A STUDY

ON

WORKING CAPITALMANAGEMENT AT

HERITAGE FOODS IND LTD

A Project report submitted to Osmania University In partial fulfillment for the Award of the Degree

of MASTER OF BUSIUNESS ADMINISTRATION

Submitted by
K. MANISHA

HT NO: 2121-19-672-078

UNDER THE GUIDANCE OF

Dr. A. RUPAVENI

ARISTOTLE PG COLLEGE
(Affliated To Osmania University,Hyderabad) Recognized By UGC under
section 2(f) of UGC Act 1956 Beside Moinabad Police Station,

Chilkur, Moinabad ,Ranga Reddy District, Telangana.

1
(2019-2021 )
 CHAPTER-I
INTRODUCTION

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 INTRODUCTION
WORKING CAPITAL:
MEANING

Cash is the lifeline of a company. If this lifeline deteriorates, the company's ability to fund operations, reinvest and meet capital
requirements and payments also deteriorate. Understanding a company's cash flow health is essential for making investment
decisions. A good way to judge a company's cash flow prospects is to look at its working capital management (WCM).

Working capital of a company reveals more about the financial condition of a business than almost any other calculation. It tells you
what would be left if a company raised all of its short term resources, and used them to pay off its short term liabilities. The more
working capital, the less financial strain a company experiences.

Working capital also gives investors an idea of the company's underlying operational efficiency. Money that is tied up in inventory or
money that customers still owe to the company can't be used to pay off any of its obligations. So, if a company is not operating in the
most efficient manner (slow collection) it will show up in the working capital. This can be seen by comparing the working capital
from one period of time to another; slow collection may signal an underlying problem in the company's operations.

DEFINITION

The definition of working capital is that it is the difference between an organization’s current assets and its current liabilities. Of more
importance is its function which is primarily to support the day-to-day financial operations of an organization, including the purchase
of stock, the payment of salaries, wages and other business expenses, and the financing of credit sales. It’s a measure of both a
company's efficiency and its short-term financial health.

The better a company manages its working capital, the less the company needs to borrow. Even companies with cash surpluses need
to manage working capital to ensure that those surpluses are invested in ways that will generate suitable returns for investors.

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There are two concepts of working capital. They are ^ Gross working capital and ^ Net working capital.

The term gross working capital, also referred to as working capital means the total current assets.
The term net working capital can be defined in two ways:

• The most common definition of net working capital is the difference between the current assets and the current liabilities.

• The alternate definition of NWC is that portion of current assets which is financed with long term funds. Since the current
liabilities represent the sources of short term funds, as long as current assets exceed current liabilities, the excess must be
financed with long term funds.

The net working capital, as a measure of liquidity is quite useful for internal control. The net working capital helps in comparing the
liquidity of the same firm over time.
Therefore:
Current Assets - Current Liabilities = Working Capital

A positive working capital means that the company is able to pay off its short-term liabilities. A negative working capital means that
a company currently is unable to meet its short-term liabilities with its current assets (cash, accounts receivable, inventory).
Management must ensure that a business has sufficient working capital. Too little of the working capital will result in cash flow
problems highlighted by an organization exceeding its agreed overdraft limit, failing to pay suppliers on time, and being unable
to claim discounts for prompt payment. In the long run, a business with insufficient working capital will be unable to meet its
current obligations and will be forced to cease trading even if it remains profitable on paper.

On the other hand, if an organization ties up too much of its resources in working capital it will earn a lower than expected rate of
return on capital employed. Again this is not a desirable situation.

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As it is said that working capital is the difference between the current assets and the current liabilities, the management of the
company has to manage their current assets and current liabilities.

What Is Working Capital?

Working capital, also known as net working capital (NWC), is the difference between a company’s current assets, such as cash,
accounts receivable (customers’ unpaid bills) and inventories of raw materials and finished goods, and its current liabilities, such as
accounts payable. Net operating working capital is a measure of a company's liquidity and refers to the difference between operating
current assets and operating current liabilities. In many cases these calculations are the same and are derived from company cash plus
accounts receivable plus inventories, less accounts payable and less accrued expenses.

Why is working capital important?

Working capital is important because it is necessary in order for businesses to remain solvent. In theory, a business could become
bankrupt even if it is profitable. After all, a business cannot rely on accounting profits in order to pay its bills—those bills need to be
paid in cash readily in hand. To illustrate, consider the case of a company that had accumulated $1 million in cash due to its previous
years’ retained earnings. If the company were to invest all $1 million at once, they could find themselves with insufficient current
assets to pay for their current liabilities.

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 CHAPTER-II
REVIEW OF LITERATURE

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 REVIEW OF LITERATURE
> Joseph Jisha (2018) closely examines the study of working capital management in Ashok Leyland and points out that the
liquidity and profitability position of the company is not satisfactory, and needed to be strengthened in order to be able to
meet its obligations in time.

