CHAPTER II REVIEW OF LITERATURE Working Capital Management Meaning and Definition of working Capital

The term working capital refers to that portion of an organizations capital which is required in the short-run to finance current assets such as cash, bank balance, debtors, marketable securities, bills receivable and inventories. The value of these assets keeps changing over a period of time.
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The institute of Chartered Accountant of India defines working capital as under:

working capital means the funds available for day-to-day operations of and enterprise. Shubin defines working capital as capital required for purchase of raw-materials and for meeting day-to-day expenditure on salaries, wages, rents and advertising, etc James C. Ven Horne has opined that, Working capital management usually is considered to involve the administration of current assets namely, cash and marketable securities, receivables and inventories and the administration of current liabilities. Thus, working capital is capital required for meeting the needs of current operations. The assets constituting working capital are relatively temporary in nature Working capital is also known as revolving or circulating capital or fluctuating capital or short-term capital.

T.S. Reddy, Y. Hari Prasad Reddy Financial and Management Accounting. Different concepts of Working Capital

There are two concepts of working capital

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Gross Concepts Net concepts

Under the gross concept it is termed as Gross Working Capital and under the net

concept it is termed as Net Working Capital. Gross working capital refers to the sum total of all current assets of a business enterprise. E.g. Cash, short term securities, accounts receivable, inventories, short-term bank deposits etc. and include all current assets with can be easily converted into cash within an accounting year. Classification of Working capital Working capital can broadly be classified in two different ways One the basis of concept and On the basis of time

1. On the basis of concept is classified as Gross working capital and net working capital 2. On the basis of time working capital may be classified under fixed or regular or permanent working capital or variable working capital.

P.K.Sikdar Advanced Cost and Management Accounting

Need for Working Capital

Working Capital is need because of the existence of operating cycle. The duration of time required to complete certain sequences of events in connection with normal business activities of an n enterprise is called the operating cycle. Can be narrated as under: Conversion of cash into raw material. Conversion of raw material into work-in-progress. Conversion of W.I.P into finished goods. Conversion of finished goods, into debtors and bills receivable or B/R. Conversion of debtors and bills receivable into cash.

Importance of Working Capital

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A business enterprise must maintain an adequate level of working capital in order

to run its business smoothly. Both excessive and inadequate working capital positions are harmful. Excessive working capital results in idle funds on which no profit is earned. Again, insufficiency of working capital results in interruptions of production and inefficiencies which impair the profitability of the enterprise. Significance of Working Capital Management In a typical manufacturing firm, current assets exceed one-half of total assets. Excessive levels can result in a substandard Return on Investment (ROI).Current liabilities are the principal source of external financing for small firms. Requires continuous, day-to-day managerial supervision. Working capital management affects the companys risk, return, and share price.

Sheeba Kapil and Kqnwal Nayan Kapil Financial Management

Measures to Improve Working Capital Management:

The essence of effective working capital management is proper cash flow

forecasting. This should take into account the impact of unforeseen events, market cycles, loss of a prime customer and actions by competitors. The effect of unforeseen demands of working capital should be factored in. It pays to have contingency plans to tide over unexpected events. While market-leaders can manage uncertainty better, even other companies must have risk-management procedures. These must be based on objective and realistic view of the role of working capital. Addressing the issue of working capital on a corporate-wide basis has certain advantages. Cash generated at one location can well be utilized at another. For this to happen, information access, efficient banking channels, good linkages between production and billing, internal systems to move cash and good treasury practices should be in place. An innovative approach, combining operational and financial skills and an allencompassing view of the companys operations will help in identifying and implementing strategies that generate short-term cash. This can be achieved by having the right set of executives who are responsible for setting targets and performance levels. They are then held accountable for delivering, encouraged to be enterprising and to act as change agents. Effective dispute management procedures in relation to customers will go along way in freeing up cash otherwise locked in due to disputes. It will also improve customer service and free up time for legitimate activities like sales, order entry and cash collection. Overall, efficiency will increase due to reduced operating costs.

V.K. Bhalla Working Capital Management

The danger of excessive Working Capital

There will be an unnecessary accumulation of inventories leading to increased waste, theft, obsolescence etc. of the same. Defective credit policy and slack collection period will result in a huge accumulation of debts which leads to a higher incidence of bad debts. A tendency will grow on the part of the management to accumulate inventories in order to make speculation profits.

It will lead to inefficiencies, ineconomies and increased losses which will adversely affect the profits earned. Paucity of Working Capital is also harmful and has the following demerits On account of inadequacy of working capital it will become very difficult to undertake profitable projects and as such there will be a stagnation in the growth of the enterprise. Fixed assets cannot be efficiently and effectively utilized on account of the lack of sufficient working capital. Ineconomies and inefficiencies creep in and on account of the same in becomes very difficult to implement different operating plans required to achieve the profit target of the enterprise. The enterprise fails to honour its short-term obligations in time and as a result of the same it losses its reputation. The enterprise becomes unable to take advantage of attractive credit opportunities. It faces tight credit terms. Working Capital Cycle Management An idea about how long working capital remains blocked with its various components might be available from annual reports. Particularly one point worth mentioning here is that they can provide measure of time lag only on average. Although

an accurate measure is not available. An average measure of working capital can be derived form the volume of the time lags of its various components. Two important bits of information are necessary for the purpose. One relates to the information on annual cost of raw materials, finished goods, produced and sold which provides data on average daily purchases, production, etc. other relates to how long on average raw materials, work-in-progress, finished goods and debtors are held up. These bits of information may be collected form annual reports. But they are based on some sweeping assumptions, hence accurate measure is not available. However, an idea is general may be derived from it. Working capital is blocked in Meaning of funds:
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Raw materials Production process Finished goods

