Working Capital Management

As a result of the vast network of domestic offices and Subsidiaries, company is able to sell directly to customers. Company believes that direct sales help to achieve higher margins as compared to agent based sales adopted their competitors.

Company have a dedicated marketing department, whose primary responsibility is to expand customer base and achieve customer satisfaction by providing prompt and good quality services to the existing customers. Its marketing department continuously strives to explore newer markets and customers for its products, obtain more registrations and product approvals, and develop new strategies for product placement, project tracking and global information sharing across its Company and Subsidiaries.

1. Revenues

Following is the breakdown of revenues on the basis of products of the company,

Following is the breakdown of revenues on the basis of client industries,

Others include, paint, pharmaceutical, chemical, dyes and dyes intermediates, fertilizer industries.

Following is the breakdown of revenue on the basis of geographical area

Virgo believes that their growth has been due to their ability to understand customer needs and build a product of optimal design.

YEAR WISE CHANGES IN PROFITS OF THE COMPANY

Year

Profit After Tax (Crores)

Increase (Crores)

% Increase

2004-05

3.4

-

-

2005-06

9.18

5.78

70

2006-07

0.87

.69

8.4

2007-08

9.57

8.7

80.0

2. Financial Ratios of the Company

RATIOS

Sr. No.

Type of ratio

2004-05

2005-06

2006-07

2007-08

Current Ratio

.61

.51

.58

.93

2

Quick Ratio

.03

.03

.05

.28

3

Debt / Equity Ratio

0.88

0.30

0.36

0.95

4

Inventory Turnover Ratio

5.11

4.81

3.32

3.30

5

Inventory Velocity

71

76

10

11

6

Debtors Turnover Ratio

5.74

4.43

4.08

4.00

7

Debtors Velocity

64

82

89

91

8

Creditors Turnover Ratio

3.87

2.39

3.63

3.93

9

Creditors Velocity

94

53

01

93

0

Fixed Asset Turnover Ratio

4.11

3.73

3.37

4.18

1

Working Capital Turnover Ratio

6.87

6.43

4.53

3.38

2

Operating Net Profit Ratio

9.96

2.50

5.30

3.46

3

Return On Capital Employed

26.49

32.62

27.66

23.21

4

Return On Share Holders Fund

21.06

41.75

9.90

30.59

5

Return On Equity

22.52

41.00

9.90

30.59

6

Interest Converge Ratio

.40

2.30

5.91

4.09

7

Earnings Per Share

9.86

9.05

0.31

9.28

8

Dividend Per Share

2.5

.31

6

4.5

9

Dividend Payout Ratio

25.35

4.48

58.18

48.47

3. Working Capital Management Theory

3.1 Introduction

Working capital management is concerned with the problems that arise in attempting to manage the current assets, the current liabilities and the interrelationship that exists between them. The term current asset refer to those assets which in the ordinary course of business can be, or will be, converted into cash without undergoing a diminution in value and without disrupting the operation of the firm. The major current assets are cash, marketable securities, accounts receivable and inventory. Current liabilities are those liabilities which are intended, at their inception, to be paid in the ordinary course of business, within a year, out of the current assets or earnings of the concern. The basic current liabilities are accounts payable bills payable, bank overdraft, and outstanding expenses. The goal of working capital management is to manage the firm's current assets and liabilities in such a way that a satisfactory level of working capital is maintained. The current asset should be large enough to cover its liabilities in order to ensure a reasonable margin of safety. Each of the current assets must be managed 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 importance of working capital management is reflected in the fact that financial managers spend a great deal of time in managing current assets and current liabilities like;

* Arranging short term financing.

* Negotiating favorable credit terms.

* Controlling the movement of cash.

* Administering accounts receivables.

* Monitoring investment in receivables.

3.2 Concepts and Definitions of Working Capital

There are two concepts of working capital: gross and net.

The term gross working capital, also referred to as working capital, means the total current assets.

The term net working capital can be defined in two ways: (i) the difference between current assets and current liabilities; and (ii) alternate definition of NWC is that portion of current assets which is financed with long-term funds.

The NWC is necessary because the cash outflows and inflows do not coincide. In other words, it is the non-synchronous nature of cash flows that makes NWC necessary. In general, the cash outflows resulting from payment of current liabilities are relatively predictable. The cash inflows are, however, difficult to predict. The more predictable the cash inflows are, the less NWC will be required. Where cash inflows are uncertain, it will be necessary to maintain current assets at a level adequate to cover current liabilities, that is, there must be NWC.

NWC can alternatively be defined as that part of the current assets which are financed with long-term funds. Since current liabilities represent sources of short-term funds, as long as the current assets exceed the current liabilities, the excess must be financed with long-term funds.

WORKING CAPITAL POLICY

Working capital management policies have a great effect on firm`s profitability, liquidity and its structural health. A finance manager should therefore, chalk out appropriate working capital policies in respect of each competent of working capital so as to ensure high profitability, proper liquidity and sound structural health of the organization.

In order to achieve this objective the financial manager has to perform basically following two functions.

. Estimating the amount of working capital.

2. Sources from which these funds have to be raised.

3.3 Determining Financing Mix

One of the most important decisions, involved in the management of working capital is how current assets will be financed. There are, broadly shaking, two sources from which funds can be raised for current asset financing; (i) short-term sources (current liabilities), and (ii) long-term sources, such as share capital, long-term borrowings, internally generated resources like retained earnings and so on. What proportion of current assets should be financed by current liabilities and how much by long-term resources? Decisions on such questions will determine the financing mix. There are three basic approaches to determine; an appropriate financing mix:

. Hedging approach:

A firm is said to be following Hedging approach if it matches the maturity of the debt with the maturity of assets. For the firm following hedging approach, long term financing will be used to finance fixed assets and permanent current assets and short term financing for temporary or variable current assets. As the level of these assets increases, the long financing level also increases. However, it should be realized that exact matching is not possible because of the uncertainty about the expected lives of assets.

2. Conservative approach:

A firm in practice may adopt a conservative approach in financing its current and fixed assets. The financing policy of the firm is said to be conservative when it depends more on long term funds for financing needs. Under a conservative plan, the firm finances its permanent assets and also a part of temporary current assets, the idle long-term funds can be invested in the tradable securities to conserve liquidity. The conservative plan relies heavily on long term financing.

3. Aggressive approach:

A firm may be aggressive in financing its assets. A firm follows aggressive policy when it uses more short-term financing than warranted by the matching plan. Under an aggressive policy, the firm financing a part of its permanent current assets with short term financing. Some extremely aggressive firms may even finance a part of their fixed assets with short-term financing.

