Working Capital Management

Every business needs investment to procure fixed assets, which remain in use for a longer
period. Money invested in these assets is called ‘Long term Funds’ or ‘Fixed Capital’.
Business also needs funds for short-term purposes to finance current operations.
Investment in short term assets like cash, inventories, debtors etc., is called ‘Short-term
Funds’ or ‘Working Capital’. The ‘Working Capital’ can be categorized, as funds
needed for carrying out day-to-day operations of the business smoothly. The
management of the working capital is equally important as the management of long-term
financial investment.

Every running business needs working capital. Even a business which is fully equipped
with all types of fixed assets required is likely to collapse, if it does not have;
a) Adequate supply of raw materials for processing;
b) Cash to pay for wages, power and other costs;
c) Creating a stock of finished goods to feed the market demand regularly; and,
d) The ability to grant credit to its customers.

Working capital is thus like the lifeblood of a business. The business will not be able
to carry on day-to-day activities without the availability of adequate working capital.

Working Capital management is concerned with the problems that arise in attempting to
manage the current assets, the current liabilities and the relationship that exists between
them.
The current assets refers to those assets which in the ordinary course of business can be,
or will be converted into cash within one year without undergoing diminution in the value
and without disrupting the operations of firm. The major current assets are:-
 Cash
 Marketable Securities
 Accounts Receivables
 Inventory

The Current Liabilities are those liabilities which are intended, at their inception, to be
paid in the ordinary course of business, within a year, out of current assets or earnings of
the concern. The basic current liabilities are:-
 Accounts Payable
 Bills Payable
 Bank Overdraft
 Outstanding Expenses

The term Working Capital may be used in two different ways.

 Gross Working Capital (or total Working Capital): The gross working capital
refers to the firm’s investment in all the current assets taken together. For
example, if a firm has a cash balance of Rs. 50000, debtors of Rs. 70000 and
inventory of raw material and finished goods has been assessed at Rs. 100000,
then the gross working capital of the firm is Rs. 220000.

 Net Working Capital: The term net working capital may be defined as the
excess of total current assets over total current liabilities. The extent, to which
these current liabilities are delayed, the firm gets availability of funds for that
period.
Gross Working Capital= Sum Total of Current Assets
= RM + WIP + FG + Debtors + Cash and Bank Balance
Net Working Capital= Difference between current assets and current
Liabilities
RM + WIP + FG + Debtors + Cash and Bank Balance
- Creditors – Direct wages - Overheads

The Operating Cycle and Working Capital Needs

The working Capital requirement of firm depends, to a great extent upon the operating
cycle of the firm. The operating cycle may be defined as the time duration starting
from the procurement of goods or raw materials and ending with the sales
realization. The length and nature of the operating cycle may differ from one firm to
another depending upon the size and nature of the firm.
In case of manufacturing concern, this series starts from procurement of raw materials
and ending with the sales realization of finished goods. There is a time gap between
happening of the first event and happening of the last event. This time gap is called the
operating cycle.
Thus, the operating cycle of a firm consists of the time required for the completion of the
chronological sequence of some or all of the following:
i. Procurement of raw materials and services.
ii. Conversion of raw materials into work-in-progress.
iii. Conversion of work-in-progress into finished goods.
iv. Sale of finished goods (cash or credit).
v. Conversion of receivables into cash.
 Cash
Creditors

Debtors Raw material

Working
Value Expenses Value
Addition Addition

Finished Goods Work in Process

Figure:1 – Working capital Cycle

Explanation of diagram

Working capital cycle involves conversions and rotation of various

constituents/components of the working capital. Initially ‘cash’ is converted into raw
materials. Subsequently, with the usage of fixed assets resulting in value additions, the
raw materials get converted into work in process and then into finished goods. When sold
on credit, the finished goods assume the form of debtors who give the business cash on
due date. Thus ‘cash’ assumes its original form again at the end of one such working
capital cycle but in the course it passes through various other forms of current assets too.
This is how various components of current assets keep on changing their forms due to
value addition. As a result, they rotate and business operations continue. Thus, the
working capital cycle involves rotation of various constituents of the working capital.
 VIDEOCON’s Operating Cycle
The operating cycle of VIDEOCON is as follows:-
 Procurement of raw material
The operating cycle for a company primarily begins with the purchase of raw materials,
which are paid for after a delay representing the creditor's payable period. VIDEOCON is
a consumer electronics goods manufacturer. Some raw materials are procured from
outside, some manufactured by its own.
Sometimes it may happen that company needs product in the form of raw material
manufactured by its own SBU’s. In this case stock is transferred within the company but
it won’t be considered as actual sale and no sale tax levied but it is liable to pay excise
duty since excise duty is paid on production and it is the liability of manufacturer.

 Conversion of Raw material into finished goods

These purchased raw materials are then converted by the production unit into finished
goods and then sold. The time lag between the purchase of raw materials and the sale
of finished goods is known as the inventory period.

Labor
Labor is vital for conversion of inputs into finished goods.
There are three types of labour here
Skilled Labour
Here a labour hour rate is fixed and the number of hours required to perform that
work is determined and on the basis of this labor expenses are determined. This is
treated as fixed overheads.

