1 LESSON 23 WORKING CAPITAL MANAGEMENT 304 CONTENTS 23.0 Aims and Objectives 23.1 Introduction 23.2 Objectives of the Working Capita Management 23.3 Approaches of the Working Capita 23.4 Determinants of Working Capita 23.5 Working Capita Poicies 23.6 Estimation of Working Capita Requirement 23.7 Cash Management Motives of Hoding Cash Objectives of Cash Management Basic Probems of Cash Management 23.8 Management of Inventories Meaning of Inventory Why Inventory is to be Controed? Major Benefits of Inventory Contro Centraised Stores Decentraised Stores Centra Stores and Sub Stores Recording Leve Minimum Leve/Safety Leve Maximum Leve Danger Leve Average Stock Leve Economic Ordering Quantity ABC Anaysis VED Anaysis 23.9 Receivabes Management Concept of Receivabes Management Objectives of Accounts Receivabes Cost of Maintaining the Accounts Receivabes Factors Affecting the Accounts Receivabes Management of Accounts Payabe/Financing the Resources Various Committee Reports on Working Capita Dheja Committee Report 1969 Contd...
2 Tandon Committee Chore Committee Report Marathe Committee Report Let us Sum up Lesson-end Activity Keywords Questions for Discussion Suggested Readings Working Capita Management 23.0 AIMS AND OBJECTIVES After studying this esson you wi be abe to: (i) describe the objectives of working capita management (ii) know how to anayse the needs of working capita (iii) describe how to manage receivabes and payabes (iv) expain how inventory is managed in a company INTRODUCTION The working capita is the amount revoving capita to meet the day today requirements of the firm. The other facets of the working capita is circuating capita, foating capita and moving capita which are required to meet the immediate requirements of the firm. The "working capita" means the funds avaiabe for day today operations of the enterprise. It aso represents the excess of current assets over the current iabiities which incude the short-term oans. Accounting standards Board, The institute of Chartered Accountant of India note the ASB has used the term working capita and not Net working capita OBJECTIVES OF THE WORKING CAPITAL MANAGEMENT Estimating the working capita requirements The working capita requirements are normay estimated to the tune of production poicies, nature of the business, ength of manufacturing process, credit poicy and so on. Sources of the working capita: The requirement of the working capita shoud be met with the hep of ong term and shot term resources. The permanent and temporary working capita requirements shoud be met out of ong term and short term financia resource respectivey APPROACHES OF THE WORKING CAPITAL The approaches of the working capita are cassified into two categories viz the hedging approach and conservative approach: The hedging approach: Under this approach, the maturity of the financia resources are matched with the nature of assets to be financed. 305
3 Permanent working capita are financed by the ong-term financia resources and the seasona working capita requirements are met out through short term financia resources. The conservative approach: Acc to this approach, a requirement of the funds shoud met out ong-term sources. The short-term resources shoud be ony for emergency requirements DETERMINANTS OF WORKING CAPITAL Foowing are the major determinants of the working capita: Genera nature of Business: The nature of the business shoud be considered for the determination of working capita ony to the tune of i) cash nature of business ii) sae of services rather than commodities: These are things considered ony on the basis of stock, book voume of debts and so on. Production cyce: The need of the working capita is determined on the basis of duration of the production cyce. The time duration taken by the manufacturing process shoud be considered from the stage of raw materias to the stage of finished goods. If the duration is engthier may require the firm to keep more amount of working capita to meet out the requirements and vice versa. Business cyce: The cyce of the business shoud be reativey considered for the need of working capita. The upswing of the business cyce requires the business venture to invest more amount of working capita due more voume of saes, resuts out of huge voume of stock, book debts and so on. During the downswing of the business require the business to have ony esser voume of working capita due esser voume of business and so on. Production poicy: The working capita requirement is determined on the basis of production poicy of the firm. Normay the production poicy of the firm is cassified on the basis of two methodoogies: (i) (ii) The firm produces the goods then and there to the tune of immediate needs of the market. This may require the firm to meet adversities due to ack of working capita to meet out, due to in adequate panning. During the peak season, it requires enormous working capita which may disturb working conditions of the business venture. The steady production poicy by considering the futuristic demands, which wi not disturb the ong-term prospects of the business venture due to effective panning. Credit poicy: The credit poicy of the firm is another determinant for the determination of the working capita. There are two different credit poicies viz ibera and stringent credit poicies (i) (ii) Libera credit poicy: The ibera credit poicy may ead to have greater voume of book debts, greater credit period, huge amount required for the buit of stock; require the firm to have greater amount of working capita Stringent credit poicy: Woud not require that much of working capita ike the earier segment. Growth and Expansion: The growth and expansion prospects of the firm shoud be appropriatey determined in order to identify the voume of working capita required during the future, uness otherwise that wi bady affect the future deveopment of the firm. 306 Acute shortage of the raw materias suppy: If the shortage of raw materias is acute, the firm is required to keep sufficient voume of working capita to have smooth fow of production process without any interruptions. In such cases the firm shoud have additiona voume of working capita not ony to avoid interruptions during the production process
