project on working capital21
TRANSCRIPT
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CONTENTS
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Executive summary
Introduction Page2
Scope and significance of
the studyPage-5
Objective of the study Page-7
Company profile Page-9
Working capital concepts Page-11
Working capital in a
construction industryPage-27
Analysis and interpretation Page-33
Findings and suggestions Page-70
conclusion Page-77
Bibliography Page-78
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INTRODUCTION
Business concerns need funds for carrying on the business. These funds are acquired
either from equity, or on borrowed basis. Concern utilizes a part of the funds for acquiring fixed
assets and for other long term purposes. Apart from financing for investing in fixed asset, every
business concern also require funds on a continual basis for carrying on its day-to-day operation.
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These include amounts expenses incurred for purchase of raw materials, for processing the raw
materials, constructions work .The moneys are blocked in the process may be in the crash form,
in raw material form, in work in process form, as receivables or in any other which shall be
converted in cash with in a period of 12 months period like (advanced paid for raw materials,
advances given to other, temporary cash payments, advance tax payment etc). These moneys
blocked and which can be subsequently converted in to cash is called as current asset in technicallanguage. Until such goods are sold and the money is realized, business transactions are
generally carried with a number of days elapsing subsequently to the sale being affected for
realization of the proceeds. While part of the raw material may be purchased by credit, the
business would still need to pay its employees, overhead expenditure, construction expenditure,
selling expenses and the balance of raw material purchases. Working capital refers to the sources
of financing required to by business on continual basis for meeting these needs.
And the working capital can be meet either from surplus left in the long term sources like
capital of the promoter, which is called as margin or liquid surplus or form the short term credit
raised form financial institution are form market etc. which are called as current liabilities.
The management of working capital is becoming increasingly important as firms realize
that approximately half of their investments are in working capital .Some special characteristics
of working capital like assets with short life span, its nearness to crash etc. Future emphasize its
importance from managerial view point
Proper management of working capital aims at protecting the purchasing power of assets
and maximizing the return on investment
Efficient working capital management is very necessary for smooth operation of a
concern. Management accounts should pay adequate attention to the management of working
capital and its components both on assets as well as liability side.
Inadequate attention to working capital in effect, involves placing different values on
different types of company funds. The inadequacy or mismanagement is one of the leading
causes for business failure.
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Management of working capital is a great help in planning the repayment of long terms
loans also. However the liquidity of the firm depends upon the availability of cash so as to
dispose of liabilities or bills at the time of their maturity.
A study of working capital is a major importance of internal and external analysis
because of its relationship with day to day activities of business. Funds collected from different
sources are invested in the business for acquisition of assets. These assets are employed for
earning revenue. The basic problem facing the finance manager of an enterprise is to trade off
between conflicting but equally important goals of liquidity and probability. The greater the
liquidity the lesser the probability and vice-verse. The firm has to maintain the working capital at
such a level as may to ensure satisfying earnings to the enterprise without jeopardizing its liquid
position. Thus, working capital management is concerned with the problems that arise in
attempting to discuss in details various tools and techniques which can gainfully employed to
solve the problem of determine optimum level of working capital.
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SCOPE AND SIGNIFICANCE OF THE STUDY
SCOPE OF THE STUDY-
The study extends to the area of working capital management inLARSEN & TOUBRO LIMITED- ECC Division. The study relates to the Sinter Plant III, RSP-
Rourkela Job Site only. The study deals with the calculation of working capital at the project site
of LARSEN & TOUBRO LIMITED.
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SIGNIFICANCE OF THE STUDY-
Study of working capital and its management are of
immense significance in the working of any organization. It is the life blood of any organization.
Without a very good amount of planning on the working capital system, the operation of a
company becomes very difficult. The larger and more complex an organization is the morecomplicated the working capital becomes. The working capital system of a huge company like
LARSEN & TOUBRO LIMITED with functional division could be complicated and a proper
study would reveal the drawback of the system and rectify it.
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OBJECTIVE OF THE STUDY
OBJETIVE OF THE STUDY-
To study the composition of working capital employed in the company.
To analyze the short term financial solvency of the company.
To analyze the financial efficiency of the company.
To ascertain the profitability of the company.
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To study various sources and applications of working capital of the company.
To make a composition of the balance sheet between different years and to form an
opinion about the progress of the company.
To give possible suggestions on the basis of study to improve the working capital
management of the company.
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COMPANY PROFILE
COMPANY PROFILE-
LARSEN & TOUBRO LIMITED (L&T) is a technology,engineering, construction and manufacturing company. It is one of the largest and most respected
companies in India's private sector.
Seven decades of a strong, customer-focused approach and the continuous quest for world-classquality have enabled it to attain and sustain leadership in all its major lines of business.
L&T has an international presence, with a global spread of offices. A thrust on international
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business has seen overseas earnings grow significantly. It continues to grow its overseasmanufacturing footprint, with facilities in China and the Gulf region.
The company's businesses are supported by a wide marketing and distribution network, and haveestablished a reputation for strong customer support.
L&T believes that progress must be achieved in harmony with the environment. A commitmentto community welfare and environmental protection are an integral part of the corporate vision.
Strategic Mission - LAKSHYA (Hindi for Target)
To compete and grow in a globalised business environment, L&T is implementing a strategicplan (LAKSHYA) for 2005-10. The plan has been drawn up in consultation with a leadinginternational strategy consultant. It has set ambitious growth targets for each business. Alsoincluded are opportunities for diversification of L&T's business portfolio.
ECC DIVISON-
The Engineering Construction & Contracts Division (ECC) of L&T is Indiaslargest construction organization with over 60 years of experience and expertise in the field.
It figures among top 225 contractors in the world. It ranks 54th among global contractors(revenues outside the home country) and 62nd among international contractors (revenues fromhome as well as outside country) as per the survey conducted by the Engineering News RecordMagazine (August 2006).
ECC is equipped with the expertise and experience to undertake lump sum turnkey (LSTK)construction with single-source responsibility. LSTK assignments are executed using state-of-the-art design tools and project management techniques.
ECCs leading-edge capabilities cover every discipline of construction: civil, mechanical,electrical and instrumentation. Its track record of over six decades covers all industrial sectorsand infrastructure projects.
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WORKING CAPITAL CONCEPTS
WORKING CAPITAL CONCEPTS-
Working capital management is an important
decision making area of financial management of an enterprise. It is also known as short termfinancial management. It is concerned with decisions relating to current assets and current
liabilities. It requires understanding of the following.
How to raise and allocate financial resources?
How to relate short term investment and financial decisions to the overall objective of the
company?
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How to relate short term financial decisions to certain long term financial decisions?
DEFINATION-
Working capital can be defined as the excess of current assets over current
liabilities. It can be defined as that portion of the companys current assets which is financed
with long term funds.
In the words of SHUBIN, working capital is the amount of funds necessary
to cover the cost of operating the enterprise.
According to GENESTENBERG, circulating capital means current assets
of a company that are charged in the ordinary course of business from one form to another, as for
example, from cash to inventories, inventories to receivables, receivables to cash.
CLASSIFICATION OR KINDS OF WORKING CAPITAL-
Working capital can be classified into two ways
(a) On the basis of concept.
(b) On the basis of time.