3.4 Planning of working capital

. Need for Working Capital

The need for working capital (grass) or current assets cannot be overemphasized. Given the objective of financial decision making to maximsie the shareholders' wealth, it is necessary to generate sufficient profits. The extent to which profits can be earned will naturally depend, among other things, upon the magnitude of the sales. A successful sales programme is, in other words, necessary for earning profits by any business enterprise. However, sales do not convert into cash instantly; there is invariably a time-lag between the sale of goods and the receipt of cash. There is, therefore, a need for working capital in the form of current assets to deal with the problem arising out of the lack of immediate realisation of cash against goods sold. Therefore, sufficient working capital is necessary to sustain sales activity. Technically, this is referred to as die operating or cash cycle. The operating cycle can be said to be at the heart of the need for working capital. 'The continuing flow from cash to suppliers, to inventory, to accounts receivable and back into cash is what is called the operating cycle'. In other words, the term cash cycle refers to the length of time necessary to complete the following cycle of events:

Conversion of cash into inventory;

2. Conversion of inventory into receivables;

3. Conversion of receivables into cash. The operating cycle, which is a continuous process, is shown below

The operating cycle consists of four phases.

In phase 1, cash gets converted into inventory. This includes purchase of raw material.

In phase 2, conversion of raw material into WIP, FG and finally the transfer of goods to stock at the end of manufacturing process.

In phase 3, goods are converted into receivables as credit sales are made to customers.

In phase 4, receivables are collected. Thus, the firm has moved from cash to inventory, to FG, to receivables and to cash again.

In case of "Trading Firm" the operating cycle will include the length of time required to:

a) Cash into inventories.

b) Inventories into accounts receivables.

c) Accounts receivables into cash.

In case of "Financing Firm" the operating cycle includes the length of time taken for 1 year.

a) Conversion of cash debtors, and

b) Conversion of debtors into cash.

2. Permanent and Temporary Working Capital

The operating cycle, thus, creates the need for current assets (working capital). However, the need does not come to an end after the cycle is completed. It continues to exist. To explain this continuing need of current assets, a distinction should be drawn between permanent and temporary working capital.

Business activity does not come to an end after the realisation of cash from customers. For a company, the process is continuous and, hence, the need for a regular supply of working capital. However, the magnitude of working capital required is not constant, but fluctuating. To carry on business, a certain minimum level of working capital is necessary on a continuous and uninterrupted basis. For all practical purposes, this requirement has to be met permanently as with other fixed assets. This requirement is referred to as permanent or fixed working capital.

Any amount over and above the permanent level of working capital is temporary, fluctuating or variable working capital. The position of the required working capital is needed to meet fluctuations in demand consequent upon changes in production and sales as a result of seasonal changes.

3.5 Changes in working capital

The changes in the level of working capital occur for the following three basic reasons:

. Changes in Sales and Operating Expenses

The first factor causing a change in the working capital requirement is a change in the sales and operating expenses. The changes in this factor may be due to three reasons: First, there may be a long-run trend of change. For instance, the price of a raw material, say oil, may constantly rise, necessitating the holding of a large inventory. The secular trends would mainly affect the need for permanent current assets. In the second place, cyclical changes in the economy leading to ups and downs in business activity influence the level of working capital, both permanent and temporary. The third source of change is seasonality in sales activity. Seasonality-peaks and troughs-can be said to be the main source of variation in the level of temporary working capital.

The change in sales and operating expenses may be either in the form of an increase or decrease. An increase in the volume of sales is bound to be accompanied by higher levels of cash, inventory and receivables. The decline in sales has exactly the opposite effect a decline in the need for working capital. A change in the operating expenses-rise or fall-has a similar effect on the levels of working capital.

2. Policy Changes

The second major cause of changes in the level of working capital is because of policy changes initiated by the management. There is a wide choice in the matter of current assets policy. The term current asset policy may be defined as the relationship between current assets and sales volume. A firm following a conservative policy in this respect having a very high level of current assets in relation to sales may deliberately opt for a less conservative policy and vice versa. These conscious managerial decisions certainly have an impact on the level of working capital.

3. Technological changes

Finally, technological changes can cause significant changes in the level forking capital. If a new process emerges as a result of technological developments, which shortens the operating cycle, it reduces the need for working capital and vice versa.

ADVANTAGES OF ADEQUATE WORKING CAPITAL

4 Cash Discount: Adequate working capital enables a firm to avail cash discount facilitates offered to it by the suppliers. The amount of cash discount reduces the cost of purchase.

5 Goodwill: Adequate working capital enables a firm to make prompt payment. Making prompt payment is a base to create and maintain goodwill.

6 Ability to face crisis: The provision of adequate working capital facilities to meet situations of crisis and emergencies. It enables a business to with stand periods of depression smoothly.

7 Credit-worthiness: It enables a firm to operate its business more efficiently because there is not delay in getting loans from banks and others on easy and favorable terms.

8 Regular supply of raw materials: It permits the carrying of inventories at a level that would enable a business to serve satisfactory the needs of its customers. That is it ensures regular supply of raw materials and continuous production.

9 Expansion of markets: A firm which has adequate working capital can create favorable market condition i.e., purchasing its requirements in bulk when prices are lower and holding its inventories for higher. Thus profits are increased.

PROBLEMS OF INADEQUATE WORKING CAPITAL

* Firm may not be able to take advantage of profitable business opportunities.

* Production facilities cannot be utilized fully.

* Short-term liabilities cannot be paid because of non-availability of funds.

* Its low liquidity may lead to low profitability. In the same way, low profitability results in low liquidity.

* It may not be able to take advantages of cash discounts.

* Credit worthiness of the firm may be damaged because of lack of liquidity. Thus it may be lose its reputation; thereafter a firm may not be able get credit facilities.

DRAWBACK OF EXCESSIVE WORKING CAPITAL:

* A firm may be tempted to over trade and lose heavily.

* Unable to extract benefits of customer's credit.

* The situation may lead to unnecessary purchases and accumulation of inventories. This cause more chances of theft, waste, losses etc.

* There arises an imbalance between liquidity and profitability.

* Excessive working capital means funds are idle.

* The situation leads to greater production, which may not be having matching demand.

* The excess of working capital leads to carelessness about cost of production.

3.6 Determinants of Working Capital

A firm should plan its operations in such a way that it should have neither too much nor too little working capital. The total working capital requirement is determined by a wide variety of factors. These factors, however, affect different enterprises differently. They also vary from time to time. In general, the following factors are involved in a proper assessment of the quantum of working capital required.

. General Nature of Business

The Nature of business is an important determinant of the level of the working capital. Working capital requirements depend upon the general nature or type of business. They are relatively low in the public utility concerns in which inventories and receivables are rapidly converted into cash. Manufacturing organisations however face problems of slow turnover of inventories and receivables and invest large amounts in working capital.