Casual labour
This is not permanent labor. They are paid on daily basis to perform work of a
non-recurrent nature. They are sourced from the Contractors of the Company.
 Vendoring
When there is a capacity constraint then a part of the work is done by vendors and
the parts manufactured by these vendors are assembled. This is also called job
work

 Conversion of Work-in-progress into finished goods

 Sale of Finished Goods

Goods are sold either on cash basis or credit basis. Upon sale of finished goods on
credit terms, there exists a time lag between the sale of finished goods and the
collection of cash on sale. This period is known as the accounts receivables period

 Conversion of Receivables into Cash

There are basically two ways available to vendors to pay their dues to
VIDEOCON.
These are:-
Cash Payment method
In this a vendor is supposed to clear his dues within a limited amount of time and
mode of payment must be highly liquid. The vendors can pay by demand drafts,
pay orders, or cheques of party which are subject to realization.

Channel Financing
Channel financing is used to receive fast money from debtors. Most of the firms
generally sells goods or services on credit and it takes a little time to realize.
Hence, receivables form an important part of working capital management.
Liquidity versus Profitability- A Risk-Return Trade off

Net Working Capital has bearing on Profitability as well as risk. The term Profitability
used in this context is measured by profits after expenses. The term Risk is defined as the
probability that a firm will become technically insolvent so that it will not be able to meet
its obligations when they become due for payment.
It is said that greater the amount of working capital the less risk prone the firm is
The decision on how much working capital is maintained involves a trade-off because
having a large working capital may reduce the liquidity risk faced by the firm, but it can
have a negative effect on the cash flows. Therefore, the net effect on the value of the firm
should be used to determine the optimal amount of working capital.

The goal of Working Capital Management is to manage current assets and liabilities
in such a way that a satisfactory level of working Capital is maintained.

The assessment of the working capital should be accurate even in the case of small and
micro enterprises where business operation is not very large. We know that working
capital has a very close relationship with day-to-day operations of a business. Negligence
in proper assessment of the working capital, therefore, can affect the day-to-day
operations severely. It may lead to cash crisis and ultimately to liquidation. An inaccurate
assessment of the working capital may cause either under-assessment or over-assessment
of the working capital and both of them are dangerous.
 Working Capital: Policy
There is an inevitable relationship, between the sales and current assets. The actual and
forecasted sales have major impact on the amount of current assets which the firm must
maintain. So, depending upon the sales forecast, the financial manager should also
estimate the requirement of current assets.
There are three types of working capital policies which a firm may adopt i.e. moderate
working capital policy, conservative working capital policy, and aggressive working
capital policy. These policies describe the relationship between sales level and the level
of current assets.
Current assets

Conservative

Moderate

Aggresive

Sales level

Figure 2 : Different types of working Capital Policies

In case of moderate working capital policy, the increase in sales level will be
coupled with proportionate increase in level of current assets also e.g. if the
sales increase or expected to increase by 10%, then the level of current assets will
also be increased by 10%.
In case of conservative working capital policy, the firm does not like to take risk.
For every increase in sales, the level of current assets will be increased more
than proportionately. Such a policy tends to reduce the risk of shortage of
working capital by increasing the safety component of current assets. The
conservative working capital policy also reduces the risk of non payment to
liabilities.

In case of aggressive working capital policy the increase in sales does not result in
proportionate increase in current asset. For example, for 10% increase in sales
the level of current asset is increased by 7% only.
This aggressive policy has many implications-
• The risk of insolvency of the firm increases as the firm maintains low liquidity.
• The firm is exposed to greater risk as it may not be able to face unexpected
change, in the market
• Reduced investment in current assets will result in increase in profitability of the
firm

VIDEOCON and its Working Capital policy

VIDEOCON follows conservative working capital policy i.e. for every

increase in sales level the level of current assets will be increased more than
proportionately. Such a policy tends to reduce the risk of shortage of working
capital by increasing the safety component of current assets. This policy also
reduces the risk of non payment of liabilities.

RECEIVABLES MANAGEMENT

The term Receivables is defined as debt owed to the firm by customers arising from the
sale of goods and services in the ordinary course of business. Receivables are a type of
loan extended by the seller to the buyer to facilitate purchase process. When companies
sell their products they sometimes demand cash on delivery, but in most cases they sell
goods on credit and allow a delay in payment. The customers’ promise to pay for their
purchases constitutes valuable assets; therefore accountants enter these promises in their
balance sheet as accounts receivables. Most of the businesses today sell goods and
services on credit and it takes times for the receivables to realize. Hence Receivables
management forms an important part of working capital management.
Need of Receivables
The sale of goods on credit is an essential part of working capital management. Credit
sale are treated as marketing tool to aid sale of goods. As a marketing tool, they are
intended to promote sales and increase profits. Hence Receivables management assumes
significance in the context of overall working capital management.

Objective of Receivables management

In a competitive environment, sometimes the firms are compelled and sometimes the
firms desire to adopt liberal credit policies for pushing up the sales. Higher credit sales at
more liberal terms will no doubt increase the profits of the firm, but simultaneously also
increases the risk of bad debts as well as result in more and more funds blocking in the
receivables. Thus, the objective of receivables management is matching the cost of
increasing sales with the benefits arising out of increases sales with the objective of
maximizing the return on investments of the firm.