On the basis of concept, working capital is classified as:
1. Gross working capital2. Net working capital
On the basis of time working capital may be classified as:
1. Permanent or fixed working capital.
2. Temporary or variable working capital.
A Graphical representation of the kinds of working capital-
Kinds of Working Capital
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On The Basis Of Concept On The Basis Of Time
Gross Working
Capital
Net Working
CapitalPermanent or
Fixed Capital
Temporary
working capital
Regular Working
Capital
Reserve Working
Capital
Seasonal Working
Capital
Special Working
Capital
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1. Permanent or Fixed 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. There is always a minimum level ofcurrent assets which is continuously required by the enterprise to carry out its normal
business operations. For example, every firm has to maintain a minimum level of raw
materials, work in process, finished goods and cash balance. This minimum level of
current assets is called permanent or fixed working capital as this part of capital is
permanently blocked in current assets. The permanent working capital can further be
classified as regular working capital and reserve working capital required to ensure
circulation of current assets from cash to inventories, from inventories to receivables and
from receivables to cash and so on. Reserve working capital is the excess amount over
the requirement for regular working capital which may be provided for contingencies that
may arise at unstated periods such as strikes, rise in prices, depreciation etc.
2. Temporary or Variable Working Capital-
Temporary or variable working
capital is the amount of working capital which is required to meet the seasonal demands
and some special exigencies. Variable working capital can be further classified as
seasonal working capital and special working capital. Most of the enterprises have to
provide additional working capital to meet the special and seasonal needs. The capital
required to meet the seasonal needs of the enterprise is called seasonal working capital.
Special working capital is the part of working capital which is required to meet specialexigencies such as launching of extensive marketing campaigns for conducting research
etc.
Temporary working capital differs from permanent working
capital in the sense that it is required for short periods and cannot be permanently
employed gainfully in the business. It has been depicted in the form of a figure below
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Temporary of Variable Working
Capital
Permanent of Fixed Working Capital
TIME
Amount of Working Capital
Figure-1
Temporary of Variable Working Capital
Permanent of Fixed Working Capital
TIME
Amount of Working Capital
Figure-2
In Fig-1 permanent working capital is stable or fixed over time while the temporary or variableworking capital fluctuates.
In Fig-2 permanent working capital is also increasing with the passage of time due to expansion
of business but even then it does not fluctuate as variable working capital which sometimes
increases and sometimes decreases.
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3. Gross Working Capital-Refers to the gross working capital and represents the
amount of funds invested in current assets. Thus the gross working capital is the capital
invested in total current assets of the enterprise.
4. Net working capital-
Net working capital is the excess of current assets over currentliabilities or its depicted as.
Current assets are those assets which in the ordinary course of business can be converted
into cash within a short period of normally one accounting year.
Current liabilities are those liabilities which are intended to be paid in the ordinary course
of business within a short period of normally one accounting year out of the current assets or the
income of the business.
Constituents of Current Assets and Current Liabilities:
Current Assets- C urrent L iabilities -
1. Cash in hand and Bank balance 1. Bills payable
2. Bills receivable or Clients outstanding 2. Accounts payable
3. Accounts receivables 3. Outstanding expenses
4. Inventories 4. Unadjusted mobilization advance
5. Prepaid expenses 5. Unadjusted material advance
6. Accrued income 6. Unadjusted plant advance
7. Deposits 7. Vendor credit
8. Security deposits
9. Bank guarantees
10. Net stock or stock at site
Net Working Capital= Current Assets Current Liabilities
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Principle of working capital management:
1. Principle of risk variation-Risk here refers of the inability of a firm to meet its
obligation as and when they become due for payment. Larger investment in current assets withless dependence on short-term borrowings increases liquidity, reduces dependence on short-termborrowings increases liquidity, reduces risk and there by decreases the opportunity for gain orloss. On the other hand less investment in current assets with greater dependence on short-termborrowings increases risk, reduces liquidity and increases probability. In other words, there is adefinite inverse relationship between the degree of risk and profitability. A conservativemanagement prefers to minimize risk by maintaining a higher level of current assets or workingcapital while a liberal management assumes greater risk by reducing working capital. However,
the goal of the management should be to establish a suitable tradeoff between profitability andrisk.
The various working capital policies indicating the relationship between current assets and sales
are depicted below
Conservative policy
Moderate
policy
Aggressive policy
Sales Cost of Assets
2. Principle of cost of capital-
The various sources of raising working capital finance
have different cost of capital and the degree of risk involved. Generally higher the risk
lower is the cost and lower the risk higher is the cost.
3. Principle of Equity position-
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According to this principle, the amount of workingcapital invested in each component should be adequately justified by a firms equity
position. Every rupee invested in the current assets should contribute to the net worth of
the firm. The level of current assets may be measured with the help of two ratios.
(1) Current assets as a percentage of total assets.
(2) Current assets as a percentage of total sales.
1. Principle of maturity of payment-
This principle is concerned with planning thesources of finance of working capital. According to this principal a firm should make
every effort to relate maturities of payment to its 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 inflows, the greater the inability to meet its obligation in time.
Need or Objective of Working Capital:
The need for working capital cannot be overemphasized. 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 in purchase of raw materials and production and sales; and sales and
realization of cash.
Thus working capital is needed for the following purposes:
1. for the purchase of raw material, components and spares.
2. To pay wages and salaries.
3. To incur day-to-day expenses and overhead costs such as fuel, power and office
expenses, etc
4. To meet the selling costs as packing, advertising, etc
5. To provide credit facilities to the customers
6. to maintain the inventories of raw material, work-in-progress, stores and spares and
finished stock
For studying the need of the working capital in a business, one has to study the businessunder varying circumstances such as a new concern, as a growing concern and as one
which has attained maturity. A new concern requires a lot of liquid funds to meet initial
expenses like promotion, formation, etc. These expenses are called preliminary expenses
and are capitalized. The amount needed as working capital in a new concern depends
primarily upon its size and the ambitions of its promoters. Greater the size of the business
unit, generally, larger will be the requirements of working capital. The amount of
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working capital needed goes on increasing with the growth and expansion of business till
it attains maturity. At maturity the amount of working capital is needed is called normal
working capital.
Operating Cycle Approach to Working Capital Management:
The continuing flow from cash to supplier, to inventory, to
accounts receivable and back into cash is what is called the operating cycle. In other
words, the term cash cycle or operating cycle refers to the length of time necessary to
complete the following cycle of events.
(1) Conversion of cash into raw materials.
(2) Conversion of raw materials into work in progress
(3) Conversion of work in progress into finished goods
(4) Conversion of finished goods into receivables
(5) Conversion of receivables into cash.
In symbols it can be expressed as follows
O=R+W+F+D-C
Where O= Time duration of operating cycle
W= Work in progress period
F= Finished goods storage period
D= Debtors collection period
C= Creditors period
WORKING CAPITAL CYCLE or OPERATING CYCLE
The components of operating cycle referred to above can be calculated as follows
R= Average Stock of Raw Materials
Average Raw Materials and Stores Consumption per Day
W= Average work in process inventory
Average cost of production per day
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F= Average finished goods inventory
Average cost of goods sold per day
D= Average book debts
Average credit sales per day
C= Average trade creditors
Average credit purchase per day
Application of the operating cycle-
Operating cycle proves quite useful as a technique for
exercising control over working capital. Each segment of operating cycle can be compared with
a pre specific norm or with the corresponding figure in the accounting year or with the
corresponding figure obtainable from the master budget of the company. Significant deviations
call for closer scrutiny by the management who can be seeking the reasons for such occurrence.