2. Production Cycle

The time taken to convert raw material into finished products is referred to as the production cycle or operating cycle. The longer the production cycle, the greater is the requirement of working capital. Care should be taken to shorten the period of the production cycle in order to minimize working capital requirements.

3. Business Cycle

The working capital requirements are also determined by the nature of the business cycle. Business fluctuations lead it cyclical and seasonal changes which, in turn, cause a shift in the working capital position, particularly for temporary working capital requirements. The variations in business conditions may be in two directions:

(i) Upward phase when boom conditions prevail, and

(ii) Downswing phase when economic activity is marked by a decline.

4. Production policy

The quantum of working capital is also determined by production policy. Production policies have to be formulated on the basis of the individual setting of each enterprise and the magnitude and dimension of the working capital problems will accordingly vary.

5. Credit Policy

The credit policy relating to sales and purchases also affects the working capital. The credit policy influences the requirement of working capital in two ways:

* Through credit terms granted by the firm to its customers/buyers of goods;

* Credit terms available to the firm from its creditors.

6. Growth and Expansion

As a company grows, it is logical to expect that a larger amount of working capital is required. It is, of course, difficult to determine precisely the relationship between the growth in the volume of business of a company and the increase in its working capital. Other things being equal, growth industries require more working capital than those that are static. Advance-planning of working capital is, therefore, a continuing necessity for a growing concern. Or else, the company may have substantial earnings but little cash.

7. Vagaries in the Availability of Raw Material

The availability of certain raw materials on a continuous basis without interruption would sometimes affect the requirement of working capital.

8. Profit Level

The levels of profits earned differ from enterprise to enterprise. In general, the nature of the product, hold on the market, quality of management and monopoly power would by and large determine the profit earned by a firm. A priori, it can be generalised that a firm dealing in a high quality product, having a good marketing arrangement and enjoying monopoly power in the market, is likely to earn high profits and vice versa. Higher profit margin would improve the prospects of generating more internal funds thereby contributing to the working capital pool.

9. Level of Taxes

The first appropriation out of profits is payment or provision for tax. The amount of taxes to be paid is determined by the prevailing tax regulations. The management has no discretion in this respect. Very often, taxes have to be paid in advance on the basis of the profit of the preceding year. Tax liability is, in a sense, short-term liability payable in cash. An adequate provision for tax payments is, therefore, an important aspect of working capital planning. Tax planning can, therefore, be laid to be an integral part of working capital planning.

0. Dividend Policy

Another appropriation of profits which has a bearing on working capital is dividend payment. The payment of dividend consumes cash resources and, thereby, affects working capital to that extent. Conversely, if the firm does not pay dividend but retains the profits, working capital increases. In planning working capital requirements, therefore, a basic question to be decided is whether profits will be retained or paid out to shareholders. Dividend policy is thus, a significant element in determining the level of working capital in an organisation.

1. Depreciation Policy

Depreciation policy also exerts an influence on the quantum of working capital. Depreciation charges do not involve any cash outflows. The effect of depreciation policy in working capital is, therefore, indirect. Higher depreciation also means lower disposable profits and, therefore, a smaller dividend pay--lent. Thus, cash is preserved. In the second place, the selection of the method of depreciation has important financial implications.

2. Price Level Changes

Changes in the price level also affect the requirements of working capital. Rising prices necessitate the use of more funds for maintaining an existing level of activity. The effect of rising prices is that a higher amount of working capital is needed. However, in the case of companies which can raise their prices proportionately, there is no serious problem regarding working capital. Moreover, the price rise does not have a uniform effect on all commodities. It is likely that some firms may not be affected at all. In brief, the implications of changing price levels on working capital position vary from company to company depending on the nature of its operations, its standing in the market and other relevant considerations.

3. Operating Efficiency

The operating efficiency of the management is also an important determinant of the level of working capital. The management can contribute to a sound working capital position through operating efficiency. Although tile management cannot control the rise in prices, it can ensure the efficient utilisation of resources by eliminating waste, improving coordination, and a fuller utilisation of existing resources, and so on. Efficiency of operations accelerates the pace of cash cycle and improves the working capital turnover. It releases the pressure on working capital by improving profitability and improving the internal generation of funds.

3.7 Computation of Working Capital

The two components of working capital (WC) are current assets (CA) and current liabilities (CL). They have a bearing on the cash operating cycle. In order to calculate the working capital needs, what is required is the holding period of various types of inventories, the credit collection period and the credit payment period. Working capital also depends on the budgeted level of activity in terms of production/sales. The calculation of WC is based on the assumption that the production/sales is carried on evenly throughout the year and all costs accrue similarly.

The steps involved in estimating the different items of CA and CL are as follows:

3.7.1 Estimation of current assets:

. Raw Materials Inventory

The investment in raw materials inventory is estimated on the basis of following equation

Budgeted Cost of raw Average inventory

Production x material(s) x holding period

(In units) per unit (months/days)

------------------------------------------------------------------------------------------

2 months/365 days

2. Work-in-Process (WIP) inventory

Budgeted Estimated work- Average time span

Production x in-process cost x ol work-in-progress

(In units) per unit inventory (months/days)

--------------------------------------------------------------------------------------------------

2 months/365 days

3. Finished Goods Inventory

Working capital required to finance the finished goods inventory is given by factors,

Budgeted Cost of goods produced finished goods

production x per unit (excluding x holding period

(in units) depreciation) (months/days)

--------------------------------------------------------------------------------------------------

2 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)

--------------------------------------------------------------------------------------------------

2 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.

3.7.2 Estimation of Current Liabilities

The important current liabilities are trade creditors, wages and overheads,

. Trade Creditors

Budgeted yearly Cost of raw Credit period

Production x material x allowed by creditors

(In units) per unit (months/days)

-------------------------------------------------------------------------------------------------

2 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)

------------------------------------------------------------------------------------------------

2 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)

--------------------------------------------------------------------------------------------------

2 months/365 days

So Net Working Capital required = Total Current Assets - Total Current Liabilities.

3.8 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,

. Trade credit

2. Bank credit

3. Commercial papers

4. Certificate of deposits

5. Factoring

3.9 Ratios to Measure the Efficiency of Working Capital

* Current Ratio: Current assets / Current liabilities.

* Quick Ratio: (Current assets - Inventories) / Current liabilities.

* Debtors Turnover Ratio: (Credit Sales) / (Debtors + B.R.)

* Debtors Velocity: (Debtors + B.R.) / Avg. Daily credit Sales.

This ratio indicates how many days are taken to for collection of receivables.

* Creditors Turnover Ratio: Credit Purchase / Creditors.