4 due ack of suppy of raw materias, but aso to enjoy greater trade discounts during the buk purchase in order to bring down the purchase cost of the raw materias. Net profit: It is one of the major sources of working capita and practicay speaking it is one of the sources of cash from operations. To maintain the iquidity, the net profit earning capacity shoud be maintained forever. Dividend poicy: The cash dividend payment eads to greater amount of cash outfows which are more essentia to the vaue of the firm to be maintained. The vaue of the firm coud aso be aternatey maintained by either through the decaration of bond dividend or stock dividend or property dividend. The ater specified methodoogies faciitate the firm to postpone the cash out fow which normay evade the immediate cash requirement. Depreciation poicy: The depreciation poicy of the firm not ony faciitates to bring down the taxabe iabiity but aso brings down the profit which enhances the iquidity of the firm on the other side. Price eve changes: The price eve changes require the firm to keep more amount of working capita to go hand in hand with the price changes which normay affect the firm's iquidity position. During the periods of infation, the firm is required to anticipate the price eve changes which drasticay affect the working capita position of the firm. Working Capita Management 23.5 WORKING CAPITAL POLICIES The working capita has to be adequatey managed by the firm, neither more nor ess than its requirement to meet out the needs. If the working capita is more than the requirement means that the firm is expected to unnecessariy keep short-term assets ide in state and vice versa. The maintaining of the working capita management is mainy depending upon three major infuences of the organizations i) Profitabiity ii) Liquidity and iii) Structura heath of the organisation Why the study of Management of working capita is required? If the working capita is ess than the requirement means that the voume of current assets are inadequate to meet the short term obigations of the firm on time, which may ead to disrepute the name and fame of the organisation. Contradictoriy to the above, if the firm keeps more working capita that means more voume of current assets are maintained in the investment structure to meet out the short term obigations of the firm which poses more iquidity but on the other hand it hurdes the righteous opportunity to invest in the fixed assets to earn more income. The excessive voume of current assets drasticay affects the profitabiity of the firm due to excess iquidity out of more amount of current assets. As a firm shoud aways maintain the righteous voume of working capita not ony to maintain the iquidity of the firm but aso to earn adequatey from the investment voume of fixed assets. The working capita management poicies are studied in the foowing context viz i) Concerned with profitabiity, iquidity and risk of the firm ii) Concerned with the composition of the current assets iii) Concerned with the composition of the current iabiities There are two major types of working capita poicies Conservative poicy of working capita: Under this poicy, the firm minimizes risk by maintaining a higher eve of current assets in meeting the iquidity of the firm. 307
5 Aggressive poicy of working capita: Under this poicy, the firm enhances the risk by way of reducing the working capita in order to earn more and more profits ESTIMATION OF WORKING CAPITAL REQUIREMENT The foowing is the proforma of the working capita requirement Statement of working capita required Current Assets: i) Cash XXXX ii) Debtors XXXX iii) Stocks XXXX iv) Advanced payments XXXX v) Others XXXX Less: Current iabiities i) Creditors XXXX ii) Lag in payment of expenses XXXX iii) Outstanding expenses if any XXXX Working capita (Current assets-current iabiities) XXXX Add: Provision for contingencies XXXX Net working capita required XXXX Prepare an estimate of working capita requirement from the foowing data of the XYZ Ltd. a) Projected annua saes voume 2,00,000 units b) Seing price Rs.10 per unit c) % of net profit on saes 25% d) Average credit period aowed to customers 8 weeks e) Average credit period aowed by suppiers 4 weeks f) Average hoding period of the inventories 12 weeks g) Aow 10% for contingencies Statement of working capita requirements Current Assets Rs 308 Debtors (8 weeks)rs.15,00,000 8/52(At cost) 2,30, Stock (12 weeks) Rs.15,00,000 12/52 3,46, Less Current iabiities Creditors (4 weeks) Rs15,00,000 4/52 1,15, Net working capita 4,61,538.0 Add: 10% contingencies 46,153.8 Working capita required 5,07,691.8
6 Check Your Progress Working Capita Management 1. The recent reease of the finance minister during the budget session on the specia excise duty on the cement industry. 2. How the construction industry is affected? In what way? Which factor of infuence affects the firm? 23.7 CASH MANAGEMENT The management of cash resources shoud not be ony in a position to afford iquidity but aso it shoud not require the firm to keep the cash resources simpy ide; which shoud be invested in the marketabe securities to earn some rate of return whenever the firm fee excessive hoding of cash resources Motives of hoding cash Transaction Motive: If the cash outfows are more than that of the cash infows, the firms are expected to maintain the cash resources. Precautionary Motive: Some times the firm may be required to meet out the contingent needs which coud not be foreseen during its ife span; warrants the adequate maintenance of working capita. Specuative Motive: It is a motive hoding the cash resources by the firm to expoit the opportunities avaiabe in the market. If the vendor of raw materias announces that there is a greater discount towards the buky purchase of raw materias, may ead the firm to bring down the cost of purchase. For which, the cash resources are required and made use of to the tune of announcements. Compensation motive: Banks provide certain services to the firms ony on the basis of the certain amount of baances in the accounts. That is the motive hoding cash resources to avai services from the banker viz compensation motive Objectives of Cash Management (i) (ii) Meeting the cash requirement: Meeting of cash requirements on time which normay invoves in the maintenance of the goodwi of the firm. The firm shoud keep the adequate cash baances to meet the requirement which are greater in importance. Minimising the funds ocked up in the cash baances: The funds ocked up in the form of cash resources shoud be more, but it shoud ony to the tune of the requirement Basic Probems of Cash Management (i) Controing eve of cash (a) Preparing the cash budget: Through the preparation of the budget, the cash requirement coud be identified which woud normay faciitate the firm to trim off the excessive cash in hoding. (b) Providing room for unpredictabe discrepancies: The separate amount shoud be maintained for the purpose to meet out the discrepancies which are not easiy foreseen. (ii) Controing of infows of cash (a) Concentration banking: The amount of coection from the oca branches are normay deposited in a particuar account of the firm, as soon as the 309
