The efficiency management of funds then should analyses investment in fixed along with short term assets. Every business needs funds for two purposes-for its establishment and to carry out its day-to-day operations. Long-term funds are required to create production facilities through purchase of fixed assets such as plant and machinery, land, building, furniture, etc. investments in these assets represents that part of firm’s capital which is blocked on a permanent or fixed basis and is called fixed capital. Funds are also needed for short-term purposes for the purchase of raw material, payments of wages and other day-to-day expenses, etc. These funds are known as working capital. In simple words, working capital refers to that part of firm’s capital which is required for financing short-term or current assets such as cash, marketable securities, debtors and


Working Capital Management

inventories. Funds, thus, invested in current assets keep revolving fast and are being constantly converted into cash and this cash out flows again in exchange for other current assets. Hence, it is also known as revolving or circulating capital or shortterm capital. In the words of Shubin, “Working capital is the amount of funds necessary to cover the cost of operating the enterprise.” According to Genestenberg, “Circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another, as for example, from cash to inventories, inventories to receivables, receivables into cash.”

OBJECTIVES OF THE STUDY: The project work is designed to fulfill the following objectives: To study the present system of working capital in the organization.  It protects a business from the adverse effects of shrinkage in the values of current assets.  It is possible to pay all the current obligations promptly and to take advantages of cash discounts.  To promote employment stabilization and identify the specific deviations of working capital funds.


Working Capital Management

3. CASH MANAGEMENT As we know that cash is the most important liquid asset of the firm, therefore the management of cash is a must for every financial manager for its holding in order to run the daily operations. Apart from this, cash is the common denominator to which all the current assets can be reduced because the other major liquid assets i.e. receivables and significance of cash management. Thus a major function of a finance manager is to maintain a sound finance position. In the narrow sense the other names termed as cash are currency, Cheques and drafts. The broader view of cash also includes near cash assets, such as marketable securities and deposits in bank. The basic characteristics of this near cash assets are that they can easily converted into cash. As we know that holding of cash has no earning power but when converted into cash these near cash items gives some profit to the firm. Thus it serves as a short-term investment. Basically management is concerned with managing of:1: cash flows into and out of firm. 2: cash flow within the firm. 3: cash balances held by the firm at a point of time by financing deficit or investing surplus cash.

3.1 OBJECTIVES OF CASH MANAGEMENT The basic objectives of cash management are:A: To meet cash disbursement needs. B: To minimize funds committed cash balances.


Working Capital Management

In the normal operations of business firms are to make payments of cash on a continuous and regular basis to supply of goods, employees and so on. At the same instant cash comes constantly through the collection of debtors. A basis objective of cash management is to meet the payment schedule that is to have sufficient cash to meet the cash disbursement need of the firm. The advantages of adequate cash are it prevents insolvency or bankruptcy arising out of the inability to pay it’s obligations, helps in making payments on due date, thus availed cash or trade discounts. Excessive cash holdings lead to a strong credit rating which enables the firm to purchase goods on favorable terms and to maintain its line of credit with banks and other sources of credit. The firm can take the advantage of favorable business opportunities that may be available periodically. Lastly it can help during emergency. In minimizing the cash balances two conflicting aspects have to be reconciled. A high level of cash balances will ensure prompt payment together with all the advantages. But it also makes large amount of funds remain idle, as cash is a nonearning asset. A low level of cash balances on the other hand may mean failure to meet the payment schedule. The aim of cash management should be to have an optimal amount of cash balances.

3.2 MOTIVES FOR CASH HOLDING From the objective of cash management we know that cash is held by firm for various profitable purposes. If we assign these objectives we can say cash is held mainly for three motives:(1). Transaction motive. (2). Precautionary motive. (3). Speculative motive. (1). Transaction Motive:The principle is that the firm has to maintain certain level of cash to maintain its operation in the ordinary course of business. The firm needs cash primarily to make payments for wages, purchase, other operating expenses, taxes, dividends and


Working Capital Management

contingencies. Similarly there is a regular inflow of cash to the firm from sales operation, return on outside investments. These receipts and payments constitute a two way flow of cash. The need of holding cash would not arsis if there is perfect synchronization between cash receipts and cash payments. But the inflows(receipts) & outflows(payments) do not perfectly synchronize or coincide. When cash payment exceeds cash receipts, the firm needs to maintain a certain level of cash balance to be able to make timely payments, the firm may invest its cash in marketable securities, whose maturity confirms to the timing of the anticipated payments, such as payment of taxes, dividends, etc. (2).precautionary Motive:In addition to the non synchronization of anticipated cash inflows and outflows of a firm should hold cash for different un-anticipated events. The precautionary amount of cash depends upon the predicted cash flows. The emergency cash balanced can be maintained after predicting the cash flow. Thus precautionary cash balance serves to provide a cushion to meet unexpected demands upon the predicted cash flows. The resemblance serves to provide a quotient meet unexpected contingencies. The more unpredicted the cash flows the larger the need for such balances. Another factor which has a bearing as the level of such cash balances is the availability of the short term credit if the firm can borrow at a short notice, then there is no need to maintain a huge balance. (3).Speculative Motive:This motive refers to the decision of the firm to take advantages of available opportunities which comes out of unexpected times and which is typically outside the normal course of business. Suppose there is attend of not raising prices of certain shares in stock market, at that time the firm may invest in that security for this they need. The speculative represents a positive and aggressive approach. Therefore firms keep necessary cash balances in order to exploit the opportunities.

3.3 CASH PLANNING: As we know that if there can be a perfect synchronization of cash inflows and cash outflows then there would have no problem in making payments and for investments.


Working Capital Management

But generally this does not happens sometimes cash payments exceed cash receipts. This cash poor position and idle cash position can be avoided if there planned in advance. Thus, cash planning can help to anticipate future cash flows and need of the firm and reduces the possibility of cash

balances.

Cash planning is teaching to plan and control of the cash. Cash planning helps in developing a projected (estimated) cash statement by forecasting the expected cash floes for a given period which helps in protecting the firm from the financial disaster. The forecast may be based on present operations. Cash planning may be done on daily, weekly or monthly basis which depends upon the like and nature of business.

3.4 CASH FORECASTING & BUDGETING Simply cash budget is a forecast or cash flows. This is also referred to as ways and means to budget. It is a summery statement of the firm expected cash inflow and outflow over a projected time period. It gives information on the timing and magnitude of expected cash flows and cash balances over a projected period. Which helps the finance manager to determine the future cash needs of the firm, plan for financing the needs and excessive control over the cash and liquidity of the firm? Cash budget may be done weekly; monthly or semi-annual basis totally depends upon the nature of the firm and the amount of the fluctuations. The purpose of cash budget is to co-ordinate the timing of cash needs. Cash forecasting may be short term or long term forecasting. SHORT TERM FORECAST:The function of short term forecasting includes the cash requirements, the future availability of short term finance and the investment of surplus cash. The other advantages of short term forecasting includes:(a)

Planning, Reduction of short term and long term debt.

(b)

Selection and amount of inventories to be purchased.

(c)

Taking advantages of cash and discount offered by suppliers.

Mostly two types of methods are used in short term forecasting:-


Working Capital Management

. Receipts and payment method . The adjusted net income method Receipts and Payment Method:This method is used to forecast all the receipts and disbursement which are accepted during this year. The main objective is to summarize these flows during the pre-determined period. This method is very useful in those case where the item is expensive and are considered important. The factors that generate cash flow are generally divided for the purpose of cash budget into three broad categories:(1) Operating (2) Non-operating (3) Financing (1)

Operating:- Among the operating factors affecting the cash flows are the collection of accounts receivable. Cash sales and collection from customers are important parts of the operating cash inflows. The term of credit and the speed with which the customers pay would determine the lag between the circulation of the accounts receivable and the bill collection, also discounts allowances for early payments returns from the customers and bad debts affects the cash inflows.

(2)

Non-Operating:- Non-operating cash inflows include sale of old assets, dividend received and interest received on investment. The amount may be very less but are useful when internal generated source are insufficient.

(3)

Financial:- Financial sources are also responsible for cash inflows, financial sources include borrowing insurance of securities etc. The cash out flows are of three types:Operating outflows Capital expenditures Contractual payment

Operating outflows like cash purchase, payments of payables, advances to supplier, wages & salaries and others are also important part of cash budget.


Working Capital Management

Capital expenditure includes purchase of machinery, investment casts, etc. Contractual payments like repayments of loans and interests, taxes payments, discretionary payments like common & preference dividends etc. are also considered while preparing cash budgets.

