1. 1

2. INTRODUCTION TO FINANCE
It would be worthwhile to recall what Henry ford once remarked “Money is an arm or
a leg; you either can use it or lose it”. This statement throws light on the significance
of money or finance. A budding concern may need a small amount of money and yet
it may be difficult for it to commence business simply because it is not in the position
to get required funds. A firm’s success and survival mainly depends upon its ability to
generate sufficient funds when need arises. Finance holds the key to all the activities.
The role of financial manager, that is, the one who is incharge of the finance function,
is difficult because he has to play that role and relate it to the role of other managers.
DEFINITIONS OF FINANCE
Ray G. Jones and Dean Dudley observe that the word finance comes indirectly from
the Latin word Finis. Finance is defined as the issuance of the distribution of and the
purchase of liability and equity claim issued for the purpose of generating revenue-
producing assets. These claims are commonly referred to as financial claims.
According to Paul.G.Hasings. ”Finance” Is the management of the monitory affairs of
the company. It includes determining what has to be paid for and when, raising the
money on the best terms available, and devoting the available funds to the best uses.
Kenneth Midgely and Ronald Burns define financing as “a process of organizing the
flow of funds so that a business can carry out its objectives in the most efficient
manner and meet it’s obligations as they fall due”.
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3. FINANCE FUNCTIONS
Finance function is a task of providing the funds required by an enterprise on the
terms most favourable to it in the light of the objectives of the business. This long-
held concept has the merit of highlighting the core of the finance function keeping the
business the most suitable way and, on the best possible terms, is the central part of
the finance supplied with enough funds to accomplish its objectives. Getting the
required funds in job.
Finance presents itself in a broad spectrum of activities. There are a number of basic
functions underlying finance. It is an essential, and at the same time a very distinct,
segment of the overall managerial function. It is the lifeblood of any business activity
and no business function can be
discharged without it. Finance must be used judiciously. It has to be systematically
controlled and regulated so that it may contribute to the different functions of business
administration. If the finance function is properly blended with production, marketing,
personnel, accounting and other business functions, the wastage of funds can be
avoided.
FINANCIAL PLANNING
In simple words financial planning means deciding well in advance as to how much
finance is required, when is it required, what are the sources through which finance is
available and how should it be put to use, so as to obtain organizational objectives.
The aim in financial planning should be to match the needs of the companies with
those of investors with a sensible gearing of short term and long-term interest
securities.
Financial planning helps the financial manager to see the financial situations clear of
stress and strains and to develop a deep insight-an essential prerequisite for financial
stewardship. The importance of financial planning lies essentially in the fact that it
enables the financial manager to develop a diagnostic skill of analyzing complex
situations and arriving at suitable solutions.
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4. STEPS INVOLVED IN FINANCIAL PLANNING
The various steps involved in financial planning are as follows:
1. Establishing objectives: Every business enterprise will have to establish its
financial objectives. It will have to state how much capital is employed in various
factors of production over the long run and how much productivity can be ensured
through the employment those factors. It would be necessary for every business
enterprise to stipulate both short-run and long run objectives so that it may operate
in a dynamic society.
2. Policy formulation: financial policies will have to have a thrust on following
policies:
• Determining the control by the parties who furnish the capital. For
example, if debt exceeds in unassuming portions, it would obviously
mean dilution of control.
• Acting as a guide in the use of debt or equity capital. For example, the
business enterprise will have to state clearly its plans about the debt-
equity proportions.
• Guiding management in the selection of the source of funds. This also
means the financial plans should state which source of funds should be
drawn upon by a business enterprise in various time phases.
2. Forecasting: forecasting is usually done on the basis of facts; but facts do not
become readily available, more particularly when they are addressed to the
future. In that case, financial management will have to forecast the future
predicting the variability of the factors influencing the type of policies the
enterprise intends to formulate.
3. Formulation of procedures: policy for formulation must invariably be
backed up by suitable procedures, for financial policies procedures which are
broad guidelines which must be capable of being translated into detailed
procedures. Very often, there is a gap between financial plans and h results in
chaotic conditions in a business enterprise. Financial managers often take
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5. shelter under the plea that the right type of procedures are not available to
support the accomplishment of the goals and objectives of the firm, where as
the chief executives grumble over the short comings inherent in the procedures
because they are not able to accomplish the plans by reason of the fact that
procedures do not support financial plans.
Factors to be considered while estimating financial requirements.
• Cost of finance.
• Availability of funds.
• Repayments.
• Interest.
• Position of assets.
• Control.
• Risk.
• Seasonality.
• Estimating costs of other functions.
• Fixed assets requirements.
• Expenditure on current assets.
• Budgetary appropriations.
• Distribution system.
• Break-even.
• Provision for contingencies.
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6. INTRODUCTION TO WORKING CAPITAL
Empirical observations show that the financial managers have to spend much of their
time to the daily internal operations relating to current assets and current liabilities of
the firms. As the largest portion of the manager’s time is devoted to working
problems, it is necessary to manage working in the best possible way to get maximum
benefit. The effective management of the business, among other things primarily
depends upon the manner in which the short-term assets and short run sources of
financing are managed. The management or current assets management consists of
inventories, accounts receivable and cash & bank balances as the major components.
There is a difference between current assets and fixed assets in terms of their
liquidity. A firm requires many years to recover the initial investments in fixed assets
such as plant and machinery and land and buildings. On the contrary, investments in
current assets are turned over many times a year. Investments in current assets such as
inventories and book debts are realized during the firm’s working capital cycle, which
is usually less than a year. Working capital is that proportion of a company’s total
capital, which is employed in short-term operations.
Even though, it is one segment of the capital structure of a business, it constitutes an
inter-woven part of the total integrated business system. Therefore, neither it can be
regarded as an independent entity, nor, can the working capital decisions be taken in
isolation. Thus, a study in this field is of major importance to both internal and
external analysis, for its close relationship with the day-to-day operations of a
business.
There are many aspects of working capital management, which form an important
function of a financial manager:-
• Working management represents a large portion of the firm’s investment in
assets.
• Working management has greater significance not only for small firms but
also for large firms.
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7. • The need for working capital is directly related to sales growth.
Most of the work dealing with working capital management in confined to the balance
sheet, which is directed towards optimizing the levels of cash and marketable
securities, receivable and inventories. For the most part, optimization of these current
assets is isolated from the optimization of the other current assets and the overall
valuation of the firm.
The decision concerning cash and resources, receivable, investments and current
liabilities is with an objective of maximizing the overall value of the firm. Once
decisions are reached these areas, the levels of working capital are also reduced.
An appropriate level of working capital is to be maintained as the excessive working
capital interrupts the smooth flow of the business activity and curbs profitability.
Also, there are a lot of circumstances where shortage of working capital has proved to
be the major factor for business failure. Operating plans are out of control and the
corporate objectives get blurred. The suppliers and the creditors give the firm an
adverse credit rating and tighten up credit terms.
The problem of managing working capital has got a separate entity as against
different decision-making issues concerning current assets individually. Working
capital has to be regarded as one of the conditioning factors in the long run operations
of a firm, which is often inclined to treat it as an issue of short-run analysis and
decision-making.
The management of working capital hence involves constant vigilance to ensure that
the right quantum is available on a continuing basis to support and promote the
activities. Sound financial and statistical techniques, supported by judgment, should
be used to predict the quantum of working capital needed at different time periods.
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8. DEFINITIONS OF WORKING CAPITAL
Working capital has been in several ways as given below.
Operating capital: - As the working capital is the capital required to operate
the business and is the capital invested in the current assets, it is called as
operating capital.
Circulating capital: - Interchangingly used word for working is circulating
capital. Gerestenberg gas suggested this item ‘circulating capital’ as all the assets of
business change from one form to another.
CONCEPTS OF WORKING CAPITAL
Conceptually, working capital is either explained as: - Net Working Capital or Gross
Working Capital. These concepts are not exclusive; rather they have equal
significance from management viewpoint. Gross working capital refers to the firm’s
investment in current assets. Net working capital refers to the difference between
current assets and current liabilities.
GROSS WORKING CAPITAL CONCEPT
It is called as ‘qualitative’ aspect of working capital and focuses attention on two
aspects of current assets management: -
1. Optimum investment in current asset
It is conventional rule to maintain the level of current assets twice the
level of current liabilities to constitute a margin or buffer for maturing
obligation of a business.
2. Financing of current asset
Another aspect of gross working capital points to the need of
arranging funds to finance current assets.
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9. NET WORKING CAPITAL CONCEPT
Net working capital can be positive or negative. A positive net working capital will
arise when current assets exceed current liabilities. A negative net working capital
mean excess current liabilities over current assets.net working capital being the
difference between current assets and current liabilities, is ‘qualitative’ concept and
hence it: -
1. Indicates the liquidity position of the firm: - A weak liquidity position poses a
threat to solvency of the company and makes it unsafe and unsound.
2. Suggests the extent to which working capital needs may be financed by
permanent sources of funds:- i.e., it covers the question of judicious mix of
long term and short term funds for financing current assets. Thus, it may be
emphasized that both gross and net concepts of working capital are equally
important for the efficient management of working capital.
NEED FOR WORKING CAPITAL FINANCE
The need for working capital finance is over-emphasized. Every business needs some
amount of working capital. The need for working capital arises due to the time gap
between production and realization of cash from sales. There is an operating cycle
involved in the sales and realization of cash. There are time gaps between purchase of
raw materials & production, production & sales and realization of cash. Thus,
working capital is needed for the following purposes.
• For the purpose of raw materials, components and spares.
• To pay wages and salaries.
• To incur day-to-day expenses and overhead costs such as fuel, power
and office expenses, etc.
• To meet the selling costs as packing, advertising etc.
• To provide credit facilities to the customers.
• To maintain the inventories of raw materials, work in progress, stores
• And spares and finished stock.
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10. OPERATING CYCLE
Operating cycle indicates the length of time between firm’s paying for materials
entering into stock and receiving the cash from sale of finished goods. In other words,
the duration of the required time to complete the sequence of events is called
operating cycle. The operating cycle may take the following sequence:
1. In a manufacturing concern
• Conversion of cash into raw materials.
• Conversion of raw materials into work in progress.
• Conversion of work in progress into finished goods.
• Conversion of finished goods into debtors.
• Conversion of debtors and bills receivables into cash.
The following figure shows the operating cycle of a manufacturing concern.
Cash Raw materials
Accounts receivable Work in progress
(or) Work in process
Finished goods
2. In a trading concern
a) Cash into inventories
b) Inventories into debtors and bills receivables
c) Debtors and bills receivables into cash
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11. The following figure shows the operating cycle of a trading concern
Account receivables
Cash
Inventories
TYPES OF WORKING CAPITAL
The working capital is classified in to two types. They are
I. Permanent working capital
II. Temporary working capital
• Permanent working capital:
Permanent or fixed working capital is the minimum amount, which is
required to ensure effective utilization of fixed facilities and for maintaining
the circulation of current assets. This investment if of a permanent type and as
the size of the firm expands the requirement of working capital also increases.
• Temporary working capital:
Temporary working capital is also called as the fluctuating or variable
working capital, which varies according to the problem and sales. It is the
capital required in addition to the working capital.
• Net working capital:
It is the difference between current assets and liabilities. It is the excess of
current assets over current liabilities. This concept enables a firm to determine
the exact amount available at its disposal for operational requirements.
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12. • Gross working capital:
It refers to the total current assets of the business. It is also known as
circulating capital, because the current assets are rotating in their nature.
• Negative working capital:
When a current liability exceeds current assets, it is called as negative working
capital.
NEED FOR MAINTENANCE OF ADEQUATE WORKING CAPITAL
An adequate or optimum working capital balance refers to the desired working capital
where a firm will not have excess or shortage of working capital and indicates both
profitability and liquidity for the firm. It is necessary to maintain an optimum cash
balance, an optimum level of inventory and an optimum level of debtors and
receivable.
DANGERS OF EXCESS WORKING CAPITAL
• It results in unnecessary accumulation of inventory in the form of raw material or
work in progress or finished goods, leading to a high cost of storage, space,
Insurance, increased theft, deterioration in the quality of goods, etc.
• Also, it is an indication of defective credit policy and slack collection period.
• Excess cash in hand indicates idle cash and even though the liquidity position of
the company is good, it lacks profitability.
• Excessive working capital makes the management complacent, which degenerates
into managerial inefficiency.
DANGERS OF INADEQUATE WORKING CAPITAL
• The production process will be obstructed if there is shortage of working capital.
• Fixed assets are not efficiently utilized if there is lot of working capital funds,
which leads to deterioration in profits.
• The firm loses its reputation when it is not in a position to honor its short-term
obligations.
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13. • Ultimately it leads to the reduction in sale, as the firm cannot meet the demand of
the customers.
EFFECT OF INADEQUATE WORKING CAPITAL ON DECISION MAKING:-
1) Stagnates the growth of the firm,
2) Threatens the solvency of the firm,
3) Creates difficulties in implementing the operating plans,
4) Renders the firm unable to avail the attractive credit opportunities
EFFECTS OF EXCESS WORKING CAPITAL ON DECISION MAKING
 Impairs firm’s profitability through idle cash and
 Makes dividend policy liberal,