* Creditors Velocity: Creditors / Avg. daily credit purchase.

This ratio indicates how many days of credit are being obtained from suppliers.

* Inventory turnover ratio: Cost of goods sold / Average inventory.

* Inventory Velocity: Avg. Inventory / Avg. daily cost of goods sold.

The ratio indicates no. of times the inventory is replaced during the year.

* Working Capital Turnover Ratio = (Total Sales/W.C.)

It measures the efficiency of the employment of working capital.

3.10 Inventory Management

Inventories constitute the most significant part of current assets for a majority of companies in India. The term inventory refers to the stock pile of the product. Inventories can be classified as,

. Raw material: Inputs that are converted into finished products through manufacturing process.

2. Work in progress: These are semi finished products that require further work to be done before they are ready for sale.

3. Finished goods: Goods which are completely manufactured products and/or ready for sale.

3.10.1 Need to hold inventories

There are three general motives for holding inventories.

. The Transaction Motive: This emphasis the need to maintain inventories to facilitate smooth production and sales operation.

2. The Precaution Motive: This necessitates holding of inventories to guard against the risk of unpredictable changes in demand and supply forces and other factors.

3. The Speculative Motive: This influences the decision to increase or reduce inventory level to take advantage of price fluctuation.

3.10.2 Objectives

The objective of inventory management is to determine and maintain the optimum level of inventory management as both excessive and inadequate inventories are not desirable. The optimum level inventory lies between the two danger points, excessive and inadequate inventories. The optimum level of inventory should be determined on the basis of trade off between costs and benefits associated with the levels of inventory.

3.10.3 Inventory Management Techniques

Attention is given to the basic concepts relevant to the management and control of inventory. The aspects include,

* Determination of the type of control required.

* The basic economic order quantity.

* The re-order point.

* Safety stock.

As a matter of fact the inventory management techniques are a part of production management. However a familiarity with them is essential for a financial manager in planning and budgeting inventory.

. ABC System:

The ABC system is a widely used classification technique to identify various items of inventory for purposes of inventory control. This technique is based on the assumption that a firm should not exercise the same degree of control on all items of inventory. It should rather keep a more rigorous control on items that are (1) most costly, and/or (2) slowest turning while items that are less expensive should be given less control effort.

On the basis of cost involved the various inventory items according to the system are categorized into three classes.

A = Largest inventory leading to most sophisticated inventory control techniques.

B = Midway and deserving less attention than 'A' but more than 'C' leading to employing less sophisticated techniques.

C = Small investment with fairly large number deserving minimum attention.

2. Economic Order Quantity (EOQ) model:

After various items are classified on the basis of the ABC analysis, the management becomes aware of the type of control that would be appropriate for each of the three categories of the inventory items. The group 'A' items warrants the maximum attention and the most rigorous control. A key inventory problem particularly in respect of the group 'A' items relates to the determination of the size or quantity of inventory.

Buying in large quantities implies a high inventory level, which will assure;

* Smooth production /sale operation and

* Lower ordering or set-up costs. However it increases the ordering costs and likelihood of interruption in the operation due to stock outs.

Thus a trade-off between benefits derived from the availability of inventory and the cost of carrying that level of inventory has to be derived by placing an optimum level of inventory order that minimizes the cost associated with inventory order that minimizes the cost associated with inventory management. The optimum level thus derived is known as Economic Order Quantity. EOQ equates the cost of ordering with the cost of storage of raw materials.

Ordering cost:

It is difficult to quantify this cost, as there are many factors involved. It includes cost of stationary, salaries of those engaged in preparing the purchase orders etc.

Cost of storage (or) cost of carrying inventory:

This includes the cost of store keeping, interest on capital locked up in stores, the incidence of insurance cost, evaporation etc.

For effective material control and to avoid overstocking and under stocking of raw materials, an important requirement is to decide upon various levels of materials. These levels are maximum level, minimum level and re-order level. By taking action on the basis of these levels, each item of material will automatically be held within appropriate limits of control. These levels are not permanent, but need revision according to the changes in the factors, which determine these levels. These factors are;

* Rate of consumption of materials.

* Lead time i.e., time lag.

* Storage capacity.

* Availability of funds for investment in inventories.

* Cost of storage.

* Risks of loss due to deterioration, theft, fine etc.

* Seasonal factors - certain materials are cheaply available during certain seasons.

* Fluctuation in market prices.

* Insurance costs.

Besides this, there are number of other classifications like:

Sr. No.

Classification

Criterion Employed

ABC analysis

Usage value (.i.e. consumption per periodic price per unit)

2

HML analysis (High, Medium, Low)

Unit price (i.e. it does not take consumption into account)

3

VED analysis (Vital, Essential, Desirable)

Criticality of the item (i.e. loss of production)

4

SDE analysis (Scarce, Difficult, Easy)

Procurement difficulties

5

GOLF analysis (Government, Ordinary, Local, Foreign)

Source of Procurement

6

SOS analysis (Seasonal-off Seasonal)

Seasonality

7

FSN analysis (Fast, Slow, Non moving)

Issue from stores

8

XYZ analysis

Inventory investment

3.11 Cash Management

Cash is the most important factor in financial management. It is also the most important current asset for the operation of the business. Every activity in an enterprise revolves round the cash. Cash is limited in every enterprise and it cannot be raised as and when required which calls for an efficient management of funds available.

Cash is the most liquid asset and is of vital importance to the daily operations of the business. While the proportion of corporate assets held in the form of cash is very small (often in between 1% to 3%) its efficient management is crucial to the business because cash is the focal point in business.

3.11.1 Meaning of cash

The term 'cash' is used in two senses. In a narrower sense it includes currency notes, cheques, bank drafts held by a firm with it and the demand deposits held by it in banks. In a broader sense it also includes near cash assets such as marketable securities and time deposits with bank. The main reason for a firm to hold cash is to meet the needs of day-to-day transactions and to protect the firm against uncertainties characterizing its cash flows. While cash serves these functions, it is an idle resource which has an opportunity cost. The liquidity provided by cash holding is at the expense of profits sacrificed foregoing alternative opportunities. Hence, the finance manager should carefully plan and control cash.

3.11.2 Motives for Holding Cash

. Transaction Motive:

This is the important reason for holding and maintaining the cash balance. This motive implies the holding of cash for meeting day to day requirements of cash in the ordinary course of business. For example, all payments of cash for meeting obligations related to purchase, wages, conversion charges, taxes, etc come under this category.