Adjusted Net Income Method:This method also called as sources and uses approach. It predicts the firm’s future requirements of cash, how much it can generate internally and externally. It is intact a projected cash flows statement. It has three parts or sources and uses of cash and cash balances. In preparing such forecast items such as net income, depreciation, taxes, dividends, etc. can easily be determined from the costs annual operating budget. The estimates of receivable and payable pose problem because they are influenced by different factors creating difficulty in estimating working capital changes. The major benefits of net income method are that it helps in keeping a control on working capital and anticipating financial requirements. LONG TERM FORECASTING:Long term forecasting is made keeping the companies future financial objectives in mind. They are very much prone to different environmental impacts such as product development, sudden policy changes of government etc. These forecasts are generally made for more than three years. The major uses are:(a)

Company’s future working capital needs.

(b)

Companies long term projected are evaluated in terms of finance.

(c)

Helps in corporate planning.

Long term forecasting can be made with receipts and disbursement method adjusted net income methods which are used for short term forecasts. Long term forecasts reflect the impact of growth, expansion or acquisition.

3. 5 MANAGEMENT OF CASH FLOW: The strategy aspects of efficient cash management are:-


Working Capital Management

(a)

Speedy Collection Of Accounts Receivable

(b)

Delaying Payments On Accounts Payable

(a)

Speedy Collection Of Accounts Receivable:-

Accelerating Cash Collection: - For efficient cash management, the cash inflow process can be accelerated through systematic, planning and refined techniques. For this customers should be encouraged to make the payments promptly and the receipts from customers should be converted into cash immediately. Prompt Payments: - For this you have avoid order processing float i.e.:- the time taken to get the invoice to the buyer. This can be removed by prompt billing. At the same time you have to discourage the buyers float i.e.:- the extra time enjoyed by the buyer for paying bills. Early Conversion of Payment into Cash: - Once the customer makes the payments by writing a cheque in favour of the firm, the collection can be expected by prompt encasement of the cheque. This can be done by:(a)

Removing postal float i.e.:- the time taken by the post office to transfer the cheque from the customer to the firm.

(b)

Time taken in processing the cheque within the firm before their deposited in bank.

(c)

Collection time within the bank. This total delayed in time is Called deposit float. An important aspect at cash management Decentralized collection.

There are two methods in decentralized collection:(1)

Concentration Banking

(2)

Lock-Box Method


Working Capital Management

(1)

Concentration Banking: - In this case customer of a particular area make payments to a company headquarter. The local branch office rather than to a company headquarter. The local branch office then deposits the cheques into a local bank account. Surplus funds are periodically transferred to a concentration account at one of the company’s principal banks. Concentration banking brings small balances together into central balances, which then can be invested in interest paying assets through a single transaction. Concentration Banking reduces mailing time and time taken to clear the cheques. It has some limitations; first it involves administrative costs to reward the banks for their services and cost of transferring funds to the concentration banks.

(2)

Lock-Box System: - Often concentration bank combined with a lock-box system. In a lock-box system the company rents a locked post office box in each principal region are instructed to send their payments to the post office box. The local bank as agent for the company empties the box at regular intervals and deposits the cheques in the company’s local account. Surplus funds are transferred periodically to one of the company’s principal banks.

3.6 DELAYING PAYMENT: The effective control of disbursement can also help the firm in conserving cash and reducing the financial requirements. Disbursement arises due to the trade credit. The firm can take maximum advantages of trade credits. As sources of funds by paying later than agreed. But this may in danger the firm’s credit position. The firm also uses the technique of paying the float to minimize, the availability of funds. But this is a risky game and should be discouraged. Excess cash should normally be invested in marketable securities.


Working Capital Management

4. CASH MANAGEMENT AT NALCO As we know that Nalco is a profit making company having a profit of Rs. 2491.98 Crores in the year ended 31st March 2008. The optimum level of cash balance is prepared by means of cash budget. From this they forecast the future cash flow. As Nalco is a cash rich company, each department has the full liberty to spend, but they have to inform the daily transactions to the corporate office. Also cash report is prepared monthly. When there is shortage of cash i.e. cash balance goes below the minimum level, it fulfils the gap by liquidating the marketable securities. When there is excess of cash, it invests them first in purchasing marketable securities, then it lend to associates, then pay to the liabilities. Mainly CDA/Deposits are purchased when there is excess of cash. For collection of cash flow centralized collection method is applied. Disbursement is also centralized. Daily cash transaction is done on computer system of account, thus avoiding the manual error. Different instruments are used for collection, but preference is given to drafts & then letter of credit (LOC). Company also dues the float for its working capital requirements, sometimes. Also company tries to find out the buffer or safety stock, but dependent on the bank finance. ANALYSIS Cash Trend:Year 2003-2004 2004-2005

Cash & Bank Balance(Rs. In Crores) 98.36 755.21


Working Capital Management

2005-2006 2006-2007 2007-2008 .

2193.71 3686.53 3516.46

The reflections of these variations can be seen from the cash & bank balance increases very rapidly from 2003-2004 to 2006-2007, but in the year 2007-2008 it decreases as compared to the previous years. CASH TURNOVER RATIO

Cash turnover = Sales/Closing Cash Balances

(Rs. In crores) Year

Sales

2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

3114.37 4123.96 4851.90 5940.19 4988.80

Closing Cash

Cash Turnover

Balances 98.36 755.21 2193.71 3686.53 3516.46

Ratio 31.66 5.46 2.21 1.61 1.42

Cash turnover ratio shows that per rupee of sales, how much cash is to be employed. That means to generate one rupee of sales the firm need, what should be the amount of cash. It indicates the number of times cash is turnover in the course of a year. This turnover ratio indicates the velocity of utilization of cash. From the above table it can be seen that sales is increasing very rapidly from 20032004 to 2006-2007. Sales increases up to 5940.19 crores but it decreases in the year 2007-2008 to 4988-80 crores. But when we come across the trend of ratio, it can be seen that even if sales and cash balance are increasing, ratio is fluctuating. In the year 2003-2004 the cash turnover ratio is 31.66 crores but it decreases very drastically in 2004-2005 then after words it decreases proportionately and by the end in the year 2007-2008 it reaches to around 1.42 crores.


Working Capital Management

CASH IN TERMS OF NUMBER OF DAYS OF OBLIGATION Cash in terms of no. of days = 365 days/Cash turnover (Rs. In Crores) Year 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

Cash Turnover

Number of days in Cash

31.66 5.46 2.21 1.61 1.42

a year 365 365 365 365 365

Holding

Period 12days 67 days 166 days 227 days 258 days

We can see that as the ratio of cash turnover is fluctuating, i.e. there is a sudden drop from 31.66 crores in 2003-2004 to 5.46 crores in 2004-2005. The cash in terms of number of days of obligation also jumps from 12 days in 2003-2004 to 67days in 2004-2005. Then again it goes up to 258 days in the year 2007-2008. So, there is a complete controlled over the cash balance. CASH TO CURRENT ASSET PERCENTAGE Cash to current asset percentage = cash/current asset*100 (Rs. In Crores) Year 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

Cash 98.36 755.21 2193.71 3686.53 3516.46

Current Asset 990.51 1811.04 3297.88 4974.08 5041.33

Percentage 9.93 41.70 66.52 74.11 69.75


Working Capital Management

This ratio indicates that what is the percentage of cash to current assets i.e. whether cash captures a major portion of current asset or not? As idle cash generates nothing, and in the same time lack of cash will lead to stoppage of work there is a need for optimal cash balance. The firm should try as much to finance the working capital with other current assets provided the other current assets giving profits. It can be observed from the above data that cash increases from 98.36 crores to 3686.53 crores in (2003-2004) to (2006-2007) but it decreases to 3516.46 crores in the year (2007-2008). Like wise current asset increases from 990.51 crores (2003-2004) to 5041.33 crores(2007-2008). So all the fluctuations in cash as well as current assets comes to a mixed picture in the ratios. The ratio trend increases from 9.93% (2003-2004) to 41.70% (2004-2005). In 2005-2006 the ratio was 66.52% while in 2006-2007 it was 74.11%. this increase may due to increase in current asset. In 2007-2008 it decreases to 69.75% due to decrease in cash balance. ABSOLUTE LIQUID RATIO Absolute Liquid Asset= Quick asset/ Current liability (Rs. In crores) Year 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

Quick Assets 510.03 1281.98 2706.30 4339.12 4354.68

Current Liability

Absolute

864.28 806.39 940.15 1218.61 1540.88

Ratio 0.59 1.59 2.88 3.56 2.83

Liquid

Although there are other current assets like receivables, debtors, etc., yet there may be doubts regarding their realisation into cash immediately or in time. So, this ratio should be calculated along with current ratio and acid test ratio to examine the liquidity of the firm at worst emergency time.


