Industrialization of Kerala: The Insiders’ Perspective

Working capital management

Every business needs funds for two purposes- for its establishment and to carry out its day-to- day operations. Long-term funds are required to create production facilities through purpose of fixed assets such as plant and machinery, land, building, furniture etc.

Investment in these assets represents that part of firm’s capital which is blocked on a permanent or fixed basis and is called fixed capital. Funds also needed for short-term purpose for the purchase of raw materials, payment of wages and other day to day expenses is called working capital.

Gross concept:- represents the amount of funds invested in current assets.

Net concept :- represents current assents – current liabilities

Current assets- cash in hand, cash at bank, debtors, stock, temporary investment, prepaid expenses, accrued incomes.

Current liabilities – bills payable, creditors, bank overdraft, provision for taxation, outstanding expenses, dividend payable.

cash raw materials

The fund invested in current

Assets keeps revolving fast

and are being constantly

converted into cash and Debtors

this cash flows out again Circular flow concept

work in progress

in exchange for other current

assets hence known as circulating

capital or revolving capital Sales

Finished goods

Classification of working capital

1. Permanent or fixed working capital: - is the minimum amount which is required to ensure effective utilization of fixed facilities and for maintain the circulation of current assets. The minimum level of current assents required is called fixed working capital.

2. Temporary or variable working capital: - is required for meeting the seasonal demands and some special exigencies.

Factors determining working capital requirements

1. Nature or characteristics of business:- public utility like electricity offers on cash sales and providing services need less working capital but in case of trading industry have to stock and need huge working capital.

2. Size of business: - size directly influenced by the need for working capital.

3. Production policy: - production can be made steady during slack period to meet the demand of peak season need more working capital for storage, as compared with arranging production according to seasons.

4. Length of production cycle:- longer the process of manufacture, larger the amount of working capital required.

5. Seasonal variations

6. Working capital cycle

7. Credit policy

8. Rate of stock turnover

9. Business cycle

10. Rate of growth of business

11. Earning capacity and dividend policy

12. Price level changes

13. Other factors(managerial ability, banking facilities, importance of labour etc)

Inventory management

Inventory is stock of goods which include raw materials, workin progress, consumables, finished goods and spares.

Risk and cost of holding inventories

Capital cost-block of financial resources

Risk of price decline

Risk of obsolescence

Risk of deterioration in quality

Objectives

· To ensure continuous supply

· To avoid both over and under stocking

· To maintain investment in inventories optimum

· To keep material cost under control

· To eliminate duplication in ordering

· To minimize loss through deterioration wastage, damage etc

· To maintain perpectual inventory system

Tool and techniques of inventory management

· Determination of stock levels (Minimum stock level, maximum level, reorder level, and danger level)

· Determination os safety stock level

· Seleacting a proper system of ordering

· Determination of EOQ(economic ordering quantity)= √ 2AC

A- Annual consumption in rupees I

C - cost of placing an order

I – Inventory carrying cost per unit

· ABC analysis (always better control method)

· VED analysis (vital, essential, desirable)

· Inventory turnover ratio

· Aging schedule of inventories

· Perpectual inventory system

· JIT control system

Cash management

Motives for holding cash - transaction motive

- Precautionary motive

- Speculative motive

Determining optimum cash balance

A firm has to maintain minimum amount of cash for settling the dues in time. The cash is needed to purchase raw materials, pay creditors, day to day expenses, dividend etc. the test of liquidity of the firm is that it is able to meet various obligations in time.

There are two approaches to determine an optimal cash balance viz, minimizing cost models and preparing cash budget

Cash budget is an estimate of cash receipts and disbursements of cash duning a future period of time.

William j Baumol’s model

An inventory theoretic approach using EOQ method for calculating optimum cash balance C= √2AF C=optimum cash balabce

O A= annual cash requirements of cash

o F= fixed conversion cost

o O= opportunity cost of holding cash.

Miller and Orr model

Baumol’s model is based on the basic assumption that the size and timing of cash flows are known with certainty. This is usually does not happen. The cash flows of a firm are neither uniform nor certain. This stochastic model overcomes the limitation. The MO model provides two control limits the upper control limit and lower control limit along with a return point as shown below.

Accounts receivable management

Receivables represent amounts owed to the firm as a result of sale of goods or services in the ordinary course of business.

Cost of maintain receivables- cost of financing receivables, cost of collection, bad debts.

Factors influencing the size of receivables

1. Size of credit sales

2. Credit policies

3. Terms of trade

4. Habit of customers

5. Relation with profit (sales beyond a point the firm allow more credit to earn more profit because the fixed cost expenses are less)

6. Expansion plans(enter into new market, liberal credit policy is needed)