Cost of Receivables

i) Cost of Financing: The credit sales delays the time of sales realization and therefore
the time gap between incurring the cost and the sales realization is extended. The firm on
the other hand, has to arrange funds to meet its own obligation towards payment to
supplier, employees, etc. these funds are to be procured at some explicit or implicit cost.
This is known as the cost of financing the receivables.

ii) Administrative Cost: A firm will be required to incur various costs in order to
maintain the record of credit customers before the credit sales as well as after the credit
sales.
iii) Delinquency Cost: This is the cost incurred if there is any delay in payment by a
customer.

iv) Cost of default by Customers: If there is default by customers and the receivables
becomes, partly or wholly unrealizable, then this amount, known as bad debt also
becomes a cost to the firms.

Costs
Total cost
of
receivables
Default cost

Delinquency Cost of
costs financing

Credit period
Administrative
(days)
Costs

Normal (20 days) Default (40 days)

 Trade off on receivables

The trade off on receivables can be applied to find out whether to liberalize credit terms
or not. More liberal credit terms may be expected to generate higher sales revenue and
higher profits; but they increases the potential costs also as the chances of bad debts
increases and there will be decrease in liquidity of firms. On the other hand a stringent
credit policy reduces the profitability but may increase the liquidity of the firms. Thus, a
firm should try to frame its credit policy in such a way as to attain the best possible
combination of profitability and liquidity.
 Figure
4:
Credit
Policy,

Profitability and Liquidity of a firm

Determinants of Receivables
In any firm the quantum of receivables is determined by several factors.
1. The percentage of credit sales to total sales. Higher the sales higher will be the
receivables. But this is not under the control of financial manager.
2. The terms of sale i.e. the credit and collection policies. These also determine the
quantum of receivables. These are under the control of financial manager.

So, the receivable management must be attempted by adopting a systematic

approach and considering the following aspects of receivables management:
• The Credit Policy
• The Credit Control
 Credit Policy
A firm makes significant investment by extending credit to its customers and thus
requires a suitable and effective credit policy to control the level of total investment in
the receivables. The basic decision to be made regarding receivables is to decide how
much credit be extended to a customer and on what terms. This is what is known as credit
policy. The credit policy may be defined as set of parameters and principles that govern
the extension of credit to its customers. This requires the determination of
i) Credit standard
ii) Credit terms

The Credit Standards: when a firm sells on credit, it takes a risk about the paying
capacity of the customers. Therefore to be on safer side, it must set credit standards
which should be applied in selecting customers for credit sales. The following points
should be noted while setting the credit standard for a firm:
• Effect of particular standard on sales volume.
• Effect of a particular standard on the total bad debts of the firm
• Effect of a particular standard on the total collection cost.

Credit Terms: It refers to set of stipulations under which the credit is extended to the
customers. The credit terms specify how the credit will be offered, including the
length of the period for which the credit will be offered, the interest rate on the credit
and the cost of default.
Credit period: It refers to the length of time over which the customers are allowed to
delay payments.
Lengthening the credit period increases the sales by attracting more and more customers,
whereas squeezing the credit period has the distracting effect. The firm must consider the
cost involved in increasing the credit period which will result in increase in the
investment in receivables.

Discount terms: The customers are generally offered cash discount to induce them to
make prompt payments. Different discount rates may be offered for different periods e.g.
3% discount if payment made within 10 days; 2% discount if payment made within 20
days. Both the discount rate and the period within which it is available are reflected in the
credit terms e.g.

3/10, 2/10, net 30 means

that a 3% cash discount if payment made within 10 days ; 2% discount if payment made
within 20 days; otherwise full payment by the end of 30 days from the date of sale.

Practical Implementation
CREDIT TERMS:
Credit Period- The credit period at VIDEOCON is not constant. For some vendors, it is
30 days, for others, it may be 45 days or 60 days. This depends entirely on company’s
policies. It can be different for different vendors.

Cash discount- The cash discount offered by VIDEOCON is 2% to 1.75%, depending

upon cash discount period.
Cash discount period- The cash discount period allowed by VIDEOCON is 1 to 3 days.
This can be summarized as follows:
Credit Discount Period Credit Discount
(days) (%)
1 2
3 1.75
30/45/60 0

There are basically two ways available to vendors to pay their dues to VIDEOCON.
These are:
Cash:
In cash payment method, a vendor is supposed to clear his dues within a limited amount
of time. And the mode of payment must be highly liquid (Cheque or Demand Draft).

Control of Receivables
Once the credit has been extended to a customer as per credit policy, the next important
step in the management of receivables is the control of receivables. The things to be taken
into consideration are:-
1. The collection Procedure: The firm should have a built in system under which
customer may be reminded a few days in advance about the bill becoming due.
The collection procedure of the firm should neither be too lenient nor too strict. A strict
collection policy can affect the goodwill and damage the growth prospects of the sales. If
the firm has a lenient credit policy, the customers with a natural tendency towards slow
payment may become even slower to settle his accounts. Thus, the objective of collection
procedure and policies should be to speed up the slow paying customers and reduce the
incidents of bad debts.

2. Monitoring of Receivables:-
The financial mangers should keep a watch on the credit worthiness of all the individual
customers as well as the total credit policy of the firm.
• A common method to monitor receivables is the collection Period or number of
day’s outstanding receivables.