 Creates difficulties to cope with the future, on the failure of the estimated
speculative profits.
IMPORTANCE OF WORKING CAPITAL
Even though the skills for maintaining the working capital are somewhat unique, the
goals are the same-viz. to make an efficient use of funds for minimizing the risk of
loss to attain profit objectives.
Firstly, the adequate of working capital contributes a lot in raising the credit-standing
of a corporation in terms of favorable rates of interest on bank loan, better terms on
goods purchased, reduced cost of production on account of the receipt of cash
discounts, etc.
Secondly, a company with sufficient working capital is always in a position to take
the advantage of any favorable opportunity either to purchase raw materials or to
execute a special order or to wait for better market position.
In the third place, the ability to meet all reasonable demands for cash without
inordinate delay is a great psychological factor to improve the all rounds efficiency of
the business.
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14. Lastly, during slump the demand for working capital, instead of coming down, shoots
up. A good amount of working capital is locked up in the inventories and book debts.
Concerns having ample resources can tide over that period of depression.
Thus, working capital is regarded as one of the conditioning factors in the long run
operations of the firm, which is often inclined to treat it as an issue of short run
analysis and decision making.
FACTORS INFLUENCING WORKING CAPITAL
 Nature of business
The working capital requirement of a firm basically depends upon the nature
of it’s business public utility undertakings like electricity, water supply and
railways need very little working capital because they offer cash sales only
and supply services, not products and such no funds are tied up in inventories
and receivables. The manufacturing undertakings also require sizable working
capital along with fixed investments because they have also to build up
inventories.
 Size of business
The working capital requirements of a concern are directly influenced by the
size of its business, which may be measured in terms of scale of operations.
Greater the size of business unit, generally, larger will be the requirements of
working capital.
However in some cases, even a smaller concern may need more working due
to high overhead charges, inefficient use of available resources and other
economic disadvantages of small size.
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15.  Production capacity
In certain industries the demand is subject to wide fluctuations due to seasonal
variations. The requirements of working capital in such cases depend on the
production policy.
Manufacturing process
In manufacturing business the requirements of working capital increase in
direct proportion to length of manufacturing process. Longer the process period
of manufacture, larger is the amount of working capital required.
 Seasonal variations
In certain industries, raw material is not available through out the year. They
have to buy raw materials in bulk during the season to ensure an uninterrupted
flow and process them during the entire year. A huge amount is, thus, blocked
in the form of material inventories during such season, which gives rise to
more working capital requirements.
 Working capital cycle
In a manufacture concern, the working capital starts with the purchase of raw
materials and ends with the realization of cash from the sale of finished
products. The speed with which the working capital completes one cycle
determines the requirements of working capital. Longer the period of cycle,
larger is the requirement of working capital.
 Rate of stock turn over
There is a high degree of inverse correlation ship between the quantum of
working capital and the velocity or speed with which the sales are affected. A
firm having as high rate of stock turnover will need lower amount of working
capital as compared to a firm having a low rate of turnover.
 Credit policy
The credit policy of a concern in its dealings with debtors and creditors
influences considerably the requirements of working capital. A concern that
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16. purchases its requirements on credit sells its products/services on cash requires
lesser amount of working capital.
 Business cycle
Business cycle refers to alternate expansion and contraction in general
business actively. In a period of boom i.e., when the business is prosperous,
there is a need for larger amount of working capital due to increase in sales,
rise in prices, optimistic expansion of business, etc. on the contrary, in the
times of depression i.e., when there is a down swing of the cycle, the business
contracts, sales decline, difficulties are faced in collections from debtors and
firms may have a large amount of working capital lying idle.
 Rate of growth of business
The working capital requirements of a concern increase with the growth and
expansion of its business activities.
 Earning capacity and dividend policy
Some firms have more earning capacity than others due to quality of their
products, monopoly conditions, etc. such firms with high earning capacity
may generate high cash profits from operations and contribute to their working
capital. The dividend policy of a concern also influences the requirement of its
working capital.
 Price level changes
Changes in the price level also affect the working capital requirements.
Generally, the rising prices will require the firm to maintain larger amount of
working capital, as more funds will be required to maintain the same current
assets. The effect of rising prices will be different for different firms. Some
firms may be affected much while some may not be affected at all by the rise
in prices.
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17.  Other factors
Certain other factors such as operating efficiency, management ability,
irregularities of supply, import policy, asset structure, importance of labour,
banking facilities, etc., also influence the requirements of working capital.
SOURCES OF WORKING CAPITAL
The various of working capital for the financing of working capital are as follows:
Sources of working capital
Permanent or fixed Temporary or variable
1) Shares 1) Commercial banks
2) Debentures 2) Indigenous bank
3) Public deposits 3) Trade credits
4) Ploughing back of profits 4) Installment credit
5) Loans from financial institutions 5) Accounts receivables
FINANCING OF PERMANENT, FIXED OR LONG TERM
WORKING CAPITAL
Permanent working capital should be financed in such a manner that the enterprise
may have its uninterrupted use for a sufficiently long period. There are five important
sources of permanent or long-term working capital:
• Shares
Issue of shares is the most important source for raising the permanent or
long capital. A company can issue various types shares as equity shares,
preference shares.
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18. • Debentures
A debenture is an instrument used by the company acknowledging its debt
to its holder. It is also an important method of raising long term or
permanent working capital.
• Public deposits
Public deposits are the fixed deposits accepted by a business enterprise
directly from the public. This source of raising short term and medium
term finance was very popular in the absence of banking facilities.
• Ploughing back of profits
Ploughing of profits means the re-investment by a concern of its surplus
earnings in its business. It is an internal source of finance and a most
suitable for an established firm for its expansion, modernization and
replacement, etc.
• Loans for financial institutions
Financial institutions such as commercial banks, Life Insurance
Corporation, industrial finance corporation, industrial bank of India, etc,
also provide short term and long-term loans.
FINANCING OF TEMPORARY, VARIABLE OR SHORT- TERM
WORKING CAPITAL
The main sources of short-term working capital are as follows:
 Commercial banks
Commercial banks are the most important source of short-term capital.
The major portion of working capital loans is provided by commercial
banks. They provide a wide variety of loans tailored to meet the specific
requirements of a concern. The different forms in which the banks
normally provide loans and advances are loans, cash credits, overdrafts,
purchasing and discounting of bills.
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19.  Indigenous bankers
Private moneylenders and country bankers used to be the only source of
finance prior to the establishment of commercial banks. They used to
change very high rates of interest and exploit the customers to the largest
extent possible.
 Installment credit
This is another method by which the assets are purchased and the
possession of goods is taken immediately but the payment is made in
installments over a predetermined period of time.
 Trade credits
As present day commerce is built upon credit, the rate credit arrangement
of a concern with its suppliers is an important source of short-term finance.
The main advantages of this source are: it is very convenient method of
finance; it is flexible and it may be possible to obtain favorable terms.
 Advances
Some business houses get advances from their customers and agents
against orders and this source is a short-term source of finance for them.
 Accounts receivables
Accounts receivable is a permanent investment in the business. As old
receivables are collected and new receivables are created, it is the major
component of the current assets.
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20. CASH MANAGEMENT
INTRODUCTION
Cash is the most liquid asset and all assets of business are finally converted into cash.
Cash is considered as the lifeblood of the business. It is essential for a business to
carry out all its transactions. Cash of a business includes cheques, currencies and bank
drafts. The cash determines the credit worthiness, solvency and liquidity position of a
business with the business. Cash management assumes more importance than other
current assets because cash is the most significant and least productive asset of a
business.
Management of cash is important not only because it is the most liquid asset but also
because all the liabilities of the business are to be met in cash. Though cash forms the
smallest part in the total assets of the company it requires a lot of time for its
management.
MOTIVES FOR HOLDING CASH
A business may hold cash with the following motives:
 Transaction motive
It requires a firm to hold cash to conduct day-to-day operations of business.
The firm needs cash to make payments for purchases, wages and operating
expenses and other inevitable payments.
 Precautionary motive
The firms to meet emergencies i.e., the unforeseen events of the business also
maintain cash. A business firm will have to fan a number of risks because it
has an environment of its own. The environment consists of many
uncontrollable factors like government legislation, natural calamities,
unpredictable consumer behaviour etc, to face all these risks, the firm needs to
hold cash in a business.
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21.  Speculative motive
To take advantage of unexpected opportunities, a firm holds cash for investing
in profit making opportunities. Such a motive is purely speculative in nature.
 Security motive
A firm should maintain cash reserves for future requirements if a firm is not in
a position to obtain finance from any other source, then it can utilize the cash
reserves.
 Compensatory motive
It is a motive to have cash to compensate against loss arising in business.
OBJECTIVES OF CASH MANAGEMENT
 To meet the payment schedule
The main objective of cash management is to make the payments to the
various types of expenditure. Every business will have payment schedule and
hence it has to generate cash inflows to meet the cash outflows.
 To maintain minimum cash reserves
Another important objective of cash management is to maintain optimum cash
balance. To meet the expenses a firm need not maintain huge reserves of cash.
Huge reserves will mean idle cash, which is not productive. On the other hand
if there is no cash reserve, a firm finds it difficult to meet the expenses. Hence,
minimum cash reserves are to be maintained.
STRATEGEIES OF CASH MANAGEMENT
Following are the various strategies for cash management.
 Cash planning
Cash planning is necessary to project the surplus or deficit of cash. It also
helps to maintain the cash balance for the planned period. It is a technique to
plan and control the use of cash. Cash planning may be done on daily, weekly
or monthly basis. The period and frequency of cash planning generally
depends upon the size of the firm.
Cash planning requires the use of two techniques namely
- Cash forecasting and
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22. - Cash budgeting
 Cash forecasting
It refers to the prediction of cash requirements and the sources of cash
generation. Cash forecasts are required to prepare cash budgets. It may be
done on a short-term basis or a long-term basis. The most commonly used
methods for cash forecasting are:
1) The receipts and disbursement method
2) Net adjusted income method
 Cash budgeting
Cash budget is the most significant device for planning and controlling the
receipts and payments. It is a summary statement of the firms expected
cash inflows and outflows over a projected time period. The time horizon
of a cash budget may differ from firm to firm. Daily, weekly or monthly.
Cash budget should be prepared for determining the cash requirements.
 Management of cash inflows
Once the cash budget has been prepared the financial manager should that
their does not exit a significant deviation between projected cash inflows
and actual cash flows. The two objectives of managing cash flows are:
- Accelerating cash inflows and
- De-accelerating cash outflows
 Optimum cash balance
Cash management involves the maintenance of optimum cash balance.
Optimum cash balance is desired amount of cash to be held by the firm. If
a firm has an optimum cash balance it will not suffer with the ideal cash or
with shortage of cash. Cash by itself cannot generate until it is invested.
Having excess cash will mean an opportunity cost to the business. If a firm
runs short of cash it cannot fulfill the basic objectives of meeting the
payment schedules hence optimum cash balance is necessary.
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23.  Management of idle cash
Business firm will face the problem of managing idle cash. At times a
business will have more cash inflows and shortage of cash. It is necessary
for the firm to generate something out of the idle cash and keep ready the
same cash at that time when it runs to shortage of cash. The best option to
manage the idle cash is to invest it on marketable securities i.e., it can
invest on the securities like shares and debentures of other companies.
While investing on the securities of other it has to consider the following
three factors:
1) Safety
2) Marketability
3) Maturity
RECEIVABLES MANAGEMENT
INTRODUCTION
Receivables management is a permanent investment in the business. As old
receivables are collected and new receivables are created, it is a major credit of the
current assets. This emerges because of the existence of credit sales. It shows the
amount receivable from the purchases. This is called by different names such as bills
receivables, accounts receivable, trade debtors, sundry debtors, trade receivables etc.
Receivables derive benefits to the firm and also involve cost to the firm. If the benefit
is more the cost is also more and hence the risk increases. On the other hand, if the
benefits are less the cost and risk is also less. Receivable management tries to trade of
between benefits and cost arising from receivables.
INVENTORY MANAGEMENT
INTRODUCTION
The important component of working capital is inventory. Inventory refers to the
stock of goods yet to be sold by a business firm. It is denied as the stock of goods a
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24. firm is offering for sale and the components that make the goods. In other words the
inventory includes raw materials, work in progress and finished goods.
OBJECTIVES OF INVENTORY MANAGEMENT
 To provide continuous supply of raw materials for production
 To reduce the wastage and to avoid loss of breakage and
deterioration
 To meet the demand for goods of ultimate consumers on time
 To provide right material at time and at right places
 To avoid excess and inadequate storing of materials
MOTIVES FOR HOLDING INVENTORY
Generally inventories are held by three motives
 The transaction motive, which emphasizes the need to maintain inventories to
facilitate smooth production and sales operation.
 The precautionary motive which necessitates holding of inventories to guard
against the risk of unpredictable changes in demand and supply process and other
factory.
 The speculative motive which influences the decision to increase or reduce
inventory levels to take advantages of price fluctuations.
INVENTORY MANAGEMENT TECHNIQUES
In managing inventories, the firm’s objective should be in consance with the wealth
maximization principle. To achieve this, the firm should determine the optimum level
of inventory. Efficiently controlled inventories make the firm flexible. To manage
inventories efficiently, the understanding economic order quantity and reorder point
can answer the questions.
ECONOMIC ORDER QUANTITY
One of the major inventory management problems to be resolved is how much
inventory should be added when inventory replenished. Economic order quantity is
that quantity of material, which is most economical in buying taking into account the
24