The word fund has different connotations for various individuals. For the

layman, it usually refers to cash. In this sense, the funds flow statement is simply a statement of cash receipts and disbursements. Such a statement s called cash flow statement. It portrays the flow and outflow of cash during a period and consequently the balance in hand. The term funds however is broader than cash. It means working capital. i.e., the difference between current assets and current liabilities. For example, the total of current assets is Rs.4,00,000 as shown in the balance sheet of a firm, then, the working capital o fund would be Rs.6,00,000 i.e., Rs.10,00,000 Rs.4,00,000. Therefore, in accounting funds and working capital are used in the same sense. Meaning of flow: The term flow refers to change or transfer and therefore the flow of funds means transfer of economic values from one asset to another. From one liability to

another, one asset to a liability or vice versa or combination of these. Viewed from the angle of the working capital concept of funds, the flow of funds refers to movement of funds involving inflow and outflow in the working capital area. All flows of funds pass through working capital. The working capital flow arises when the net effect of a transaction is to increase or decrease the amount of working capital means Flow of funds. In business, several transactions take place. When a transaction results in the increase of fund, such a transaction is said to be a source of funds. On the other hand, if a transaction results in the decrease of funds, such a transaction is said to be an application of funds. A transaction that does not result in either increase or decrease of fund does not result in the flow of funds. Definition Foulke defines this statement as A statement of sources and application of funds is a technical device to analyze the changes in the financial condition of a business enterprise between two dates. In the words of Anthony the funds flow statement describes the sources from which additional funds were derived and the use to which these sources were put. Stages involved in preparation of funds flow statement Funds flow statement is usually prepared for one year on the basis of balance sheets and additional information. Preparation of funds flow statement involves the following steps: i. ii. iii. iv. Preparation of schedule of changes in working capital Preparation on non-current accounts Preparation on adjusted profit and loss account Preparation of fund flow statement

Mr. Khan & Jain - Financial Management

CASH FLOW STATEMENT Meaning

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Cash flow statement is in many respects similar to funds flow statement cash

flow statement of changes in the financial position f the business due to inflow and outflow of cash. It is required for short range planning. The plans for more immediate future cannot rely upon the information supplied by funds flow statement. Funds flow statement conceals certain vital information because it treats all current assets and current liabilities at par. Increase in stock and debtors and even short term investment are treated equivalent to increase in cash. In actual practice, it is not the real position. Payment from debtors may be realized within a month, from stock within three to six months but increase in cash balance is the immediate receipts. In the same way, increase in outstanding wages and salaries are treated equivalent to increase in bank overdraft. Infact, outstanding wages and salaries are payable within ten days or so, but bank overdraft may continue for a longer period. There is always a danger that funds flow statement may show sufficient net working capital but practically, there is a technical solvency. This may happen due to piling up of large quantity of stock or considerable amount of credit sale or inefficiency of the business in the collection side. Cash flow statement provides the details in respect of cash generated and applied during the accounting period. It s prepared to show the impact of various transactions on the cash position of the firm. It can be prepared for a year half year or quarter or for any other duration. The term cash is used to refer to bank balance also. Thus, a cash flow statement may be defined as a summary of receipts and disbursements reconciling the opening cash balance with the closing balance of the concerned period with information about the various items appearing in the balance sheet and profit and loss account. Thus a cash flow statement summarized the causes of changes in cash position of a business enterprise between dates of two balance sheets. Transactions which increase the cash position of the entity are labeled as inflow of cash and those which decrease the cash position as outflow of cash. The cash flow statement analyses the

changes in both the current and non-current accounts to determine thee inflow of cash. Hence, there is no need for separate statement for the changes in the working capital. Further, it may be noted there that this statement is prepared on the basis of actual cash concept. However, if information about the cash inflow and outflow is not available, national cash concept may be used. For example, when raw materials are acquired on credit basis, it results in outflow of national cash. Here, we assume that the supplier of raw materials has given cash loan which the company utilized for acquiring the raw materials. Techniques of cash flow statement The cash flow statement is prepared with the help of balance sheet, profit and loss account and some additional information. As mentioned above, cash inflow and cash outflow are explained and shown in cash flow statement. All sources from which cash moves in the concern are narrated and on the other hand, the various uses to which cash is put to and thus cash moves out of the concern are shown in this statement. The net effect of such cash movements is known as net cash flow which is added / deducted to the opening balance of cash/bank to give closing balance of cash/bank. Therefore, it becomes necessary to have at least theoretical knowledge about the various items of cash inflow and the various items of cash outflow. Preparation of cash flow statement Opening of accounts for non-current items Preparation of adjusted profit and loss account Calculation of cash from operations Preparation of cash flow statement

B.L. Mathur Financial Management