The deviations may have occurred due to a variety of reason. For example, an increasing in the
average conversion period may have occurred due to shortage of an important raw material (in
which case the purchase manager may be ask for an explanation), plant break down (in which
case the maintenance engineer may be asked for an explanation), a wild-cat strike by the workers
(which calls for an explanation from the chief of personnel and industrial relations) etc. Once the
reasons are know, remedial measures can be taken in respects of immediately controllable factors
and the other factors may be accepted as constraints for the time being, pending long-term
solutions. For example, frequent break down of plant may call for replacement of certain sections
and/or modernization which cannot be implemented immediately but can be implemented say in
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about a year. Toward the end of exercising better control, the operating cycle may be calculated
on a quarterly basis and/or on a product group basis.
In the case of seasonal industries such as tea
industry, two sets operating cycles may be calculated- one for the busy season and other for the
slack season- for excising better control. As inter-temporal comparison for monitoring workingcapital efficiency for a company are likely to be affected by the inflation factor, necessary
adjustment can be made by the application of appropriately chosen price-index. The comparisons
made, after neutralizing the impact of inflation both on sales and working capital, are more likely
to prove greater insight into the efficiency of working capital management across the year.
Another important area for the application of operating cycle approach lies in estimating the
working capital requirement of a company to support the forecasted level of sales. Given the
duration of various components of the operating cycle, the working capital needs can be
estimated.
Working capital is to necessarily maintained by an organization, because of the following
reasons-
1. If it were possible to complete the sequence instantaneously there would be no need for the
current asset but since it is not possible, the company is forced to have current asset.
2. The companies must invest adequately in short term liquid securities so that they will be in a
position to meet obligations when they become due.
3. The companies must have an adequate inventory to guard against the possibility of not being
able to meet obligations when they become due
4. If companies have to be competitive they must sell goods to their customers on credit, withnecessitates the holding of accounts receivables.
Factors influencing working capital requirement:
1. Nature and size of business-
Working capital requirement of a company are basically
influenced by the nature of the business. Trading and financial companies have less
investment in fixed assets, but require a large sum of money to be invested in working
capital need of a manufacturing concern fall between the two extreme requirements of
companies and public utilities.
2. Production policy-
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In certain industries the demand is subject to wide fluctuation due to
seasonal variations. The requirements of working capital, in such cases, depend upon the
production policy. The production could be kept either stead by accumulating inventories
during the slack periods with a view to meet high demand during the peak season or the
production could be curtailed during the slack season and increased during the peak
season. If the policy is to keep production steady be accumulating inventories it willrequire higher working capital.
3. Manufacturing process or length of production cycle-
In manufacturing business the
requirement of working capital increases in direct proportion to length of manufacturing
process. Longer the process period of manufacture, larger is the amount of working
capital required. The longer the manufacturing time, the raw materials and other supplies
have to be carried for a longer period in the process with progressive increment of labor
and service costs before the finished product is finally obtained. Therefore if there are
alternative processes of production the process with the shortest production period shouldbe chosen.
4. Seasonal variations-
In certain industries raw material is not available throughout 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. Generally during the busy season a firm requires larger working capital
than in the slack season.
5. Working capital cycle-
In a manufacturing concern the working capital cycle starts with
the purchase of raw materials and ends with the realization of cash from the sale of
finished products. This cycle involves purchase of raw materials and stores its conversion
into stocks of finished goods through work in progress with progressive increment of
labor and service costs, conversion of finished stock into sales, debtors and receivables
and ultimately realization of cash and this cycle continues again from cash to purchase of
raw materials and so on. The speed with which the working capital completes one cycle
determines the requirements of working capital- longer the period of the cycle larger isthe requirement of working capital.
6. Rate of stock turnover-
There is a high degree of inverse co-relationship between the
quantum of working capital and the velocity or speed with which the sales are affected. A
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firm having a high rate of stock turnover will need lower amount of working capital as
compared to a firm having a lower rate of turnover. For example in case of precious stone
dealers the turnover is very slow. They have to maintain a large variety of stocks and the
movement of stocks is very slow. Thus the working capital requirements of such a dealer
shall be higher than that of a previous store.
7. Business cycle-
Business cycle refers to alternate expansion and contraction in general
business activity. In a period of boom i.e. when the business is prosperous, there is a need
for large amount of working capital due to increase in sales, rise in prices, optimistic
expansion of business, etc. on the contrary in the time 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.
8. Rate of growth of business-
The working capital requirements of a concern increase withthe growth and expansion of its business activities. Although its difficult to determine
the relationship between the growth in the volume of business and the growth in the
working capital of a business, yet it may be concluded that normal rate of expansion in
the volume of business, we may have retained profits to provide for more working capital
but in fast growing concern, we shall require larger amount of working capital.
9. Earning capacity and Dividend policy- Some firm have more earning capacity than others
due to quality of their products, monopoly conditions etc. such firma with high earning
capacity may generate cash profits from operations and contribute to their working
capital. The dividend policy of a concern also influences the requirements of its working
capital. A firm that maintains a steady high rate of cash dividend irrespective of its
generation of profits needs more working capital then the firm that retains larger part of
its profits and does not pay so high rate of cash dividend.
10. Price level changes-
Changes in the price level also affect the working capitalrequirements. 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 effects of rising prices may be different for different firms. Some firms may be
affected much while some others may not be affected at all by the rise in prices.
Importance or advantage of adequate working capital
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Working capital is theblood and nerve center of a business. Just as circulation of blood is essential in the human
body for maintaining life, working capital is very essential to maintain the smooth
running of a business. No business can run successfully without an adequate amount of
working capital. The main advantages of maintaining adequate amount of working capital
are as follows:
1. Solvency of the business-Adequate working capital helps in maintaining solvency of
the business by providing uninterrupted flow of production
2. Goodwill-Sufficient working capital enables a business concern to make prompt
payments and hence help in creating and maintaining goodwill.
3. Easy loans-A concern having adequate working capital, high solvency and good
credit standing can arrange loans from bank and others on easy and favorable terms.
4. Cash discounts-Adequate working capital also enables a concern to avail cash
discounts on the purchases and hence it reduces costs.
5. Regular supply of raw materials-Sufficient working capital ensures regular supply
of raw materials and continuous production
6. Regular payment of salaries, wages and other day-to-day commitments-A
company which has ample working capital can make regular payment of salaries,
wages and other day-to-day commitments which raises the moral of the employees,
increases their efficiency, reduces wastages and costs and enhances production and
profits.
7. Exploitation of favorable market conditions-Only concern with adequate working
capital can exploit favorable market conditions such as average purchasing its
requirement in bulk when the prices are lower and by holding its inventories for
higher prices.
8. Ability to face crises-Adequate working capital enables a concern to face business
crisis in emergencies such as depression because during such periods, generally, there
is much pressure on working capital.
9. Quick and regular return on investments-Every investor wants a quick and regular
return on his investments. Sufficient of working capital enables a concern to pay
quick and regular dividends to its investors as there may not be much pressure to
plough back profits. This gains the confidence of its investors and creates a favorable
market to raise additional funds in future.
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10.High morale-Adequate working capital creates an environment of security,
confidence, and high morale and creates overall efficiency in a business.