25. operational requirements of the company. The economic order quantity is that
inventory level, which minimizes the total ordering cost and carrying cost.
PRINCIPLES OF WORKING CAPITAL MANAGEMENT
The objectives of working capital management are to manage the firm’s current assets
and current liabilities in such a way that a satisfactory level of working capital is
maintained. The following general principles help us to maintain a sound working
capital:
• Principle of risk variation
• Principle of cost of capital
• Principle of Equity position
• Principle of maturity of payment
 PRINCIPLE OF RISK VARIATION
Risk here refers to the capability of a firm to meet its obligations as and when
they become due for payment. Larger investment in current assets with less
dependency on short-term borrowing increases liquidity, like for example:
conversion of resources into inventories, into cash, here cash outflows occur
before cash inflow. But then the cash inflows are not certain because sales and
collections, which give rise to cash inflows, are difficult to forecast
accurately. Cash outflows on the other hand are relatively certain. The firm is
therefore, required to invest in current assets for a smooth, uninterrupted
functioning. It needs to maintain liquidity to purchase raw materials and pay
expenses such as wages and salaries, other manufacturing administrative and
selling expenses as there is hardly a matching between cash inflows and
outflows.
On the other hand investment in current assets with greater dependence on
short-term borrowings increases risks, reduces liquidity and increases
profitability. For example: Acquiring resources on credit, temporarily
postpones payment of certain expenses. Thus, the time interval between cash
collections from sale of products and cash payments for resources acquired by
the firm reduces liquidity and increases profitability. In other words there is a
definite inverse relationship between the degree of risk and profitability. The
25