> Turan M. S., BamalSucheta, VashistBabita and Turan Nidhi (2016) attempt to examine the relationship between
working capital management and profitability by making an inter sector comparison of two manufacturing industries i.e.
Chemical industries and Pharmaceutical industries. 50 companies from each sector based on market capitalization and listed
on BSE and 500 indices were selected for the research for the period from 2002 to 2011. At the end of the analysis it was
concluded that in spite of similar nature of both the industries in the manufacturing sector, working capital management
variables affect profitability indices more strongly in the chemical industry than in the pharmaceutical industry. It was also
observed that both the industries have a significant relationship between profitability and working capital management
variables. Besides, working capital management variables affect more strongly the profitability indices of chemical industry
than those of pharmaceutical industry.

> KushalappaS.andKunder Sharmila (2017) closely study the relationship between working capital management policies
and profitability of the thirteen listed manufacturing firms in Ghana. At the end of the study, a significantly negative
relationship between profitability and accounts receivable days is found to exist. Profitability is significantly positively
influenced by the firm’s cash conversion cycle (CCC), current assets ratio and current asset turnover. It is also suggested
that managers can create value for the shareholders by creating incentives to reduce their accounts receivable to 30 days.

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> HaqIkramUl, Sohail Muhammad, Zaman Khalid and AlamZaheer, (2011)

examine the relationship between working capital management and profitability by using data of 14 companies in the Cement
Industry in the Khyber Pakhtonkhuwa Province (KPK) (2004-09). The main purpose of the study was to find out whether
financial ratios affect the performance of the firms in the special context of the cement industry in Pakistan. For the purpose
of analyzing the data, the techniques of corelation, co-efficient and multiple regression analysis were used. We can deduce
from the result that there is a moderate relationship between working capital management and the firm"s profitability.

> Arunkumar O. N. and Jayakumar S. (2010) explain how working capital is considered to be the lifeblood and
controlling nerve centre of the business. Profitability and solvency are two vital aspects of working capital management.
The survival and growth of the company depends upon the ability to meet profitability and solvency. Here the authors have
concentrated on the analysis of liquidity and solvency position of the major Public Sector Electrical Industries in Kerala
such as Kerala Electrical and Allied Engineering Company Ltd (KEL) and Transformers and Electrical Kerala Ltd (TELK)
for the financial years 1997-98 to 2007-08 and 1997-98 to 2005-06 respectively. In conclusion the authors have made a few
important observations with regard to the companies. Both the companies show a trend of very low level of solvency
position. The liquidity position of the companies is below the normal value. KEL has a lower level of net profit compared to
TELK for the stated period. In comparison with KEL, the sensitivity of changes in the level of current assets is high in case
of TELK.

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WORKING CAPITAL MANAGEMENT

Management of working capital plays a very important role in the financial management of a company because maintaining a balance
of income to debt can be difficult and owners must be diligent to assure that it is kept. Sometimes it takes a little assistance to
maintain levels of fluidity or make major purchases.

If working capital dips too low, a business risks running out of cash. Even very profitable businesses can run into trouble if they lose
the ability to meet their short-term obligations. Working capital financing can be used as a fast cash option to cushion the periods
when the flow is not ideal or readily available. Even when owners are meticulous in managing working capital, finding the right
levels to remain comfortable and competitive can be difficult.
The Importance of Good Working Capital Management

Working capital constitutes part of the Company’s investment in a department. Associated with this is an opportunity cost to the
company. (Money invested in one area may "cost" opportunities for investment in other areas.) If a department is operating with more
working capital than is necessary, this over-investment represents an unnecessary cost to the Company

From a department's point of view, excess working capital means operating inefficiencies. In addition, unnecessary working capital
increases the amount of the capital charge which departments are required to meet
OBJECTIVES OF MANAGING WORKING CAPITAL
• Describe the risk-return trade-off involved in managing a firm's working capital.
• Explain the determinants of net working capital.
• Calculate the effective cost of short-term credit.
• List and describe the basic sources of short-term credit.
• Describe the special problems encountered by multinational firms in managing working capital.

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Working capital management takes place on two levels:

• Ratio analysis can be used to monitor overall trends in working capital and to identify areas requiring closer management
• The individual components of working capital can be effectively managed by using various techniques and strategies

When considering these techniques and strategies, departments need to recognize that each department has a unique mix of
working capital components. The emphasis that needs to be placed on each component varies according to department.

Furthermore, working capital management is not an end in itself. It is an integral part of the department's overall management.
The needs of efficient working capital management must be considered in relation to other aspects of the department's
financial and non-financial performance.
Working Capital Ratio

Current Assets divided by Current Liabilities

The working capital ratio (or current ratio) attempts to measure the level of liquidity, that is, the level of safety provided by the
excess of current assets over current liabilities.

