INTRODUCTION OF THE TOPIC

WORKING CAPITAL MANAGEMENT

Working capital could be defined as the portion of assets used in current operations.
The movements of the funds from capital to income and profits and back to working capital
are one of the most important characteristics of the business. This cyclical operation is
concerned with utilization of the funds with the hope that will return with an additional
amount called income. If the operations of the company are to run smoothly, a proper
relationship between fixed capital and current capital has to maintain. Sufficiently liquidity is
important and must be achieved and maintained to provide that funds to pay off obligation as
they arise.

The adequacy of cash and other current assets together with their efficient handling,
virtually determine the survival o demise of the company. A businessman should be able to
judge the accurate requirement of working capital and should be quick enough to raise the
enquired funds to finance he working capital needs. Working capital is also called as net
current assets, “it is the excess of current assets over current liabilities.” All organization has
to carry working capital. It is important from the point of view of both liquidity and
profitability. Poor management of working capital means that funds that unnecessarily tied up
in idle assets hence educing liquidity and also reducing ability to invest in productive assets
such as plant and machinery thus affecting profitability.

Types of working capital

The type, kinds of a thing are depending upon the different utilization of working
capital. It prominently works in the direction of performing different functions in different
situation and in the context of divergent variables. So following are some important types of
working capital.

 Net Working Capital:

Term Net working capital can be defined in two ways. It is the difference between
current assets and current liabilities. Amount left for operational requirement.

10
 Gross Working Capital:
Gross working capital means the total current assets.

 Permanent Working Capital:

It is the minimum amount of the current assets, which are needs to conduct the
business even during the dullest season of the year. This amount varies from year to year
depending upon the growth of a company and stage of the business cycle in which it operates.
It is the amount of funds required to produce the goods and services, which are necessary to
satisfy demand at a particular point.

It represents the current assets, which are required on a continuing basis over the year.
It is maintain as the medium to carry on operation at any time. Permanent working capital has
following features:

a. It is classified on the basis of the time factor.

b. Its size increase with the growth of the business.
c. It constantly shifted from one assets o another and continues to remain in the
business process.
 Temporary Working Capital:
It represents the additional assets, which are required at different times during the
operating year. Seasonal working capital is the additional amount of current assets
particularly cash, receivables, and inventory which is required during the more active
business seasons of the year. It is the temporary investment in the current assets and
possesses he following features:

 It is not always gainfully employed, though is May also shift from one asset to
another as permanent working capital does.
 It is particularly suited to business of seasonal on cyclical nature.

Factors Determining Working Capital:

1. Nature of business:
In the case of public utility concern like railways, electricity etc most of the
transactions are on cash basis. Further they do not require large inventories. Hence working
capital requirements are low. On the hand, manufacturing and trading concerns require more

11
working capital since they have to invest heavily in inventories and debtors. Example cotton
or sugar mil

2. Size of business
Generally large business concerns are required to maintain huge inventories are
required. Hence bigger the size, the large will be the working capital requirements.

3. Time consumed in manufacture

To run a long production process more inventories is required. Hence the longer the
period of manufacture, the higher will the requirements of working capital and vice-versa.

4. Seasonal fluctuations
A number of industries manufacture and sell goods only during certain seasons. For
example the sugar industry produces practically all sugar between December and April. Their
working capital requirements will be higher during this session. It is reduced as the sales are
made and cash is realized.

5. Fluctuations in supply
If the supply of raw materials is irregular companies, are forced to maintain huge
stocks to avoid stoppage of production. In such case, working capital requirement will be
high.

6. Speed of turnover
A concern say hotel which affects sales quickly needs comparatively low working
capital. This is because of the quick conversion of stock into cash. But if the sales are slow,
more working capital will be required.

7. Terms of sales
Liberal credit sales will result in locking up of funds in sundry debtors. Hence a
company, which allows liberal credit, will need more working capital than companies, which
observe strict credit norms.