26. various working capital policies, such as conservative policy, moderate policy,
and aggressive policy indicate the relationship between current assets and
sales.
A conservative management prefers to minimize risk by maintaining a higher
level of current assets for working capital while a moderate or aggressive
management assumes comparatively greater risk by reducing working capital.
However, the goal of the management should be to establish a suitable trade
off between profitability and risk.
 PRINCIPLE OF COST OF CAPITAL / PERMANENT AND VARIABLE
CAPITAL
Cost of capital varies with the source of finance and the degree of risk
involved. Generally, it is, higher the risk, lower is the cost and lower the risk
higher is the cost. A sound working capital management should always try to
achieve a proper balance between these two.
The magnitude of current assets needed is not always the same; it keeps
fluctuating (increases and decreases) over time. However there is always a
minimum level of current assets, which is continuously required by the firm to
carry on its business operations. This minimum level of current assets is
referred to as permanent, or fixed, working capital. Depending upon the
changes in production a sales, the need for working capital over and above
permanent working capital will fluctuate.
For example: extra inventory of finished goods will have to be maintained to
support the peak periods of and investment maintained to support the peak
period of sale, and investment in receivables may also increase during such
periods. On the other hand, investment in raw material, work in progress and
finished goods will fall if the market is slack
The extra working capital, needed to support the changing production and
sales activities is called fluctuating, variable or temporary working capital.
26

27. The firm to meet liquidity requirements that will last only temporarily creates
temporary working capital.
 PRINCIPLE OF EQUITY POSITION
This principle is concerned with planning how much to earmark for CA from
the total investment. According to this principle, the amount of working
capital invested in each component should be adequately justified by a firm’s
equity position. Every rupee invested in the current assets should contribute to
the net worth of the firm. Excessive working capital needs idle funs, which
earn no profits for the firm. Paucity of working capital not only impairs the
firm’s profitability but also results in production interruptions and
inefficiencies.
 PRINCIPLE OF MATURITY OF PAYMENT
This principle is concerned with planning the source of finance for working
capital. A firm should make every effort to relate maturities of payment
(sundry creditors) to this flow of internally generated funds. Maturity pattern
of various current obligations is an important factor in risk assumptions and
risk assessments. Generally, shorter the maturity schedule of current liabilities
in relation to expected cash inflow, greater the liability to meet its obligations
in time. In the words of Louis Brand, “we need to know when to look for
working capital funds, how to use them and how to measure, plan and control
them”. To achieve the above-mentioned objectives of working capital
management, the financial manager has to perform the following basic
functions:
a) Estimating the working capital requirements.
b) Analysis and control of working capital.
c) Financing of working capital needs.
27

28. DESIGN OF THE STUDY
TITILE OF THE STUDY: A study conducted for HGS APPARELS
PRIVATE LIMITED on Working Capital Management & Ratio analysis.
STATEMENT OF PROBLEM
Working capital is an important requirement for any business, without
which no business can survive. Every activity of the business is related to
the availability of the working capital. That is, arranging short-term
financing, negotiating favorable credit terms, controlling the movement
of cash, administering the account receivable and monitoring the
investment in inventories. All this consumes a great deal of time of
finance managers. Also the obstacles inhabiting the effective working
capital management throws open challenges to the finance managers in
managing working capital.
Initially American companies were the core customers through which the
garment business of HGS APPARELS PRIVATE LIMITED was carried
on, but in the year 2000, economy of America came down, and a
recession in the garment industry there, reduced the buying power of
American customers, thereby reducing the demand for garments. Due to
which the sales of HGS APPARELS came down which affected the
profitability of the company directly.
As profitability effects the working capital management of a firm, it
created an opportunity to prepare a case study at HGS APPARELS.
28

29. OBJECTIVES OF THE STUDY
 The study was conducted mainly to understand and analyze the issue
of working capital management, being practically employed in HGS
APPARELS PRIVATE LIMITED.
 To understand the practical difficulties faced by managing the
working capital.
 To analyze the various external and internal factors effecting working
capital management in HGS APPARELS PRIVATE LIMITED.
 To understand and learn the various policies framed by HGS
APPARELS PRIVATE LIMITED for effective management of
working capital.
DATA AND METHODOLOGY
Mainly data is obtained from the annual reports of the company. Further
data is collected through interviews with the key personnel and concerned
of the company. Sampling techniques are not applicable to the study as it
pertains to the study of a single company. Media of collecting the data is
the office of this company’s chartered accountant, K.V.
Gopalakrishnayya in Bangalore.
SCOPE OF STUDY
The study of working capital management is limited to the specific
company, HGS APPARALS PRIVATE LIMITED.
REFERENCE PERIOD
29

30. The study period covered in this case study is for 4 financial years i.e.,
from 2000-2001, 2001-2002, 2002-2003, 2003-2004.
DEFINITIONS OF CONCEPTS
Some of the concepts used in different senses from time to time in the
literature of financial management are discussed below in order to make
the study clear and meaningful.
WORKING CAPITAL
It is the fund, which is used to finance its day to day activities of
business, and it has to be employed in short term operations. There are
two concepts of working capital-gross concept and net concept.
WORKING CAPITAL MANAGEMENT
It means administration of current assets and current liabilities.
Objects in managing working capital –profitability and liquidity
PROFITABILITY
It is the ability of the firm to meet the claims of suppliers of short-term
capital for building up of current assets and also means short-term debt
repaying capacity of enterprise, in a limited sense.
OPERATING CYCLE
It is a period involved from the time cash is invested in inventory till the
time cash is recovered from sales of goods.
LIMITATIONS OF STUDY
30