The "quick ratio" a derivative, excludes inventories from the current assets, considering only those assets most swiftly realizable.
There are also other possible refinements.

There is no particular benchmark value or range that can be recommended as suitable for all government departments. However,
if a department tracks its own working capital ratio over a period of time, the trends-the way in which the liquidity is
changing-will become apparent.
Current assets:

The term current assets refer to those assets which in the ordinary course of business can be, or will be, converted into cash
within one year without under going any diminution in the value and without disrupting the operations of the firm. The major
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current assets are cash, cash equivalent, marketable securities, accounts receivable, inventory, prepaid expenses and other
short term investments.
Debtors

Debtors are people or other firms who owe money to the firm. This will usually happen where the firm has sold goods with a period
of credit. The firm sells the good or service but allows the purchaser a period of credit to pay - usually a month. During this month the
purchaser owes the firm the money and is therefore a debtor.

If the firm has debts these are considered an asset, because when the debtors pay the firm will have converted the debt into cash in the
bank. Because most debts are relatively short-term they are considered current assets the amount of debtors a firm has depends on the
line of business they are in.
CASH

In a business the term cash may have a broader meaning. Cash is an asset to the business and is usually considered to be one of the
current assets. Under the heading cash on the balance sheet may be included a number of items of varying liquidity. A small amount
may actually be cash (or readies) held in tills or as petty cash, but the majority is likely to be held in various bank accounts. However,
since money in current accounts rarely earns interest, if a business has a surplus of cash it may invest it in various ways. Some will
have to be in very liquid accounts so that if necessary they can get at it very quickly, but some may be tied up for longer periods of
time.
Inventory

Inventory is also a current asset which can be either raw materials, finished items available for sale, or goods in the process of being
manufactured. Inventory is recorded as an asset on a company's balance sheet.
Raw material
An item used to produce something else is called a "raw material." Some raw materials are easy to spot, but many require detective
work. Raw material of a company may be imported or indigenous. Raw material should be managed in such a way that flow of
production is not interrupted. Reordering quantity and time should be estimated in a proper manner.

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Work in process

An operation is composed of processes designed to add value by transforming inputs into useful outputs. Inputs may be materials,
labor, energy, and capital equipment. Outputs may be a physical product (possibly used as an input to another process) or a service.
Processes can have a significant impact on the performance of a business, and process improvement can improve a firm's
competitiveness.
Finished Goods
Definition: Commodities that will not undergo further processing and are ready for sale to the final demand user, either an individual
consumer or business firm. This includes unprocessed foods such as eggs and fresh vegetables, as well as processed foods such as
bakery products and meats.

This also includes durable goods such as automobiles, household furniture and appliances, and Nondurable goods such as apparel and
home heating oil.
Prepaid Expenses:

In the course of every day operations, businesses will have to pay for goods or services before they actually receive the product
Sometimes companies decide to prepay taxes, salaries, utility bills, rent, or the interest on their debt. These would all be pooled
together and put on the balance sheet under the heading prepaid expenses. By their very nature, Prepaid Expenses are a small part of
the balance sheet
Current liabilities

The term current liabilities are those liabilities which are intended at the time of their inception, to be paid in the ordinary course of
business, within a year, out of the current assets or earnings of the concern. The basic current liabilities are accounts payable, bills
payable, bank overdraft and outstanding expenses and other short term debts.

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Creditors:

Creditors (Accounts Payable) are suppliers whose invoices for goods or services have been processed but who have not yet been paid.
In other words, creditors are people to whom the company owes the money.

The term creditor is frequently used in the financial world, especially in reference to short term loans, long term bonds, and
mortgages.

The term creditor derives from the notion of credit. In modern America, credit refers to a rating which indicates the ability of a
borrower and likelihood to pay back his or her loan. In earlier times, credit also referred to reputation or trustworthiness.

Classification of Current Assets and Current Liabilities

The current classification applies to those assets that will be realized in cash, sold, or consumed within one year (or operating cycle,
if longer), and those liabilities that will be discharged by use of current assets or the creation of additional current liabilities within
one year (or operating cycle, if longer). The current liability section of a balance sheet is also intended to include obligations that are
due on demand or will be due on demand within one year from the balance sheet date, even though liquidation may not be expected
within that period. Short-term obligations shall be excluded from current liabilities only if the enterprise intends to refinance the
obligation on a long-term basis and has the demonstrated ability to consummate the financing.

The ordinary operations of a business involve a circulation of capital within the current asset group. Cash is expended for materials,
labor, operating expenses, and other services, and such cash expenditures are included in the inventory value. Upon sale of the
products or performance of services, the accumulated expenditures are converted into receivables and ultimately into cash again. The
average period of time intervening between the cash-to-cash conversion is the operating cycle of the business. When the business has
no clear operating cycle, or when the operating cycle is shorter than 15 months, a 15-month period should be used to segregate
current assets.