7 deposit has reached the certain imit, the amount in the respective branch account wi be transferred to the account at where the firm maintains in the head office. This process of transfer is normay taking pace ony through teegraphic transfer during the eary days but on now a days the anywhere banking is faciitated to transfer the amount of deposit instantaneousy. (b) Lock box system: The process of coection is carried out with the hep of oca post offices ony in order to avoid the posta deays in the transit. This system enhances the speed of the coection at rapid and finay the oca branch messenger coects the cheques from the parties through specified post box aocated for the process of coection. (iii) Controing of cash outfows (a) Centraizing of disbursing the payments: The centraizing the process of payment may faciitate the enterprise to take advantage of time in setting the payments i.e., reduces the need of immediate cash requirements. (b) Stretching payment schedue: It is another methodoogy to avai the maximum possibe credit period to postpone the payment by making use of the cash resources most effectivey. (iv) Investing the excessive cash surpus (a) (b) Determine the need of the surpus cash: Identify the excessive cash resources which are kept simpy ide more than the requirement. Determination of the various avenues of investment: After identifying the various investment opportunities, the excessive cash resources shoud be invested to earn appropriate rate of return during the sack season at when the firm does not require greater voume of working capita and vice versa. Check Your Progress 1. Expain the modern instruments avaiabe in the financia market to entertain the cash management strategies Cash means a) Cash in hand b) Cash in hand and at bank c) Cash in hand, at bank and near d) None of the above cash i.e marketabe securities 2. To avai the trade discount at the moment of buk purchase is a) Transaction motive b) Specuative motive c) Compensating motive d) Precautionary motive 3. Stretching cash payment is a) Controing the cash infow b) Controing cash outfows c) a) & b) d) None of the above 23.8 MANAGEMENT OF INVENTORIES Meaning of Inventory The inventory incudes the foowing : Stock of raw materias: It means that the vaue of the raw materias stored for the purpose of production in the storage yard. The stock of raw materias can be
8 cassified normay into two categories viz opening stock and cosing stock of raw materias. Stock of work in progress: During the production process, the firm usuay stores the semi finished goods which are neither a raw materias nor finished goods. The purpose of the storage of work in progress in order to shorten the time duration to manufacture the finished goods. The vaue of the semi finished / work in progress stored in the storage house may be cassified into two categories viz opening stock and cosing stock. The finaizing the vaue of the stock of the work in progress is inevitabe process in transfer pricing. The vaue of the work in progress normay expressed in two different ways viz on the basis of prime cost and works cost. Stock of finished goods: This is the stage at which the goods are readiy avaiabe for seing in the market. The vaue of the stock of the goods is computed on the basis of cost of production. Stock of Stores suppies, components and accessories. Working Capita Management Inventory Raw materias Work in progress Finished goods Why inventory is to be controed? The utimate purpose of controing the inventory arises ony due to the conficting and heterogeneous objectives of the various functiona departments of the organizations. How inventory infuences the various department of the organization? Normay, the inventory infuences on the foowing departments viz Production Purchase, Finance and Saes department How it infuences the various departments at a time together. On/of the Production department: The manager production frequenty insists the organisation to maintain the continuous and uninterrupted suppy to have smooth fow production. This requires the production manager to buid ampe stock of raw materias. This is routed through the purchase requisition by the manager production to the purchase manager. Less the stock of raw materias and accessories - Risk of Lock out due to insufficient quantities and vice versa On/of the Purchase department: Due to the infuence from the production manager, the purchase department is demanded to procure the requirements. As per the requisition of the production department, meeting the requirements is not tough task but the department shoud know about the financia intricacies of the organisation through the finance department which is especiay meant for the purpose. Lesser the quantum of purchase wi ead to esser financia commitment but expected to oose the benefits out of the buk procurement. Not advisabe for the materias which are in scarcity. Lesser the quantum of purchase - Greater wi be cost of procurement and esser wi the economic benefits and vice versa 311
9 On/of the Saes department: Due to the market pressure/greater demand of the products require the saes department to suppy the goods in time as we as to meet the needs and demands of the intermediaries and consumers. To suppy them in time, the saes manager need not wait for the production cyce to be competed to produce the finished goods. To save time, the saes manager must be given ampe faciity to store the finished goods in the depot not ony to meet the needs but aso traps and drags the existing customers and consumers. More the stock of the finished goods - Better the position for the firm to meet the needs of the biz environment and more the cost of storage and investment on the current assets and vice versa On/of the Finance department : Due to infuence from the department of the production, purchase and saes departments, the finance department is required to concentrate on the various anges. It is the ony department bearing a difference of opinion in maintaining more voume of inventory in the firm; which certainy sashes the earning capacity of the firm due to east voume of assets depoy on the productive purpose. Lesser the inventory - Higher the risk in meeting the needs of production, purchase and saes - but better the return of the firm. For e.g. The famous MNC Jinda Corporation Ltd. has wound up its operations at industria site in Bangaore due to the cost of raw materias cost. The transportation cost, acquisition cost of copper ore gone up due to escaated cost in the biz market. They were neither to store nor to transport more and more which ed to the winding up of operations of the enterprise at Bangaore. The foowing diagram wi obviousy faciitate the Inventory Contro: Purchase Department Finance Department Production Department Saes Department Inventory contro: Inventory contro means that maintenance of desired eve of inventory by way of taking into the economic interest of the firm. The economic interest of the firm differs from one functiona dept. to another due to the heterogeneous objectives. The economic desired benefits of the dept. are iustrated to the tune of the preceding iustrated diagrams. Production department: Benefits towards ess production cost through mass production. Purchase department: Benefits towards discounts, carrying cost and so on. Saes department: Timey suppy of the goods to the requirements, faciitates the firm to earn greater voume of earning. To reduce the operating cyce in duration in order to reaize the economic benefits as eary as possibe. 312 Finance department: Benefits towards the carrying cost, storage cost of the entire inventory.