Working Capital Management

It can be seen that there is an increase in quick assets from Rs. 510.03 crores in 20032004 to Rs. 1281.98 crores in 2004-2005. It also increases the quick assets in every year. This may arise due to increase in cash balance. Current liability drops from Rs. 864.28 crores in 2003-2004 to Rs. 806.39 crores in 2004-2005. In the year 2005-2006 it increases to Rs. 940.15 crores and so on. Due to the fluctuations in both current assets and current liability, the ratio was 0.59 in 2003-2004 then it becomes 1.59 in 2004-2005. This may be done due to decrease in current liability from Rs. 64.28 crores to Rs. 806.39 crores and increase in quick asset from Rs. 510.03 crores to Rs. 1281.98 crores. Then it again rises from 1.59 to 2.88 in 2005-2006 and a sudden increase from 2.88 to 3.56 in 2006-2007. Again the ratio drops to 2.83 in 2007-2008. This may happen due to increases in current liability. PERCENTAGE OF SHORT TERM DEPOSITS TO CASH BALANCES Percentage of short term deposits to cash balances= Short term deposits / Cash balances *100

(Rs. In crores) Year 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

Cash Balances

Short term/ Fixed

Percentage

98.36 755.21 2193.71 3686.53 3516.46

deposits 8.92 13.85 8.37 16.22 16.03

9.07 1.83 0.38 0.44 0.46

It shows that cash trend although increasing, has a drop in the year 2007-2008. Short term / fixed deposits is rather fluctuating irrespective of increasing cash balances. In 2003-2004 it was Rs. 8.92, increases to Rs. 13.85. This may be due to increase in cash balance. The deposits decreases to Rs. 8.37 in 2005-2006 and again increases to Rs. 16.22 in the year 2006-2007 and at last year it decreases to Rs. 16.03.


Working Capital Management

It can be seen that nearly all the cash is deposited in short term / fixed deposits. In 2003-2004 it was 9.07%, while in 2004-2005 it decreases to 1.83% and it again decreases to 0.38% and further rises to 0.44% in 2006-2007 and 0.46% in 2007-2008.

SUMMARY From the cash trend it is seen cash is increasing each year expect in 2007-2008, which is a good sign for the firm. But the real good sign can be shown / known from the cash turnover in sales ratio. From cash turnover sales ratio it is seen that cash turn ratio in 2003-2004 was 31.66. This indicates that per one rupee of sales of cash. This was a very good performance of the firm. Next year it decreases to 5.46. Again it decreases to 2.21 in 2005-2006. In 2006-2007 and in 2007-2008 it comes to 1.42. If the ratio decreases in the next future year it would not be a healthier indication for the firm. The cash in terms of number of days of obligation in 2003-2004 is only 11.53 days, which is a good sign. But then it starts increasing to 257.04 days in 2007-2008. Looking at the cash to current asset ratio and absolute liquid ratio, it seems that Nalco is a cash rich company and has heavy amount idle cash. The cash to Current Asset in 2003-2004 is 9.93% increases to 41.70% in 2004-2005 and it rises up to 74.11% in 2006-2007. But in the year 2007-2008 it reduces to 69.75%. So, it can be seen that cash has a major portion in filling the working capital gap. This position can also be understood from the absolute liquid ratio. The standard ratio for absolute liquid ratio is 0.5. But in Nalco it was for absolute liquid ratio is 0.5. But in Nalco it was always above 1.00 expect in 2003-2004. The table showing percentage of short term / fixed deposits to each cash balance, it can be well understood that Nalco has not much of idle cash, because it invests a larger amount of cash balance in short term or fixed deposits.


Working Capital Management


Working Capital Management

5. INVENTORY MANAGEMENT One of the major portions of working capital constitutes inventory, which is the most significant part of current assets. The term inventory refers to stockpile of the product a firm is offering for sale and the components that make up the product. The major difference between inventory and other current assets is that in case of inventory person from different fields like marketing, purchasing, research and development, finance are involved. So its management should be done both commercially and scientifically, this predominant position of inventories in total working capital obviously cost for the maximum efficient management of working capital.

5.1 COMPONENTS OF INVENTORY: The word “inventory” is understood differently by various authors. In accounting language it may mean a stock of finished goods only. In manufacturing concern it may include raw materials, work-in-progress, store supplies etc. To understand the exact meaning of the word inventory we may study it may from the usage side or from the “side of point of entry” in the operations. The inventory consists of:1) Raw Material:These are the primary products purchased by the firm to convert into useable products through the manufacturing process. They are required to carry out production activities uninterruptedly. The quantity of raw materials required will be determined by the rate of consumption and the time required for replenishing the supplies.

2) Work-in-Progress:These are the basic inputs which have gone through at least one of the manufacturing operation and are stored for future operations. These products are


Working Capital Management

then processed for finished goods. The quantum of working process depends upon the time taken in the manufacturing process. 3) Finished Goods:These are the products which have gone through the total operations and are ready to use. Finished goods are store to effective marketing operations. 4) Supply:This kind of inventory maintained by the firm for the necessity of smooth operation. Mainly lubricants, lights, bulbs, etc. which do not enter production process. This supply contains a small part of inventory.

5.2 NEED TO HOLD INVENTORIES: If the question arises why do we need to hold inventory? The answer is same as that of holding cash. There are three general motives for holding inventories:•

Precautionary motive

Transitive motive

Speculative motive

PRECAUTIONARY MOTIVE:This motive emphasis the need for holding of inventories against the risk associated with the short-term supply of raw material and semi-finished goods. It is impossible for the firm to predict all the future irregularities and risks attached with the supply of raw material. So they keep inventory in order to keep the business going without any risk. TRANSITIVE MOTIVE:This motive emphasizes the need to hold inventories for the uninterrupted flow of production operations. It is impossible for the firm to get raw material in time, to predict the wastages during production. There is a time lag between demand for materials and supply materials. For this difficulty the firm maintains a certain level of inventory for this smooth operation.


Working Capital Management

SPECULATIVE MOTIVE:This motive emphasizes the need to purchase raw materials by taking the optimum advantage of time and facilities available. The firm reduces or increases the inventory according to the price situations. Other factors which may affect the purchase decisions are discounts, unanticipated inventory.

5.3 OBJECTIVES: The primary objectives of inventory management are:•

To minimize the possibilities of disruption in the production schedule of a firm for a want of raw materials, stores and spares etc.

To keep down capital investment in inventories.

These two converse objectives call for an optimum level of inventory. The optimum level of inventory sought for striking a balance between excessive and too little inventory. The efficient management and effective control of inventories help in achieving better operational results and reducing investment in working capital which have a bearing on the maximization of owner’s wealth or net worth. The major objective of the financial manager is to use the funds in maintaining an optimum level of inventory is determined on the basis of the trade-off between costs and benefits associated within the level of inventory. COSTS:There are several costs included in maintaining and inventory we categorized them as follows:Ordering cost:Also known as the acquisition or set up costs are the entire costs associated with the acquisition of raw materials. It includes costs of requisitioning, purchase ordering, transporting, receiving, inspecting and storing. This cost is directly proportional to the number of orders placed and inversely related to the size of inventory. Thus such costs can be minimized by placing fewer orders for a larger amount. But acquisition of a larger quantity would increase the cost associated with the maintenance of inventory that is carrying cost.


Working Capital Management

Carrying Cost:a) Those cost arising out of storing materials i.e. tax, depreciation, insurance, maintenance of the building, utilities and janitorial services, detritions of materials due to pilferage, fire etc and service costs i.e. labour for handling inventory clerical and supervision cost. b) The opportunity cost of funds which are in raising the finance of acquisition of inventory which may have used in any profitable work. Carrying cost is directly proportional to the size of inventory. The sum of ordering cost and carrying cost contribute total cost. BENEFITS:Benefits are the functions of the firm. In other words inventories performed certain basic functions which are of crucial importance in the firm’s production and marketing strategies. 1) Benefits in Purchasing:The purchase of raw materials should not be tied to the production of sales. The efficient method of purchase sought for taking the advantages available if you purchase larger quantities, then you should go for it. Again this bulk purchase may decrease the ordering cost. 2) Benefits in Production:During the pick sale season the firm should go for higher production. For this firm may need for larger inventory. Again this reduces the carrying costs. Otherwise you should carry on production continuously and make an extra inventory of finished goods which can be sold during the period of seasonal demand. 3) Benefits in Sales:The maintenance of inventory also helps a firm to enhance its sales efforts. If there is no inventory of finished goods the sales have to be depend upon the Current production; which hampers firms supply position. So inventories held in order to bridge the gap between the current productions and actual sales. Inventory thus ensures the continued patronage of customers.

5.4 TECHNIQUES OF INVENTORY MANAGEMENT As it been figured out that the financial manager should aim at an optimum level of inventory on the basis of the trade-off between cost and benefit to maximize the


Working Capital Management

owners wealth. For this he has to use some mathematical techniques to solve the problems arise at the time of determination of stock level. Major problem are the classification problem i.e. how much to order and when to order.