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This concept of the nature of current assets would exclude from that classification such resources as 1) cash and claims to cash that
are restricted as to withdrawal or other use for current operations; 2) investments in securities (whether marketable or not) or
advances that have been made for the purpose of control, affiliation, or other business advantage; 3) cash surrender value of life
insurance; 4) depreciable assets; 5) long-term receivables; and 6) land.
For analytical purposes, specific recommendations of the FFSC are:

1. Principal debt due within 15 months, even on notes with monthly payments, should be included as a current liability.
2. Capital leases should be accounted for on the balance sheet, with the current portion of the principal due and the accrued interest
shown as a current liability.
3. Cash value of life insurance should be a non-current asset.
4. Loans to family members should be treated based on the characteristics of the notes. (The amount of these loans should be
separately disclosed, if material.)
5. PIK certificates should be treated as current assets.
6. Retirement accounts should be shown as non-current assets.

The current portion of both deferred tax assets and deferred tax liabilities are to be recorded as current assets or current liabilities.

WORKING CAPITAL
Inventories are MANAGEMENT
lists of stocks-raw INVENTORY
materials, work in progressMANAGEMENT
or finished goods-waiting to be consumed in production or to be sold.

The total balance of inventory is the sum of the value of each individual stock line. Stock records are needed:
• To provide an account of activity within each stock line;
• As evidence to support the balances used in financial reports.

A department also needs a system of internal controls to efficiently manage stocks and to ensure that stock records provide reliable
information.

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Departmental financial reports show only the total inventory balance. Analysts from outside the department can examine this balance
by using ratio analysis or other techniques. However, this gives only a limited assessment of inventory management and is not
adequate for internal management. Good financial management necessitates the careful analysis of individual inventory lines.

Inventory Management involves the control of assets being produced for the purposes of sale in the normal course of the company's
operations. The goal of effective inventory management is to minimize the total costs - direct and indirect - that are associated with
holding inventories. However, the importance of inventory management to the company depends upon the extent of investment in
inventory.

The task of inventory planning can be highly complex in manufacturing environments. At the same time, it rests on fundamental
principles. The system used for inventory must tie into the operations of the firm. Inventory planning and management must be
responsive to the needs of the firm. The firm should design systems, including reports that allow it to make proper business decisions

Inventory management is an important aspect of working capital management because inventories themselves do not earn any
revenue. Holding either too little or too much inventory incurs costs.
Costs of carrying too much inventory are:

• Opportunity cost of foregone interest;

• Warehousing costs;
• Damage and pilferage;
• Obsolescence;
• Insurance.

Costs of carrying too little inventory are:

• Stock out costs:

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- Lost sales;
- delayed service.
 Ordering costs:

- Freight;
- order administration;
- loss of quantity discounts.

Making frequent small orders can minimize carrying costs but this increases ordering costs and the risk of stock-outs. Risk of
stock-outs can be reduced by carrying "safety stocks" (at a cost) and re-ordering ahead of time.

The best ordering strategy requires balancing the various cost factors to ensure the department incurs minimum inventory
costs. The optimum inventory position is known as the Economic Reorder Quantity (ERQ). There are a number of
mathematical models (of varying complexity) for calculating ERQ.

Analytical review of inventories can help to identify areas where inventory management can be improved. Slow moving
items, continual stock outs, obsolescence, stock reconciliation problems and excess spoilage are signals that stock lines need
closer analysis and control.

However, it is important to keep an overall perspective. It is not cost-effective to closely manage a large number of low value
inventory lines, nor is it necessary. A usual feature of inventories is that a small number of high value lines account for a large
proportion of inventory value. The "80/20" rule (PARETO) predicts that 80% of the total value of inventory is represented by
only 20% of the number of inventory items. Those high value lines need reasonably close management. The remaining 80%
of inventory lines can be managed using "broad-brush" strategies.

The overall management philosophy of an organization can affect the way in which inventory is managed. For example, "Just
in Time" (JIT) production management organizes production so that finished goods are not produced until the customer needs
them (minimizing finished goods carrying costs), and raw materials are not accepted from suppliers until they are needed.
(Large organizations have the power to insist that suppliers hold stocks of raw materials and thereby pass the carrying cost
back to the supplier). Thus, JIT inventory strategies reduce bottlenecks and stock holding costs.
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In summary:
 • There is a trade-off to be made between carrying costs, ordering costs, and stock out costs. This is represented in
the Economic Reorder Quantity (ERQ) model.
• Inventories should be managed on a line-by-line basis using the 80/20 rule.
• Analytical review can help to focus attention on critical areas.
• Inventory management is part of the overall management strategy.