10 Major Benefits of Inventory Contro It eads to effective utiization of funds ony through an appropriate investment on inventory It faciitates to obtain the economic suppy of raw materias It possess the firm comfortaby to meet the needs and wants of the consumers in time It neither aows the firm to undergo the practices of overstocking nor understocking. It eads to effectiveness in the materia handing which reduces the wastage, piferage and so on. Before discussing the methods of inventory contro, every one must obviousy understand the organization of the stores department. The stores department is the ony department which appies a the techniques of inventory contro. The organization of the inventory contro are various in dimensions. The organization of differs from one industry to another industry, one firm to another within the same industry, from one nature to another, from voume to another. They are as foows: a) Centraised stores b) Decentraised stores c) Centra and Sub stores Working Capita Management Centraised Stores Under this type, the materias are received by and issued at one centra pace by the department to the requirements of the other functiona departments. The foowing diagram wi faciitate to understand the organisation structure of the centraized stores of the manufacturing department. The materias are continuousy received by the stores dept. through the purchase department and the received materia are distributed to the various assisting departments. This type of organization of stores contro has its own advantages and disadvantages in appication The major advantages are foowing: It requires ess space It faciitates to minimize the stock investment The centraization eads to ower administrative and maintenance cost of stores 313
11 In addition to the advantages, the present organization suffers with its own imitation whie in appications; which are foowing: The centraization of stores eads to enhance the cost of transportation as we as handing cost of materias. The centraized system eads to ot of inconvenience and deay to other department due to distance There is a greater risk of caamity oss of materias which are stored under one roof The success is subject to the effectiveness of the transportation Decentraised Stores Under this method, the separate stores are maintained by the departments on their own as we as run by the excusive store keeper. It ensures the smooth fow materia to the tune of requirements and reduces the time invoved in the transit of materias from the stores to the respective departments. The foowing diagram wi faciitate to have an insight on the organization of the stores Centra stores and Sub stores This is a method which attempts to discard the bottenecks of the above mentioned as we as brings forth unique organization of stores. Under this method, each department is given separate sub store which is within easier access and shorter in distance to suppy the materia requirements through the store keeper. The sub store keeper shoud have to make requisition to centra stores where a the materias are centray procured and suppied then and there to the tune of the individua departments. C e n t r a S t o r e Sub Store Sub Store Weding Dept Panning Dept Production Dept 314 The roe of the store keeper is most inevitabe in controing the stores. Whie controing the stores, the store keeper shoud neither disturb the production process nor undergo the practices of overstocking. By earmarking the above enisted objectives, every store keeper is ed by the various methods of inventory vauation in addition to various methods of requisitioning of materia.