Classification Problem:a) ABC Analysis:The first step in the inventory control system is classification of different types of inventories to determine the type and degree of control require for each material. Some items account for major portion of total consumption value of all the items, but they are small in number. Efficient inventory management demands that item of higher value should attract greater attraction of the management. This objective is achieved by selective control techniques or ABC analysis. This ABC analysis is also known as always better control. ABC analysis is based on the concept that inventory item should be ranked according to their relative investments in each item in inventory. This ABC analysis concentrates on important terms and also known as control by importance and exception. As items are classified in the importance of their value, this approach is known as proportional value analysis. The inventories are grouped as follows:Group

Investment

A

Large

B

Reasonable

C

Least

Inventory Control Most rigorous, intensive and Sophisticated method Less Sophisticated method then Group A Minimum attention on control

The following steps are involve in implementing the ABC analysis:•

Classifies the items of inventories, determining the expected use in units and the price for unit of each item.


Working Capital Management

Determining the total value of each item by multiplying the expected units by its unit price.

Rank the items in accordance with the total value giving first rank to the item with highest total value and so on.

Compute the ratios of numbers of units of each item to total units of all items and the ratios of total value of each item to total value of all items.

Combine items on the basis of their relative value to form three categories A, B&C.

b) VED Analysis:VED analysis is generally used for spare parts. The requirements and urgency of spare parts is different from that of materials. ABC analysis may not be properly used for spare parts. The demand for spares depends upon the performance of the plant and machinery. Spare parts are classified as Vital (V), Essential (E), and Desirable (D). Vital spares are must be stored adequately. The non availability of vital spares will cause havoc in the concern. The E type of spares is also necessary but their stocks may be kept at low figures. The stocking of D type of spares may be avoided at times. If the lead time of this spares is less than stocking of this spares can be avoided. The classification of spares under three categories is an important decision. A wrong classification will create difficulties for the production department.

Quantity Problem:EOQ model:One of the major problems is how much inventory is to be added when inventory is replenished, and should the quantity be purchased large/small or in one lot. The task of the firm is to determine or economic order quantity. The determination of inventory level calls for trade-off between ordering cost and carrying cost and the benefits. Generally economic order quantity it is assumed that cost off managing inventories is composed of two costs:-carrying cost & ordering cost.


Working Capital Management

Assumptions:The EOQ model, as a technique to determine the economic order quantity is based on three assumptions 1) The firm is aware of its annual usage. 2) The rate at which the firms uses inventory is steady over time. 3) The order placed to replenished inventory stocks are received at exactly that point in time when inventory reaches zero. Approaches:1) Trial and error approach:The firm has different options. It can buy all inventories in one lot required for one accounting year or it can buy in small lots periodically, say weekly, monthly, quarterly, etc. The lower the inventory the higher the carrying cost. The EOQ uses different permutation and combination of lots of inventory purchase. EOQ is the order size with lowest total of carrying costs and using costs. The EOQ is calculated in the following steps:Total inventory requirement No of order =

Order size

Average inventory = Order size / 2 Total carrying cost = average inventory *carrying cost per unit Total ordering cost= no of orders *cost per unit Total cost= cost of items purchased +total carrying cost and ordering cost The quantity which gives the lowest total cost is the EOQ. Another formula for calculating EOQ:EOQ= 2so / c


Working Capital Management

Where S= total inventory requirement in units O=ordering cost per order C=carrying cost per unit 2) Graphic approach:The EOQ can be calculated from the following graph also. In the above graph costs (both carrying and ordering along with total) are taken in Yaxis and order size is taken in X-axis. It is seen that total carrying costs increases with regard to increase in order size and ordering cost decline as there is less no. of orders. The total cost line seems to decline at instances but start rising when the decreases in average ordering cost is more than offset by the increase in carrying cost. The EOQ occurs at the point E where the total unit is minimum. Thus firms operating profit is optimum at point E. 3) When to order (Order point problem):Another problem in inventory management is determination of re-order point. Reorder point is that inventory level at which an order should be placed to replenish the inventory. To determine the reorder point with accuracy we have to calculate. (i)Lead time (ii)Average usage (iii)EOQ Lead time refers to the time taken in receiving the delivery of the inventory after placing orders to the suppliers. It covers the time span from the point when a decision to place an order for the procurement of inventory is made to the actual receipt of the inventory by the firm. Thus reorder point =lead time*average usage

4) Safety stocks:We have already determined the EOQ and reorder point which are calculated under some conditions of certainty. But real world situations are very much uncertain. Thus the lead time and average usage cannot be calculated accurately.


Working Capital Management

6. INVENTORY MANAGEMENT AT NALCO As Nalco is one of the largest limited companies of India with a huge production in every year, it has to employ a huge amount in investment in current assets, mainly to maintain the size of inventory. So, Nalco has to go through all the methods and formalities required in inventory management from purchasing and supervision to disbursements. The inventory in Nalco contains both raw materials and finished goods of intermediaries. Raw Materials:Caustic Soda C.P.Coke C.T.Pitch Aluminium Flouride Lime Others(Calcined Alumina) Finished Goods and Intermediary:Bauxite Aluminium Hydrate Calcined Aluminium Aluminium Ingots Aluminium Wire Rods Other Items Purchase Procedure:Due to large investment in inventories the purchase procedure is equally tough for Nalco officials. They have mainly few suppliers. For the purchasing work all the formalities are maintained.


Working Capital Management

Valuation of Inventory:Raw materials, stares of spare parts and loose tools are valued at weighted average cost. Finished goods are valued at the lower of cost or net realizable value. Intermediary products are valued at direct material cost. Value of scrap is recognized in the accounts as and when sold. The minimum level of inventory is determined by the EOQ model, i.e. by consumption during lead period and safety stocks. For this the trial and error method is applied. Mainly fixed order quantity system is followed.

Inventory report is prepared every month in Nalco, because there is necessity to check all the purchases, wastages, etc., to keep a balance. As we know that there is a need for clarification of inventory, Nalco is doing ABC Analysis for such classification i.e. classifying inventory according to their investments. For stores and spares the company is following vital, essential, desirable (VED) analysis. Size of Inventory and Inventory Trend:Inventory in Nalco mainly comprises of:(a)

Raw Material

(b)

Finished Goods

(c)

Stores & Spares


Working Capital Management

RAW MATERIAL TURN OVER RATIO (Rs. In Crores) Year

Raw Material

2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

48.08 56.17 50.48 82.45 65.59

Finished

Stores &

Total

Goods 148.85 175.41 235.35 346.60 266.93

Spares 251.42 260.12 241.03 247.94 268.66

Inventories 448.35 491.70 526.86 576.99 601.18

From the above table we can see that raw materials always increasing except in 20052006, where it dropped to Rs. 50.48 Crores from Rs. 56.17 Crores in 2004-2005. Again it rises and reaches up to Rs. 82.45 Crores in 2006-2007 and it again decreases to Rs. 65.59 Crores in 2007-2008. Finished goods are always in increasing trend. In the year 2003-2004 it was Rs. 148.85 crores and it was gradually increases in every year and at last it reaches up to Rs. 266.93 crores in the year 2007-2008. But the inventory of stores and spares is always increasing except in the year 20052006, where it dropped to Rs. 241.03 Crores from Rs. 260.12 Crores. Again it rises and reaches up to Rs. 268.66 Crores in 2007-2008. Mixing all the figures we are getting that total inventory was increasing each year from 2003-2004 to 2007-2008. In 2003-2004 it was Rs. 448.35 Crores and it was gradually increases and reaches to Rs. 601.18 Crores in the year 2007-2008.

FINISHED GOODS TURNOVER RATIO Finished Goods Turnover Ratio= Cost of goods sold/ Average Finished goods inventory

(Rs. In Crores) Year

Cost of goods

Average

Finished

Finished


Working Capital Management

sold 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

1658.03 1905.86 2278.67 2342.41 2738.09

finished goods

goods

goods storage

inventory 143.225 162.130 205.380 240.975 256.765

turnover ratio 11.57 11.75 11.09 9.72 10.66

period (days) 32 days 32 days 33 days 38 days 35 days

The finished goods turnover ratio shows how rapidly the finished goods are turning into receivables through sales. Generally a high level of turnover is indicative of goods inventory management. A low turnover implies excessive inventory of finished goods levels than warranted by sales activity, or a slow moving or absolute inventory. Slow disposal of stocks will mean slow recovery of cash, hence will effect the liquidity position of the firm. From the above table it can be observed that cost of goods sold is increasing from 2003-2004 to 2007-2008. In 2003-2004 it was Rs. 1658.03 Crores in 2004-2005 Rs. 1905.86 Crores and rises up to Rs. 2738.09 Crores in 2007-2008. Average finished goods inventory also inventory is also in increasing trend. In 20032004 it was Rs. 143.225 Crores & in the year 2004-2005 it was Rs. 162.13 Crores and finally reaches to Rs. 256.765 Crores in 2007-2008. Looking at the turnover ratio, it can be seen that ratio is increasing from 2003-2004 to 2004-2005. In 2003-2004 it was 11.57 & in 2004-2005 it was 11.75. In 2005-2006 it decreases to 11.09 and. It also gradually decreases to 10.66 in the year 2007-2008. The total picture is reflected in the storage period also. The storage period is always increases except in the year 2004-2005 & 2007-2008 i.e. in the year 2004-2005 it was 32 days & in the year 2007-2008 it was 35days. SPARE PARTS & STORES TURNOVER RATIO Stores & Spares Turnover Ratio= Stores & spares consumed /Avg. stores of spares


