Working Capital Management Long Answer Type Questions

Question 1.
Explain the determinants of working capital.
Answer:
Many factors have to be considered while deciding on the working capital requirements. Following are some of the important factors influencing the working capital.
(1) Operational efficiency: If a firm is very efficient in the operations it will utilise the available resources to the maximum extent eliminating wastages this will inturn increase the profitability and help the firm to reduce its costs. The pressure on working capital will be less when the firm is efficient in its operation whereas the firms that are not efficient will consume more working capital.

(2) Growth and Expansion: If the firm is desirous to expand its operations and aims at growth accordingly, the requirement of working capital will also be more, hence the growth and expansion programmes of a firm is an important factor influencing the requirement of working capital.

(3) Profit Appropriation: The earnings available to the firm through its operations are not available for working capital purposes. Only a certain proportion of the earning is available for working capital requirements. Because the company has to apportion its earnings in the form of depreciation, taxes, dividend and retained earnings. Whatever the amount left out after apportionment is available for working capital purposes.

(4) Capital structure of the company: If the policy of the company is such that the shareholders provide some funds towards the working capital needs then it will be easy for the management because it need not arrange from outside sources whereas if no such policy is followed then, the company has to raise money from outside sources and with an additional obligation of interest payment.

(5) Policies of RBI: If RBI follows stringent credit policies it will affect the companies intending to raise funds from outside sources for working capital requirements it may have to pay more interest. But if RBI follows liberal credit policies raising money in the capital or money market will not be a problem.

(6) Changes in prices: If the firm experiences fluctuations in the prices it has to keep more amount of working capital to meet the changes in the prices but if the prices are stable the working capital to be arranged is considerably less than in the previous case. Therefore the changes in the prices are one of the important factors influencing the working capital requirements.

(7) Profitability: There are concerns earning more profit because of good quality products, customer’s preference brand loyalty, less competition, monopoly power etc. Therefore a portion of the profit can be used as working capital. Whereas the other concerns are earning less profit because of more competition, inferior quality of product, more substitute etc. profit may not be sufficient to meet the working capital purposes as a result of which they may. have to borrow from other sources.

(8) Nature and size of the firm: If the nature and size of the firm is small then the requirement of working capital is less when compared to that of the firms which are bigger in size and with larger operations.

(9) Sales volume: The sales volume and the size or requirement of working capital are directly related to each other. As the volume of sales increases, there is an increase in the investment of working capital.

(10) Business terms: A firm which allows liberal credits to its customers may enjoy higher sales but will need more working capital as compared to a firm following stringent credit terms.

Conclusion:
Finance manager has to consider all these factors at the time of deciding the amount of working capital. His/Her main aim should be to reduce the cost to the maximum possible extent and makes funds available as and when required.

Question 2.
Explain the different sources of finance for funding working capital or short term finance requirements.
Answer:
The main sources of finance for short term working capital are as follows:
1. Trade Credit: It refers to the credit extended by the suppliers of goods in the normal course of business. This is an important source of short term finance. The credit worthiness of a firm and the confidence of its suppliers are the main basis of securing trade credit. It is most granted on open account basis whereby supplier sends goods to the buyer for the payment to be received in future as per terms of the sales invoice. It may also take the form of bills payable whereby the buyer signs a bill of exchange payable on a specified future date.

Accrued Expenses and Deferred Income are other spontaneous sources for short term financing. Accrued expenses are the expenses which have been incurred but not yet due and hence not yet paid also. These simply represent a liability that a firm has to pay for the services already received by it. Wages, salaries, interest and taxes are the most important components of accrued expenses.

Deferred incomes are incomes received in advance before supplying goods or services. They represent funds received by a firm and constitute an important source of short term finance. However, firms having great demand for its products and services, and those having good reputation in the market can demand deferred incomes.

2. Bank Borrowing: Commercial banks are the most important source of short term capital. The major portion of working capital loans are provided by commercial banks. They provide a wide variety of loans tailored to meet the specific requirements of a concern. The different forms in which banks normally provide loans and advances are as follows:

(a) Loans: When a bank makes an advance in lump-sum against some security it is called a loan. The entire loan amount is paid to the borrower either in cash or by credit to his account. The borrower is required to pay interest on the entire amount of loan from the date of sanction.

(b) Cash Credit: It is an arrangement by which a bank allows his customer to borrow money upto a certain limit against some tangible security or guarantee. The customer can withdraw from his cash credit limit according to his needs and he can also deposit .any surplus amount with him. The interest is charged on daily balance.

(c) Overdrafts: It is an agreement with a bank by which a current account holder is allowed to withdraw more than the balance to his credit upto a certain limit. There are no restrictions for operation of overdraft limits. The interest is charged on daily overdrawn balances. However it is allowed for. a short period and to a temporary accommodation.

(d) Purchasing and Discounting of bills: This is the most important form in which a bank lends without any collateral security. The seller draws a bill of exchange on the buyer of goods on credit. Such a bill may either be a clean bill or a documentary bill which is accompanied by documents of title to goods such as a railway receipt. The bank purchases the bills payable on demand and credits the customers’ account with the amount of bill less discount. On maturity, bank presents the bill to its acceptor for payment.