Sources of finance for working capital-
1. Long term finance-
Equity capital( including retained earnings and surplus)
Debenture and preference share
Long term loans
1. Short term, temporary or variable sources-
Indigenous banker
Trade creditor
Installment credit
Advances Accrued expenses
Deferred income
Commercial paper and Bank
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WORKING CAPITAL IN A CONSTRUCTION
INDUSTRY
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An understanding of working capital is crucial to understand and analyze the
financial position of construction contractors. The sureties base their bonding to a great
extent on the amount and quality of working capital available to the contractors. Now
how working capital is dealt within an organization perfectly it has been described below
with an industry as an example to it.
Analyzing working capital-Working capital and current ratio analysis are considered
to be measure of liquidity. Liquidity is one of the key financial statement analysis
measures. The key financial statement analysis measures are generally considered to be
as follows.
Profitability
Assets utilization and efficiency
Liquidity
Capital structure
Return on invested capital
Liquidity refers to a companys ability to meet its short term obligations. It is important
that a company have sufficient working capital or access to funds to meet its short term
obligations.
Working capital defined-
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Working capital is the excess of current assets over currentliabilities. That leads to the obvious next question as to the definition of assets and
liabilities.
Assets are defined as: probable future economic benefits obtained or controlled
by a particular entity as a result of past transactions or events.
Liabilities are defined as: probable future sacrifices of economic benefits
arising from present obligations of a particular entity to transfer assets or provide services
to other entities in the future as a result of past transactions or events.
NOTE- Current in accounting term does not mean imminent. It refers to the next
accounting cycle, or next business year. That is usually assumed to be one year for
most companies. In other words current assets are those that can reasonably be
expected to be realized in cash or either sold, or consumed, in the accounting cycle.
Current ratio-
The current ratio is computed by dividing current assets by current liabilities and
is then expressed in mathematical terms. Working capital by contrast is expressed as an absolute
dollar amount. Both concepts are measurements or analysis of the same components of a balance
sheet. For instance assume company current assets of Rs 10,000,00 and liabilities of Rs 5,00,000
This would result in a working capital of Rs 5,00,000 ( 1000000-500000) and a current ratio of
two to one ( 1000000 divided by 500000=2).
By paying Rs 250000, on liabilities, the current
ratio would change from two to one to three to one. Working capital would remain at Rs
5,00,000. (7,50,000-2,50,000). Financial ratios should be interpreted very carefully.
Sureties and Banks-
In the soft market of the 1990s, it was assumed that a contractor couldobtain bid and performance bonds for almost any project. Also, credit lines and other debt were
easily obtained from banks.
After the recession of last year, and post September 11 th, the market
has tightened. Sureties and lending institutions have instituted greater scrutiny of the key
financial indicators of construction contractors. Of course, the current ratio and working capital
are not the only financial indicators examined but they have assumed a greater importance.
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The sureties have a unique way of computing working capital. As
part of their analysis, they will eliminate some items and add some items not considered by the
accounting profession to be in accordance with generally accepted accounting principles.
Those items adjusted by the surety and not credited for the
contractor are paid expenses, prepaid income taxes, and anything else that does not provide fundsto meet a payroll. All of those items are subtracted from current assets before computing
available working capital.
However sureties will often allow one-half of the value of the
inventory, unless the inventory has been purchased for specific construction projects.
On the positive side, there are some items included by the surety
but not normally included in working capital under traditional analysis. Those items are cash
surrender value of life insurance, and marketable equitable securities not held for sale.
It is also important to keep working capital clear of bank liens. Ifthe bank uses receivables and inventory as security, then the survey will not credit those amounts
towards working capital.
EXHIBIT-1
Sample Income Statement and Working Capital Data
Electrical contractor- Income statemen ts
(Data in thousands)
Revenues 250000
Cost of revenues( includes 12500 depreciation and 50000 labor) 212500
Gross profit 37500
G & A expenses 27250
Operating income 10250
Less: income taxes 3600
Net income 6650
Electrical contractor- working capital data
(Data in thousands)
Cash 1000
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Receivables
Ending inventory 3000
Under billings 2500
Prepaid
Total Current Assets 36750
Current portion of long term debts (2500)
Overbillings (2500)
Payables
Accruals
Total current assets (23500)
Optimum working capital-
The construction financial managers association survey for allparticipating companies for the last year available, 2001, shows a current ratio of slightly over
one to one (1.3 to 1).
Its important to remember that the optimum amount of working capital
theoretically would be zero. If a company could structure its finances so that the liquidity risks
were somehow reduced to zero, there would be no need for working capital. Funds invested in
working capital are not as productive as operating assets.
If you can minimize working capital, you can maximize cash flow. The
available cash can then be more profitably invested in the business.
However the fact remains that working capital is needed to meet current
obligations.
EXHIBIT-2
Computation of asset conversion days
Electrical Contractor- Asset Conversion Days
(Data in thousands)
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Receivables turnover days
BALANCE DAYS SALES DAYS
600 times 365 / 5000 = 44
Inventory turnover days
BALANCE DAYS MOD COST DAYS
OF SALES
60 times 365 / 3000 = 4
Payable turnover days
BALANCE DAYS MOD COST DAYS
OF SALES
(350) times 365 / 3000 = (26)
Net asset conversion days
Computation of minimum working capital required-
There are some simplecomputations to be made to determine the required amount of working capital.
Exhibit-1 presents a simplified income statement and balance sheet working capital data of a
sample electrical contractor.
Primarily working capital requirements of a company depends on its net asset conversion days.
Or phrasing it another way, determining its net trade cycle in days. They both mean the same
thing. How long does it take to convert receivables and inventory, less trade payables, into cash?
Asset conversion days= receivable turnover days (net of over / under billings), plus inventory
turnover days, minus payable turnover days.
Exhibit-2 presents a computation of asset conversion days. Note that the cost of revenues was
adjusted to remove depreciation and labor. This is done because depreciation and labor costs are
not reflected in the trade accounts payable balances.
If the daily sales (annual sales of 250000 divided by 365) are 685, then the required working
capital would be 15755 (685*23 days). It appears that the company is not quite at the minimum
working capital level required.
As a reasonableness check to our calculations, we can compare to a hypothetical bond program.
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Many sureties will often grant a bonded program of ten to twenty times working capital.
Therefore 265 working capital times 15 would produce a bonded program of 3975, or close to
4000 revenues. Twenty times working capital would produce a program of 5300. Since twenty
times working capital is the maximum available and not the norm, this surety rule of thumb
indicates that the company is borderline, but has insufficient working capital.
ANALYSIS AND INTERPRETATION
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Analysis and Interpretation-
After going through the company financial records over aperiod, the company has seen many up and down in the market. This was known by me after i
went the reports of the company. From this point of view what I understood is that the company
working capital is very healthy as all of its dues are cleared of in time with very less amount of
liability in hand. As this is a construction site being handled by Larsen & Toubro at Rourkela
Steel Plant the company does not publish the balance sheet. The datas are being sent to the head
office at Kolkata. So the datas which has been interpreted here are all datas those over a certain
period of year. This datas which have been jolted down by me are all those datas belonging to
the overall financial results of the company. It has been inferred from the head office and
whatever they have provided me over the past few year data I have showed them in the form of
graphs, tables and charts.
