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Working Capital Management

Extracts from this document...

Introduction

1. Executive Summary Working capital is the capital required for maintenance of day-to-day business operations. The present day competitive market environment calls for an efficient management of working capital. The reason for that is attributed to the fact that an ineffective working capital management may force the firm to stop its business operations, may even lead to bankruptcy. Hence the goal of working capital management is not just concerned with the management of current assets & current liabilities but also in maintaining a satisfactory level of working capital. Holding of current assets in substantial amount strengthens the liquidity position & reduces the riskiness but only at the expense of profitability. Therefore achieving risk-return trade off is significant in holding of current assets. While cash outflows are predictable it runs contrary in case of cash inflows. Sales program of any business concern does not bring back cash immediately. There is a time lag that exists between sale of goods & sales realization. The capital requirement during this time lag is maintained by working capital in the form of current assets. The whole process of this conversion is explained by the operating cycle concept. This study gives in detail the working capital management practices in VIRGO ENGINEERS LTD. Management of each current asset, namely inventory, cash, accounts receivable is studied related to VIRGO ENGINEERS LTD. Similarly management of accounts payable is studied to understand the managing of current liabilities. The study of working capital management has shown that VIRGO ENGINEERS LTD. has a strong working capital position (from 2004-till date) since its inception in 1987. The overall position of VIRGO ENGINEERS LTD. is good & the same is expected by continuum of existing management policies, checking exchange rate risk, competing with domestic and global players in terms of quality & quantity. 2. Purpose of the Study The main aim of any firm is to maximize the wealth of shareholders. ...read more.

Middle

depreciation) (months/days) -------------------------------------------------------------------------------------------------- 12 months/365 days 4. Debtors The WC tied up in debtors should be estimated in relation to total cost price (excluding depreciation) symbolically, Budgeted Cost of sales per Average debt Credit sales x unit excluding x collection period (In units) depreciation (months/days) -------------------------------------------------------------------------------------------------- 12 months/365 days 5. Cash and Bank Balances Apart from WC needs for financing inventories and debtors, firms also find it useful to have some minimum cash balances with them. It is difficult to lay down the exact procedure of determining such an amount. This would primarily be based on the motives for holding cash balances of the business firm, attitude of management toward risk, the access to the borrowing sources in times of need and past experience, and so on. 13.7.2 Estimation of Current Liabilities The important current liabilities are trade creditors, wages and overheads, 1. Trade Creditors Budgeted yearly Cost of raw Credit period Production x material x allowed by creditors (In units) per unit (months/days) ------------------------------------------------------------------------------------------------- 12 months/365 days 2. DIRECT WAGES Budgeted yearly Direct labor Avg. time-lag in Production x cost per unit x payment of wages (In units) (Months/days) ------------------------------------------------------------------------------------------------ 12 months/365 days 3. OVERHEADS Budgeted yearly Overhead cost Average time-lag Production x per unit x in payment of overheads (In units) (Months/days) -------------------------------------------------------------------------------------------------- 12 months/365 days So Net Working Capital required = Total Current Assets - Total Current Liabilities. 13.8 Working Capital Financing After determining level of working capital, a firm has to decide how it is to be financed. The need for financing arises mainly because the investment in working capital/current assets, that is, raw material, work in process, finished goods and receivables typically fluctuates during the year. Although long-term funds partly finance current assets the main sources of working capital financing, namely, 1. Trade credit 2. Bank credit 3. Commercial papers 4. Certificate of deposits 5. Factoring 13.9 Ratios to Measure the Efficiency of Working Capital * Current Ratio: Current assets / Current liabilities. ...read more.

Conclusion

A firm needs cash to make payments for acquisitions of resources and services for normal conduct of business. Cash is also held to meet emergency situations. Some firms hold cash to take advantage of speculative changes in prices of input and output. Management of cash involves three things. a. Managing cash flows in and out of a firm b. Managing cash flows within a firm c. Financing deficit or investing surplus cash And thus, controlling cash balance at any point of time. Firms prepare cash budget to plan and control and cash flows. Cash budget can serve its purpose only when firm can manage its collection and payments within the allowed limits. A firm should hold optimum amount of cash at any time and invest the temporary excess amount in short term securities. Trade credit creates book debts accounts receivable. It issued as a marketing tool to expand or maintain the firm's sales. A firm's investment on account receivable depends on volume of credit sales and collection period through credit policy. VEL is a multi product manufacturer unit with varying cycle time for each product with huge capital turnover where the working capital requirement depends on the level of operation and the length of operation cycle. In finance, working capital is synonymous with current assets; monitoring the duration of the operating cycle is an important aspect of current assets management and control. 18. Future Scope 1. The analysis of annual report for the financial year 2008-09 is not done because the reports are yet to be released. So, this can be added as scope for future study after it gets released. 2. Due to lack of financial information related to valve industry and other listed valve manufacturing companies, it is not possible to compare Virgos performance with valve industry as whole and also with the listed valve manufacturing companies, which can be a constructive part of future study. 3. One more part of future study can be to study valve industry as whole and to find out the contribution of VEL in context of India and world. 19. ...read more.

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