12 First we wi discuss, the various methods of requisitioning of materias. Working Capita Management Reordering Leve This is the eve at which the firm shoud go for fresh purchase requisition of materia through the store keeper to meet the requirements. The reordering eve which takes into consideration of minimum eve of consumption of raw materia during the course of production process as we as the amount materia required by the firm during period of purchase and goods in transit immediatey after the order. Reordering Leve Minimum Leve Amount of materias required during the periods of consumption Reordering eve=minimum eve of stock for uninterrupted fow of production process + Amount of materias required during the periods of consumption Or Lead time stock eve Aternate method is avaiabe by using the maximum consumption and maximum reorder period Re ordering eve= Maximum consumption Maximum Re- order period This method registers the maximum consumption of the firm during the production as we as the maximum time period required for the suppy of required materias. Under this aternate approach, the firm at any moment wi not face any difficuties due to short suppy or insufficient amount of materias Minimum Leve/Safety eve The firm shoud at aways maintain minimum amount of materia in its hands to faciitate the fow of production process as unaffected.due to short fa in the quantum of materias. The foowing points are most important in designing the minimum eve of stock: Lead time shoud be predominanty considered to determine the time ag in between the materias ordered and received. The firm shoud find out the practica difficuty of the vendor in suppying the materia for the determination for minimum eve of stock. Amount of consumption of the materia during the ead time Minimum stock eve=reordering eve- (Norma eve consumption Norma Reorder period) Minimum eve = Reorder eve + (Average eve of consumption Average Reorder period) Average and norma eve of consumption are synonymous with each other. If norma or average consumption is not given, the formua is as foows 315
13 Average consumption = Minimum eve consumption + Maximum eve consumption Maximum Leve This is the eve at which the firm hods maximum quantity of materias as stock during the process. The utimate aim of fixing the eve of maximum eve is that to avoid the overstocking. If the stock eve of the firm exceeds the maximum eve aready fixed is known as overstocking eve of the firm, more than the requirement. Why over stocking is considered not advisabe? It eads to excessive investment on inventory more than the requirement It eads to unnecessary wastage of the materias due to excessive stock The excessive storage of materias may certainy affect the price of the product Maximum stock eve= Reordering eve+ Reordering quantity - (Minimum consumption Minimum Reordering period) Danger eve At this eve, the firm shoud not further issue any materias to the various functiona departments.at the danger eve, the purchase department is vested with greater responsibiity to immediatey arrange the suppy of raw materias in order to maintain the fow of production as uninterrupted. The consumption eve of the materias is getting varied from one time period to another. During the specified period, there may be maximum consumption and minimum consumption, which shoud be averaged to find the mid point in between the two, in order to either fufi the minimum consumption or maximum consumption to the extent possibe. Why the maximum reorder period is taken into consideration? The purpose of considering is that the greater period taken by the suppier to suppy the required materias Danger Leve= Average consumption Maximum reorder period Average Stock Leve Average stock eve =Minimum stock eve + ½ of the reorder quantity Economic Ordering Quantity The ordering of materias usuay tagged with three different component of costs viz: Acquisition cost of materias Ordering cost of materias Carrying cost of materias The ordering quantity of materias may be either arger or meager in voume, which carries its own advantages and disadvantages. If the quantity ordered is arger in voume, the foowing are some of the important advantages: The buk purchase order reduces the ordering cost of the materias. The greater the size of the order which eads to reduce the number of the orders in procuring the materias. Quantity discounts: The discount can be cassified into two categories viz Trade discount and Cash discount. What is trade discount?
14 Trade discount is the discount granted by the suppier to the buyer of materias at the moment of buk purchase. This % of discount is greaty possibe ony during the periods of greater voume of purchase; which reduces the over a cost of the acquisition. If the quantity is procured in meager voume, the foowing are construed as advantages: The carrying cost wi come down in the case of esser inventories The cost of storage is esser as far as the meager quantities of materias Loss due to deterioration, obsoescence, wastage wi be minimum Insurance cost is ess due to meager voume of materias Working Capita Management 2AO Economic Ordering Quantity = 1 A = Annua requirement in units O = Ordering cost I = Cost of storing per year or cost of carrying the inventory Graph of EOQ: Tota cost Rupees Ordering cost Cost of carrying Units per order Insert the picture anpve Iustration 1 Annua Requirement =20,000 units Ordering cost= Rs.100 per order Cost per unit =Rs.4 Carrying cost =16% Determine the EOQ of the firm and finay justify the EOQ 2AQ Economic Ordering Quantity (EOQ) = I = 2 20,000 Rs % on Rs.4 = 2,500 units 317