2. Precautionary Motive:

It refers to maintaining cash balance to meet the unexpected contingences such as floods, strikes, riots and other calamities. Generally, more the profitability of occurrence of such unexpected contingencies, the more the cash is required to be maintained to meet them. However, the facility of availability of short-term credit has an important bearing on the volume of cash required under this motive. If a firm can get short term at a very short notice for meeting unexpected contingences, the requirement of maintaining cash may be less and vice-versa. As the amount of cash under such motive is not require in day-to-day business, it is held in the form of marketable securities to contribute towards the profitability of the company.

3. Speculative Motive:

It refers to that portion of cash, which is maintained for taking advantage of expected contingences, which generally occur outside the normal course of business. The motive represents a positive and aggressive approach unlike the precautionary motive, which is a defensive in nature. It aims at exploiting the profitability opportunities leading to speculative gains. For example, suppose the government is going to increase the controlled commodity, which acts as a major raw material in any unit. So a firm may take an advantage of such an opportunity and purchase the available raw material from the market at old rates. This is done by using the cash balance maintained under the speculative motive.

4. Compensation Motive:

It refers to that portion of cash balance which is maintained to compensate banks for certain services free of cost or at a lower rates such as forwarding of accounts statement, clearance of cheques, supply of credit information, etc. therefore, the banks try to compensate themselves by requiring their clients to hold a minimum balance with them. The firm for their transaction motive cannot use this cash balance, but banks use this money to earn the return, the compensating themselves indirectly. This balance is called the "Compensating Balance".

3.11.3 Principles of Cash Management

The objective of cash management is to reduce the operation cash requirement to the minimum possible extend without affecting the routine transaction. This can also be achieved by undertaking the followings steps.

* Accelerate cash collection.

* Delay cash payments.

* Investment of excess cash balance.

* Maintenance of minimum cash balance.

* Decentralised collection.

3.12 Receivables Management

Accounts receivables constitute a significance portion of the total current assets. They are direct consequences of "trade credit" which has become an essential marketing tool in modern business.

3.12.1 Meaning of Receivable:

Receivables are asset accounts representing amounts owed to the firm as a result of sale of goods or services in the ordinary course of business.

The management of receivables is basically a problem of balancing profitability and liquidity. Soft credit terms are attractive for higher sales and hence longer the time a company allows its customers to pay, the higher are the sales and hence profits. However, on the other hand the longer the period of credit, the greater the risk, greater the level of debt and greater the strain on the liquidity of the company.

3.12.2 Cost of Receivables

. Capital cost: It is the cost associated with the blocking of firm's resources in the receivables because of the time lag between the sale of goods to customers and realization of sales. The firm therefore has to customers and realization of sales. The firm therefore has to arrange for additional funds to meet its current obligations.

2. Administrative cost: The firm has to incur additional administration costs for maintaining account receivable in the form of salaries etc.

3. Collection cost: The firm has to incur costs for collecting the payments.

4. Defaulting cost: Sometimes after making all serious efforts to collect money from defaulting customers the firm may not able to recover the over debts because of the inability of the customers. Such debts are treated as bad and have to be written off since they cannot be realized.

3.12.3 System for receivable control:

The management should consider the following four factors in keeping the level of investment in receivables within the controllable limits.

. Deciding acceptable level of risk: The first point is to decide to whom goods should be supplied bearing in mind the risk involved. It is therefore essential to assess the credit worthiness of the customers before advancing any credit to them.

2. Terms of credit sales: The second step in this regard in to decide terms of credit sales and the level of cash discounts. Cash discount has important bearing on the cost of capital and on credit sales.

3. Credit collection policy: The management should provide for bad debts to keep the losses minimum. (Usually 5% to 7% of sundry debtors are provided for bad debts). A collection procedure should be established and action should be taken accordingly. The other steps should record the age of debt to facilitate the collection of debts.

The effective of the receivable management should be analyzed from time to time with the help of certain ratios such as average collection period, debtor's turnover ratio,

3.13 Payable Management

Management of accounts payable is as much important as the management of accounts receivable. However there is a basic difference between the approaches adopted by the Finance Manager in both the cases. The underlying objective in case of accounts receivables is to maximize the acceleration of collection process while in case of accounts payable it is to slow down the payments process as much as possible. The delay in payments of accounts payable may result in saving of some interests costs but proves very costly to the firm in the form of loss of credit in the market. The Finance Manager therefore has to ensure that the payments to the credits are made at the stipulated time period after obtaining the best credit term possible.

4. Working Capital Management of VEL

Company's business is working capital intensive and requires significant working capital for its sundry debtors and inventories. Company usually gives a credit to its sundry debtors (other than our Subsidiaries) for a period of 30-90 days. Company stocks its products with some of its Subsidiaries and in order to handle logistics, stocking and selling time, company gives an extended credit period to them which varies from 90-180 days. The lead time to manufacture company's products varies between 2-3 months and thus, results in increased inventory levels.

Company avails a major portion of working capital in the ordinary course of our business from its banks as loans. As per the lending practice of company's banks, it is required to bring in part of the working capital out of net owned funds (of approximately 25% of working capital requirements). Net owned fund required is to be provided by shareholders by way of share capital, share premium and reserves and surplus.

The estimates about working capital requirements are based on past experience and projections for the future. The estimates of working capital and margin requirements have been arrived at based on working capital and margin money requirements that we incur in relation to our existing operations, in consonance with industry practices and past trends.

ASSUMPTIONS FOR WORKING CAPITAL REQUIREMENTS:

Particulars Number of days outstanding

Sundry Debtors:

From Subsidiaries 120-180

From others debtors 30-90

Inventories 109

Sundry Creditors: 90

. Company's business requires a large amount of working capital, used significantly to finance the purchase of raw materials and other work on projects before payments are received from customers.

2. Company's working capital requirements may increase if, under certain orders, payment terms do not include advance payments or such orders have payment schedules that shift payments toward the end of the order or otherwise increase its working capital burdens.

3. In addition, company's working capital requirements have increased in recent years because it has undertaken a growing number of orders within a similar timeframe and due to the growth of the Company's business generally. All of these factors may result, or have resulted, in increases in its working capital needs.

4. In addition company also provides bank guarantees in favor of customers to secure obligations under contracts.

5. Letters of credit are often required to satisfy payment obligations to suppliers and subcontractors.

Companies ability to arrange financing and the costs of capital of such financing are dependent on numerous factors, including general economic and capital market conditions, credit availability from banks, investor confidence, the continued success of its current projects and other laws that are conducive to its raising capital in this manner.

4.1 Sources of funds

VIRGO ENGINEERS LTD. raises its working capital by multiple banking arrangements with 4 Banks. These 4 banks are as follows;

. State Bank of India

2. Canara Bank

3. Union Bank of India

4. Kotak Mahindra Bank Ltd.

In VEL working capital requirement is assessed by

* Fixing the target production

* Preparation of Budget (in rupees)

Working capital requirement are prepared taking into account:

* Actual value of the previous year working capital.