Average collection period= Average Receivables

Credit sales per day
Another technique for monitoring the Receivables is known as aging schedule. The
quality of the receivables of a firm can be measured by looking at the age of receivables.
The older the receivables, the lower is the quality and greater the likelihood of a default.
In the aging schedule, the total outstanding receivables on particular days are classified
into different age groups together with percentage of total receivables that fall in each age
group.
For example, the receivables of a firm, having a normal credit period of 30 days may be
classified as follows:

Age Group %of total outstanding

(Number of Days) Receivables
Less than 30 days 60%
31-45 days 20%
46-60 days 10%
61 and above 10%

Here the firm has a credit period of 30 days and 60% of the total receivables are less than
30 days old. 20% of the receivables are over due by 15 days, 10% of the receivables are
overdue but 30 days and 10% are over due by more than 30 days.
This type of aging schedule can provide a kind of an early warning suggesting
i) Deterioration of receivables quality
ii) Where to emphasize the appropriate corrective actions

3. Lines of Credit: It is the maximum amount a particular customer may have as due to
the firm at any time. Different lines of credit may be allowed to different customers. As
long as the customer’s unpaid balance remains within this maximum limit, the account
may be routinely handled. However if new order is going to increase the indebtedness of
a customer beyond his line of credit, then the case must be taken for an approval for a
temporary increase in the line of credit.

4.Accounting Ratios: Two accounting ratios may be calculated in particular may be

calculated to find out the changing pattern of receivables. These are
i) Receivables Turnover Ratio
ii) Average collection Period
Both the ratio should be calculated on a continuous basis to monitor the receivables. The
ratios so calculated for the firm must then be compared with the standard for that industry
or with past ratios of the same firm.

Payable Management

As the firm sells goods on credit it may also procure/purchase raw material and finished
goods on credit basis. The payment for these purchases may be postponed for the period
of credit allowed by suppliers. So, the supplier of the firm in fact provides working
capital to the firm for the credit period.

For example, a firm makes a credit purchase of Rs. 60000 per month and the credit
allowed by supplier is two month, then the working capital supplied by creditors is Rs.
120000 (i.e. Rs. 60000*2months). It means the firm would be getting the supplies
without however, making the payment for two months. The postponement of payment to
the creditors makes the firm to utilize this money elsewhere or help the firm to sell on
credit without blocking its own funds.

Since, Working Capital is the difference between current assets and current
liabilities and creditors form an important part of current liabilities. So, a firm can
save a considerable amount if these creditors are managed. The extent, to which the
payment to these current liabilities is delayed, the firm gets the availability of funds for
that period. So, a part of the funds required to maintain current assets is provided by
current liabilities and the firm will be required to invest the funds in only those current
assets which are not financed by current liabilities. So, the aim of the firms is to realize
its debtors as fast as possible but too pay its creditors as late as possible.
Creditors can be managed by discounting of bills.

Bill Discounting is a relatively new concept in India. When a firm buys goods on credit
the supplier will state a final payment date . To encourage firm to pay before final
payment date , the supplier will offer a cash discount for prompt settlement. Now it’s the
decision of firm whether to avail or not that discount facility provided by supplier. For
that they should see whether it is profitable for them or not.

By using discounting of bills technique huge sums of money can be saved, by just paying
the discounted amount in time. Big firms, ( like VIDEOCON ), which have huge cash
reserves, generally, get into a contract with financial institutions or banks( like ICICI
bank or VIDEOCON finance Ltd.). These financial institutions pay the suppliers the
requisite amount on behalf of these firms and they charge some interest on the amount
paid by them to the suppliers from these firms.

Benefits of Discounting of Bills

• Discounting of Bills makes it easy to decide whether the discount being allowed
by the supplier is worth taking or not.
• Also, it make possible to calculate savings being received on account of availing
discount, in monetary terms
• It also helps in improving relationship between vendors/suppliers.
• It’s an indirect cash inflow , because the company is going to pay less than what it
was supposed to pay initially
• The cash thus saved can be invested elsewhere.
• It’s a win-win situation for both-the company as well as suppliers as the suppliers
will be getting money much before the stipulated time and the company is able to
enjoy the benefits of discount offered by the suppliers.
 Inventory Management
The Dictionary meaning of Inventory is 'a list of goods'. In a wider sense,
inventory can be defined as an idle resource which has an economic value. It
is however, commonly used to indicate various items of stores kept in stock in
order to meet future demands.

Inventory is assets to the firm and requires investment and hence involves the
commitment of firm’s resources. The inventories need not be viewed as an idle asset
rather these are an integral part of firm’s operations.
Inventory refers to stockpile of products that a firm is offering for sale and the
component that makes up the product. We can also say that inventory is composed of
assets that will be sold in the future in the normal course of business. But the question
arises how much inventory be maintained? If the inventories are too big, they become
strain on the resources; however, if they are too small, the firm may loose sales.

In any organization, there may be following four types of inventory:

(a) Raw materials & parts-- These may include all raw materials,
components and assemblies used in the manufacture of a product;

(b) Consumables & Spares -- These may include materials required

for maintenance and day-to-day operation;

(c) Work in progress -- These are items under various stages of

production not yet converted as finished goods;

(d) Finished Products -- Finished goods not yet sold or put into use.
Need For Inventory

Every organization needs to maintain a minimum amount of inventory so as to fulfill its

customer’s demands. Also, the organizations foresee future demand and they plan their
inventory levels accordingly. These reasons can be classified as:
Transactionary motive: to meet the day to day requirements of sales, production
process, and customer demand etc.
Precautionary motive: A firm should keep some inventory for unforeseen circumstances
also.
Speculative Motive: The firm keeps some inventory in order to capitalize opportunity to
make profit.