15 The foowing Tabe 23.1 iustrates the justification of the EOQ at the 2,500 units eve Annua requirement of 20,000 units Particuars Size of the Orders 20,000 10, , Number of order to paced = Tota Annua Need Size of the order Average stock = Size of the order 2 10,000 5,000 2,500 1, Average stock vaue =Average stock cost per unit Rs Carrying cost = Average Stock vaue 16% Rs 40,000 20,000 10,000 5,000 1,000 6,400 3,200 1, Ordering cost Rs ,000 Tota cost Rs 6,500 3,500 2,000 1,600 4,160 Iustration 2 Cacuate EOQ Annua Requirement units Cost of materias per unit Rs.40 Cost pacing and receiving -Rs.50 Annua carrying cost of inventory -10% on vaue Economic Ordering Quantity (EOQ)= 2AO 1 EOQ = Rs.50 10% on Rs.40 = 200 units Iustration 3 Consumption during the year -600 units Ordering cost Rs. 12 per order Carrying cost 20% Price per unit Rs. 20 B.Com. (Punjab) Economic Ordering Quantity (EOQ)= 2AO Rs.12 EOQ = 20% on Rs.20 = 60 units Iustration 4 A manufacturer purchases certain machinery from outside suppiers Rs.60 per unit. Tota annua needs are 800 units. The foowing are the additiona information 318 Annua return on investments 10%
16 Rent, insurance, taxes per unit per year Rs 2 Cost of pacing an order Rs.200 Determine the economic order unit First step to find out the earnings= 10% Rs.60= Rs.6 to be earned from the investment The amount of rent, insurance, taxes per unit year =Rs 2 I= 10% on Rs.60 + Rs.2= Rs.8 Working Capita Management Economic Order Quantity (EOQ) = 2AO Rs.200 = 10% on Rs.60 +Rs.2 = 200 units Iustration 5 Given the annua consumption of materia is 1,800 units, ordering costs are Rs.2 per order, price per order price per unit of materia is 32 paise and storage costs are 25% per annum of stock vaue, find the economic order quantity. (B.Com. Caicut) 2 A O Economic Order Quantity (EOQ) = 1 2 1,800 Rs.2 = 25% on 32 paise = 300 units Iustration 6 Find out the Re ordering eve from the foowing information a) Minimum stock 1000 units b) Maximum stock 2000 units c) Time required for receiving the materia 20 days d) Daiy consumption of materia 100 units Reordering eve = Minimum eve + Lead time stock eve The first step is to find out the Lead time stock eve Lead time stock eve is nothing but the amount of stock eve required by the firm, ti the next fresh receipt of goods, subject to the time normay taken by the suppier to suppy. Lead time stock eve= Time required for receiving the materia Daiy consumption Lead time stock eve= 20 days 100 units per day= 2000 units Reordering eve= 1, ,000 units= 3,000 units Iustration 7 Cacuate maximum eve, minimum eve and reordering eve from the foowing data Reorder quantity 2,000 units Reorder period 8 to 12 weeks Maximum consumption 800 units per week 319
17 320 Norma consumption 600 units per week Minimum consumption 500 units per week Reordering eve = Minimum eve + Lead time stock eve Or = Maximum consumption Maximum ead time Minimum eve= Reordering eve (Average consumption Average ead time ) Maximum eve= Reorder eve + Reorder quantity (Mini consumption Mini Lead time) First step is to find out the Re ordering eve Reordering eve = 800 units per week 12 weeks= 9,600 units The next step is to find out the Maximum eve Maximum eve = 9,600 units + 2,000 units - (500 units 8 weeks) = 11,600 units- 4,000 units =7,600 units The next step is to find out the minimum eve. For that Average consumption has to be found out. The average consumption is nothing but norma consumption. The norma ead time period is the average of minimum and maximum re order period of the firm in getting the suppy of the materias from the suppiers Minimum eve = 9,600 units (600 units 20/2) = 9,600 units 6,000 units= 3,600 units Iustration 8 Two components A and B are used as foows Norma usage 50 units per week each Minimum usage 25 units per week each Maximum usage 75 units per week each Re order quantity A: 300 units B: 500 units Re order period A: 4 to 6 weeks B: 2 to 4 weeks Cacuate for each component (B.Com., Madras) (a) Re order eve (b) Minimum eve (c) Maximum eve and (d) Average stock eve First step is to find out the Reorder eve for both A and B components The maximum usage is common for both A and B components but the reorder period are different from each other Reorder eve = Maximum consumption /usage Maximum Reorder period (A)= 75 units 6 weeks= 450 units (B)=75 units 4 weeks= 300 units The next step is to determine the Maximum eve of both Components A and B Maximum eve = Reordering eve + Reordering quantity (Mini Consumption Mini Lead time)
18 (A)= 450 units units ( 25 units 4 weeks) = 650 units (B)=300 units units (25 units 2 weeks) = 750 units Minimum Leve = Reordering eve ( Average consumption Average ead time) Working Capita Management (A) (4 + 6)) = 450 unit (50 unit 2 = 450 units 250 units = 200 units (2 + 4)) (B) = 300 unit (50 unit 2 =300 units ( 150 units )=150 units Average stock eve = Minimum stock eve + ½ Re order quantity (A)= 2 00 units + ½ 300 units = 350 units (B)=150 units+ ½ 500 units = 400 unit Iustration 9 The foowing information is avaiabe in respect of components of R 100 Maximum stock eve 10,000 units Budgeted consumption Maximum 3,000 units per month Minimum 1,600 units per month Estimated deivery period Maximum 4 months Minimum 2 months You are required to cacuate (i) Re-order eve (ii) Re-order quantity Re order eve = Maximum consumption maximum ead time = 3,000 units 4 months=1,200 Units The Reordering quantity coud be found out with the hep of Maximum eve equation Let us assume Re ordering quantity =X Maximum eve = Re-ordering eve + Re-ordering quantity - (Minimum consumption Mini Re order period) = 1,200 units+ (X)-(1,600 units 2 months) (-X) = 1,200 units-3,200 Units = 2000 units X = 2,000 units In the stores contro, there are two important documents viz Bin card system and stores edger. Bin Card: Bin card is a record prepared by the store keeper at the moment of issuing and receiving the materias. It is maintained by the store keeper for physica verification with accuracy and effectiveness. The inventory contro can be accessed through physica verification then and there, whenever the situation warrants. The bin card system is adopted by many firms for their inventory contro either in the form of bin tag or stock card hanging outside the rack in order to portray the information 321