Working Capital Management

(Rs. In Crores) Year

Stores & Spares Consumed

Avg. Stores & Spares

2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

176.73 170.24 224.51 215.34 209.88

250.195 255.77 250.58 244.49 258.30

Stores & Spares Turnover Ratio 0.71 0.66 0.89 0.88 0.81

Storage Period In Days 515days 554 days 411 days 415 days 451 days

From the above table it can be seen that the stores & spares consumed inventory is increase in the year 2003-2004 & 2005-2006 i.e. Rs. 176.73 Crores and Rs. 224.51 Crores but in remaining three years it decreases gradually. The trend of average stores & spares inventory is in fluctuation phase. In 2003-2004 it was Rs. 250.195 Crores, in 2004-2005 it increases to Rs. 255.77 Crores and in 20052006 it drops to Rs 250.58 Crores, in 2006-2007 also it drops down to Rs. 244.49 Crores but finally in the year 2007-2008 it increases to Rs. 258.30 Crores. The reflection is on the stores & spares inventory ratios. You can see that ratio in all 5 years is below 1. In the year 2003-2004 it was 0.71, in 2004-2005 it decreases to 0.66, it again increases to 0.89 but in further two year i.e. in 2006-2007 & 2007-2008 it decreases i.e. 0.88 & 0.81 respectively. As a result of which the stores of spares conversion days shows that in the year 20032004 it was 515days and it was increased in the year 2004-2005 to 554 days. But in next three years the conversion days decreases as compared to 2004-2005. Stores & Spares turnover ratio which is the ratio between stores of spares consumed versus average stores & spares inventory, shows how effectively stores & spares inventory is used in emergency times and in the course of business. TOTAL INVENTORY TURNOVER RATIO Total Inventory Turnover Ratio= Sales / Avg. Inventory (Rs. In Crores)


Working Capital Management

Year 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

Avg. Inventory 480.48 529.06 591.58 634.96 686.65

Sales 3114.37 4123.96 4851.90 5940.19 4988.80

Turnover Ratio 6.48 7.79 8.20 9.35 7.27

Conversion Period 57 days 47 days 45 days 40 days 51 days

Inventory turnover ratio measures the velocity of conversion of stock into sales. Usually a high inventory turnover / stock velocity indicates efficient management of inventory because more frequently the stocks are sold, the lesser amount of money is required to finance the inventory. A low inventory turnover ratio implies to an inefficient inventory management. Or in other words the selling activity of the firm is whether efficient or not, can be known from this ratio. From the above table it indicates that the average inventory increases from 2003-2004 to 2007-2008. In 2003-2004 the average inventory Rs. 480.48 Crores and it gradually increases & reaches to Rs. 686.65 Crores in the year 2007-2008. In 2003-2004 the sales figures was Rs. 3114.37 Crores and it increases to Rs. 4123.96 Crores in 2004-2005 and it rapidly increases for the next two years & finally reaches to Rs. 5940.19 Crores in the year 2006-2007 and at last it decreases to Rs. 4988.80 Crores in the year 2007-2008. The variation can be diagnosed in the ratio column. In 2003-2004 it was 6.48 increased to 7.79 in the year 2004-2005, peak to 8.20 in the year 2005-2006, again peak to 9.35 in 2006-2007 & at finally it reaches to 7.27 in 2007-2008. As a result of which the days of inventory holding also shows some variation. In 2003-2004 it was 57 days, down to 47 days in 2004-2005, it further decreased to next three years and reached to 51 days in 2007-2008.

RAW MATERIAL TURNOVER RATIO Raw material turnover ratio= Raw material consumed*average of Raw material


Working Capital Management

(Rs. In Crores) Year

2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

Raw material

Average raw

Raw material

Raw material

consumed

material

turnover ratio

storage period

432.57 436.15 526.74 526.62 591.21

59.85 52.13 53.33 66.47 47.02

7.23 8.37 9.88 7.91 7.99

51 days 44 days 37 days 47 days 46 days

The raw material inventory turnover ratio indicates how quickly the raw material is turning in to production. A high raw material hence less cost of supervision and the chance of deterioration in quality is decreases. In the other hand a low quality raw material increases cost. It can be observed from the above tables that the consumption of material was at its peak in 2005-06. It was Rs.526.74 crores in that period. Before that period it was Rs.432.57 crores in2003-04 and Rs.436.15 crores in 2004-05. After 2005-06 it was slightly decreases to 526.62 crores in 2006-07 and again it peaks to Rs.591.21 crores in 2007-08. Having a glimpse and the average raw material inventory trend, it is a increasing two expects in 2004-05, 2005-06 i.e. Rs.52.13 crores & Rs.53.33 crores as compared to the year 2003-04. The reflection of both raw material consumption trend and average inventory trend is on the raw material turnover ratio trend. The trend shows that raw material turnover ratio was increasing from 2003-04 to 2005-06. In 2003-04 it was 7.23 and reaches up to 9.88 in 2005-06. From 2006-07 onwards it starts decreasing & reaches to 7.99 in 2007-08 as compared to 1st 3 years. As a result of which the raw material storage period starts decreasing from 2003-04 (51 days) to 46 days in 2007-08. SUMMARY


Working Capital Management

Looking at the inventory imposition in NALCO, we can see that stores and spares control a major portion of investment in inventory. Here raw materials constitute a negligible amount of inventory ranging between 9%-14% where as finished goods inventory stands in second position. Thus from the above analysis it can be concluded that there some important stores & spare material which are required at any moment & are costly. Finished goods turnover ratio, shows that the holding period after three consecutive years of increase and then decrease. This slight decrease is a rather of satisfaction for the management. But only in this decline continuous in the future years will be a satisfactory thing for management. But the trouble comes in utilising the raw material inventory. The raw material inventory ratio is not constant in case of NALCO. In first three years it performed well as compared to previous years but after that in the year 2005-06 the turnover ratio goes on decreasing while the raw material storage period increasing simultaneously, so it is a bad sign for management. Because the larger the inventory, larger is the maintenance cost and extra storage space has to be taken. Stores and spares are also plays a vital role, here stores and spares turnover ratio is not in a good position. In these five years only in the year 2005-06 there is an improvement. As we know that NALCO is VED Analysis and has some stores and spares which has very limited use and the event for using them is unexpected. Shortage of one of these stores and spares material at the time of need may lead to production ceasing, the greater responsibility for this is goes to in the hands of management.


Working Capital Management

7. MANAGEMENT OF ACCOUNTS RECEIVABLES It has been observed that a basis strategy to reduce the operating cash requirements of firm is to accelerate the collection of receivables so was to reduce the average collection period. This accounts receivable or trade credit has three features i.e. (a)It involves an element of risk. (b)It is based on economic value. (c)It implies futurity.


Working Capital Management

Therefore it is important to analyze the important dimensions of the efficient management of receivables within the frame work of a firms objectives. Therefore credit manager and academic persons have a common interest in designing models that monitor the growth rate level of account receivables. ESTABLISHING OPTIMUM CREDIT POLICY A firm’s investment in account receivables depends on (a)The volume of credit sales (b)The collection period Then the firm’s average investment in accounts receivables is daily credit sales * average collection period. The average collection period can be computed as follows:Average collection period =360/Debtors turnover The investments in receivables may be expressed in terms of costs instead of sales value. The volume of credit sales is a function of firm’s total sales and percentage of credit sales to total sales. Total sales depend on market size, firm’s market share, product quality, intensity of competition, economic condition, change in Government policy etc. The finance manager hardly has any control over these variables. The percentage of credit sales to total sales is mostly influenced by the nature of business and industry norms. There is one way in which the financial manager can affect the volume of credit sales and collection period &consequently, investment account receivables. The term credit policy is used to refer to the combination of 3 decision variables. Goals of credit policy:A firm may follow lenient or stringent credit policy tends to sell on credit to customers on very liberal terms and standards; credits and granted for longer periods even to those customers who may become doubtful debtors in future. In contrast a firm following a stringent credit policy sells on credit on highly selective basis only to those customers who have already proved their creditworthiness in the past or whose financial resources are very strong. In practice nearly all firms follow credit policies in between lenient credit policy and stringent credit policy. The reasons for allowing credit:-


Working Capital Management

Competition: - Generally the granting of credit is directly proportional to the degree of competition.