Objectives of Inventory management

a. To ensure a continuous supply of raw materials to facilitate uninterrupted

production.
b. To maintain sufficient stock of raw materials in periods of short supply and
anticipate price changes.
c. To control inventory investment by maintaining optimum Inventory.
d. To minimize investment in inventory and to ensure maximum turnover of
inventory in an accounting period.
e. To ensure stocking of relevant materials in adequate quantities and to ensure that
unwanted or slow- moving items and/or non-moving items do not pile up.
f. To minimize inventory carrying costs in business- both ordering cost and carrying
cost.
g. To eliminate waste and delays in the process of manufacturing at all stages so as
to reduce inventory pile up.
h. To ensure adequate and timely supply of finished goods to the market through
proper distribution.
 Cost of holding Inventory
Every firm maintains some stock of raw materials, work-in-progress and finished goods
depending upon the requirement and other features of the firm. It is benefited, by holding
inventory but there is cost involved with it. had these cost not there, there would not have
been any problem of inventory management and every firm would have maintained
higher and higher level of inventories. The cost of holding inventory includes the
following:-

• Ordering Cost- The cost associated with the acquisition or ordering of inventory
is known as ordering cost. Firms have to place order with suppliers to replenish
inventory of raw materials. Such expenses involved are referred to as ordering
cost. The ordering cost may have fixed component which is not affected by the
order size; and a variable component which changes with the order size. It
includes:

o Carriage Inward
o Insurance Inward
o Communication cost
o Stationary Cost
o Demurrage Charges

Ordering Cost= (A*O)/Q

Where, A= Annual Requirement of a particular material in units or numbers

or kgs.
O= Ordering cost per order
Q= Lot size, in units
 • Carrying Cost:

The very fact that the items are required to be kept in stock means additional expenditure
to the organization. The different elements of costs involved in holding inventory are as
follows:

(a) Interest on capital / cost of capital / opportunity costs

(b) Obsolescence and depreciation

(c) The cost of storage, handling and stock verification

(d) Insurance Costs

The average inventory carrying costs can, therefore, be as follows:

Interest/costs of capital/opportunity cost 15 to 25%

Obsolescence and depreciation cost 2 to 5%
Storage, handling etc. 3 to 5%
Insurance costs 1 to 2%
Total 21 to 37%

Carrying Cost is calculated by:

Carrying Cost= ( C*O)/Q

where, C is carrying cost

• Stock-out Cost (A Hidden Cost):

A stock out is a situation when the firm is not having units of an item in store but there is
demand for that either from the customers or production department. There is always a
cost of stock out in the sense that the firm faces a situation of lost sales or back orders.

Some examples are:

o Non availability/ small amount available with vendors
o Non availability of substitutes
o Quality desired not matching with the supplied ones
o Updated or improved product not available.

Total Cost
The total cost associated with inventory is the sum of ordering and carrying cost i.e.

Total cost= Carrying Cost+ Ordering Cost

= C*O/Q + A*O/Q

One Underlying principle should be kept in time that ordering cost and carrying cost are
inversely related to each other. Suppose the ordering cost increases because more number
of times the order is repeated, a direct consequence would be reduction in inventory held
and hence carrying cost would be less. Conversely, if the number of order is less, this
means that average value of inventory held is higher with the consequence of higher
inventory carrying cost.

Techniques used for inventory management

The finance department of every organization aims at maintaining an optimum level of
inventory on the basis of the trade-off between cost and benefit to maximize the owners
wealth. There are various tools for effective inventory management. The tool depends
upon the type of inventory, namely materials, work-in-progress or finished goods. some
of these tools have an impact not only on inventory but on whole structure of the
organization. They help in reducing cost and improving the efficiency of organization as
a whole.

Perpetual Inventory Verification

This is done to check out actual inventory level and is done on a continuous basis. In
PIV method, the amount of inventory is checked both in documents as well as stores.
Here, some items are checked randomly and while checking those items issues and
receipt of those items is stopped we can say that these items are brought to freezing state.
The database which, ideally, should be refreshed simultaneously whenever there is a
change in inventory and it should match with physical inventory level. Practically, these
two numbers rarely match. This happens because of various reasons, which may or may
not be under the control of management.

Some of the reasons for mismatch are:

• Delay in entering data
• Technical Errors (intranet or SAP not working)
• Documentation Error (document not submitted)
• Posting Error
• Material issued but document not processed
• Document processed but material not issued
• Material send for job work but not received effectively
• Pilferage
• Material waiting for quality check

Benefits Of Perpetual Inventory Verification

 a. The exact amount of inventory present in the plant can be checked.
b. Checking it against the database of the stores can give us a fair idea about
how efficiently the system is working
c. Any faults in the system, regarding the errors associated with updating of
database of stores department can be traced.

Recommendations

• PIV should be done as frequently as possible.

• It should be made sure that data is updated from time to time that is as soon as
material is issued or received, corresponding data should be updated on the plant
database.
• Unless or until data is entered no material should be issued or received.