* Projected value for the next year

Limits:

VEL is having fund-based limits of Rs.57 crores and Non-fund based limits up to Rs.19.5 crores.

Procedure for procurement of funds

Virgo Engineers Ltd. applies a credit monitoring and appraisal (CMA) report. The document consists of past 1 year data about the company and profit and loss account, balance sheet, current assets current liabilities, working capital assessment, fund flows etc. SBI subscribes the maximum working capital limit (up to extent of 34%) of the entire working capital assessed. The other banks of the under the multiple banking arrangement above provide the rest of Working capital limits.

WORKING CAPITAL LIMITS (UNDER MULTIPLE BANKING ARRANGEMENT)

(Rs. In Millions)

Name of Bank

Fund Based Loan

Non-Fund Based Loan

Total

State Bank of India

200

25

325

Canara Bank

40

75

315

Kotak Mahindra Bank Ltd

20

75

95

Union Bank of India

10

20

30

Total

570

395

965

Types of working capital source:

. Fund based limits: Under this source, Virgo Engineers Ltd. can obtain working capital finance by bank borrowing in the form of cash credit or export packing credit.

2. Non-fund based limits: Virgo Engineers Ltd. receives non-fund based working capital in the form of letter of credit or bank guarantee.

4.2 Year Wise Changes in Working Capital

Year

Total Sales

W.C.

Increased By

% Increase

WC as % of Total Sales

All Fig. in Cr

2004-05

89.72

3.06

-

4.56

2005-06

82.59

2.8

-0.26

-1.99

5.50

2006-07

46.45

32.35

9.55

52.73

22.09

2007-08

233.56

69.09

36.74

13.57

29.58

Interpretation: The above table indicates that working capital was highest for the year 2007-08. The net working capital has shown a substantial increase from 2005-06 to 2006-07. Statement of changes in working capital is shown below to give the complete picture of variations in working capital.

4.2.1 STATEMENT OF CHANGES IN WORKING CAPITAL FOR THE YEAR 2005-2006

Particulars

31-Mar-05

31-Mar-06

Increase

Decrease

Current Assets

Rs.

Rs.

Rs.

Rs.

Inventories

24,842,126

20,733,301

4,108,825

Sundry Debtors

56,193,152

86,629,497

30,436,345

Cash and Bank Balance

22,254,539

8,730,120

3,524,419

Other Current Assets

25,071,005

6,413,592

8,657,413

Loans and Advances

7,305,211

39,270,217

21,965,006

Total CA

345,666,033

381,776,727

Current Liabilities

Liabilities

209,601,377

243,166,035

33,564,658

Provisions

5,422,757

0,226,112

4,803,355

Total CL

215,024,134

253,392,147

Net Working Capital

30,641,899

28,384,580

Change in WC

-2,257,319

Source: Annual reports of VEL

Interpretation:

Net working capital has decreased by Rs. 2,257,319 due to the increased current liabilities and at the same time inventories, cash and bank balance and other current assets too decreased. Although there is an increase in the remaining current assets the net effect is decrease in working capital.

4.2.2 STATEMENT OF CHANGES IN WORKING CAPITAL FOR THE YEAR 2006-2007

Particulars

31-Mar-06

31-Mar-07

Increase

Decrease

Current Assets

Rs.

Rs.

Rs.

Rs.

Inventories

20,733,301

293,889,519

73,156,218

Sundry Debtors

86,629,497

358,743,605

72,114,108

Cash and Bank Balance

8,730,120

30,727,269

1,997,149

Other Current Assets

6,413,592

82,182,706

65,769,114

Loans and Advances

39,270,217

15,033,958

75,763,741

Total CA

381,776,727

880,577,057

Current Liabilities

Liabilities

243,166,035

509,547,787

266,381,752

Provisions

0,226,112

47,475,767

37,249,655

Total CL

253,392,147

557,023,554

Net Working Capital

28,384,580

323,553,503

Change in WC

95,168,923

Source: Annual reports of VEL

Interpretation:

An increase in networking capital is observed (Rs.195, 168,923) due to significant increase in inventories, Sundry debtors, cash & bank balances, other current assets and loans &advances. Although current liabilities are also increased significantly the net effect is increase in working capital.

4.2.3 STATEMENT OF CHANGES IN WORKING CAPITAL FOR THE YEAR 2007-2008

Particulars

31-Mar-07

31-Mar-08

Increase

Decrease

Current Assets

Rs.

Rs.

Rs.

Rs.

Inventories

293,889,519

483,553,916

89,664,397

Sundry Debtors

358,743,605

583,486,782

224,743,177

Cash and Bank Balance

30,727,269

32,389,457

,662,188

Other Current Assets

82,182,706

58,562,031

76,379,325

Loans and Advances

15,033,958

75,457,007

60,423,049

Total CA

880,577,057

,433,449,193

Current Liabilities

Liabilities

509,547,787

680,821,624

71,273,837

Provisions

47,475,767

61,694,330

4,218,563

Total CL

557,023,554

742,515,954

Net Working Capital

323,553,503

690,933,239

Change in WC

367,379,736

Source: Annual reports of VEL

Interpretation:

An increase in networking capital is observed (Rs. 367,379,736) due to significant increase in inventories, Sundry debtors, cash & bank balances, other current assets and loans &advances. Although current liabilities are also increased significantly the net effect is increase in working capital.

4.2.4 Current Ratio

A current ratio of 2.1 is considered to do ideal. The ration is an indicator of the firm's commitment to meet its short-term liabilities. It indicates the rupees of current assets available for each rupee of current liability. Higher the current ratio higher is the fund available for a rupee of current liabilities. As a convention rule a current ratio of 2:1 or more is considered satisfactory.

Current ratio = Current Assets / Current Liabilities.

YEAR

CURRENT RATIO

2004-05

.61

2005-06

.51

2006-07

.58

2007-08

.93

Interpretation:

The current ratio is stable at around 1.5 to 1.6 during the years 2004 to 2007. The ratio has been increasing from 1.58 to 1.93 in 2007-08. This shows that there is increase in firm's current assets which shows the liquidity position of the firm.

4.2.5 Working Capital Turnover Ratio

Working capital turnover ratio = Net Sales / Average Working Capital.

It is indicator of efficiency of working capital management. Higher the ratio greater is the efficiency.

YEAR

WORKING CAPITAL TURNOVER RATIO

2004-05

6.87

2005-06

6.43

2006-07

4.53

2007-08

3.38

Interpretation:

The working capital turnover ratio has decreased from 2004-05 till date. This is mainly due to % increase in sales over the period is less as compared to % increase in working capital . The reason for this is the inventory, forming substantial part of working capital.