A system for effective inventory management involves three subsystems namely:

1. Economic order quantity(EOQ)

2. Reorder point
The effective management of inventory involves a trade off between having too little and too much inventory. In achieving
this 3.
trade off, level
Stock the Finance Manager should realize that costs may be closely related. To examine inventory from the cost side,
five categories of costs can be identified of which three are direct costs that are immediately connected to buying and holding
COST
goods and ASSOCIATED
the last two areWITH INVENTORIES
indirect costs which are losses of revenues that vary with differing inventory management
decisions.

The five costs of holding inventories are:

1. Material Costs of Inventory:

These are the costs of purchasing the goods including transportation and handling costs.

2. Ordering Costs:
Any manufacturing organization has to purchase materials. In that event, the ordering costs refer to the costs associated with
the preparation of purchase requisition by the user department, preparation of purchase order and follow-up measures
17 ordered for, inspection and handling at the warehouse for
taken by the purchase department, transportation of materials
storing. At times even demurrage charges for not lifting the goods in time are included as part of ordering costs. Read more
3. Carrying Costs:

These are the expenses of storing goods. Once the goods have been accepted, they become part of the firm's inventories. These costs
include insurance, rent/depreciation of warehouse, salaries of storekeeper, his assistants and security personnel, financing cost of
money locked-up in inventories, obsolescence, spoilage and taxes.
4. Cost of funds tied up with Inventory:

Whenever a firm commits its resources to inventory, it is using funds that otherwise might be available for other purposes. The firm
has lost the use of funds for other profit making purposes. This is its opportunity cost. Whatever the source of funds inventory has a
cost in terms of financial resources. Excess inventory represents an unnecessary cost.

It does not follow any particular inventory management technique. It makes use of the weighted average pricing technique to
calculate the price of the inventory. They have various categories of inventories and they maintain different reorder levels for
different products. The monthly calculation of the inventory through weighted average method of the chemical products of the
company is shown in the annexure.

CASH MANAGEMENT

Good cash management can have a major impact on overall working capital management.

The key elements of cash management are:

• Cash forecasting;
• Balance management;
• Administration;
• Internal control.
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Cash Forecasting. Good cash management requires regular forecasts. In order for these to be materially accurate, they must be based
on information provided by those managers responsible for the amounts and timing of expenditure. Capital expenditure and operating
Balance Management: Those responsible for balance management must make decisions about how much cash should at any time be
on call in the Departmental Bank Account and how much should be on term deposit at the various terms available.

There are various types of mathematical model that can be used. One type is analogous to the ERQ inventory model. Linear
programming models have been developed for cash management, subject to certain constraints. There are also more sophisticated
techniques.

Administration. Cash receipts should be processed and banked as quickly as possible because:
• They cannot earn interest or reduce overdraft until they are banked;

• Information about the existence and amounts of cash receipts is usually not available until they are processed.

Where possible, cash floats (mainly petty cash and advances) should be avoided. If, on review, the only reason that can be put
forward for their existence is that "we've always had them", they should be discontinued. There may be situations where they are
useful, however. For example, it may be desirable for peripheral parts of departments to meet urgent local needs from cash floats
rather than local bank accounts.

Internal Control. Cash and cash management is part of a department's overall internal control system. The main internal cash
control is invariably the bank reconciliation. This provides assurance that the cash balances recorded in the accounting systems are
consistent with the actual bank balances. It requires regular clearing of reconciling items.
The key to successful cash management is milestones:

o Capital is provided to execute a business plan

o Cash use must track growth in enterprise value
o Enterprise value is measured by milestones, not the fiscal calendar
Cash management is not cost control

o Cost control is a reactive measure using crude tools e.g. % cuts19

o Cost control often depletes value (e.g. by using people as

accounting chips)
CREDITORS MANAGEMENT

Creditors are the businesses or people who provide goods and services in credit terms. That is, they allow us time to pay rather than
paying in cash.

There are good reasons why we allow people to pay on credit even though literally it doesn't make sense! If we allow people time to
pay their bills, they are more likely to buy from your business than from another business that doesn't give credit. The length of credit
period allowed is also a factor that can help a potential customer deciding whether to buy from a company or not: the longer the
better.

Creditors will need to optimize their credit control policies in exactly the same way as the debtors' turnover ratio.
CREDITORS TURNOVER RATIO:

Average Creditors
Creditors' Turnover =
(Cost of Sales/365)

As with the stock turnover ratio, creditor values relate to the costs of raw materials, goods and services
DEBTORS MANAGEMENT

The objective of debtor management is to minimize the time-lapse between completion of sales and receipt of payment. The costs of
having debtors are:
• Opportunity costs (cash is not available for other purposes);

• Bad debts.

Debtor management includes both pre-sale and debt collection strategies.