31.  This report is based on the annual reports, which are provided by the
company that cannot be relied upon.
 The collection of data for analysis is restricted to HGS APPARELS
PRIVATE LIMITED only and
 Time was major limiting factor to the study.
PROFILE OF HGS APPARELS PRIVATE LIMITED
ORIGIN AND DEVELOPMENT
In the achievement of the strategic objectives of a self-reliant and
dynamic economy, the government considers a substantial expansion in
export earnings to be of great importance. In order to achieve national
objectives, the government has adopted new and scientific approach to its
export policy. Depending upon the tax paid by the company government
calculates and provides certain incentives to all the Indian exporters. HGS
APPARELS is one among such exporters. HGS APPARELS is a private
limited company, which is involved in manufacturing and exporting of
finished garments.
Pradeep.H.Hingorani established this company on 12th February 1990.
At the initial stages his father H.B.Hingorani and uncle G.B.Hingorani
were the promoters of liberty brand of garments in Mumbai, but there
business did not reach a higher level due to which they had to start a
separate export business in Mumbai. By 1985 Pradeep took over the
export business. He was then forced to shift the business to Bangalore
due to labour unrest. After this Pradeep strived hard and has gained
success in bringing his export business to a top most level which was
commenced in most critical circumstances. HGS APPARELS has its
office in THAVAREKERE and its manufacturing unit, located in BTM
Layout. HGS APPARELS was first started with a rental premises but
today it has its own premises where in which machine capacity of 100
31

32. machines is increased to 450 machines. Earlier there was no washing
plant and today there is a washing plant along with the latest technology
production plant.
In the factory there are about 1100 laborers working with subject to a
regular bonus and other benefits. It is very tough to start a company from
the scratch in spite of facing hurdles, but still Pradeep Hingorani
managed to do so with a success and as a result HGS APPARELS is one
of the major exporters to companies such as:
GAP in US
DECABHLON in FRANCE
MATALON in UK etc.
COMPETITION
As there are various exporters of garments in Bangalore, HGS
APPARELS has to go through a cutthroat competition and make sure that
it overcomes this competition with ease. Some of the major competitors
of HGS APPARELS are:
ZENITH EXPORTS
MNS EXPORT ORIVATE LIMIITED
LT KARLE EXPORTS LIMITED
SAI LAKSHMI INDUSTRIES etc.
In order to overcome this competition the company has adopted the
following techniques:
 Charging reasonable price as per the range of the product.
 Maintaining the quality of the product and making sure that it is as per
the demand of the customers.
32

33.  Timely delivery of the product to the overseas buyer without any
delay.
 Providing discounts to the customers.
 Retaining the customers
RANGE OF PRODUCTS
 Shirts
 Blouses
 Shorts
ORGANISATION STRUCTURE
Organization structure is basic framework with in which the manager’s
decision-making behaviour takes place. The structure gives an established
pattern of relationship among the various components of an organization.
33

34. It is a vital tool for providing information about organizational
relationships.
HGS follows top to bottom chart, which is as follows
ORGANIZTION CHART
Mr. Pradeep H. Hingorani
(Managing Director)
Mr. Chandrashekhar Mr. Mahesh V Sukhij
(Production Mgr) (Chief Executive Officer)
Cutting Department
Batch Department Mr. Gabrial Mr. L Rughuraj Mr.Patil
Washing Department (Purchase Mgr) (General Mgr) (Marktg Mgr)
Finishing Department Marketing Dept.
Q C Department
Fabric Dept.
Trims & Exercise Dept.
Accounts Dept. Shipping Dept. Personnel Dept. Maintenance Dept.
MARKETING ACTIVITIES
The major market for HGS APPARELS prevails in foreign as it is export
oriented. It exports to various countries as discussed earlier.
This company does not have any subsidiary at present. Initially it had a
subsidiary in USA called NEXT APPARELS CORPORATE but now it
does not exist. There are local resources in India through whom the
company gets to know about the wants and desires of foreign buyers.
34

35. SOURCES OF WORKING CAPITAL TO HGS APPARELS
Shares: Issues of shares is the most important source for raising the
permanent or long-term capital. HGS APPARELS has 15000 equity
shares of RS 100, each which are fully paid up.
Loans: Financial institutions such as commercial banks, life insurance
Corporation, industrial finance corporation of India, state financial
corporation etc provides long term, short term, and medium term loans to
the companies.
1. Secured loans: HGS APPARELS gets secured loans by borrowing
money from banks. It also allocates 18% non-convertible
debentures to KSFC. Borrowings from banks are generally secured
by the following;
Hypothecation of stocks, sundry debtors and machineries.
Personal guarantee of all the directors.
Mortgage of title deeds in respect of land and building belonging to
an associate firm.
2. Unsecured loans: HGS APPARELS gets unsecured loans from the
directors of the company, from shareholders and from Bangalore
fashion apparels private limited. Directors who grant unsecured
loans are as follows:
GB HINGORANI
HB HINGORANI
KG HINGORANI
PH HINGORANI
RS SUKHIJA
LEELA.S.SUKHIJA is the shareholder who grants unsecured
Loans to HGS APPARELS PVT LTD.
35

36. Companies that grant loans are: Bangalore fashion apparels private
limited and Karnataka financial service limited.
ANALYSIS OF WORKING CAPITAL MANAGEMENT AND
RATIOS OF HGS APPARELS PRIVATE LIMITED
Working capital is looked as a driving seat of finance manager in HGS
APPARELS PRIVATE LIMITED. As it involves manufacturing activity
it requires efficient amount of working capital to meet its day-to-day
needs. The long-term working capital needs are for building, plant,
furniture, etc., and the short-term needs are cash, inventories, securities,
etc. The balances sheet shows the financial position of a company at a
given point of time. It provides a snapshot and is regarded as a static
picture. The income statement or the profit and loss statement reflects the
performance of a company over a period of time. The significant
accounting policies followed by HGS APPARELS PRIVATE LIMITED
are as follows;
SIGNIFICANT ACCOUNTING POLICIES
 Basis of preparing financial statements
The financial statements of HGS APPARELS PRIVATE LIMITED are
prepared under the historical cost convention on an accrual basis.
 Fixed assets
36

37. Fixed assets are stated at their original cost of acquisition and subsequent
improvement thereto, including taxes, duties, freight and other incidental
expenses related to acquisition, construction and installation of asset(s)
concerned.
 Depreciation
Depreciation on fixed assets is provided at rates prescribed on written
down value basis in schedule XIV of the companies’ act of 1956 on a
prorata basis from the date of acquisition of the asset.
 Inventories
Inventories are valued at lower of cost or net realizable value. Cost is
determined on first in first out basis and includes an appropriate portion
of production and factory related overheads
 Long-term investments
Long-term investments are accounted at cost, and no provision has been
made for dimunition in the value of the same.
 Foreign exchange transactions
Foreign exchange transactions are dealt with in accordance with the
accounting standards on accounting for effects of changes in foreign
exchange rates (AS11) issued by institute of chartered accountant of
India.
 Gratuity
Provision of gratuity is made on an estimated basis as per the provision of
the payment of gratuity act 1972.
 Research and development
37

38. Research and development expenditure is charged to profit and loss
account in the year of incurrence. Fixed assets acquired for the purpose of
research and developments are capitalized.
Share capital
Out of the equity shares issued, 15000 shares of Rs.100 each were
allotted as fully paid up.
[
The current assets and current liabilities of HGS APPARELS PRIVATE
LIMITED are given below.
CURRENT ASSETS
 INVENTORIES
Raw materials and packing materials.
Work in progress.
Finished goods.
Finished goods in transit.
Packing material.
Scrap.
 SUNDRY DEBTORS (unsecured considered good)
Debts outstanding for a period exceeding 6 months
Others
 CASH AND BALANCES
Current account with scheduled banks.
Current account with deutsche bank.
Margin deposit account.
Cash in hand.
 LOANS AND ADVANCES (unsecured considered good)
Advances receivable in cash or kind.
Deposits.
38

39. CURRENT LIABILITIES AND PROVISIONS
 CURRENT LIABILITIES
Sundry creditors.
Advance from customers.
Liability for expenses.
Interest accrued but not due on debentures.
 PROVISIONS
For taxation (net of Advance income tax).
For gratuity.
For leave encashment.
By studying the working capital in HGS APPARELS LIMITED, one can
know the factors influencing the growth prospects of the company.
Let us understand gross and net working capital changes of HGS
APPARELS LIMMITED over the years.
39