The significance of working capital is providing liquidity to Larsen &
Toubro pvt ltd can never be understated. An analysis and interpretation of the same is attempted
in this particular body. The overall position of the working capital is analyzed by both the parties
in the company i.e. its being audited by the management of the company in the company and
outside parties such as trade creditors, banks and financial institutions, debenture holders andexisting and potential share holders. So going ahead of the datas first we have the composition
of the total current assets and current liabilities in the company.
Composition of the current assets and current liabilities-
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The composition of workingcapital means total of current assets less total of current liabilities. So the current assets and the
current liabilities of the company are being shown in the form of a table from year 2003 to 2008.
TABLE NO-1
Composition of current assets (Rs in corers)
Years InventorySundry
debtors
Cash and
bank
balance
Other
current
assets
Loans and
advancesOthers
2003-04 892.54 838.51 103.62 43.12 444.91 2323.00
2004-05 1417.35 685.14 880.21 47.47 539.60 3569.76
2005-06 1742.17 748.26 760.31 48.81 633.46 3933.01
2006-07 1196.21 1982.07 550.28 53.12 712.36 4494.05
2007-08 1441.26 2586.51 727.67 73.96 968.35 5797.73
Mean 1337.91 1368.16 604.42 53.29 569.74 4023.51
Mean
proportion 33.25% 34.00% 15.02% 1.32% 16.41% 100.00%
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Source- company financial records
From the above table it is clear that the value of sundry debtors is the highest among all current
assets. It is followed by inventories, loans and advances, cash and bank balances and other
current assets in that order.
TABLE NO-2
Composition of current liabilities (Rs in corers)
Years Liabilities Bank overdraft Provision for
taxationTotal
2003-04 830.59 10.78 119.84 961.24
2004-05 1355.45 26.56 63.81 1445.82
2005-06 2117.32 - 34.69 2152.01
2006-07 2479.84 129.54 169.95 2779.33
2007-08 2733.08 15.68 113.35 2862.11
Mean 1903.26 36.52 100.38 2040.10
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Mean
proportion 93.29% 1.79% 4.92% 100.00%
Source- company financial records
From the above table it is clear that the value of sundry creditors is the highest among all
current liabilities. It is followed by expenses payable, duties and taxes, provision for taxation in
that order.
Net working capital:
The excess of current assets over current liabilities is the net workingcapital. The following table shows the net working capital of Larsen and Toubro pvt. ltd.
TABLE NO-3
Net working capital (Rs in corers)
Year Current assets Current liabilities Net working capital
2003-04 2323.00 961.21 1361.79
2004-05 3569.76 1445.82 2123.94
2005-06 3933.02 2152.01 1781.01
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These ratios are used to judge a companys ability to meet short term
obligations. These can also be working capital ratios. By calculating these ratios, much insight
can be obtained into the present solvency of the company and its ability to remain solvent in the
event of adversities. Some of the most general and frequently used liquid ratios are.
1. Current ratio-
This ratio expresses the relationship between current assets and current
liabilities. This ration is an indication of the companys ability to meet its short term
liabilities. It is the ratio of current assets and current liabilities. The most ideal current
ratio of a company is 2:1. This means every current liability should be covered by at least
twice the amount of current assets.
Current ratio= Current assets
Current liabilities
TABLE NO-4
Current ratio (Rs in corers)
Years Current assets Current liabilities Current ratio
2003-04 2323.00 961.21 2.42:1
2004-05 3569.76 1445.82 2.47:1
2005-06 3933.02 2152.01 1.83:1
2006-07 4494.05 2779.33 1.62:1
2007-08 5797.74 2862.10 2.03:1
Mean 4023.51 2040.10 1.97:1
Source- company financial records
The average current ratio for the period under study is 1.97:1 which is as good as the
conventional norm of 2:1(i.e. current assets double the current liabilities) the current ratio of the
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company depicts necessary liquidity and it provides for delay and losses in the realization of
current assets. Also the obligations of the company can be met on time.
Chart-2
Trends in current ratio
.
2 Quick ratio-
This ratio is also called liquid ratio or quick ratio. This is the ratio of
quick assets to quick liabilities. An asset is liquid if it can be converted into cash within a
short period without loss of value. In this respect, inventory can be termed as liquid asset.
Also in quick liabilities bank overdraft cannot be included as it is considered to be a
permanent way of financing and is not subject to be called on demand. A ratio of 1:1 isconsidered as ideal.
Quick Ratio= Quick assets
Quick liabilities
TABLE NO-5
Quick ratio (Rs in corers)
Year Quick assets Quick liabilities Quick ratio
2003-04 1430.46 961.21 1.49.1
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2004-05 2152.41 1445.82 1.49.1
2005-06 2190.01 2152.01 1.02.1
2006-07 3279.84 2779.33 1.19.1
2007-08 4356.48 2862.10 1.51.1
Mean 2682.01 2040.10 1.32.1
Source- company financial records
The company has been maintaining a little more than necessary quick ratio. The average quick
ratio of the period is 1.32.1. The high quick ratio indicates the company is liquid and has the
ability to meet its liquid liabilities in time. The quick ratio of the company reveals satisfactoryliquidity position since it also has considerably fast moving debtors.
CHART-3
Trends in quick ratio
1. Cash position ratio-
This is a more rigorous test of liquidity. It can be calculated byrelating cash and equivalent (marketable security) to current liabilities. The standard
norm of cash position ratio is 0.5:1. This means that each current liability should be
covered at least half times by real cash or its equivalents.
Cash position ratio= Cash and Equivalents
Current Liabilities
TABLE NO-6
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Cash position ratios (Rs in corers)
YearsCash and bank
balance Current liabilities Cash position ratios
2003-04 103.62 961.21 0.11:1
2004-05 880.21 1445.82 0.61:1
2005-06 760.31 2152.01 0.35:1
2006-07 550.28 2779.33 0.20:1
2007-08 727.67 2862.10 0.25:1
Mean 604.42 2040.10 0.30:1
Source- company financial records
The average cash position ratio is 0.30:1 which is less than the standard norm of 0.5:1. This
shows that he amount of real cash and its equivalents maintained are not sufficient. Insufficient
cash held by the company can mean that the short term obligations may not be meet in time.More than adequate cash position ratios mean cash is remaining idle which is waste. A company
with a higher percentage of its current assets in the form of cash would be more liquid. In the
sense of being able to meet the obligations as and when they become due.
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CHART-4
Trends in cash position ratio
The turn over ratios indicates the efficiency with which the capital employed is rotated in the
business. They are also known as activity ratios, performance ratios or efficiency ratios. With
these ratios it is easy to judge how well facilities at the disposal of the concern are being used.
On other words, this ratios help in judging the efficiencies of the company.
These ratios are usually calculated on the basis of sales or cost of sales and are expressed in
integer rather than in percentage. Such ratios should be calculated separately for each type of
assets. Higher the turnover ratio, better the profitability and use of capital resources will be the
followings are the important turnover ratios.
2. Working capital turnover ratio-
The turnover ratio indicates the turnover ofworking capital of the company. This indicates whether or not working capital has been
effectively used. It expresses the number of times the unit invested in working capital
produces sale. It is calculated by simply dividing the net sales by net working capital. It
helps in measuring the efficiency of the employment of working capital. Generally
speaking the higher the turnover, the greater the efficiency and larger the profits.
However a very high ratio may signify a potentially dangerous situation of the shortage
of working capital.
Working capital turnover ratio gives us a better and whole picture of
efficiency and inefficiency then stock or inventory turnover ratio. This is because the
amount invested in stock is only a part of working capital.