12
8. Terms of purchase
Working capital requirements are also affected by the credit facilities enjoyed by the
company. A company enjoying liberal credit facilities from its suppliers will need lower
amount working capital. (For example book shops). But a company that has to purchase only
for cash will need more working capital.

9. Labor intensive Vs. Capital intensive industries

In labor intensive industries, large working capital is required because of heavy wage
bill and more time taken for production. But the capitals intensive industries require lesser
amount of working capital because of have investment in fixed assets and shorter time taken
for production.

10. Growth and expansion of business

A growing concern needs more working capital to finance its increasing activities and
expansion. But working capital requirements are low in the case static concerns.

11. Price level changes

Changes in price level also affect the working capital requirements. Generally the
rising prices will require the firm to maintain large amount of working capital. This is
because more funds will be required to maintain the same amount of working capital to
maintain the same level of activity.
Sources of Working Capital:

Mainly there are two sources of working capital:

 Permanent or Fixed working capital

 Temporary or variables working capital
In any concern, a part of the working capital investments are as investment in fixed
assets. This is so because there is always a minimum level of current assets, which are
copiously required by the enterprise to carry out its day-to-day business operation and this
minimum, cannot be expected to reduce at any time. This minimum level of current assets
need long term working capital, which is permanently blocked.

13
 Similarly, some amount of working capital may be required to meet the seasonal
demands and some special exigencies such as rise in prices, strikes, etc. this gives rise to
short term working capital which is required for day to day transaction also.

The fixed proportion of working capital should be generally financed from the fixed
capital sources while the temporary or variable working capital equipment may be met from
the short term sources of capital.
SOURCES OF WORKING CAPITAL

Long term Sources Short Term sources

Shares Commercial Banks
Debentures Indigenous Banks
Public Deposits Trade Creditors
Ploughing back of Profits Installment Credit
Loans from Financial institution Advances
Account receivable
Credit
Accrued Expenses
Differed Income
Commercial Paper

WORKING CAPITAL CYCLE:

The working capital cycle is also known as operating cycle. It refers to the duration
between the firm’s payment of cash for raw material, entering into production and inflow of
cash from debtors and realization of receivables. Simply speaking, operating cycle is the
duration between the outflow of cash and inflow of cash and this may be evidenced from the
following working capital cycle.

Receivables

Cash Finished Goods

Raw Material Work In Progress

14
 The above and network diagram may offer a clear picture of a complete working
capital i.e. it is a cash phenomenon. In the diagram, raw material, stock refers to material
only. In work in process, components involve are raw material, wages, and overhead more
specifically manufacturing overheads. Finished stock consists components of material, wages
and overheads inclusive of factory, office and administration and selling and distribution.
Debtors include material, wages, overheads and profits. Credit involves for the components
of raw material, etc. something a contingency margin is also given while estimating the
working capital requirement.

Management of working capital:

Working capital, in general practice, refers to him excess of current assets over
current liabilities. Management of working capital therefore, is concerned with problems that
arise in attempting to manage him current assets, current liabilities, and interrelationship that
exists between them. In other word it refers to all aspects of administration of both current
assets and current liabilities.

The basic goal of working capital management is to manage the current assets and
current liabilities of a firm in such way that a satisfactory level of working capital is
maintained, i.e. neither inadequate nor excessive. This is so because both inadequate as well
as excessive working capital position is bad for the business. Inadequacy of working capital,
may lead the firm insolvency and excessive working capital implies idle funds, which earn no
profit for the business. Working capital management policies of the firm have a great effect
on its profitability, liquidity and structural health of the organization. In this context, working
capital management is three dimensional in nature:

 Dimension I is concerned with the formulation of the policy with regard to

Profitability, risk and liquidity.
 Dimension II is concerned with the decision about his composition and level of
current assets.
 Dimension III is concerned with the decision about his composition and level of
current liabilities.