Company’s bargaining power: - This is a major reason of companies granting credit. The bargaining power depends on the buyer’s personal report with the marketing manager, the talkative power of the buyer etc.

Buyer’s requirement: - The no. of business sector there is a need for credit without which the buyer cannot operate. So the credit is granted.

Buyer’s status: - Buyers creditworthiness is also a major factor in granting credit.

Marketing tool: - Credit is used as a marketing tool, particularly when a new product is launched or when a company wants to push its weak product. Other reasons may be industry practice, transit delays etc.

Credit policy variables: The credit policy of a firm provides the framework to determine: a. Whether or not to extend credit to a customer. b. How much credit should be granted? In establishing an optimum credit policy the financial manager must consider decision variables which influence the level of receivables. The major decision variables are i.

Credit standards

ii.

Credit terms

iii.

Collection efforts

The credit policy of a firm may be administered by financial manager. It should however appreciate that credit policy has important implications of the firm’s production, marketing and finance functions. Therefore it is advisable that the firm’s credit policy be formulated by committee which consists of executives of all the 3 departments.


Working Capital Management

Credit standards:Credit standards are the criteria which a firm follows in selecting customers or the purpose of credit extension the firm may have tight credit standards; that is it may sell mostly in cash basis, and may extended credit to only reliable customers. Such standards avoids bad debt losses and less cost of credit administration. But the firm’s sales may be squeezed. On the contrary if the firm adopts loose credit standards the firm may have larger sales but may have heavy bad debt losses. The quantity basis of establishing credit standards are factor such as credit ratings, credit references, average payment period and certain financial ratio. Thus the choice of optimum credit standards involves a trade off between incremental rate of return and incremental cost. The trade off with reference to credit standards covers. i.

Collection cost

ii.

Average collection period

iii.

The level of bad debt losses

iv.

Level of sales

Collection cost: - These are the cost relating to the collection of accounts receivables. The more the liberalized credits, the more will be the collection costs, and in case of more tightened credit the less is collection cost. This is a semi-variable cost. Average collection period:-The investments in accounts receivables involves a capital cost as funds have to be arranged by the firm to finance them till customers make payments. A relaxation credit standard implies an increase in sales which in term would lead to higher average accounts receivables. Further, relaxed standards would mean that credit is extended liberally so that it is available to even less credit worthy customers, who will take a longer period to pay there overdue. In case of a strict credit standards would signify a decrease in sales and extension of credit limit to more credit worthy customers, who can promptly pay there bills, thus a lower average level of accounts receivables. Thus change in sales and collection while standards are relaxed produce a higher a carrying cost and in tightened credit standards produce lower cost. Bad debt losses: - These happen when customer fails to pay. They will increase with relaxation of credit standards and decrease in tightened credit standard position. Every company giving credit on liberal terms makes provisions for doubtful debts.


Working Capital Management

Sales Volume: - This will increase when there will be liberalized credit standard position, and in tightened condition this will decrease. It releases itself from tight to loose credit policy, the opportunity cost declines but administration cost and bad debts risk is increased. But when the firm move from line to stringent condition the reverse will happen. Credit Terms: Credit terms are the conditions and stipulation under which the firm extends credit to the customer. Credit term has two components. Credit Period: - The times span for there repayment of debts is called credit period, generally expressed in terms of a net date. Credit Period varies industry to industry; depending on the firm’s nature objectives and policy. Firm extension of credit is mainly for increasing the sales. However there will be net increase in operating profit only if the cost of extended credit period is less than the incremental operating profit. Incremental sales result into incremental receivables and existing customers will take more time to repay credit obligation. Incremental investment in receivables =New level of receivables-Old level of receivable = ((New sales/360)*New average collection period) = ((Old sales/360)*Old average collection period) = ((SalesN/360)*ACPN) = ((SalesO/360)*ACPO)

Where Sales N= New sales Sales O= Old sales ACPN= Average Collection Period (new) ACPO= Old Collection Period Cash Discount: - This is the amount of cash reduction from the prompt creditor. Normally cash discount period is less than that of the credit period.


Working Capital Management

A firm uses cash discount as tool to increase the sales and accelerate cash collection from customers. Thus the level of receivables and associated cost may be reduced.

Collection Policies/ Efforts: The main objective of collection policies is to accelerate collections from the smooth payers and to reduce bad debt losses. This will result in declined in average collection period. Prompt collection is necessary for fast turnover of working capital, keeping collection cost and bad debts within limits and maintaining collection efficiency. Optimum Credit Policy (A Cost Benefit Analysis):It is known that optimum credit policy is that credit policy which maximizes the firm value. It is also known that firm’s value becomes optimum value when marginal rate of return becomes equal to marginal cost of capital. The incremental cost of funds is the rate of return required by the supplier of funds given the risk of the investment in accounts receivables. The required rate of return is directly proportional to higher risk of investment. Thus the rate of required rate of return is upward sloping curve. Credit Procedures for Individual Accounts:For effective management of credit, the firm should lay down clear cut guidelines and procedures for granting credit individual accounts. The firm should adopt different procedures for granting credit. The credit evaluation procedure of the customers should involve the following steps. (a)Credit Information: - In extending credit to customers, the firm should ensure that receivables are collected in full and on due date. Otherwise the firm will suffer a great loss. Collecting credit information involves expenses the cost of collecting information should, therefore, be less than the potential profitability. For small account, the decision to grant credit may be made on the basis of limited information to lesser the cost. In addition to cost the time required to collect information should also be considered. Depending on these two factors of time and cost, any, or a combination of the following sources may be employed to collect the information. 1) Financial Statements.


Working Capital Management

2) Bank References. 3) Trade References. 4) Credit Bureau Reports etc. (b)Credit Investigation and analysis: After collecting all the record information the firm will get an idea regarding the matter which should be further investigated the factors affecting the credit investigation are:1) The type of customers. 2) The customer business line. 3) The nature of the product. 4) Size of customers order and expected further volumes of business with him. 5) Companies credit policies and practices. A Comprehensive and meaningful investigation requires adequate data about the customer and his business. The data should be promptly gathered. Unnecessary delay in responding to a customer request can prove to be detrimental. To collect dues from slow paying or non paying customer, as stated above the collection steps be taken in sequence. First with a letter with additional letters, after that all the legal works. In practice cash discount is given for the prompt payment.

7.1 ACCOUNTS RECEIVABLES MANAGEMENT AT NALCO Sundry debtors trend:Year 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

Sundry Debtors(Rs. In Crores) 102.24 92.81 29.42 34.13 60.65

From the above table we can see that Sundry Debtor is devoid of sales. As we know that sales are increasing in NALCO each year except in the year 2007-2008. But the


Working Capital Management

Sundry Debtor have taken and trend, which can be seen from the graph as if a y=sin x curve. In the earlier years it starts increasing in 2003-2004 it was Rs102.24 crores, it starts decreases from the year 2004-2005 Rs92.81 crores to Rs34.13 crores in 20062007 but finally in the year 2007-2008 it was Rs60.65 crores as compared to last 3 years. Percentage of share of trade debtors to current assets:= Trade Debtors/Current assts*100 (Rs. In crores) Year

Total Sundry

Total Current

Percentage of

Debtor 102.24 92.81 29.42 34.13 60.65

Assets 990.51 1811.04 3297.88 4974.08 5041.33

S.D to C.A 10.32 5.12 0.89 0.69 1.20

2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

This ratio shows how much portion the trade debtors have taken in total current asset. As we know that trade debtors are those buyers who buy goods on credit. There is a chance of bad-debt or doubtful debt, which means a loss for the company. In 2003-2004, the ratio was 10.32, decreases to 5.12 in 2004-2005, and it further decreases in 2005-2006 to 2006-2007 and finally it reaches to 1.20 in 2007-2008.