40. TABLE - 01
TABLE SHOWING GROSS WORKING CAPITAL CHANGE
OF HGS APPARELS LIMITED
Particulars 2000-2001 2001-2002 2002-2003 2003-2004
Current Assets
Inventories 18450170 22444998 17500270 29520878
Sundry Debtors 5239150 11818945 4174430 5947413
Cash &Balance 2863563 1034108 1952882 2011974
Loans advances 9264595 10509307 9301065 8741638
Gross Working Capital 35817478 45807358 32928647 46221903
INFERENCE
The gross working capital has fluctuated with the growth of the business
over a series of years. There is an increase in the current assets of the
company.
40

41. TABLE – 02
TABLE SHOWING NET WORKING CAPITAL CHANGE OF
HGS APPARELS
Particulars 2000-2001 2001-2002 2002-2003 2003-2004
Gross Working Capital 35817478 45807358 32928647 46221903
Current Liabilities 10004325 21128392 11339964 25537988
Net Working Capital 25813153 24678966 21588683 20683915
INFERENCE
The net working capital table indicates that excess current asset is
available at the disposal of the company for the operational requirements.
OPERATING CYCLE OF HGS APPARELS
Operating cycle is one of the important determinants of working capital
requirements. In most of the companies, cash inflows and cash outflows
are not synchronized. Therefore, HGS holds the stock of finished goods,
to meet the demand of the customers and also make an adequate
investment in inventories and cash balance for a smooth and
uninterrupted production and sales, while book debts are created since the
goods are sold on credit basis for marketing sand competitive reasons.
The operating cycle of HGS can be divided into two broad phases, which
are as follows:
 Inventory conversion period: - It is requirement of time to produce and
sell the product and includes conversion period of raw material, work-in-
progress and finished goods.
 Book debts conversion period: - It is the time required to collect sales
receipt from customers.
TABLE - 03
41

42. TABLE SHOWING STATEMENT OF COST OF HGS
APPARELS PRIVATE LIMITED
Sl no Particulars 2000-2001 2001-2002 2002-2003 2003-2004
01 Opening stock 8175307 7481660 8907507 33832308
02 Purchase of raw materials 43303740 24383562 30274949 65882129
Closing raw material inventory
03 7481660 8907507 5350148 10373012
04 Raw material consumed 43997387 22957715 33832308 60859265
(1+2-3)
05 Exgratia 139625 49369 5658 -------------
06 Freight inwards 239433 309140 387719 731840
07 PRIME COST 44376445 23316224 34225686 61591105
(4+5+6)
08 Factory Overheads 12453261 7553167 8941795 8451148
09 Depreciation on Buildings 69952.17 91593.97 112154 131686
10 Depreciation on Machinery 3153437.82 3707471.55 4280630 5034385
11 Depreciation on Electrical 439861.53 474952.98 510224 538760
12 (7+8+9+10+11) 60492958 35143410 48070489 75747084
13 Opening work in progress 63599110 5577575 5054229 6535267
14 Closing work in progress 5577575 5054229 6535267 7057849
15 WORKS COST 61275294 35666756 46589451 75224502
(12+13+14)
16 Office Overheads 9714821 6683649 7154488 7926537
17 Depreciation on Computer 690939.81 888069.77 1006348 1077315
18 Depreciation on Office 127467.44 163329.35 184063 203059
equipments
19 Depreciation on 36553.61 49102.85 58403 65295
motorcycle
20 Depreciation on Motorcar 35639.83 540532.51 676995 778128
21 Depreciation on Furniture 500193.94 584159.53 643786 700437
& Fittings
COST OF PRODUCTION 72701667 44575599 56313534 85975273
22 (15+16+17+18+19+20+21)
23 Opening stock of finished 4694511 5057710 8205812 5047149
goods
24 Closing stock of finished 5057710 8205812 5047149 11137287
goods
25 COST OF GOODS SOLD 72338468 41427497 59472197 79885135
(22+23-24)
26 Selling Overheads 4414936 4038567 5771556 3566365
27 Labour Charges 11718355 8094779 2160423 1621333
42

43. 28 COST OF SALES 88471759 53560843 67404176 85072833
(25+26+27)
Notes;
Factory overheads include; wages, production incentives, EL
encashment, repairs and maintenance of machinery and electrical, power
and electricity, repairs and maintenance of dg set, fabric and processing
charges, repairs and maintenance building.
Office overheads include; audit fees, bonus, conveyance, council charges,
entertainment, ESI contribution, gratuity, PF contribution, insurance,
membership and subscription, printing and stationery, professional fees,
rates and taxes, rent, salaries, staff welfare, water charges, courier
charges.
Selling overheads include; claims on export sales, commission, traveling
expenses, vehicle maintenance, freight outwards, sales promotion, service
charges, donations, bad debts written off.
TABLE - 04
TABLE SHOWING SALES AND DEBTORS OF HGS APPARELS
Particulars 2000-2001 2001-2002 2002-2003 2003-2004
Sales 82298796 48397521 62649553 90124131
Opening 16929055 5239150 11818945 4174430
debtors
Closing 5239150 11818945 4174430 5947413
debtors
Opening 11912242 4776658 1287919 7452623
creditors
Closing 4776658 12827919 7452623 20032834
43

44. creditors
INFERENCE
From the above table, it is evident that the sales of the HGS have
increased over a period of time and this increases the size and
components of working capital. There is also an increase in the debtors,
which is apparent from the table, which implies that the company is
running short of cash or there is inadequate cash in the hands of the
company.
To understand the operating cycle concept better and to analyze how
exactly it affects working capital, let us study the table showing the
operating cycle calculations.
TABLE - 05
TABLE SHOWING OPERATING CYCLE CALCULATION OF
HGS APPARELS PRIVATE LIMITED
SL NO PARTICULARS 2000-2001 2001-2002 2002-2003 2003-2004
01 Raw material
consumption period
A Raw material consumption 43997387 22957715 33832308 60859265
B Raw material consumption 120540.78 62897.84 92691.25 166737.71
per day
C Raw material inventory 7481660 8907507 5350148 10373012
D 62 Days 142 Days 58 Days 62 Days
02 Work-in-progress
conversion period
A Cost of production 72701667 44575599 55845068 85149868
44

45. B Cost of production per day 199182.64 122124.92 153000.18 233287.30
C Work-in-progress 5577575 5054229 6535267 7057849
inventory
D Work-in-progress holding 28 Days 41 Days 43 Days 30 Days
days
03 Finished goods
conversion period
A Cost of goods sold 72338468 41427497 59003731 79059730
B Cost of goods sold per day 198187.58 113499.99 161654.05 216602
C Finished goods inventory 5057710 8205812 5047149 11137287
D Finished goods inventory 26 Days 72 Days 31 Days 51 Days
holding days
04 Collection period
A Credit sales 82298796 48397521 62649553 90124131
B Sales per day 225476.15 132595.94 171642.61 246915.42
C Book debts 5239150 11818945 4174430 5947413
D Book debts outstanding 23 Days 89 Days 24 Days 24 Days
days
05 Payment deferral period
A Credit purchases 44491045 25501189 32984848 69718267
B Purchases per day 121893.27 69866.27 90369.44 191008.95
C Creditors 4776658 12827919 7452623 20032834
D Credit holding days 39 Days 184 Days 82 Days 105 Days
Formulae used to get the proper data in the above table are as follows:
1. Raw material Raw material inventory
Inventory = ------------------------------------- * 365
Holding days Raw material consumption
2. Work-in-progress work-in-progress inventory
Inventory = --------------------------------------- * 365
Holding days Cost of production
3. Finished Goods Finished Goods inventory
Inventory = -------------------------------------- * 365
Holding days Cost of goods sold
4. Book debts Book Debts
Outstanding = -------------------------------------- * 365
45

46. Days Credit Sales
5. Creditors Creditors
Holding = --------------------------------------- * 365
Days Credit Purchases
ANALYSIS OF OPERATING CYCLE CALCULATIONS
From the table number 30 the raw material inventory level in the year
2000-2002 to 8907507 when compared to 2000-2001 which stood as
7481660, indicating that the company has good production and does not
have any uncertainty in supply of raw materials, but in the year
2003-2004 raw material inventory has increased to 10373012 when
compared to year 2002-2003 which fallen down to 5350148 when
compared to it’s previous year which is satisfactory.
There has been an increase in the level of work in progress inventory and
hence it is a satisfactory level, also HGS has maintained an increasing
level of finished goods inventory to meet the demand of the customers.
In the case of collection period the book debts have increased by 2.25
times more than in the year 2000-2001, and by 1.42 times in the year
2002-2003. This indicates that HGS has been extending its credit
facilities to the customers in order to avoid competition.
The company’s creditors are increased to 20032834 in 2003-2004 and
payment deferral period as accordingly increased in order to decelerate
the cash outflows. In the view of the company’s financial position in
46