15
1.4 OBJECTIVES OF THE STUDY
Primary objective:
 To study on the efficiency of Working Capital Management of Autokshi Engineers
Pvt Ltd, Chennai.
Secondary objective:

 To find out the purchase process of raw materials, components and spares.
 To find out the payroll mechanism for paying salaries and wages.
 To trace day-to-day expenses and overhead costs such as fuel, power and office
expenses, etc.
 To find out the changes in the Profitability.
 To find out the changes in the current assets position and proposition.
 To find out the Liquidity and Solvency position.

1.5 NEED OF THE STUDY

 Investment in current assets represents a substantial portion of the total investment.
 Investments in current asset and the level of current liabilities have to be geared
quickly to change in sales, which helps to expand volume of business.
 Gives a company the ability to meet its current liabilities.
 Take advantage of financial opportunities as they arise.
SCOPE OF THE STUDY
 The management of working capital helps us to maintain the working capital at a
satisfactory level by managing the current assets and current liabilities. It also helps to
maintain proper balance between profitability, risk and liquidity of the business
significantly.
 By managing the working capital, current liabilities are paid in time. If the firm makes
Payment to it creditors for raw material in time, it can have the availability of raw
material regularly, which doesn’t cause any obstacles in production process. Adequate
working capital increases paying capacity of the business but the excess working
capital causes more inventory, increases the possibility of delay in realization of
debts.
 The Current Assets should be large enough to cover its current liabilities in order to
ensure a reasonable margin of safety. Each of the current assets must be managed

16
 efficiently in order to maintain the liquidity of the firm while not keeping too high a
level of any one of them. Each of the short term sources of financing must be
continuously managed to ensure that they are obtained and used in the best possible
way. The interaction between current assets and current liabilities is, therefore, the
main theme of the theory of management of working capital
1.6 LIMITATIONS OF THE STUDY

 Department heads were busy so time for interaction was less.

 The entire financial position of the company cannot be disclosed
 Company provides only secondary data, so certain type of bias is in study

REVIEW OF LITERATURE Greg Filbeck, Thomas M. Krueger, (2005) founds that

Firms are able to reduce financing costs and/or increase the funds available for expansion by
minimizing the amount of funds tied up in current assets. He provides insights into the
performance of surveyed firms across key components of working capital management by
using the CFO magazine’s annual Working Capital Management Survey. He discovered that
significant differences exist between industries in working capital measures across time. In
addition, to that these measures for working capital change significantly within industries
across time.

Maynard E. Rafuse, (1996) examines that attempts to improve working capital by delaying
payment to creditors is counter-productive to individuals and to the economy as a whole.
Claims that altering debtor and creditor levels for individual within a value system will rarely
produce any net benefit. Proposes that stock reduction generates system-wide financial
improvements and other important benefits. those organizations seeking concentrated
working capital reduction strategies to focus on stock management strategies based on “lean
supply-chain” techniques

Morris Lamberson (1995) describes that how the working capital position of small firms
responds to changes in the level of economic activity. Fifty small firms were studied for the
time period 1980-1991. The findings from this study showed that liquidity increased slightly
for these firms during economic expansion with no noticeable change in liquidity during
economic slowdowns. Their investment in working capital, as measured by the inventory to
17
total assets and current assets to total assets ratios, were relatively stable over the time period
of this study. Findings suggest that working capital management practices of small firms in
response to changes in economic activity do not follow commonly held expectations.

Carole Howorth , Paul Westhead (2003) examined that Working capital management
routines of a large random sample of small companies in the UK are examined. Considerable
variability in the take-up of 11 working capital management routines was detected. Principal
components analysis and cluster analysis confirm the identification of four distinct ‘types’ of
companies with regard to patterns of working capital management. The first three ‘types’ of
companies focused upon cash management, stock or debtors routines respectively, whilst the
fourth ‘type’ were less likely to take-up any working capital management routines. Influences
on the amount and focus of working capital management are discussed. Multinomial logistic
regression analysis suggests that the selected independent variables successfully
discriminated between the four ‘types’ of companies. The results suggest that small
companies focus only on areas of working capital management where they expect to improve
marginal returns. The difficulties of establishing causality are highlighted and implications
for academics, policy-makers and practitioners are reported.