Pre-sale strategies include:

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• Offering cash discounts for early payment and/or imposing penalties for late payment;
 • Requiring cash before delivery;
• Setting credit limits;
• Setting criteria for obtaining credit;
• Billing as early as possible;
• Requiring deposits and/or progress payments.
Post-sale strategies include:

• Placing the responsibility for collecting the debt upon the center that made the sale;
• Identifying long overdue balances and doubtful debts by regular analytical reviews;
• Having an established procedure for late collections, such as

- a reminder;
- a letter;
- cancellation of further credit;
- telephone calls;
- use of a collection agency;
- legal action.
Objectives of Receivables management:

Debt• Control
To maintain an optimum
and Debt levelPeriod
Collection of investment in receivables.
• To maintain optimum volume of sales.
Debt control is an important part of business activity because although a debt is an asset, it is not as liquid an asset as cash in the
• To control the cost of credit allowed & to keep it at the minimum possible level.
bank. Firms have to ensure they collect their debts as efficiently as possible within the terms they have set for the debt.
• To keep down the average collection period.
The •only
Toway
obtainwebenefit
can consider
from thehow efficientinthe
investment firm'satdebt
debtors control
optimum has been is to use a ratio. This ratio is known as the debt
level.
collection period.
21
 DEBT COLLECTION PERIOD = 365
(in days) debt turnover ratio

The figure measures (in number of days) how long on average it has taken the firm to collect its debts. The higher the figure the
longer it has taken. However, the normal period for collecting debts will differ between industries. For example, a figure of 13 days
may sound very impressive, but if this was the figure for a chain of supermarkets it would be high. Therefore no debt is incurred and
retail firms will tend to have very few debtors and a low debt collection period. Firms who do a lot of business on credit though will
have much higher debt collection periods.
Debtors' Turnover

Debtors control is a vital aspect of working capital management. Many businesses need to sell their goods on credit, otherwise they
might find it difficult to survive if their competitors provide such credit facilities; this could mean losing customers to the
opposition.
The formula for debtors' turnover is:

Net credit sales

Debtors' Turnover =
Average debtors

Debtor’s management Working

Capital Cycle
The way working capital moves around the business is modeled by the working capital cycle. This shows the cash coming into
the business, what happens to it while the business has it and then where it goes.

The working capital cycle shows the movement of cash into and out of the business. The components of working capital cycle
are the debtors, creditors, raw materials and cash.
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The cycle starts with buying of raw materials on credit from the suppliers. These suppliers become the creditors of the company.
The raw materials undergo through different value addition stages and are converted into finished goods. The finished goods are
sold to the customers on credit who become the debtors of the company. At the end of the credit period the company gets the cash
from the debtors whom they pay to the creditors and the cycle goes on.

It is must for any company to have an ideal working capital cycle. It should neither be too long nor too short. If the cycle is too long
the funds get stuck up with the debtors and prompt payment to the creditors cannot be made.
A simple working capital cycle may look something like:

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 Payment
CASH CREDITORS

Collection Supply

DEBTORS
ii

Sales Production
FINISHED
GOODS
Value added conversion

WORKING CAPITAL FINANCING

Banks are the main institutional sources of working capital finance in India. After trade credit bank credit is the most important
source of working capital requirement of firms in India. A bank considers a firm’s sales and production plans and the desirable levels
of current assets in determining its working capital requirements. The amount approved by the bank for the firm’s working capital is
called credit limit.
FORMS OF BANK FINANCE.

A firm can draw funds from its banks within the maximum credit limit sanctioned. It can draw funds in the following forms.
^ Overdrafts ^ Cash
credit 24
^ Bills purchasing or discounting ^ Working
capital loan ^ Letter of credit
TANDON COMMITTEE

Like many other activities of the banks, method and quantum of short-term finance that can be granted to a
corporate was mandated by the Reserve Bank of India till 1994. This control was exercised on the lines suggested
by the recommendations of a study group headed by Shri Prakash Tandon.

The study group headed by Shri Prakash Tandon, the then Chairman of Punjab National Bank, was constituted by
the RBI in July 1974 with eminent personalities drawn from leading banks, financial institutions and a wide
crosssection of the Industry with a view to study the entire gamut of Bank's finance for working capital and
suggest ways for optimum utilization of Bank credit. This was the first elaborate attempt by the central bank to
organize the Bank credit. The report of this group is widely known as Tandon Committee report.Most banks in
India even today continue to look at the needs of the corporates in the light of methodology recommended by the
Group.