47. paying more interest HGS has to reduce its creditors, and it has done the
same in the year 2003-2004
.
TABLE – 06
TABLE SHOWING SUMMARY OF OPERATING CYCLE
CALCULATION OF HGS APPARELS
NO PARTICULARS 2000-2001 2001-2002 2002-2003 2003-2004
01 Inventory conversion period
A Raw material 62 Days 142 Days 58 Days 62 Days
B Work-in-progress 28 Days 41 Days 43 Days 30 Days
C Finished goods 26 Days 72 Days 31 Days 51 Days
02 Receivable conversion 23 Days 89 Days 24 Days 24 Days
period
03 Gross Operating Cycle 139 Days 344 Days 156 Days 167 Days
(1+2)
04 Payment Deferral period 39 Days 184 Days 82 Days 105 Days
05 Net Operating Cycle 100 Days 160 Days 74 Days 62 Days
(3-4)
INFERENCE
According to the above table the operating cycle takes 62 days to convert
raw materials into cash. The net operating cycle has increased from
100-160 days in the year 2001-2002 and has decreased to 72 days in the
year 2002-2003. The following reasons can be highlighted about these
fluctuations.
47

48. In the year 2002-2003 raw material holding days have increased by 4
days this is because raw material consumption has increased to 60859265
and at the same time the level of raw material inventory has increased to
10373012.
One reason would be the policy of company, to reduce the inventory
holding to bring the cost down, but there is an increase in the work in
progress holding days when compared to that of the year 2000-2001, due
to fluctuations of demand for the company’s product in the market.
Collection period is reduced so as to increase the cash inflows, where as
the payment deferral period is increased to 105 days in the year
2003-2004 when compared to 39 days in the year 2000-2001, and 82 days
in 2002-2003. This indicates that the company has to take necessary steps
to control disbursements for maximum availability of cash.
48

49. RATIO ANALYSIS
INTRODUCTION
The ratio analysis is one of the most important and powerful tools of
financial analysis. It is the process of establishing and interpreting various
ratios. It is with the help of ratios that the ratios that the financial
statement can be analyzed more clearly and decisions made from such
analysis.
CONCEPT OF RATIO
A ratio is a simple arithmetical expression of the relationship of one
number to another. It may be defined as the indicated quotient of two
mathematical expressions. According to Accountant’s handbook by
Wixonkell and Bedford, a ratio “is an expression of the quantitative
relationship between two numbers”.
RATIO ANALYSIS
Ratio analysis is the technique of calculation of number of accounting
ratios from the data found in the financial statements, the comparison of
the accounting ratios with those of the previous years or with those of
other concerns engaged in similar line of activities or with those of
standard ratios and the interpretation of the comparison.
CLASSIFICATION OF ACCOUNTING RATIOS
49

50. The use of ratio analysis is not confined to financial manager only. There
are different parties interested in the ratio analysis for knowing the
financial position of a firm for different purposes. In view of various
users of ratio which can be calculated from the information given in the
financial statement.
Ratios
Traditional classification Functional classification Significance ratios
1. Balance sheet ratios 1. Primary ratios
1. Liquidity ratios
2. Revenue statement ratios 2. Secondary ratios
2. Leverage ratios
3. Mixed ratios
3. Activity ratios
4. Probability ratios
CLASSIFICATION ACCORDING TO TESTS
Liquidity ratios Long-term solvency ratios Activity ratios Probability ratios
1. Debt equity ratio 1. Stock turn over ratio 1. Gross profit ratio
1. Current ratio 2. Debtors turnover ratio
2. Proprietory ratio 2. Net profit ratio
2. Acid test ratio 3. Debt-collection
3. Capital gearing 3. Operating profit
3. Absolute liquid period
ratio ratio
ratio 4. Creditors turnover
4. Fixed assets to net 4. Return on capital
worth ratio employed
5. Current assets to net 5. Debt-payment period 5. Return on total
worth 6. Fixed assets turnover resources
ratio 6. Return on equity
7. Total assets turnover
ratio
8. Working capital
turnover ratio
9. proprietory fund 50
turnover ratio

51. LIQUIDITY RATIOS
CURRENT RATIO
Current ratio may be defined as the relationship between current assets
and current liabilities. This ratio is also known as working capital ratio. It
is calculated by dividing the total current assets by total current liabilities.
Current Assets
Current ratio = -------------------------
Current Liabilities
Current assets include cash in hand, cash at bank, bills receivable,
sundry debtors, inventory, prepaid expenses, outstanding incomes
temporary investments and advances. Current liabilities include
bills payable, sundry creditors, bank overdraft, unclaimed dividend,
outstanding expenses, provision for taxation and proposed dividend
etc.
TABLE – 01
TABLE SHOWING CURRENT RATIO
Year Current Assets Current Liabilities Current Ratio
2000-2001 25813153 10004325 2.58
2001-2002 24678965 21128392 1.16
2002-2003 21588683 11339964 1.90
2003-2004 20683915 25537988 0.80
51

52. INFERENCE
The current ratio decreased to 1.16 in the year 2001-2002 , when
compared to the year 2000-2001, and again it is increased to 1.90 in
2002-2003, later it is again fallen down to 0.80. This shows that
there is no improvement in the short-term solvency of the company
for the year 2003-2004.
GRAPH – 01
GRAPH SHOWING CURRENT RATIO
3
2.5
2 2000-2001
2001-2002
1.5
2002-2003
2003-2004
1
0.5
0
Current Ratio
52

53. ACID TEST RATIO
Acid test ratio may be defined as the relationship between liquid assets
and liquid liabilities. It is also known as liquid ratio or quick ratio. Liquid
assets include all current assets except inventory and prepaid expenses.
Liquid liabilities include all current liabilities except bank overdraft.
Liquid Assets
Acid test ratio = ----------------------------
Liquid liabilities
TABLE – 02
SHOWING THE LIQUID RATIO
Year Liquid assets Liquid liabilities Liquid ratio
2000-2001 17367308 10004325 1.73
2001-2002 23362359 21128392 1.10
2002-2003 15428377 11339964 1.36
2003-2004 16701025 25537988 0.65
INFERENCE
The liquid ratio is decreased to 1.10 in the year 2001-2002 when
compared to the previous year 2000-2001, and again it is increased to
1.36 in the year 2002-2003. This further confirms that there are
fluctuations in the short-term liquidity of the company.
53

54. GRAPH – 02
GRAPH SHOWING LIQUID RATIO
54

55. 1.8
1.6
1.4
2000-2001
1.2
2001-2002
1 2002-2003
0.8 2003-2004
0.6
0.4
0.2
0
Liquid ratio
55

56. ABSOLUTE LIQUID RATI0
Absolute liquid ratio may be defined as the relationship between
Absolute liquid assets and liquid liabilities. Absolute liquid assets include
cash in hand, cash at bank and marketable securities.
The absolute liquid ratio can be calculated by dividing absolute liquid
assets by liquid liabilities. Thus,
Absolute liquid assets
Absolute Liquid Ratio = ---------------------------------
Liquid liabilities
TABLE – 03
SHOWING ABSOLUTE LIQUID RATIO
Year Liquid Assets Liquid Liabilities Absolute Liquid Ratio
2000-2001 22720507 10004325 2.27
2001-2002 23493785 21128392 1.11
2002-2003 18659035 11339964 1.64
2003-2004 18302726 25537988 0.71
INFERENCE
The absolute liquid ratio is increased to 1.64 when compared to 1.11 in
the year 2001-2002, but again it shows a fall in the year 2003-2004 which
stands at 0.71
56

57. GRAPH – 03
GRAPH SHOWING ABSOLUTE LIQUID RATIO
2.5
2
2000-2001
1.5 2001-2002
2002-2003
1
2003-2004
0.5
0
Absolute Liquid
Ratio
57