Ghosh and Maji (2003) obtained that efficiency of working capital management of Indian
cement companies during 1992-93 to 2001-2002. They calculated three index values
-performance index, utilization index, and overall efficiency index to measure the efficiency
of working capital management, instead of using some common working capital management
ratios. By using regression analysis and industry norms as a target efficiency level of
individual firms, Ghosh and Maji [8] tested the speed of achieving that target level of
efficiency by individual firms during the period of study and found that some of the sample
firms successfully improved efficiency during these years.

Mathuva (2014) examined the influence of working capital management components on

corporate profitability by using a sample of 30 firms listed on the Nairobi Stock Exchange
(NSE) for the periods 1993 to 2013. He used Pearson and Spearman’s correlations, the
pooled ordinary least square (OLS), and the fixed effects regression models to conduct data
analysis. The key findings of his study were that: i) there exists a highly significant negative
relationship between the time it takes for firms to collect cash from their customers (accounts
collection period)and profitability, ii) there exists a highly significant positive relationship

18
between the period taken to convert inventories into sales (the inventory conversion period)
and profitability, and iii) there exists a highly significant positive relationship between the
time it takes the firm to pay its creditors (average payment period) and profitability.
Eljell[9] empirically examined the relationship between profitability and liquidity, as
measured by current ratio and cash gap (cash conversion cycle) on a sample of 929 joint
stock companies in Saudi Arabia. Using correlation and regression analysis, Eljelly [9] found
significant negative relationship between the firm's profitability and its liquidity level, as
measured by current ratio. This relationship is more pronounced for firms with high current
ratios and long cash conversion cycles. At the industry level, however, he found that the cash
conversion cycle or the cash gap is of more importance as a measure of liquidity than current
ratio that affects profitability. The firm size variable was also found to have significant effect
on profitability at the industry level.

Lazaridis and Tryfonidis (2005) conducted a cross sectional study by using a sample of 131
firms listed on the Athens Stock Exchange for the period of 2001-2004 and found statistically
significant relationship between profitability, measured through gross operating profit, and
the cash conversion cycle and its components (accounts receivables, accounts payables, and
inventory).Based on the results analysis of annual data by using correlation and regression
tests, they suggest that managers can create profits for their companies by correctly handling
the cash conversion cycle and by keeping each component of the conversion cycle (accounts
receivables, accounts payables, and inventory) at an optimal level.

Long et al (1999) obtained a model of trade credit in which asymmetric information leads
good firms to extend trade credit so that buyers can verify product quality before payment.
Their sample contained all industrial (SIC 2000 through 3999) firms with data available from
COMPUSTAT for the three-year period ending in 1987 and used regression analysis. They
defined trade credit policy as the average time receivables are outstanding and measured this
variable by computing each firm's days of sales outstanding(DSO), as accounts receivable per
dollar of daily sales. To reduce variability, they averaged DSO and all other measures over a
three-year period. They found evidence consistent with the model. The findings suggest that
producers may increase the implicit cost of extending trade credit by financing their
receivables through payables and short-term borrowing.

19
Shin and Soenen (1998) found that the relationship between working capital management
and value creation for shareholders. The standard measure for working capital management
is the cash conversion cycle (CCC). Cash conversion period reflects the time span between
disbursement and collection of cash. It is measured by estimating the inventory conversion
period and the receivable conversion period, less the payables conversion period .In their
study, Shin and Soenen [7] used net-trade cycle (NTC) as a measure of working capital
management. NTC is basically equal to the cash conversion cycle (CCC) where all three
components are expressed as a percentage of sales.NTC may be a proxy for additional
working capital needs as a function of the projected sales growth. They examined this
relationship by using correlation and regression analysis, by industry, and working capital
intensity. Using a COMPUSTAT sample of 58,985 firm years covering the period 1975-
1994, they found a strong negative relationship between the length of the firm's net-trade
cycle and its profitability. Based on the findings, they suggest that one possible way to create
shareholder value is to reduce firm’s NTC.