As per the recommendations of Tandon Committee, the corporates should be discouraged from accumulating too
much of stocks of current assets and should move towards very lean inventories and receivable levels. The
committee even suggested the maximum levels of Raw Material, Stock-in-process and Finished Goods which a
corporate operating in an industry should be allowed to accumulate these levels were termed as inventory and
receivable norms. Depending on the size of credit required, the funding of these current assets (working capital
needs) of the corporates could be met by one of the following methods:

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First Method of Lending:

Banks can work out the working capital gap, i.e. total current assets less current liabilities other than bank borrowings (called
Maximum Permissible Bank Finance or MPBF) and finance a maximum of 75 per cent of the gap; the balance to come out of long-
term funds, i.e., owned funds and term borrowings. This approach was considered suitable only for very small borrowers i.e. where
the requirements of credit were less than Rs.13 lacs. This method will give a minimum current ratio of 1:1
Second Method of Lending:

Under this method, it was thought that the borrower should provide for a minimum of 25% of total current assets out of long-term
funds i.e., owned funds plus term borrowings. A certain level of credit for purchases and other current liabilities will be available to
fund the build up of current assets and the bank will provide the balance (MPBF). Consequently, total current liabilities inclusive of
bank borrowings could not exceed 75% of current assets. RBI stipulated that the working capital needs of all borrowers enjoying
fund based credit facilities of more than Rs. 13 lacs should be appraised (calculated) under this method this method will give a
current ratio of 1.3:1.
Working Capital assessment on the formula prescribed by the Tandon Committee.

Working Capital Requirement (WCR) = [Current assets i.e. CA (as per industry norms) -Current Liabilities i.e. CL]
Permissible Bank Financing [PBF} = WCR - Promoter’s Margin Money i.e. PMM (to be brought in by the promoter)

As per Formula 1: PMM = 25% of [CA - CL] and thereby PBF = 75% of [CA - CL] As per Formula 2: PMM = 25% of CA and
thereby PBF = 75%[CA] - CL

As is apparent Formula 2 requires a higher level of PMM as compared to Formula 1. Formula 2 is generally adopted in case of bank
financing. In cases of sick units where the promoter is unable to bring in PMM to the extent required under Formula 2, the difference
in PMM between Formulae 1 and 2 may be provided as a Working Capital Term Loan repayable in installments over a period of
time.

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METHODS FOR DETERMINING PERMISSIBLE BANK BORROWINGS

1st method 2nd method

(a)
Current 130 130
assets(CA)
(b) Current 20 20
liabilities(CL)
(c)
80 80
Working capital gap (CA-CL)(a-
b)

(d) Borrower’s 20(25% of c) 25(25% 0f a)

contribution
(e)
60 55
Permissible bank finance,(c-d)

The main factors used in the estimation of working capital requirement:

• The nature of business and sector-wise norms

• Factors such as seasonality of raw materials or of demand may require a high level of inventory being maintained by the
company. Similarly, industry norms of credit allowed to buyers determine the level of debtors of the company in the normal course of
business.
•
• The level of activity of the business

Inventories and receivables are normally expressed as a multiple of a day’s production or sale. Hence, higher the level of activity,
higher the quantum of inventory, receivables and thereby working capital requirement of the business. So in order to arrive at the
working capital requirement of the business for the year, it is essential to determine the level of production that the business would
achieve. In case of well-established businesses, the previous year’s actual and the management projections for the year provide good
indicators. The problems arise mainly in the case of 27
 determining the limit for the first time or in the initial few years of the business. Banks often adopt industry standard
norms for capacity utilization in the initial years.

Steps involved in arriving at the level of working capital requirement:

• Based on the level of activity decided and the unit cost and sales price projections, the banks calculate at the annual sales and cost
of production.
• The quantum of current assets (CA) in the form of Raw Materials, Work-in-progress, Finished goods and Receivables is estimated
as a multiple of the average daily turnover. The multiple for each of the current assets is determined generally based on the industry
norms.
• The current liabilities (CL) in the form of credit availed by the business from its creditors or on its manufacturing expenses are
deducted from the current assets (CA) to arrive at the Working Capital Requirement (WCR).
• The issue of computation of working capital requirement has aroused considerable debate and attention in this country over the
past few decades. A directed credit approach was adopted by the Reserve Bank of ensuring the flow of credit to the priority sectors
for fulfillment of the growth objectives laid down by the planners. Consequently, the quantum of bank credit required for achieving
the requisite growth in Industry was to be assessed. Various committees such as the Tandon Committee and the Chore Committee
were constituted and studied the problem at length.
• Norms were fixed regarding the quantum of various current assets for different industries (as multiples of the average daily
output) and the Maximum Permissible Bank Financing (MPBF) was capped at a certain percentage of the working capital
requirement thus arrived at.
Negative Working Capital
Some companies can generate cash so quickly they actually have a negative working capital. This is generally true of companies in
the restaurant business (McDonalds had a negative working capital of $698.5 million between 1999 and 2000). Amazon.com is
another example. This happens because customers pay upfront and so rapidly, the business has no problems raising cash. In these
companies, products are delivered and sold to the customer before the company ever pays for them.
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A negative working capital is a sign of managerial efficiency in a business with low inventory and accounts receivable (which means
they operate on an almost strictly cash basis). In any other situation, it is a sign a company may be facing bankruptcy or serious
financial trouble

Ratio Analysis:
The ratio analysis is one of the most powerful tools of financial analysis. it is the process of establishing and interpreting various
ratios (Quantities relationship between figures and groups of figures).it is with the help of ratios that the financial statements can be
analysis more clearly and decision are made from such analyses.
A ratio is simple arithmetic expression of the relationship of one to another. According to accountants Handbooks by Ixen and
Bedford a ratio is an expression of the quantities relationship between two numbers.