Working capital turnover ratio = Sales
Net working capital
TABLE NO-7
Working capital turnover ratio (Rs in corers)
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Years Net sales Net working capital Working capital
turnover ratio
2003-04 4269.32 1361.79 3.13 times
2004-05 4977.32 2123.94 2.34 times
2005-06 5259.42 1781.01 2.95 times
2006-07 8188.23 1714.72 3.50 times
2007-08 6606.43 2935.64 2.25 times
Mean 5860.14 1983.42 2.95 times
Source- company financial records
The lowest and the highest turnover were achieved in 2007-08(2.25 times) and 2006-07(3.50
times) respectively. The average working capital turnover ratio for the period under the study is
2.95 times. This means that working capital has turned over 2.95 times in the course of a year.
A higher ratio indicates efficiency utilization of working capital in the company. The
ratio can be used by making of comparative and trend analysis for different companies in thesame industry and for various periods.
Chart-5
Trends in working capital turnover ratio
3. Debtor Turnover Ratio-
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Debtor is an important constituent of current assets and
therefore the quality of debtors to a greater extent determines the companys liquidity and
efficiency. This is one of the ratios used by financial analysis to judge the efficiency of
the company.
The debtor turnover ratio indicates the number of times of the average that
debtors turnover each year. Generally higher the value of debtor turnover, the more theefficiency is the credit management.
Debtor Turnover Ratio= Total sales
Debtors
TABLE NO-8
Debtor turnover ratio (Rs in corers)
Years Total sales Debtors Debtor turnover ratio
2003-04 4269.32 838.81 5.09 times
2004-05 4977.32 685.14 7.26 times
2005-06 5259.42 748.26 7.02 times
2006-07 8188.23 1982.07 4.13 times
2007-08 6606.43 2586.51 2.55 times
Mean 5860.14 1368.16 4.28 times
Source- company financial records
Debtor turnover is high in the year 2004-05 and 2005-06 which is 7.26 times and 7.02 times
respectively. Efficiency of management of debtors is good in this year. In 2007-08 the ratio is
only 2.55 times which is due to poor management of debtors. To get a better insight of debtorsturnover of the company, the ratio should be compared with ratio of the similar companies and
the industry average. The table elicits a declining trend.
CHART-6
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Trends in working debtor turnover ratio
4. Debtor collection period-
It represents the average number of days for which acompany has to wait before its receivables are converted into cash. It is very useful to
lenders because it explains to them whether their borrows are collecting money within a
reasonable time. An increase in the period will result in greater blockage of funds in
debtors and vice versa.
It brings out the nature of the companys credit policy and the
quality of debtor more clearly. It is calculated by dividing number of days in a year by
debtors turnover ratios.
Debt collection period= No of working days
Debtor turnover ratio
TABLE NO-9
Debt collection period
YearsNumber of days in a
year
Debtors turnover
ratioDebt collection period
2003-04 360 5.09:1 71 days
2004-05 360 7.26:1 50 days
2005-06 360 7.02:1 51 days
2006-07 360 4.13:1 87 days
2007-08 360 2.55:1 141 days
Mean 360 5.21:1 69 days
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Source- company financial records
As is customary, number of working days in a year is assumed as 360. The collection period for
2004-05 and 2005-06 were 50 days and 51 days respectively which depicts the companys
restrictive credit policy. In the later part of the period of study the company follows a lenient
credit policy. But the average debt collection period is 69 days, which shows the company isfollowing a liberal credit policy. To know the collection efficiency, the average collection period
of the company should be compared with the credit terms and policy.
CHART-7
Debt collection period
5. Creditors turnover ratio-
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It is similar to debtors turnover ratio. It indicates thespeed with which the payments for credit purchases are made to the creditors. It is also
known as Accounts payable turnover ratio. It can be calculated by dividing purchases
by Accounts payable. The term accounts payable includes both trade creditors and
bills payable.
Creditors turnover ratio= Total purchase
Accounts payable
TABLE NO-10
Creditor turnover ratio (Rs in corers)
Years Total purchases Accounts payable Creditors Turnoverratio
2003-04 1663 506.83 3.28 times
2004-05 2642 650.24 4.06 times
2005-06 2723 737.61 3.69 times
2006-07 3037 1748.91 1.73 times
2007-08 3306 2065.01 1.60 times
Mean 2674.20 1141.72 2.34 times
Source- company financial records
The years 2003-04 and 2004-05 makes clear that creditors are being paid frequently and
that the company is not utilizing the chances of better credit facilities. This enhances the
worthiness of the company. It is a realization that the company is not taking advantages
of credit facilities which can be supplied by the creditors.
CHART-8
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Trends in working creditor turnover ratio
8. Debt payment period-
Thisperiod represents the average number of days takenby the company to pay its creditors. Generally lower the ratio the better is the liquidity position
of the company and higher the ratio less liquid is the position of the company. A greater payment
period also implies greater credit period enjoyed by the company.
Debt payment period= No of days in a year
Creditors turnover ratio
TABLE NO-11
Debt payment period
Years No of days in a year Creditors turnover
ratioDebt payment period
2003-04 360 3.28:1 109 days
2004-05 360 4.06:1 59 days
2005-06 360 3.69:1 98 days
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2006-07 360 1.73:1 208 days
2007-08 360 1.60:1 225 days
Mean 360 2.87:1 125 days
Source- company financial records
Comparison of debt collection period and debt payment period-
TABLE NO-12
Years Debt payment period Debt collection period
2003-04 109 days 71 days
2004-05 89 days 50 days
2005-06 98 days 51 days
2006-07 208 days 87 days
2007-08 225 days 141 days
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Mean 125 days 69 days
Source- company financial records
The average debt payment period is 125 days which is more than the average debt collection
period of 69 days. The table of comparison of debt payment period and debt collection period
states that debt collection takes place much faster than debt payment in all the years under
study. A company is said to be operating profitably if the debt collection period is less than the
debt payment period.
CHART-9
Comparison between collection and payment periods
Financial ratios-
It gives an idea about the financial position of the company. A company issaid to be financially sound if it is in a position to carry on its business smoothly and meet all its
obligations in time. These ratios are calculated to judge the solvency of the concern.
Profitability ratios-
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It is an indication of the efficiency with which the operations of the
business are carried on. A lower profitability may arise due to the lack of control over the
expenses. Creditors look at the profitability ratio as an indicator of whether or not the company
earns substantially more than what it pays as interest for the use of borrowed funds and whether
the ultimate repayment of their debts appears reasonably certain. Owners are interested to know
the profitability as it indicates the return which they can get on their investment. The followingsare the important profitability ratios.
1. Gross profit ratio-
The first and foremost profitability ratio in relation to sales is the
gross profit ratio. Any big changes in this ratio over a period of years should be
investigated. The change may be due to change in economic situation or due to errors
or due to change in the basics of accounting. Higher the gross profit, better it is for
the company.
Gross profit ratio= Gross profit
Sales
TABLE NO-16
Gross profit ratio (Rs in corers)
Years Gross profits Sales Gross profit ratio
2003-04 728.61 4269.32 17.02%
2004-05 837.44 4968.52 16.86%
2005-06 294.49 5259.42 5.60%
2006-07 563.54 8188.23 6.88%
2007-08 271.32 6606.43 4.10%
Source- company financial records
The gross profit ratio has been steadily declining from 2003-04. The low gross profit ratio could
be because of high cost of goods sold, unfavorable purchasing policy, lesser sales, lower selling
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prices, excessive competition, over investments in plants and machinery. A comparison of gross
profit ratio over time or for different companies in the same industries is a good measure of
profitability.