ABC Analysis
This is done to solve classification problem. The most important thing in inventory
control management is classification of different types of inventories to determine the
type and control required for each. The ABC analysis is based on the assumption that
same degree of control should not be exercised on all items of inventory. The ABC
analysis classifies various inventory items into three sets of groups of priority and
allocates managerial efforts in proportion of the priority. The most important items are
classified as class ‘A’ , those of intermediate importance are classified as class ‘B’ and
the remaining items are classified as class ‘C’.
The financial Manager should monitor different items belonging to different groups in
that order of priority. Utmost attention is required for class ‘A’ items, followed by
items in class ‘B’ and then items in class ‘C’.
This is done based on the experience
That 10% of items in the inventory accounts for 70% of consumption in value so they are
classified as ‘A’ class items
20% of items in the inventory account for 20% of consumption in value so they are
classified as ‘B” class items
70% of the items in the inventory accounts for 10% of consumption in value so they are
classified as ‘C’ class items.

Class No Of Inventory
Items (%) Value (%)
A 10 70
B 20 20
C 70 10
Total 100 100

Table :- ABC Analysis

Benefits Of ABC analysis

• It serves as a tool for classification for inventory.

• Each item can be given appropriate attention as per classification.

Limitations of ABC analysis

This system suffers from major drawback. An item of inventory may not be very
expensive, but may be very critical to production process and/ or may not be easily
available; still it will be classified under group ‘C’. It would require serious attention but
due to this classification, it will receive less attention. Similarly a not very important
component may receive extra attention then it deserves . In either case it is detrimental to
the growth of the company. This is a serious limitation of ABC analysis.

Practical Implementation
ABC analysis is strictly followed in VIDEOCON . It keeps an eye ion those items which
are more crucial for production process than others, such items are given due attention so
that there is neither an excess nor deficit of such materials. On the other hand there is not
much to worry about class B and class C items. There are around 7000 items which are
categorized as A, B, and C items.

Economic Order Quantity Model:

This is to solve order quantity problem.
After ABC analysis we get to know which item deserves how much attention. The next
Problem is to determine the lot size in which a particular item of inventory will be
required. The importance of effective inventory management is directly related to size of
the inventory. A firm should neither place too large or too small orders. The inventory
management basically focuses on maintaining an optimum level of inventory in order to
minimize the cost attached with different inventory levels.
The optimum level of inventory is known as Economic Order Quantity (EOQ) or
Economic lot size. This refers to that quantity per order, which ensures that total of
carrying and ordering cost is minimum.
The approach to determine EOQ is based on the following assumptions:-
• The total usage of particular item for a given period (usually a year) is known
with certainty and the usage rate is even throughout the year.
• There is no time gap between placing an order and getting its supply
• The cost per order of an item is constant and the cost of carrying inventory is also
fixed and is given as a percentage of average value of inventory.
• There are only two costs associated with the inventory, and these are the cost of
ordering and the cost of carrying the inventory.

EOQ is generally used to determine the order quantities of class ‘C’ items and
sometimes for class ‘B’ items also. This method is rarely used for class ‘A’ items because
class ‘A’ items are ordered only when requirement arises, there is no need to keep
inventory of class ‘A’ items.

The formula for estimating EOQ is:

EOQ= √ (2A*O)/C

Where, A = annual requirement of a particular material in units or numbers

Or Kgs
O = Ordering cost per order
C = carrying cost per unit
Figure 7 :- Graphical Presentation Of EOQ Model

Explanation
The figure shows that the total ordering cost for any particular item is decreasing as the
size per order is increasing. This will happen because with the increase in the size of
order, the total number of order for a particular item will decrease resulting in decrease in
the order cost. The total annual carrying cost is increasing with the increase in order size.
This will happen because the firm would be keeping more and more items in the stores.
However, the total cost of inventory (i.e. the total carrying cost + the total ordering cost)
initially reduces with the increase in size of order. The trade-off of these two costs is
attained at the level at which the total amount of cost is least. At this particular level the
order size is designated as the economic order quantity. If the firm places the orders for
that item of this economic order quantity, then the total annual cost of inventory of that
item will be minimized.
Benefits of EOQ

• It makes sure that there is neither an excess nor deficit of inventory.

• It saves cost as it saves carrying and ordering cost.
• It also results in strong relationship with vendors.
• It results in saving of time.

Practical Implication
EOQ is a relatively old technique for assessing the lot size of the order. Moreover, it
suffers from the disadvantage that the order cost is assumed to be uniform during a
particular period. The main point of problem in calculating EOQ is regarding the
estimation of ordering and carrying costs. Because there are no set rules to find exact
storage cost, maintenance cost etc. Since the production unit of VIDEOCON is involved
in manufacturing of tailor-made products, assessment of EOQ is not very relevant for this
kind of business line. However, the general usage items like nuts, bolts, crimps, wires,
batons, nails, lubricants, gaskets etc. are common for all types of items. Hence, it may
have restricted application in the Refrgerator plant.
EOQ is estimated on the basis of prior experience and future requirements. This happens
so because it is very difficult to classify to calculate storage and maintenance costs. They
have to be estimated because there are no provisions available to calculate them. To
prove the usefulness of this method, some arbitrary costs (ordering cost and carrying
cost) are assumed. Accordingly, EOQ is calculated to show how this model works and
how it can be useful in maintaining proper inventory levels.