Types of Ratios:
i. Liquidity Ratios
ii. Leverage Ratios
iii. Profitability Ratios
iv. Activity Ratios
i. Liquidity Ratio
Measures firms ability to meet its obligation; leverage ratios show the proportions of the debt equity in financing the firm’s assets;
activity ratios reflect the firm efficiency in utilizing its assets, and profitability ratios measure overall performance and effectiveness
of the firm.
ii. Leverage Ratio
The short-term creditors, like bankers and suppliers of raw materials, are more concerned with the forms current debt paying
ability. On the other hand, long term creditors like debenture holder’s financial institution etc. are more concerned with the firm’s
long term financial strength. A firm should have strong short as well as longterm financial position.

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 iii.
Profitability Ratio
Profitability refers to net result of business operation two types of ratios are used to measure profitability. These are profit
margin ratios rate of return ratios. While profit margin ratios shows the relationship between profit and investment.
The important profit margin ratios are:
Gross profit Ratio,
Operating profit ratio,
Net profit Ratio.
The important rate of return ratios are:
Return on assets Return of capital employed,
iv.
Return on shareholders’ equity,
Return on equity share capital.
Activity Ratio
These ratios are also referred to activity ratios asset management ratios. They measure how efficiency a firm employs the
assets. They are based on the relationship between level of activity and levels of various assets. The important turnover
ratios are
The comparative inventory
balance turnoverisratio,
sheet analysis debtors’
the study of theturnover ratio,
trend of the creditors’
same turnover
items, group ratio,and
of items fixed turnover
computed ratio,
items totalorassets
in two
turnover
more balance sheetsratio.
of the same enterprise on different dates. The changes in periodic observed by comparison of the balance
Comparative
sheet at the end of a period and these changes can help in informing balanceabout
an opinion sheetthe progress of and enterprise.

While interpreting comparative balance sheet the interpreter is expected to study the following aspects;-

1. Current interpreting comparative and liquidity position

2. Long term financial position
3. Profitability of the concern

30
 CHAPTER-III
RESEARCH METHODOLOGY

31
NEED OF THE STUDY:

Working capital management is one of the key areas of financial decision-making. It is significant because, the management must see
that an excessive investment in current assets should protect the company from the problems of stock-out. Current assets will also
determine the liquidity position of the firm.

The goal of working capital management is to manage the firm current assets and current liabilities in such a way that a satisfactory
level of working capital is maintained. If the firm cannot maintain a satisfactory level of working capital, it is likely to become
insolvent and may be even forced into bankruptcy.

SCOPE OF THE STUDY:

A study of the Workingcapital involves an examination of long term as well as short term sources that a company taps in order to
meet its requirements of finance. The scope of the study is confined to the sources that HERITAGE FOODS IND LTD tapped over
the years under study i.e. 2016-2020.

32
 OBJECTIVES OF THE STUDY:

• To study the existing working capital management system of HERITAGE FOODS IND LTD.
• To find the liquidity position of the current assets and current liabilities of the company.
• To examine feasibility of present system of managing working capital.
• To understand how the company finances its working capital
• To analyze the financial performance of the company with reference to working capital.
• To give some suggestions to the management based on the information studied.

RESEARCH METHODOLOGY

• The study of Working Capital management is based on primary as well as secondary data.
Data relating to. Has been collected through SECONDARY SOURCES:

Published annual reports of the company for the year 2016-2020.

PRIMARY SOURCES:
Detailed discussions with Vice-President.

Discussions with the Finance manager and other members of the Finance department. Statistical Tools: MS-excel and pie and bar

diagrams are used to analyze the data.

DATA ANALYSIS
The collected data has been processed using the tools of

33
• Ratio analysis
• Graphical analysis
These tools access in the interpretation and understanding of the Existing scenario of the Working capital .

• The primary data was gathered through personal interaction with the director of the company.

• The secondary data was collected from company’s annual reports from 2016-2020, various books and Internet.

LIMITATIONS

■ Due to the busy schedule of the executives in the company, all the required primary data could not be collected, which might
affect the results of the study.

■ Recommendations of the study are only personal opinions. Hence the judgments may be biased and could not be considered as
ultimate and standard solutions.

■ Short period of time is one of the limitations, due to which a detailed study could not be conducted on the topic

34