2. Net profit ratio-
This ratio measures the rate of net profit earned on sales. It is alsocalled as net profit to sales ratio. The profit is income from non trading assets and
expenses.
Higher the net profit ratio, better it is for the company. Some companies
calculate the net profit after deducting the tax payable on the net profit. It can be
calculated by dividing the net operating profit by sales.
Net profit ratio= Net operating profit * 100
Sales
TABLE NO-17
Net profit ratio (Rs in corers)
Years Net operating profits Sales Net profit ratio
2003-04 156.38 4269.32 3.66%
2004-05 132.79 4968.52 2.67%
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2005-06 -633.58 5259.42 -
2006-07 816.16 8188.23 9.97%
2007-08 78.40 6606.43 1.19%
Source- company financial records
The net profit ratios for the company are very less. In 2005-06 there was a net loss of Rs 633.58
corers, so it does not affect ratios. The highest ratio was achieved in the year 2006-07 (9.97%)
and the lowest ratio was in 2007-08 (1.19%). If this ratio is less the company will not be able to
achieve a satisfactory return on its investment. Net profit ratios highlight the companys
capability or incapability to face advertises.
Net profit ratio
3. Operating ratio-
Operating ratio indicates the percentage of net sales consumed by
operating cost. It explains the changes in net profit ratio. It measures the extent of
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cost incurred for making the sales. The ratio of all operating expenses (i.e.
administrative expenses) to sales in the operating ratio. A rise in the operating ratio
indicates a decline in the efficiency. Lower the ratio the better it is for the company.
Operating ratio= Operating cost * 100
Sales
TABLE NO-18
Operating ratio (Rs in corers)
Years Operating costs Sales Operating ratio (%)
2003-04 2556.88 4269.32 59.89%
2004-05 3113.44 4968.52 62.66%
2005-06 3524.11 5259.42 67.01%
2006-07 4247.27 8188.23 51.87%
2007-08 4288.43 6606.43 64.01%
Source- company financial records
There is no rule for thumb for this ratio as it may differ from one company to another company.
However many consider 75% to 85% as a good ratio in case of a manufacturing company. Here
the company is in a favorable situation as it has been able to keep the operating ratio much
below 75% in all of the year under study. Operating ratio is considered to be a yardstick of
operating efficiency but should be used cautiously. To get a better idea of the ratio, a trend
should be shown by calculating operating ratio for a number of years. A comparison can be
made with the ratio of other companies of the industries.
CHART-13
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Trends in operating ratio
Statement or schedule of change in working capital-
It is prepared to analyze
the changes in working capital between the two balance sheets dates.
This statement is prepared with the help of current assets and current
liability derived from two balance dates.
The difference in the amount of current assets or current liabilities inthe current balance sheet as compared to that of previous balance
sheet is recorded. Increase in current assets causes an increase in
working capital and vice versa. Increase in current liabilities decrease
in working capital and vice versa. The total increase or decrease is
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compared and the difference shows net increase or decrease in
working capital.
Schedule of changes in working capital
TABLE NO-19
Particulars 2003-04 2004-05 Increase Decrease
Current assets
Inventory 892.54 417.35 524.81
Sundry debtors 838.81 685.15 - -
Cash and bank
balance
103.62 880.21 776.59 153.67
Other current
assets
43.12 47.47 4.35 -
Loans andadvances
444.91 539.60 94.69 -
Total(A) 2323.00 3569.77 - -
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Current liability
and provision
Liability 830.59 1355.45 - 524.86
Bank overdraft 10.78 26.56 - 15.78
Provision for
taxes
119.84 63.81 56.03 -
Total(B) 961.21 1445.82 - -
Working capital
(A-B)
1361.79 2123.95 - -
Increase in
working capital
762.16 - - 762.16
2123.95 2123.95 1456.47 1456.47
Source- company financial records
Schedule of changes in working capital for the year 2005-06 (Rs in corers)
TABLE NO-20
Particulars 2004-05 2005-06 Increase Decrease
Current assets
Inventory 1417.35 1742.17 324.82 -
Sundry debtors 685.14 748.26 63.12 -
Cash and bank
balance
880.21 760.31 - 119.90
Other current
assets
47.46 48.81 1.35 -
Loans and
advances
539.60 633.46 93.86 -
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A 3569.76 3933.01
Current liability
and provision
Liability 1355.45 2117.32 - 761.87
Bank overdraft 26.56 - 26.56 -
Provision for
taxes
63.81 34.69 26.12 -
B 1445.82 2152.01 - -
Working capital
(A-B)
2123.94 1781.00 - -
Decrease in
working capital
- 342.94 342.94 -
2123.94 2123.94 881.77 881.77
Source- company financial records
The components of current assets of 2005 and 2006 vividly stated that there is an overall
increase in the amount of current assets, but the current liabilities for 2006 has been increased
much more than the current assets. This huge increase in current liabilities results in a net
decrease in the amount of working capital.
TABLE NO-21
Schedule of changes in working capital for the year 2006-07 (Rs in corers)
Particulars 2005-06 2006-07 Increase Decrease
Current assets
Inventory 1742.17 1196.21 - 545.96
Sundry debtor 748.26 1982.07 1233.81 -
Cash and bank
balance
760.31 550.28 - 210.03
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Cash and bank
balance
550.28 727.61 177.39 -
Other current
assets
53.12 73.94 20.82 -
Loans and
advances
712.36 968.36 256.00 -
A 4494.04 5797.74 - -
Current liability
and provision
Liability 2479.84 2733.08 - 253.25
Bank overdraft 129.54 15.68 113.86 -
Provision for
taxes
169.95 113.34 56.61 -
B 2779.33 2862.10 - -
Working capital 1714.71 2935.64 - -
Increase in
working capital
1220.92 - - 1220.92
2935.64 2935.64 1474.17 1474.17
Source- company financial records
The overall current assets have grown significantly in 2007-08. There is only a slight change
(decrease) in current liabilities. The current assets are much more than the previous period. The
effect of this is a net increase in the amount of working capital.
Common size balance sheet-
It is a statement in which balance sheet items are expressed asthe ratio of each asset to total assets and the ratio of each liability is expressed as a ratio of total
liabilities in percent. It can be used to compare companies of different size or comparison of
figures in different periods of the same company. There are no standard norms for various assets.
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The balance sheet has been shown below and as well as a future projected balance sheet has also
been given.