ITEM EOQ
 SL98354BOOOS 219
CS94314KOOOS 237
SL97299OMOOS 327
SH97609OOKOS 245
SH97608OOMOS 258

Table – Economic Order Quantity

RECOMMENDATIONS:

• Provisions to calculate EOQ must be made because a guess work may

prove to be wrong.
• At first, the total cost involved in ordering, transporting, procurement,
storage and maintenance must be calculated. Than, a part of this
(say 20%) should be taken as carrying cost and rest as ordering cost.

Lean Manufacturing

There are many hidden wastes in any organisation . To get rid of these hidden wastes we
need to first unhide them. The best way to do this is to have a VISUAL FACTORY
where there is nothing hidden . Lean Manufacturing is a tool to enable us to achieve this
objective

Fundamentals of Lean Manufacturing :

1. Smooth flow of Material & Information to meet on demand service to customers

but without having to hold high inventories .
 2. Elimination of hidden wastes .These wastes fall into seven basic categories :
a. Over Production
b. Defects/Rework
c. Motion
d. Transportation
e. High Inventory
f. Over processing &
g. Waiting
3. To achieve waste elimination , workplace organization using the 5 S System is
necessary:
a. Sort ... Remove unneeded items
b. Set –in – order... A place for everything and everything in its place (PEEP)
c. Shine ... Clean enough to inspect and expose any defect .
d. Standardize.. Create instructions and Standard Operating procedures
e. Sustain... Maintain the above through support and encouragement
4. Reducing Lead Time at every stage of every process through
a. Visual Controls using Kanban cards
b. Receiving material just in time (JIT).
c. Line Balancing to avoid up piling up of material at any stage.
d. Studying the flow of material or Value Stream Mapping.
e. Total Productive Maintenance to improve overall operation of the
equipment.
f. Set up time reduction using SMED (single minute exchange of dies ).

Lean manufacturing is a management philosophy focuses on reduction of the seven

wastes to improve overall customer value. Lean management (also known as Big JIT)
is a philosophy of operations management that seeks to eliminate waste in all aspects of
aspects of firm’s production activities: human relations, vendor relations, technology and
management of materials and inventory.
BY eliminating waste quality is improved, and automatically, production time and cost
are reduced. To solve the problem of waste lean manufacturing has several tools at its
disposal. All of these tools aim at reducing wastes, of one of several types, as far as
possible.
Some of the tools of lean manufacturing which helps in inventory management and
control are:-

• Just In time ( right amount in the right place at right time)

• Kaizen ( continuous improvement process)
• Kanban (pull production)
• Single Piece Flow System
• Gemba Walking
• Virtual Storage

Lean Manufacturing can be achieved by implementing following tools:

Just in Time Concept:

The basic philosophy behind JIT is that the firm should keep minimum level of inventory
on hand relying on suppliers to furnish ‘stock’ ‘just in time’ as and when required. This is
in direct contrast to the traditional inventory philosophy which emphasizes keeping
sufficient levels of safety stocks to ensure that production will not be interrupted.
Thus JIT system benefits in two ways:-
• By reducing the ordering cost. This is attempted by locating inventories supplies in
convenient locations.
• By reducing the safety stock . This is attempted by developing a strong relationship
with suppliers and setting up restocking strategies that cut time.

Practical Implementation
Just-in-time is implemented, nearly, at each and every stage of manufacturing/production
in the plant. Stores Department and Fabrication Departments are the main users of this
technique.

While manufacturing switchboards, earlier, for an order of say 1000 items in three
months period, one part of the whole manufacturing was done and than other steps took
place. So, inventory of material used to pile up. Also, the different parts used to lie
scattered here and there.
After implementation of JIT, the process is done such that all the steps are taken
simultaneously. So, material keeps moving. Moreover, provisions are made so that all the
parts of a product are kept together.

Procurement of packing cases is another good example of implementation of JIT

concept in VIDEOCON . All the finished goods need to be packed in wooden packing
cases (also known as crate packing cases).
There are certain issues related to wooden packing cases:
• They are bulky and over-sized.
• They have storing constraints.
• Dryness of wood up to a specific point is allowed (if the wood gets drier, it
becomes very difficult to pierce nails in it).

So, in order to avoid all these problems, what best can be done is – as soon as the
material is about to complete, the Final Assembly Department informs it to Packing and
Purchase Department. Now, packing and Purchase Department gets ready with their
wooden packing materials, just-in-time as the finished goods are received by them.

RECOMMENDATIONS:
 • All the workers, especially those who are working in Fabrication
Department, Stores Department and Purchase Department, must be
given proper training regarding the practical implementation of JIT.
• Any sort of delay between any two processes should be minimized as far as
possible. Any kind of idle time should not be allowed.
• Another point that must be kept in mind is that, right amount of material should
pass from one stage to the other. There is no need to pile-up materials, which are
not going to be used immediately.

CASH MANAGEMENT
Cash is the most liquid current asset. It is the common denominator to which all current
assets can be reduced because the other major liquid assets, i.e. inventory and receivables
get eventually converted into cash. This clearly underlines the significance and essence of
cash management.
Cash can be defined in many ways, it’s not only the money in hand or bank, it is much
more than that.