4.3 Inventory management in VEL

Virgo Engineers Ltd. is multi-product company; also its operations are project based. This makes VEL to store, handle and process of large quantity and variety of material. This calls from efficient inventory management on the part of VEL. VEL holds three types of inventory, these are:

. Raw materials: It includes raw castings of body, b/a, ball, trunion, housing, seat rings etc.

The raw materials are stocked and controlled by stores department.

2. Stores, spares: It includes paint, fasteners, nameplate, stem, end caps etc. These items are stocked and controlled by stores department.

3. Semi/finished goods: It includes semi finished components and valves. These items are stocked and controlled by machine shop, vendor and assembly department respectively according to their functions.

The raw materials, spares are procured by purchase department and stored by stores department. The company has highly integrated ERP Ln system which shows requirement for raw materials, as new order gets booked in the system, on the basis of available stock and material required for new booked orders. The raw materials are ordered on the basis of this system requirement. This is the basic principle followed by VEL in ordering and holding raw material inventory.

4.3.1 Inventory Control

Inventory control is major responsibility of all respective departments in VEL. It adopts following procedure for inventory control:

. The production, stores, dispatch department generates inventory status report monthly and conducts analysis of it. The same is circulated to finance department.

2. ABC categorization of all items is based on values of item contributing to total value of stock.

3. Identification of non-moving and slow moving items on periodic basis and intimating it to user departments and thereby reducing the indent quantity.

4. Identification of absolute and surplus items which are of no use and disposal of the same after receiving clearance from top management.

5. Standardization of general store material and spares and reduce the number of items.

The split of raw material and components, semi-finished goods, finished goods and loose tools their percentage and total inventory are given in the below table;

Particulars

31-Mar-05

% of Total

31-Mar-06

% of Total

31-Mar-07

% of Total

31-Mar-08

% of Total

Rs.

Rs.

Rs.

Rs.

RM and Components

66,070,542

52.92

51,001,972

42.24

28,326,855

43.66

93,829,590

40.08

Semi-finished goods

52,933,896

42.40

66,744,622

55.28

43,150,590

48.71

240,938,889

49.83

Finished Goods

4,352,909

3.49

,782,674

.48

1,807,252

4.02

31,126,429

6.44

Loose Tools

,484,779

.19

,204,033

.00

6,091,412

2.07

3,957,683

2.89

Consumable and Packing Material

4,513,410

.54

3,701,325

0.77

Total

24,842,126

20,733,301

293,889,519

483,553,916

Interpretation:

The above table shows that the contribution of RM & Components and semi-finished goods to total inventory is 94-96%, which is very high. This shows that more time is required to convert them into finished product i.e. decreased inventory turnover ratio i.e. increased inventory velocity. This results into more time requirement for realisation of cash. One of the important areas in VEL is to control too slow moving inventory (above 1 year). One of the top priorities of VEL now is to either consume these too slow moving items or take necessary action after receiving clearance from top management.

The details of time required for each stage of inventory is as below;

R M

(Days)

MRIR

(Days)

Inward QC

(Days)

Machining

(Days)

Assembly & Testing (Days)

Painting

(Days)

Inspection & DA (Days)

Packing & Dispatch (Days)

Total

(Days)

SVD

Carbon Steel

42

2

0

0.125

.5

0.5

58.13

Stainless Steel

42

2

0

0.125

-

0.5

56.63

SMALL TMBV

Carbon Steel

56

2

20

0.125

2

0.5

82.63

Stainless Steel

56

2

20

0.125

-

0.5

80.63

LARGE TMBV

Carbon Steel

56

2

25

0.33

2

0.5

87.83

Stainless Steel

56

2

25

0.33

-

0.5

85.83

AUTOMATION

Carbon Steel

96

2

-

0.33

2

0.5

02.83

Stainless Steel

96

2

-

0.33

-

0.5

00.83

655.33

Avg. Inv Turnover (Days)

81.92

4.3.2 Inventory Turnover Ratio

Inventory Turnover Ratio = Cost of Goods Sold / Avg. Inventory.

YEAR

Inv. Turnover ratio

Inventory Velocity

2004-05

5.11

71

2005-06

4.81

76

2006-07

3.32

10

2007-08

3.3

11

Interpretation:

The ratio is continuously decreasing from 5.11 in 2004-05 to 3.3 in 2007-08. This is however a low value, indicating huge quantity of funds locked up in stock. As mentioned earlier the reason for low inventory turnover is due to large amount of nonmoving (above 1 year) items and large amount of RM and semi finished items.

4.4 Receivables Management in VEL

Procedure of receivables management:

Virgo sells its product directly to its customers. Its marketing offices are spread within and outside the country. The costing department in coordination with production, machine shop, marketing department formalize the price of different products jointly. The price list for each product in their region is circulated to all branch offices.

The sales and billing are done at the individual branches and the record of the daily transactions is maintained. The cash deposits are done at one of the respective banks and the entire sum in turn is transferred to the banks at Pune.

Credit policy of VEL:

The credit policy of VEL is strict in one sense and flexible in other. Virgo Engineers Ltd. does not give same credit period to all its customers. To government agencies and to some of its well known customers it gives credit period and from others it accepts advance payments.

VEL follows two types of credit sales of its products. They are:

) Secured credit sales

2) Unsecured credit sales

Secured sales are backed by securities, which can be

a) Letter of credit: letter of credit is an agreement whereby the banks opens letter of credit of its customers in favor of suppliers and undertakes the responsibility of payment obligation of its client.

b) Bank guarantee: bank guarantee is like issuance letter of credit where by the customers bank gives the guarantee to VEL to undertake responsibility of payment obligation of its credit.

4.4.1 Debtors' Turnover Ratio

Debtors turnover ratio = Credit Sales / Average (Debtors + Receivables)

This ratio measures how rapidly receivables are collected. A high ratio is indicative of shorter time-lag between credit sales and cash collection. A low ratio shows that debts are not being collected rapidly.

YEAR

Debtors Turnover Ratio

Debtors Velocity

(Days)

2004-05

5.74

64

2005-06

4.43

82

2006-07

4.08

89

2007-08

4

91

Interpretation:

The debtors' turnover ratio has always been low. The turnover ratio for VEL is 5.74 in 2004-05 and has been decreasing continuously till 2007-08 and hence debtors velocity is increasing from 2004-05 to 2007-08. The ratio was low in 2007-08 and is 4. This is because % increase in debtors is more as compared to % increase in credit sales. This show that maximum amount of sales is through credit only.

4.5 Payables Management in VEL

In VEL all payments are done through the cash section of finance department in Pune. Cash sections monitor the cash position on a daily basis and prioritize the payments. Cash section prepares periodic cash report and checks with the banks for cash balance. Based on the balance available in the banks and prioritization of payments, cheques are issued to the parties. Payments are prioritized so as to optimize the cost. Prioritization is done based on the financial implication of non-payment of the due.