19 immediatey to faciitate the store keeper to understand the stock position of the store room. The bin card system is avaiabe in two major categories viz: Two Bin card system: Under this system two different bins are used. As soon as the goods or materias received by the store keeper, that shoud be recorded in terms of quantities. One among the two shoud be maintained for Re order eve and minimum eve another for Maximum stock eve. To aarm the firm neither to store more than the maximum eve nor to issue ess than the minimum eve of the stock. If the firm once reaches the maximum eve, it shoud immediatey caution the impications due to the overstocking. The same firm, if reaches the minimum eve of stock, it shoud not go for further issue of materias to functiona department or otherwise, the firm's production may be disturbed due to the poor stocking. Bin card for Mini and Reorder eve Bin card for Maximum Leve Maximum Leve Maximum Leve Reorder Leve Three Bin Card system: It is an extension of the eary method, which incorporates the ead time stock eve in addition to the other eve viz Maximum, Reorder and Minimum eve of the stock. Among the three, two cards are excusivey used by the firm in order to maintain the appropriate stock eve, i.e., for maximum stock eve and minimum stock eve. The firm shoud neither to store beyond the maximum eve nor to issue ess than the Minimum eve. In between, a separate bin card is used ony for the Reorder eve and Lead time stock eve at which the firm shoud go for the pacement of an order to get fresh deivery of materias and faciitate the firm to undergo production without any interruption by considering the time taken by the suppier to suppy the ordered materias. Reorder eve 322 Minimum stock eve Lead time stock eve Maximum stock eve
20 Some other methods of the inventory contro There are few modes exercise the inventory contro, which faciitates the firm to avoid either under or over stocking. ABC Anaysis VED Anaysis Working Capita Management ABC anaysis Normay the materias are cassified on the basis of the foowing covenants viz: Voume and Vaue Based on the basis the materias are cassified into three categories: Lesser percentage in voume and Greater percentage in Vaue- Category A Greater percentage in voume and Lesser percentage in Vaue - Category B and Percentage in voume and Percentage in vaue are more or ess - Category C This wi be expained with the hep of foowing exampe for insight. A store has 4,000 items of consumption and a monthy consumption of Rs 20,00, items wi have a consumption of Rs. 15,00, items wi account for Rs 4,00,000 and 2,680 items consume materia worth Rs.1,00,000 ony. Tabe of Items and vaue Group No. of Items % of Items Vaue Rs % of Vaue A 320 8% 15,00,000 75% B % 4,00,000 20% The C importance of 2,680 the anaysis is exercising 67% the contro 1,00,000 on the inventory. 5% Tota 4, % 20,00,000 How the contro of the inventory is being exercised? Group A items are high vaued items among the other items of the enterprise, require greater monitoring and controing. Group B items are comparativey esser in vaue among the three items given next to the Group A, require ess rigid contro and monitoring. Group C items are the major voume of items among the 4000 items of the enterprise which are east in vaue, need very itte contro and monitoring. The foowing of contro of inventory on A, B and C items of the enterprise: Group No. of Items Leve of Contro % of Items Vaue Rs % of Vaue A 320 Rigid Contro 8% 15,00,000 75% B 1000 Moderate Contro 25% 4,00,000 20% C 2,680 Very itte Contro 67% 1,00,000 5% From the above tabe, it is obviousy understood that the items which have greater % (75%) in the tota vaue requires rigid contro than any other quantity of materias. The Group C items are bearing 67% of tota consumption amounted which 5% of tota vaue of the items procured by the enterprise. 323
21 The Unique features of the ABC anaysis: Nature A Group of Items B Group of Items C Group of Items Leve of Contro Rigid contro Moderate contro Very itte contro Order frequency Frequent orderingweeks, Fortnights Once in 2 months Once in 6 months Lead time probem To be cut off drasticay To be reduced moderatey Lead time probem due to cerica shoud cut off Safety stock eve Due to greater vaueeast voume safety stock to be maintained Due to moderate vaue-esser safety stock is required Due to ower vaue- High safety stock is required System of Purchase Higher vaue demands centraized system of procurement Moderate vaue requires centraized and decentraized system of purchase Lower vaue needs decentraized system of purchase Supervision By Senior officers By Midde eve managers By cerica staff Advantages (1) It guides the management to exercise the contro based on the vaue of goods to the tota composition. (2) Systematic inventory contro can be exercised through this anaysis on the basis of vaue of the materias. The high vaue materias of Group A are rigidy controed which finay ed to esser investments. (3) Scientific system faciitates to essen the storage cost of the inventory VED anaysis VED anaysis is appied for the inventory contro of the manufacturing enterprise. V-Vita E-Essentia and D-Desirabe The spare parts are cassified into vita, essentia and desirabe to the cruciay to the production. The non avaiabiity of certain spares for short time eads high cost stock out known as vita spares. The non avaiabiity of spares cannot be toerated even for few hours or one day and the cost of ost production is enormous, known as Essentia spares to production. The absence of spares even more than one week, not affecting the fow production, known as desirabe spares. 1) Inventory means Check Your Progress a) Stock of Cash b) Stock of Raw materias, work in progress and Finished goods c) Stock of spares d) Both b) & c) ony 324 Contd...