Cash includes:
 • Currency
• Cheques
• Drafts
• Demand deposits
• Marketable securities
• Time deposits

NEED OF CASH:
Cash, of all types, acts as a reserve pool of liquidity that provides cash quickly, as and
when needed. They also provide a short-term investment outlet for excess cash and are
also useful for meeting planned outflows of funds.

The major reasons of keeping cash are:

• Transaction motive – this refers to the holding of cash to meet routine cash
requirements

• Precautionary motive – these refer to the cash balances held in reserve for
random and unforeseen fluctuations in cash flows

• Speculative motive – it refers to the desire of a firm to take advantage of

opportunities which present themselves at unexpected moments

• Compensating motive – usually banks ask clients to maintain a minimum

balance of cash with them (bank). Since this balance can not be utilized by the
firms for transaction purposes, the banks themselves can use the amount to earn a
return. Such balances are compensating balances.
OBJECTIVES OF CASH MANAGEMENT:

The basic objectives of cash management can be classified majorly in the following three
types:

a. To meet the cash disbursement needs (payment schedule) – these include payments
to vendors as well as salaries to employees etc.

b. To minimize funds committed to cash balances – this is important as cash which is

lying idle is of no use to the firm

c. To synchronize inflows and outflows of cash – an excess of either inflow or outflow

may be detrimental to the growth of the company.

COST OF HOLDING CASH:

Cash management has some costs associated with it.
No earning power - Irrespective of the form in which cash is held as an
asset, it has no earning power. That is, cash does not earn any return.

Depreciation cost - Cash keeps lying idle, without earning anything; in

fact it keeps depreciating with time.

BENEFITS OF CASH MANAGEMENT:

Some of the major benefits of cash management are:
a. To prevent insolvency or bankruptcy arising out of inability of a firm to
meet its obligations.
b. The relationship with bank is not strained.
c. It helps in fostering good relations with trade creditors and suppliers of
raw materials, as prompt payment may help their own cash management.
d. A cash discount can be availed if payment is made within the due date
e. It leads to a strong credit rating
f. To take advantage of favorable business opportunities that may be
available periodically
g. The firm can meet unanticipated cash expenditure within a minimum of
strain during emergencies (strikes, fire, new market strategy by competitor
etc.)

Cash is the most liquid current asset. It is of vital importance to the daily operations of
business. While the proportion of assets held in the form of cash is very small, its
efficient management is crucial to the solvency of the business. Therefore, planning
cash and controlling its use are very important tasks.
Cash budgeting is a useful device for this purpose.

Cash Budget
Cash budget basically incorporates estimates of future inflows and outflows f cash
over a projected short period of time which may usually be a year ,half or a quarter
year. Effective cash management is facilitated if he cash budget is further broken down
into month, week or even on daily basis.

There are two components of cash budget

(i) cash inflows and
(ii) cash outflows.
The main sources for these flows are given hereunder:

Cash Inflows
(a) Cash sales
(b) Cash received from debtors
(c) Cash received from loans, deposits, etc
(d) Cash receipt of other revenue income
(e) Cash received from sale of investments or assets.

Cash Outflows
(a) Cash purchases
(b) Cash payment to creditors
(c) Cash payment for other revenue expenditure
(d) Cash payment for assets creation
(e) Cash payment for withdrawals, taxes
(f) Repayment of loans, etc.

A suggestive format for ‘Cash Budget’ is given below:

Cash Budget of M/s…

Particulars Months

January Feburary
March
Estimated cash inflows
------------
-----------

I. Total cash inflows

Estimated cash outflows

------------
-----------

II. Total cash outflows

III. Opening cash balance

IV. Add/Deduct surplus/Deficit

during the month (I–II)

V. Closing cash balance (III–IV)

VI. Minimum level of cash

Balance

VII. Estimated excesses or shortfall ofcash (V–VI)

How VIDEOCON Manages its cash?

Managing cash is very essential for the business since it is crucial for solvency of
business. VIDEOCON uses various techniques to manage its cash operations.

Sweeping Facility

Rather than keeping cash at different locations, the collections and disbursals of all the
locations are recorded and the cash is kept at one central location as it is quite
cumbersome for an organization to maintain records of collection and disbursals of cash
of its different offices. It also involves a number of extra personnel, and is certainly a
waste of work force, time and money. Also, the money lying scattered with various
offices is of no use as such, because it is simply lying idle. A better option will be to
deposit this cash into a bank, having central banking facility, where it can be invested to
earn some profit. For this a suitable multi-locational bank is selected, preferably the one,
which has branches in all the locations where the different offices of the company are
located.

Moreover, if all the money is kept at one place, it will definitely amount to a huge sum.
This huge sum will make it easier for the company to negotiate with the bank regarding
the interest rate which VIDEOCON is supposed to pay for availing such facility.

Conclusion
The objective of working capital management is to maintain the optimum balance of each
of the working capital components. This includes making sure that funds are held as cash
in bank deposits for as long as and in the largest amounts possible, thereby maximizing
the interest earned. However, such cash may more appropriately be "invested" in other
assets or in reducing other liabilities. When considering these techniques and strategies of
Working capital, 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. For example, some departments have significant
inventory levels; others have little if any inventory.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.