TABLE NO-23
Common size balance sheet on 2003-04 to 2007-08
Particulars 2003-04 2004-05 2005-06 2006-07 2007-08
Amount (%) Amount (%) Amount (%) Amount (%) Amount (%)
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Sources of
funds
Long term
funds(A)
4313.25 5205.62 4815.81 4510.73 5437.19
81.78% 78.26% 69.12% 62.43% 65.51%
Bank overdraft 10.78 26.56 0 64.8 15.68
0.20% 0.40% 0.00% 0.90% 0.19%
Provisions 119.84 63.81 34.69 169.95 113.34
2.27% 0.96% 0.50% 2.35% 1.37%
Liabilities 830.59 1355.45 2117.32 2479.84 2733.08
15.75% 20.38% 30.39% 34.32% 32.93%
Total current
liabilities(B)
5274.46 6651.44 6967.82 7225.32 8299.29
100.00% 100.00% 100.00% 100.00% 100.00%
Application of
funds
Fixed assets(C) 2833.12 2985.3 3009.12 2709.23 2479.52
53.71% 44.88% 43.19% 37.50% 29.88%
Investment(D) 23 23.05 23.05 22.05 22.05
0.44% 0.35% 0.33% 0.31% 0.27%
Inventories 892.54 1417.35 1742.17 1196.21 1441.26
16.92% 21.31% 25.00% 16.56% 17.37%
Sundry debtors 838.8 685.14 748.26 1982.07 2586.51
15.90% 10.30% 10.74% 27.43% 31.17%
Cash and bank
balance
103.62 880.21 760.31 550.28 727.68
1.96% 13.23% 10.91% 7.62% 8.77%
Loans and
advances
444.91 539.6 633.46 712.36 968.34
8.44% 8.11% 9.09% 9.86% 11.67%
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Others 43.12 47.47 48.81 53.12 73.93
0.82% 0.71% 0.70% 0.74% 0.89%
Misc expenses 95.35 73.32 2.64 0 0
1.81% 1.10% 0.04% 0.00% 0.00%
Total current
assets(E)
807.93 840.5 922.27 1287.1 1435.31
38.09% 40.51% 44.16% 49.29% 49.02%
Total
assets(C+D+E)
5274.46 6651.44 6967.82 7225.32 8299.29
100.00% 100.00% 100.00% 100.00% 100.00%
The company is benefited from adequate and sufficient working capital. The percentage of
current asset is more than the percent of current liabilities during all the years under study. Thecurrent assets are in access of current liabilities during the period of study.
A close look at common size balance sheet from the period 2003-04 to 2007-08 reveals the
investment in fixed assets have been fully financed by long term funds in all the years. Working
capital has not been distributed to finance fixed assets.
An analysis of pattern of financing of the company over the years shows that slowly the company
is depending more and more on outsiders fund. In 2003-04, 81.78% of funds were financed by
own funds, but in 2007-08 this has come down to 66.51% in the present day economy world,
company depends more upon outsiders funds. This is because debt is a much cheaper source of
capital.
Note: as the study of working capital is concerned only with current assets and current
liabilities, the details regarding fixed assets and long term liabilities are not given in the
common size balance sheet.
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Findings and suggestions
.
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Findings-
Management of working capital plays a vital role in the overall financial management of the
company. The present study was undertaken to analyze the working capital position of Larsen
and Toubro private limited.
The working capital position of this company was analyzed with the help of various ratios,
statement of change in working capital.
Mostly secondary data were used to analyze the working capital management of the company. It
was collected from the annual report of the company and as well as being instructed by
management personals in the company.
To this study of working capital I have also attached the next five years balance sheet of the
company from 2008 to 2011 as it forms a crucial factor for the company to take necessary steps
for the future prospectus of the company.
During my visit to the company I also got a glimpse of various softwares being used by the
company in managing the inventory and expenses in the company. As its a part of the Larsen
and Toubro company i.e. ECC division they are not maintaining the balance sheet of the
company whereas they are sending the datas which I have given a sample of it in the end to the
head branch at Kolkata for overall financial calculations. As its a construction site being
undertaken by Larsen and toubro pvt limited at Rourkela Steel Plant, it basically deals with the
engineering division.
The time span of the study related a period of five financial year from 2003-04 to 2007-08, theresult of which is being furnished below.
Below I am attaching the company data which is in a PDF format. Pls check
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Liquidity of working capital-
The liquidity position of the company in s measured by the following methods
1. The current ratio of the company reveals that there is a sufficient current asset to pay its
current liabilities as and when they are due. The average current ratio for the period under
study meets the hypothetical norms of 2:1.
2. The liquidity ratio if the company has always been above the conventional norms of 1:1
the quick ratio of the company is more than satisfactory.
3. The cash position ratio of the company always falls below the standard norms 0.5:1
expect in the year 20004-05. The cash and bank balance maintained by the company is
not satisfactory.
4. Net working capital for the period under study is fluctuating. The working capital is
positive in nature. The liquidity position of the company is very high.
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Efficiency of working capital management-
1. Ratio of sales to working capital elucidate that the working capital turnover rate was
very low during the entire period of study.
2. The company has considerable long collection period. It implies very liberal credit
and collection performance. This certainly delays the collection of cash and impairs
the liquidity position. Debtor turnover ratio of the company is not satisfactory
3. The companys payment period is longer than the collection period. It reflects that the
company is fully utilizing the credit facility extended by supplier. This delay in the
payment of cash means cash remains with the company for a longer period of time.
The creditor turnover ratio is very satisfactory.
4. The inventory turnover ratio of the company is fluctuating.
Working capital policy-
The ratio of current assets to fixed assets shows that initially
the company follows an aggressive policy. But towards the later part of the period of
study, it moves to a more conservative policy which implies greater liquidity and
lower risk.
The current assets constitute more than half of the total assets. This also proves that
the companys liquidity position is sound.
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Improvement of working capital in the company-
Some look for a magic bullet with which to solve problem. They think there must be some
simple formulae to enhance the working capital. Every element of working capital is the result of
some functions of the business process or cycle. All elements of a balance sheet are interrelated.
If one pays down current payables, one has changed the ratio of days in cash and has also
changed the current ratio.
It is important to remember that every cash spent when expended on a non current position of the
balance sheet, decreases working capital. Also when cash is increased provided it does not come
from current liabilities.
One of the primary ways to decrease the need for working capital is to decrease the number of
asset conversion days.
Some other ways to improve the working capital of current ratio is as follows-
1. Increase cash balances with long term debt. This is a strategy that is frequently employed
in an industry that often has assets with a fair market value substantially in excess of the
book value.
2. Invest in the business. This is for owners that have consistently taken large bonuses or
loans from the company in the past.
3. Sell excess equipment. Many contractors of construction have excess equipments that
could be sold and converted into working capital. A sin worse than having excess
resources in working capital is having excess capacity in fixed assets. If the fixed assets is
never used, the return on capital is zero.
4. To enhance the current ratio, without increasing working capital, pay down accountspayable.
5. Analyze inventory for slow moving or obsolete items.
6. Have a manger hand deliver an invoice. If there are any disputes, they can be reconciled
more expeditiously.
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CONCLUSION
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Conclusion-
Working capital is an important liquidity indicator that has historically been a
major benchmark of the surety and credit granting institutions. In todays environment becauseof the tight bond and credit markets, both institutions are scrutinizing the amount and quality of
working capital more than ever. The fewer resources that need to be invested in working capital,
after recognizing liquidity risk, the better is for the company.
So at the end what I fell the company should do to maintain a healthy working capital in the
company are as follows
Maintain the liquidity position of the company as its.
Improve the cash and bank balance of the company.
Increase working capital turnover.
Increase the debtor turnover.
Reduce average collection period.
Improve the profitability of the company by increasing the profit and by reducing the
operating expenses.
Finance more on the working capital from long term fund.
Increase the debt capital to about a standard norm of 60% to 75% as it is a much cheaper
source of capital.
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Bibliography
1.Company financial data
2.Internet
3.Management accounting book
4.Journals