22 2) Inventory contro is for the maintenance of Working Capita Management a) High eve of inventory b) Optimum eve of inventory c) Low eve of inventory d) Average eve of inventory 3) Excessive inventory hoding is a) Better for the firm b) Worse for the firm c) Neither better nor worse for the firm d) Either better or worse for the firm 4) The purpose of inventory contro is a) To minimize the excessive stock b) To meet the needs of the consumer c) To maintain iquidity d) a),b) & c) 5) Inventory contro is in reevance with a) Storage cost b) Carrying cost c) Ordering cost d) (a), (b) and (c) 23.9 RECEIVABLES MANAGEMENT Concept of Receivabes Management The receivabes are normay arising out of the credit saes of the firm. What is meant by the accounts receivabe? It is an asset owed to the firm by the buyer out of the credit saes with the terms and conditions of repayment on an agreed time period. Meaning of the receivabes management: The receivabes out of the credit saes crunch the avaiabiity of the resources to meet the day today requirements. The acute competition requires the firm to sustain among the other competitors through more voume of credit saes and in the intention of retaining the existing customers. This requires the firm to se more through credit saes ony in order to encourage the buyers to grab the opportunities unike the other competitors they offer in the market Objectives of Accounts Receivabes i) Achieving the growth in the voume of saes ii) Increasing the voume of profits iii) Meeting the acute competition Cost of Maintaining the Accounts Receivabes Capita cost: Due to in sufficient amount of working capita with reference to more voume of credit saes which drasticay affects the existence of the working capita of the firm. The firm may be required to borrow which may ead to pay certain amount of interest on the borrowings. The interest which is paid by the firm due to the borrowings in order to meet the shortage of working capita is known as capita cost of receivabes. Administrative cost: Cost of maintaining the receivabes. Coection cost: Whatever the cost incurred for the coection of the receivabes are known as coection cost. Defauting cost: This may arise due to defauters and the cost is in other words as cost of bad debts and so on. 325
23 Factors Affecting the Accounts Receivabes i) Leve of saes: The voume of saes is the best indicator of accounts receivabes. It differs from one firm to another. ii) Credit poicies: The credit poicies are another major force of determinant in deciding the size of the accounts receivabe. There are two types of credit poicies viz enient and stringent credit poicies. Lenient credit poicy: Enhances the voume of the accounts receivabe due to ibera terms of the trade which normay encourage the buyers to buy more and more. Stringent credit poicy: It curtais the motive buying the goods on credit due stiff terms of the trade put forth by the suppier unike the earier. iii) Terms of trade: The terms of the trade are normay bifurcated into two categories viz credit period and cash discount Credit period: Higher the credit period wi ead to more voume of receivabes, on the other side that wi ead to greater voume of debts from the side of buyers. Cash discount: If the discount on saes is more, that wi enhance the voume of saes on the other hand that wi affect the income of the enterprise Management of Accounts Payabe/Financing the Resources It is more important at par with the management of receivabe, in order to avai the short term resources for the smooth conduct of the firm VARIOUS COMMITTEE REPORTS ON WORKING CAPITAL The foowing committees were especiay appointed for the purpose to administer the working capita i) Dheja Committee Report 1969 ii) Tandon Committee Report 1975 iii) Chore Committee Report 1980 iv) Marathe Committee Report 1984 The various committee report impications are the foowing: Dheja Committee Report 1969 "The study carried out on the credit need of the industry and trade and how that needs infated and such trends were checked" by the under the chairmanship of Dheja Committee. Findings i) Genera tendency was found among the firms to avai the bank credit more than their requirements ii) Another tendency was among them that the short term credit was generay made use of by thee for the acquisition of the ong term assets iii) The ending through cash credit shoud be done on the basis of security in order to assess the financia position of the firm 326
24 Recommendations i) Appraisa shoud be done by the bankers on the present and future performance of the firms ii) The tota deaings are segmented into two categories viz core and short-term needs iii) The committee suggested the firms to maintain ony one account with the one banker For huge amount of borrowing, consortium was suggested among the bankers to end the corporate borrowers Working Capita Management Tandon Committee The next committee was appointed Tandon Committee 1975, in an intention of granting oans and advances to the industry on the need basis through the study of the deveopment proceeds ony in order to improve the weaker section of the peope. Findings of the Committee i) The bank shoud not revea this much ony to ent to the requirements of the firm in accordance with ending poicy, in spite of that the banks were expected to end to the tune of firm's requirement ii) iii) It shoud be treated as suppementary source of finance but not as major source of finance Loans were ent ony in accordance on the basis of the securities produced by the borrower but not on basis of eve of operations iv) Security compiance wont provide any safety to the banks but the periodica foow up ony shoud faciitate the banker to get back the amount of oans and advances ent Recommendations: It reached the and mark in studying the need of the industries towards the requirements of the working capita. The committee has submitted its report on 9th Aug, 1975 by studying the ending poicies. i) Necessary information about the future operations are to be suppied ii) The supporting current assets shoud be shown to the banker at the moment of borrowing iii) The bank shoud understand that the bank credit is ony for the purposes to meet out the needs of the borrower but not for any other Chore Committee Report 1979 This committee especiay constituted ony for the purpose to study the sanctionabe imits of the banker and the extent of the oan amount utiization of the borrower. The another purpose of the committee to appoint that to provide the aternate ways and means to afford credit faciity to the industries to enhance the productive activities in the country. i) Continuance of the existing three system of credits by the banker viz cash credit, oans and bis ii) iii) iv) No need to bifurcate the cash credit accounts of the borrower for the impementation of the differentia rate of interest According to the specifications of the borrower, the banker shoud come to one concusion which in norma peak eve and non peak eve of operations ony to the tune of operations No frequent sanction of ad hoc imits of borrowing from the banker 327