Debtor’s turnover ratio:Debtor’s turnover ratio= Domestic Sales/Average debtor

(Rs. In Crores)


Working Capital Management

Domestic Year 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

Sales 1621.60 2239.74 3017.96 3929.11 3339.83

Average

Debtors

Debtors

turnover ratio

102.08 97.53 61.12 31.78 47.39

15.89 22.96 49.38 123.63 70.48

Average collection period 23 days 16 days 74 days 3 days 6 days

Debtor’s velocity indicates that number of times the debtors are turned over during a year. Generally higher the value of debtor’s turnover the more efficient is the management of debtors or more liquid is the debtors. But a precaution is needed while interpreting a very high debtors turnover ratio because a very high ratio may imply a firms inability due to lack of resources to sell on credit, thereby losing sales and profits. NALCO is granting credit on only domestic sales. The domestic sales trend always increasing from 2003-2004 to 2007-2008. From the above table we can see that average debtor for the 1 st year was Rs102.08 crores. In 2004-2005 it was Rs97.53 crores and it was gradually decreases to Rs31.78 crores in 2006-2007 and finally it reaches to Rs47.39 crores in 2007-2008. As a result of which the debtor’s turnover ratio shows to increasing trend except in the year 2007-2008. In 2003-2004 it was 15.89, in 2004-2005 it increases to 22.89 and finally it increases to 123.63 in 2006-2007 and in the last year it decreases to 70.48. In Average Collection period it shows that it was in fluctuating stage i.e. in 20032004 it was 23 days, in 2004-2005 it was decreases to 16 days, it rise up to 74 days in 2005-2006, again it decreases to 3 days in 2006-2007 and finally it increases to 6 in 2007-2008. SUMMARY From the above tables it is seen that the sundry debtors are increasing till 20052006 and after that it increases, so it is a bad sign for NALCO, it has to make control


Working Capital Management

over it and also try to decrease the debtor amount. But if we move deeply we can see that sundry debtor captures a significant portion in total current asset. But it has come nearly 50% in 2007-2008. Analyzing the turnover ratio of sundry debtors, it has been seen that the average collection period, a heavy amount is still unpaid in the year 2003-2004 but in the year 2006-2007 it reduce to minimum i.e. 3 days and afterwards it again increased. So, the company will face trouble in future. From the above findings it has been seen that management should look after the collection of debts as quickly as possible through every possible methods.


Working Capital Management

8. FINANCING OF WORKING CAPITAL Having determined the requirements of current assets in the aggregate and in various components of working capital, the next important task before the financial manager is to select an assortment of appropriate sources to finance the current assets. A business firm has diverse sources to meet its financial requirements. In selecting a particular source a financial manager has to consider the merits and demerits of each source in the constraints of the firm. The concept of permanent and temporary working capital helps in determining the quantum sources of finance. It has been emphasised by financial experts that the permanent working capital should be financed by equity capital or other long term sources of finance where as temporary working capital should generally be financed from short term sources. But the distinction between the temporary and permanent working capital is that the minimum level of current asset must be determinable precisely which in practice is difficult. Sources of finance:The major sources of finance are 1) Trade credit 2) Bank Finance 3) Long term sources comprising equity capital and long term borrowings 4) Others

TRADE CREDIT:It has been indicated by R.B.I. that in India the use of trade credit has grown faster than of sales. Trade credit is a ratio of current asset is about 40 per cent. Trade credit refers to the credit that a customer gets from supplier of goods in the due course of business. All customers do not pay immediately after getting services or the products. This deferral payment is called trade credit, in India it is one of the largest


Working Capital Management

sources of working capital finance. It contributes to about one third of the short term financing. Small firms mainly revive on these trade credits. Trade credit is mostly done informal. A supplier sends raw material and the buyer accepts it on the credit. However he doesn’t formally acknowledge it as debt. Once the trade links has been established, the confidence grows and the trade credit becomes routine activity. Open account trade credit appears as trade creditors on the buyer’s balance sheet. Trade credit may also take the form of bills payable. When the buyer signs a bill a negotiable instrument to obtain trade credit. It appears the buyer’s balance sheet as bills payable. The period and volume of open account trade credit varies from firm to firm and industry to industry. The main advantage of trade credit is that it has generally no cost if discount is not a part of credit terms. It is spontaneous, being available without any formalities. But the basic limitation of trade credit is that originally it is available in the form of goods or services only. The term of trade are so determined that as far as possible it is not utilized for other purposes, but if a firm fails to avail itself of discount offered, it is comparatively the costliest of all. Credit terms: - Credit terms refer to the priority agreed conditions under which the supplier sells on credit to the buyer. The conditions are due and may be cash discount for payment before schedule. Due date is the last date on which the buyer has to repay cash discount is the cash exemption offered by the supplier for the prompt payment. The typical way of expressing credit terms is x/y net z i.e. x per cent of discount is available if the credit is repaid on the yth date and in case the discount is not taken, the payment is due by the zth day. Benefits and costs of trade credit: - In India trade credit is spontaneous process and older marketing activity. As the volume of the firms purchase and number of supplier increases the trade credit also increases. Both advantages and disadvantages prevail in trade credit. The advantages are:1) Easy Availability:-


Working Capital Management

As the trade credit does not mostly depend upon the mutual understanding between the supplier and the buyer, so it is easily available and automatic, which is very useful to smaller firms?

2) Flexibility:The growth of trade credit is parallel to the growth of the firm’s sales. The expansion in the firms sales cause its purchase of goods and services to increase which is automatically financed by the trade credit. On the other hand the decline in the firms sales causes decline trade credit.

3) Informality:Trade credit being a informal and spontaneous of finance is very useful to small firms for their existence. Also it saves time and cost as it does not poses restrictions which are usually parts of negotiated sources of finance.

Trade credit appears to be cost less as it doesn’t involve any explicit cost. But actually it involves an implicit cost. The cost of credit is added to the price of goods or services. So the complete analysis of cost should be carried out before going for a trade credit. Trade credit is the opportunity cost for the supplier in the form of the fund which he may invest in some profitable operation. So he transfers this cost to the buyer via increased price of goods supplied by him. So here the buyer should avoid trade credit if he has sufficient cash. In case the trade credit involves cash discount, the buyer should face the decision whether or not to avail it after considering the primary and consecutive. Therefore he should know the implicit rate of interest which can be known by the formula:-


Working Capital Management

Implicit rate=%Discount/100-%Discount*360/(credit perioddiscount period)

This implicit rate of interest makes the decision of buyer easy whether to accept trade credit or to negotiate for lower purchase price.

BANK FINANCE: Bank credit is the primary institutional sources for working capital in India. Working capital requirements are assessed as part of total financing package and the bank needn’t do a separate appraisal. But in other cases working capital is required to be assessed with reference to production schedule sales and cash generation through taking into consideration various other factors including utilization of capacity and requirement of raw material. Besides the bankers take into consideration the order book position, operations of accounts in bank, turnover, cheque returned, bills returned sales tax and income tax assessments, credit practices followed, business cycle pattern, constraints in achieving production/cash/sales generation and different ratios. The amount of fund approved by the bank for the firm’s working capital called credit limit which may be either peak level or normal non-peak level. Banks usually deduct some money which is used for security. This is known as margin money.

Types of bank finance for working capital Different forms of bank finance are as follows:•

Fund based

Non-fund based

Fund Based:(1) Overdraft: - Under this arrangement the borrower is allowed to withdraw funds in excess of balance in his current account up to a certain specified limit during a stipulated period. Though overdrawn amount is repayable on demand, they generally continue for a long period by annual renewals of


Working Capital Management

the limit overdraft facility may or may not backed by surety limit of overdraft is fixed keeping in view the value of the security, margin and credit worthiness of the client company. It is very flexible arrangement from the borrower’s point of view since he can withdraw and repay funds whenever he desires within the actual stipulations. Interest is charged on daily balance on the amount actually withdrawn subject to some minimum changes.

(2) Cash Credit: - A credit limit is fixed by bank out of which the client is allowed to draw cash against security of the hypothecation or pledge of the stock/merchandise goods. Thus the cash credit facility may be provided against hypothecation or both depending upon the comfortable position of the borrower’s position. Here the entire amount is not withdrawn, only a part of the whole amount is withdrawn and the rest is deposited in his cash credit account. There is no commitment charge, therefore the interest is payable on the amount actually utilised by the borrower.

(3) Bill Finances: - Bankers provide facility to provide finance against the bill drawn by the purchaser in favour of the client company. This facility covers the bills for collection. Bills may be either clean bills or documentary bills. To encourage bill as instrument of credit R.B.I introduced the new bill market scheme in 1970. The scheme was interested to reduce the borrower’s reliance or cash credit system which is susceptible to misuse. It was also encouraged that the scheme will facilitate banks to deploy their surpluses or deficits by rediscounting or selling the bills purchased or discounted by them.

(4) Demand

Loans:

-

Bank

advances

a

fixed

amount

against

demand promising notes executed by the borrower by crediting the amount


Working Capital Management

to loan account. Fresh loans are granted only when the existing amount is liquidated security for demand loans may be in addition to the promissory notes the life policies, corporate securities or pledge.

Non Fund Based:(1) Letter Of Guarantee: - Banks commit on behalf of their clients to pay to the third party in the event of default by the client by the way of a written instrument known as letter of guarantee. Such letter of guarantee is for a definite period not more than one year, specific amount and definite purpose related to business transactions.

(2) Letter Of Credit:- Under letter of credit the issuing banks commit to the supplier of goods to accept client bill up to the amount stated in the letter of credit provided to those confirm to the terms and conditions stipulated in the letter. Such letter of credit may be revocable, irrevocable or revolving letter of credit depending upon the terms agreed to between the parties.