58. LONG TERM SOLVENCY RATIO
DEBT-EQUITY RATIO
Debt-Equity Ratio, also known as External-Internal Equity ratio is
calculated to measure the relative claims of outsiders and owners against
the firm’s assets. The Debt-Equity ratio can be calculated by dividing the
total Debts by equity. Thus,
Total debts
Debt-Equity ratio = ----------------------
Equity
A total debt equals all long term debts plus current liabilities and
provisions and equity includes share capital, reserves and surplus minus
capital losses
TABLE – 04
TABLE SHOWING DEBT-EQUITY RATIO
Year Total debt Equity Debt-Equity Ratio
2000-2001 62072358 28620421 2.16
2001-2002 74357442 28416205 2.61
2002-2003 55024148 28057713 1.96
2003-2004 70288556 30391887 2.31
INFERENCE
Debt equity ratio has increased to 2.61 in 2002-2003 when compared to
2000-2001 and again it is increased to 2.31 in the year 2002-2003 though
it was decreased to 1.96 in the year 2001-2002. 7This shows that there is
improvement in the long-term solvency position of the company.
58

59. GRAPH- 04
GRAPH SHOWING DEBT-EQUITY RATIO
3
2.5
2000-2001
2 2001-2002
1.5 2002-2003
2003-2004
1
0.5
0
Debt-Equity Ratio
PROPRIETORY RATIO
59

60. The ratio that expresses the relationship between proprietor’s fund and
total assets is called Proprietory ratio. This ratio can be calculated as
under.
Equity
Proprietory Ratio = ----------------------
Total Asset
TABLE – 05
TABLE SHOWING PROPRIETORY RATIO
Year Equity Total Assets Proprietory Ratio
2000-2001 28620421 52068033 0.54
2001-2002 28416205 53229050 0.53
2002-2003 28057713 43684184 0.64
2003-2004 30391887 44750568 0.67
INFERENCE
This ratio is decreased in the year 2001-2002 to 0.53 when compared to
2000-2001 and further increased to 0.67 in the year 2003-2004 when
compared to 2000-2001. this shows that there is an increase in the long-
term solvency of the business.
60

61. GRAPH - 05
TABLE SHOWING PROPRIETORY RATIO
0.7
0.6
0.5 2000-2001
2001-2002
0.4
2002-2003
0.3 2003-2004
0.2
0.1
0
Proprietory Ratio
FIXED ASSETS TO NETWORTH RATIO
61

62. The ratio, which establishes the relationship between fixed assets and
shareholder’s funds, is called fixed assets to Net worth ratio. This ratio
can be calculated as follows
Fixed Assets (After depreciation)
Fixed assets to Net worth Ratio = -------------------------------------
Shareholder’s funds
TABLE – 06
TABLE SHOWING FIXED ASSETS TO NETWORTH RATIO
Year Fixed Asset Net worth Fixed assets to
Net worth Ratio
2000-2001 6335879 28620421 0.22
2001-2002 6079307 28416205 0.21
2002-2003 5378748 28057713 0.19
2003-2004 7775901 30391887 0.25
INFERENCE
The ratio of fixed assets to net worth ratio is found to be fluctuating in the
year 2001-2002 and 2002-2003. But it is slightly increased in the year
2003-2004 to 0.25.
62

63. GRAPH – 06
GRAPH SHOWING FIXED ASSETS TO NETWORTH RATIO
0.7
0.6
0.5 2000-2001
2001-2002
0.4
2002-2003
0.3 2003-2004
0.2
0.1
0
Proprietory Ratio
RATIO OF CURRENT ASSETS TO SHARREHOLDER’S FUND
63

64. The ratio which establishes the relationship between current assets and
shareholder’s funds is called ratio of current assets to shareholder’s fund
ratio. The ratio can be calculated as follows.
Current Assets
Current assets to Net worth ratio = --------------------------
Shareholder’s funds
TABLE – 07
TABLE SHOWING RATIO OF CURRENT ASSETS TO
SHAREHOLDER’S FUND RATIO
Year Current Assets Net worth Current Assets
to Net worth Ratio
2000-2001 25813153 28620421 0.90
2001-2002 24678965 28416205 0.86
2002-2003 21588683 28057713 0.76
2003-2004 20683915 30391887 0.68
INFERENCE
The above table shows that the current assets to net worth ratio in the
year 2001-2002 has come down to 0.86 when compared to the year
2000-2001 and the current asset ratio is on a declining trend in subsequent
years.
64

65. GRAPH – 07
GRAPH SHOWING RATIO OF CURRENT ASSETS TO
SHAREHOLDER’S FUND RATIO
0.9
0.8
0.7
2000-2001
0.6
0.5 2001-2002
0.4 2002-2003
0.3 2003-2004
0.2
0.1
0
Current Assets to
Net worth Ratio
CAPITAL GEARING RATIO
65

66. Capital gearing ratio is a ratio, which expresses relationship between
fixed interest and dividend bearing securities and equity share capital.
This ratio is calculated as follows.
Fixed interest and dividend bearing
Securities
Capital Gearing Ratio = --------------------------------------------
Equity share capital
TABLE – 08
TABLE SHOWING CAPITAL GEARING RATIO
Fixed interest and
Year dividend bearing Equity share capital Capital gearing
securities ratio
2000-2001 1627673 1500000 1.08
2001-2002 1528950 1500000 1.01
2002-2003 1548490 1500000 1.03
2003-2004 1621805 1500000 1.08
INFERENCE
Capital gearing ratio is constant in the year 2000-2001 and 2003-2004 but
it has decreased in 2001-2002 and , to 1.01 and 1.03 respectively.
66

67. GRAPH - 08
GRAPH SHOWING CAPITAL GEARING RATIO
1.08
1.06
2000-2001
1.04
2001-2002
1.02 2002-2003
2003-2004
1
0.98
0.96
Capital gearing ratio
ACTIVITY RATIOS
67

68. INVENTORY TURNOVER RATIO
Inventory turnover ratio is the ratio, which indicates the number of times
the stock is turned over i.e., sold during the year. In other words, it is the
ratio between the cost of goods sold and closing stock. This ratio can be
calculated as follows.
Sales
Stock Turnover Ratio = ----------------
Inventory
TABLE – 09
TABLE SHOWING INVENTORY TURNOVER RATIO
Year Sales Inventory Stock turnover
Ratio
2000-2001 82298796 18450170 4.46
2001-2002 483975 21 22444998 2.15
2002-2003 62649553 17500270 3.57
2003-2004 90124231 29520878 3.05
INFERENCE
Inventory turn over ratio has decreased to 2.15 in the year 2001-2002
when compared to 2000-2001 and again increased in the year 2002-2003
to 3.57 but in the year 2003-2004 it shows a fall that is 3.05.
68

69. GRAPH – 09
GRAPH SHOWING INVENTORY TURNOVER RATIO
4.5
4
3.5
3 2000-2001
2.5 2001-2002
2 2002-2003
1.5 2003-2004
1
0.5
0
Stock turnover
Ratio
DEBTORS TURNOVER RATIO
69

70. Debtors turnover rate is in between credit sales and debtors. In other
words, it indicates the number of times the debts are collected in a year.
This ratio is calculated as follows.
Credit Sales
Debtors Turnover Ratio = -----------------------
Debtors
TABLE - 10
TABLE SHOWING DEBTORS TURNOVER RATIO
Year Credit Sales Debtors Debtors
Turnover Ratio
2000-2001 82298796 5239150 15.70
2001-2002 48397521 11818945 4.09
2002-2003 62649553 4174430 15.0
2003-2004 90124131 5947413 15.15
INFERENCE
The debtors turn over ratio has decreased to 4.09 in the year
2001-2002 and again has increased to 15.15 in the year 2003-2004
70

71. GRAPH – 10
GRAPH SHOWING DEBTORS TURNOVER RATIO
16
14
12
2000-2001
10 2001-2002
8 2002-2003
6 2003-2004
4
2
0
Debtors Turnover
Ratio
DEBT COLLECTION PERIOD RATIO
71

72. Debt collection period ratio is the ratio, which shows the average time
taken by the firm to collect the debts. This is calculated as follows.
Debtors
Debt collection period ratio = ----------------------- * 365 days
Credit Sales
TABLE – 11
TABLE SHOWING DEBT COLLECTION PERIOD RATIO
Year Debtors Credit Sales Debt collection Ratio
2000-2001 5239150 82298796 23 Days
2001-2002 11818945 48397521 89 Days
2002-2003 4174430 62649553 24 Days
2003-2004 5947413 90124131 24 Days
INFERENCE
The debt collection period ratio remains constant in the 2002-2003 and
2003-2004 but has increased in the year 2001-2002 to 89 days when
compared to that of 23 days in the year 2000-2001
72