Raheman and Nasr (2005) examines the effect of different variables of working capital
management including average collection period, inventory turnover in days, average
payment period, cash conversion cycle, and current ratio on the net operating profitability of
Pakistani firms. They selected a sample of 94 Pakistani firms listed on Karachi Stock
Exchange for a period of six years from 1999 -2004 and found a strong negative relationship
between variables of working capital management and profitability of the firm. They found
that as the cash conversion cycle increases, it leads to decreasing profitability of the firm and
managers can create a positive value for the shareholders by reducing the cash conversion
cycle to a possible minimum level.

Chris Hall (2002) describes that Cost-effective funding always will be a guiding principle
for the treasurer, but not everybody recognizes the need to utilize all available sources -
internal as well as external. By paving the way for a more holistic approach to working
capital management (WCM) the treasurer can meet both new and traditional objectives.
Replace the traditional accounting definition of working capital with an approach that
encompasses all the processes surrounding accounts payable, accounts receivable and
inventory, and one begins to understand the potential knock-on impacts of a change in
working capital practice or policy. When looking in detail at any of these three core areas, it
soon becomes clear that WCM can touch all the firm buys, makes and sells

20
Dong (2015) describes that the firms’ profitability and liquidity are affected by working
capital management in his analysis. Pooled data are selected for carrying out the research for
the era of 2006-2013 for assessing the companies listed in stock market of Vietnam. He
focused on the variables that include profitability, conversion cycle and its related elements
and the relationship that exists between them. From his research it was found that the
relationships among these variables are strongly negative. This denote that decrease in the
profitability occur due to increase in cash conversion cycle. It is also found that if the number
of days of account receivable and inventories are diminished then the profitability will
increase numbers of days of accounts receivable and inventories.

Yong H. Kim (1996). Part I: obtained that the value of short-term cash flow forecasting
system (T.W. Miller, B.K.Stone). Liquidity and the financing policy of the firm: an empirical
test (E.O. Lyn, G.J.Papaioannou). Part II: Trade Credit: Efficient Market, Imperfect
Information, and an International Perspective. A role for trade credit in an efficient market
(R.E. Rouault, Jr, D.J. Kaufman, Jr). Unbiased trade credit decisions under imperfect
information (D.R. Fewings). An international accounts receivable management model (P.
Ahtiala, Y.E. Orgler). Part III: Managing Cash: Behavioral and International Perspectives.
Behavioral relations and the optimal cash discount (W. Beranek). Optimum cash balances for
international firms (Jongmoo Jay Choi, D.K. Ghosh and Yong H. Kim). Determination of
multicurrency cash balances: strong versus weak dollar cycles (L.A. Soenen, J. Madura).
Swaps as a cash management tool (J.F. Marshall, V.K. Bansal and A.L. Tucker). A test of
one-way arbitarge in the Canadian/U.S. dollar commercial paper markets (M. Anvari, A.H.R.
Davis).

Saswata Chatterjee (2015) focused on the importance of the fixed and current assets in the
successful running of any organization. It poses direct impacts on the profitability liquidity.
There have been a phenomenon observed in the business that most of the companies increase
the margin for the profits and losses because this act shrinks the size of working capital
relative to sales. But if the companies want to increase or improve its liquidity, then it has to
increase its working capital. In the response of this policy the organization has to lower down
its sales and hence the profitability will be affected due to this action. For this purpose 30
United Kingdom based companies were selected which were listed in the London Stock
exchange. The data were taken of three years 2006-2013. It analyzed the impact of the
working capital on the profitability. The dimensions of working capital management included
in this research which is quick ratios, current ratios C.C.C, average days of payment,

21
Inventory turnover, and A.C.P (average collection period. on the net operating profitability of
the UK companies.

22