Security Required In Bank Finance (1) Hypothecation: - Under this mode of security the banks provide credit to the borrowers against the security of moveable properties, usually inventories of goods. The goods hypothecated, however continue to be in possession of the owner. The rights of the lending bank depend upon the terms of the lender. Although the bank doesn’t have physical possession of the goods it has the legal rights to sell the goods to retrieve the outstanding loan.

(2) Pledge: - Here the borrower is required to transfer the physical possession of the property offered as a security to the bank to obtain


Working Capital Management

credit. The borrower who offers the security is called a pawner, while the bank is called the Pawnee. The pledging of the goods by the pawner to the Pawnee is a kind of bailment. Therefore pledge creates some liabilities for the bank. It must take reasonable care of the goods.

(3) Mortgage: - It is the transfer of interest in specific immovable property for securing the payment of money advanced. The person who parts within the interest in the property is called mortgager and the person in whose favour the transfer takes place is the mortgagee. Mortgage is thus conveyance of interest in the mortgaged property is thus determined as soon as the debt is paid.

(4) Lien: - Lien refers to the right of a party to retain goods belonging to another party until a debt a due to him is paid. It can be general or particular. Particular lien is a right to retain goods until a claim pertaining to these goods is fully paid. On the other hands general lien can be applied till all dues are paid. Banks usually accept general lien.

(5) Accrued Expenses: - Accrued expenses and deferred income are other sources of short term financing. Accrued expenses represent a liability that a firm has to pay for the goods or services it has already received. This is an interest free spontaneous financing. Accrued wage and salaries represent obligations payable by the firm to its employees. Accrued taxes and interest constitute another source of financing.

(6) Deferred Income: - Deferred income represents funds received by the firm for goods and services which it agreed to supply in future. Advance payments made by the customers constitute the main item of deferred income. These payments are not recorded as revenue until


Working Capital Management

goods and services have been delivered to the customers. They are therefore shown as liability in the firm’s balance.

9. WORKING CAPITAL MANAGEMENT ANALYSIS


Working Capital Management

Current Assets Ratio (Rs. In crores) Year 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

Current Assets 990.52 1811.04 3297.88 4974.08 5041.33

Current liabilities 864.28 806.39 940.15 1218.61 1540.88

Current Ratio 1.15 2.25 3.51 4.08 3.27

This ratio indicates the liquidity of the firm. This is a ratio between current assets and current liabilities. It indicates the availability of current assets in rupees for every one rupee of current liabilities. A ratio greater than 1 means that the firm has more current assets than claims against them. From the above table it shows that current assets trend always increases from year to year. In 2003-2004 it was Rs990.51 crores and it finally reaches to Rs5041.33 crores in 2007-2008. In the same way the trend of current liabilities also increases in every year except in 2004-2005. In 2003-2004 it was Rs864.28 and decreases to Rs806.39 crores in 2004-2005 and finally it reaches to Rs1540.88 crores in 2007-2008. The current ratio is always in increasing trend, except in 2007-2008.

Liquid Ratio Liquid Ratio = Liquid Asset/Current liabilities

Where liquid Asset = Current Asset - Inventory (Rs. In crores) Year

Liquid Assets

Current liabilities

Liquid Ratio


Working Capital Management

2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

510.03 1281.98 2706.30 4339.12 4354.68

864.28 806.39 940.15 1218.61 1540.88

0.55 1.59 2.88 3.56 2.83

This ratio established between quick or liquid assets and current liabilities. An asset is liquid if it can be converted into call immediately or reasonably soon without a loss of value. Cash is the most liquid asset. Other assets which are considered liquid or bookdebts, marketable securities. Inventories are not considered less liquid. Standard Ratio 1:1 From the above table we can see that the trend of liquid assets increases from year to year. In 2003-2004 it was Rs510.03 crores and finally it reaches to Rs4354.68 crores in 2007-2008. We can also know that current liabilities are always increasing except in 2004-2005. From the liquid ratio column it is seen that it is fluctuating i.e. in 20032004 it was 0.55 it increases to 1.59 in 2004-2005 and it goes on increases and reaches to 3.56 in 2006-2007 and at last year it decreases to 2.83 in 2007-2008

Turnover of Working Capital Turnover Of Working capital= Net Working

Capital/Sales

Where Net Working Capital = Current Assets – Current Liabilities.

Year

2003-2004

Net Working Capital

126.23

Sales

Ratio

3114.37

0.04


Working Capital Management

2004-2005

1004.65

4123.96

0.24

2005-2006

2357.73

4851.90

0.49

2006-2007

3755.47

5940.19

0.63

2007-2008

3500.45

4988.80

0.70

Working Capital turnover indicates the velocity of the utilization of net working capital. The ratio indicates the number and items the working capital is turned over in the course of a year. The ratio measures the efficiency with which the working capital is being used by the firm. A higher ratio indicates efficient utilization of working capital of a low ratio indicates the opposite. The column of net working capital shows that it was in a up-down curve i.e. it first increased from 2003-2004 to 2006-2007, then it starts decreasing in 2007-2008. The column of sales also shows as same as net working capital i.e. sales increases from 2003-2004 to 2006-2007, then it decreases in 2007-2008. We can also see that working capital turnover ratio is always in increasing trend form.

SUMMARY From the above tables, it is seen that the liquidity position of the firm is quite good which is proved by both the current asset ratio and the liquid ratio, where the standard for current asset is 2:1, in case of NALCO, it is more than 2 in every year except in 2003-2004 and in case of liquid ratio, it is above 1 in every year except in 2003-2004. In NALCO project we see that the current ratio and liquid ratio of NALCO is below standard in 2003-2004 and for further years it was maintaining the standards of current ratio and liquid ratio. So, there is definitely idle cash. But as we know that NALCO is putting all the cash in bank, so it must have earning interest. But if NALCO invested in some more risky project it must have earned some more money.


Working Capital Management


Working Capital Management

10. DEHEJA COMMITTEE REPORT The national credit council constituted in October 1968 a study group under the chairmanship of V.T.DEHEJA to examine the purpose and direction of commercial bank landing operations in the country. Submitted its reports which are known as the “DEHEJA COMMITTEE REPORT.� The committee high lighted the security and profitability oriented approach which prevented them. The financing of inventories was of proportion compared to sales or production. In other words, non moving inventories of stock piling were indirectly encouraged by easy availability of finance. The study group revealed that though the commercial banks theoretically financed industry for the short term needs, in practice, a big portion of bank lending was actually long term in character short term borrowing lasted over years. Look the shape of long term loans, they were hardly paid off as they were renewed respectively. This committee recommended that these term loans should be paid back by the borrowers in the shortest possible time. The banking system should turn to financing industry on the basis of a total study of the borrowers operations rather than a security concerned the situation did not improve and the recommendation were not enforced strictly.


Working Capital Management

11. TONDON COMMITTEE REPORT The reserve bank of India set up a study group to frame guidelines for follow up of bank credit in July 1974 under the chairmanship of Mr. P.L.TONDON the then chairman of PUNJAB NATIONAL BANK. This committee recommended that the current assets requirements should be financed by industry out of equity and far out of long term borrowings from term financial at situations. It was represented that the present state of capital market was such that there were no prospects in the force able future of raising sustainable funds through equity to finance the hardcore. The rate of plough back of earning was also inadequate to provide required resources. The firm financing institutions also look clear state that they would not undertake. The responsibility to provide the funds for the hardcore as this would inevitably tie up their resources in financing old units instead of furthering their objective of financing the promotion of new industrial activities. Thus the logic of the hardcore being financed by equity and/or long term sources of funds has gained recognition. The problem however is one of the difficulties in implementing it quickly in the context of the passive state of the capital market and the long term sources.


Working Capital Management

12. CONCLUSION The project undertaken by me is working capital management, at NALCO ANGUL. Here I collected all the documents related to my topic from various annual reports, magazines, brochures, and also from net. From my consideration I collected previous five years data i.e. from 2003-2008, in these five year we observed the ratios, portfolios of NALCO and also came to a conclusion. It was true that NALCO is a huge profit making govt. sector which producing Aluminium, but as per my consideration in the year 2007-2008 the cash and bank balances, sales decreases but the liability increases as compare to its previous years. The turnover ratios of Raw Material, Stores & Spares were not in a good position in the last 3 years, but the finished goods turnover ratio is in a proper increasing order, so these through proper management. As per debtors turnover ratio it has been observed that a heavy volume of amount has been unpaid in the year 2003-2004 and it was again seen in the year 2007-2008, so it will create problem of financing, NALCO has to minimize that amount by collecting them, and further try to collect the credit amount in that particular period. So, that it cannot face any problem in future. Overall the management of NALCO was good, but proper and effective management will help in achieving stars in future. So it is an advice from me to NALCO.


Working Capital Management

11. BIBLIOGRAPHY  Financial Management: - I.M.Pandey  Financial Management: - Sharma & Gupta  Websites: - www.google.com www.nalcoindia.com Magazines: - Annual Report Of NALCO


Stud on Working Capital Management 1