The financial implications considered by VEL for non-payment of due are

. Interest cost penal and overdue.

2. Penalties and fines in case of statuary obligation.

3. Impact of production and sales in case of payment is for critical item.

Close liaison is maintained between purchase department, vendor department, bill-passing section of finance department and cash section for efficient management off account payable. The major payments of the plant are towards:

. Purchase of raw material ( Castings )

2. Purchase of stores and spares

3. Vendor payment ( Outsourcing )

4. Employee wages

5. Freight payment

6. Interest on loans including working capital

7. Statutory duties like excise and sales tax.

4.5.1 Creditors' Turnover Ratio

Creditors Turnover Ratio = Credit Purchase / Avg. Creditors

A low turnover ratio reflects liberal credit terms granted by suppliers, while a high ratio shows that accounts are to be settled rapidly. The creditor's turnover ratio is an important tool of analysis of as a firm can reduce its requirements of current assets by relying on supplier's credit.

YEAR

Creditors Turnover Ratio

Creditors Velocity

(Days)

2004-05

3.87

94

2005-06

2.39

53

2006-07

3.63

01

2007-08

3.93

93

Interpretation:

Company's creditors' turnover ratio is within 2.39 to 3.93. This ratio was low in 2005-06 i.e. 2.39 because of decrease in credit purchase. Company is managing to stretch its creditors. It is good from company's point of view, so that company can stretch its creditors as long as possible ultimately reducing its working capital requirements.

5. Observations

. The current ratio of the company is within 1.5 to 2, which is indicative of better liquidity of the company, conventionally a current ratio of 1.33 is considered satisfactory.

2. Generally, quick ratio of 1:1 is considered satisfactory. In case of VEL the ratio is within 1 to 1.3 which indicates that company can easily meet all current claims. It shows that company's short term financial position is satisfactory.

3. D/E ratio of 2:1 is considered satisfactory. Company's D/E ratio is varying from 0.3 to 0.95. There is therefore, a safety margin available to the creditors of the company, as owners are putting relatively sufficient money. For the company also servicing of debt is less burdensome and consequently its credit standing is not adversely affected and it will be able to raise additional funds.

4. The inventory turnover ratio is decreasing from 2004-05 till date. It is least in 2007-08 i.e. 3.3 and hence inventory velocity is high. It shows that inventory does not sell fast and stays in company for a long time (3 months). So capital remains locked up in the form of inventory for long time hence results into more working capital requirement. So company has to take necessary action to reduce conversion time, delays in production and in other related things in order to decrease inventory velocity.

5. Company's debtors' turnover ratio is varying from 5.74 to 4 and is decreasing every year, and hence increased debtors velocity, which is an indicative of delay in collection of debts. Still company manages to collect its debtors within credit period given by it to its debtors. An increased debtors' turnover ratio will reduce company's working capital requirement.

6. Company's creditors' turnover ratio is within 2.39 to 3.93. Company is managing to stretch its creditors. It is good from company's point of view, as company can stretch its creditors as long as possible ultimately it will reduce its working capital requirements.

7. Company's fixed asset turnover ratio is within 3 to 4.

8. Company's working capital turnover ratio is decreasing continuously from 2004-05 till date, which is not a good from company's point of view. It is mainly because of increase in working capital every year.

9. Although operating net profit ratio has decreased in 2007-08 as compared with previous year the ratio is increasing as compared with 2004-05.

0. The return on capital employed is more than 23 % till date and was lowest in 2007-08 i.e. 23.21 %. It was highest in 2005-06 i.e. 32.62%.

1. Return on share holders fund was lower in 2006-07 i.e. 19.9 % but overall it is good. This shows that owners' funds have been profitably utilized by the company.

2. Return on Equity was also in 2006-07 i.e. 19.9 % but overall it is showing positive trend. This shows that company has earned a satisfactory return for its equity holders.

3. Company's interest coverage ratio has been increasing over the period. So from point of view of lenders, the larger the coverage, the greater is the ability of the company to handle fixed-charge liabilities and the more assured is the payment of interest to them. The ratio was highest in 2006-07 i.e. 7.27.

4. Figures show that earning per share and dividend payout ratios are increasing over the period.

5. The total sales of VEL have shown a negative trend in 2005-06 and after that it has shown a positive trend till date. For the year 2005-06 the fall in sales was 7.93% as compared to 2004-05. For the year 2006-07 the rise in sales was 77.31% as compared to 2005-06 and for the year 2007-08 rise in sales was 59.48 % as compared to 2006-07. The average increase in sales is over 42% indicates the excellence achieved by VEL.

6. Companies WC requirement for every year is decided in proportion to past sales and current year sales target.

6. Recommendations

. Over the period of the year the net profit after tax forms nearly 8 % of the total sales so company should try for production enhancement system and cost efficient manufacturing so that the company comes to a position for further increasing its net profits.

2. Unlike any other valve company, VEL is not having its own sources of raw material i.e. foundry so the company always depends on its supplier for its raw material.

3. Although company is growing and its profits are also increasing company must analyse its performance over the period.

4. Over the period inventory is forming 34 % of current assets and is mainly consists of Raw Materials and Semi-finished components. So company's lot of money is blocked into it. So company should try to convert this inventory into finished goods so that it can minimize this locked fund and will help for realisation of cash. This will ultimately result in reduced working capital requirement.

5. Too slow moving inventory (above 1 year) is one of the important areas in VEL's working capital management. It accounts for 31% of value total inventory. This is really a critical area where VEL's management should focus to bring down the level of this inventory. VEL has to identity areas for using such inventory to dispose it. Also identification of such items will help in preventing procurement of such items on future.

6. Each department i.e. production, stores, machine shop and dispatch should maintain their respective inventory and WIP properly as per system stock.

7. Debtors are forming 44 % (approximately) of current assets, so company should try to minimize this amount by speedy collection of debtors, this will also help in reduced working capital requirement.

7. Conclusion

The concept of working capital is used in two ways i.e., gross and net. Gross working capital refers to the firms investments in current assets. Net working capital means the difference between current assets and current liabilities, and therefore represents the position of current assets, which is financed either from long term funds or banks borrowings.

Cash is required to meet a firm's transactions and precautionary needs. 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.

8. Future Scope

. 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.

9. Bibliography

* Khan & Jain - Financial Management

* I. M. Pandey - Financial Management

* Annual Reports of Virgo Engineers Limited.

* www.virgoengineers.com

Working Capital Management

Vivekanand Education Society's Institute of Management Studies and Research Page 1