In addition to the above, banks help their customers in obtaining credit from their suppliers through the arrangement of Letter of credit. This is an undertaking by a bank, to honour the obligations of its customers upto a specified amount.

Question 3.
Explain Cash Management.
Answer:
Cash Management is concerned with the managing of:
(i) Cash flows into and out of the firm
(ii) Cash flows within the firm and
(iii) Cash balances held by the firm at a point of time by financing deficit or investing surplus cash. Cash management seeks to accomplish this cycle at a minimum cost. At the same time, it also seeks to achieve liquidity and control.’ Following are some of the facts of cash management.
(1) Cash Planning:
Cash Planning is a technique to plan and control the use of cash. A projected cash flow statement may be prepared based on the present business operations and anticipated future activities. The cash inflows from various sources may be anticipated and cash outflows will determine the possible uses of cash. Cash inflows and outflows should be planned to project cash surplus or deficit for each period of the planning period. The cash inflows International Financial Management should be accelerated while as far as possible, the cash out lows should be decelerated. Cash budget should be prepared for this purpose.

(2) Cash Forecasts and Budgeting:
A Cash budget is the most important device for the control of receipts and payments of cash. A cash budget is an estimate of cash receipts and disbursements during a future period of time. It is an analysis of flow of cash in a business over a future, short or long period of time. It is a forecast of expected cash intake and outlay. The short term forecasts can be made with the help of cash flow projections.

The finance manager will make estimates of likely receipts in the near future and the expected disbursements in that period. Though it is not possible to make exact forecasts even then estimates of cash flows will enable the planners to make arrangement for cash needs. The long term cash forecasts are also essential for proper cash planning. Long term forecasts indicate company’s future financial needs for working capital, capital projects etc.

(3) Investment of Surplus Funds:
The surplus cash balances should be properly invested to earn profits. The firm should decide about the division of such cash balance between alternative short term investment opportunities such as bank deposits, marketable securities, or intercorporate lending. As the firm invests its temporary cash balance, its primary criteria in selecting a security or investment opportunity will be its quickest convertibility into cash, when the need for cash arises. Besides this, the firm would also be interested in the fact that when it selis the security or liquidates investment, it atleast gets the amount of cash equal to the investment outlay. Thus, in choosing among alternative investment, the firm should examine three basic features of security: safety, maturity and marketability.

Question 4.
Discuss various Cash Management Techniques.
Answer:
Cash Management is concerned with the managing of:
(i) Cash flows into and out of the firm
(ii) Cash flows within the firm and
(iii) Cash balances held by the firm at a point of time by financing deficit or investing surplus cash. Cash management seeks to accomplish this cycle at a minimum cost. At the same time, it also seeks to achieve liquidity and control. .Following are some of the facts of cash management.
(1) Cash Planning:
Cash Planning is a technique to plan and control the use of cash. A projected cash flow statement may be prepared based on the present business operations and anticipated future activities. The cash inflows from various sources may be anticipated and cash outflows will determine the possible uses of cash. Cash inflows and outflows should be planned to project cash surplus or deficit for each period of the planning period. The cash inflows should be accelerated while as far as possible, the cash outlows should be decelerated. Cash budget should be prepared for this purpose.

(3) Investment of Surplus Funds:
The surplus cash balances should be properly invested to earn profits. The firm should decide about the division of such cash balance between alternative short term investment opportunities such as bank deposits, marketable securities, or intercorporate lending. As the firm invests its temporary cash balance, its primary criteria in selecting a security or investment opportunity will be its quickest convertibility into cash, when the need for cash arises. Besides this, the firm would also be interested in the fact that when it sells the security or liquidates investment, it atleast gets the amount of cash equal to the investment outlay. Thus, in choosing among alternative investment, the firm should examine three basic features of security: safety, maturity and marketability.

Question 5.
Explain the Management of Accounts Receivable.
Answer:
Accounts Receivables Management is the process of making decisions relating to investment in trade debtors. The objective is to take a sound decision as regards investment in debtors as this involves cost consideration and a risk of bad debts too.

Dimensions of Accounts Receivables Management: Accounts Receivables Management involves the careful consideration of the following aspects:
(1) Forming of Credit Policy: A credit policy is related to decisions such as credit standards, credit, terms and collection efforts. Credit standards are criteria to decide the types of customers to whom goods could be sold on credit. If a firm has more slow paying customers, its investment in accounts receivable will increase. The firm will also be exposed to higher risk of default.

Credit terms specify duration of credit and terms of payment by customers. Investment in accounts receivable will be high if customers are allowed extended time period for making payments. Collection efforts determine the actual collection period. The lower the collection period, the lower the investment in accounts receivable and vice versa.

(2) Credit Evaluation of Individual Accounts: The firm need not follow the policy for treating all customers equal for the purpose of extending credit. Each case may be fully examined before granting any credit terms. Similarly, collection procedure will differ from customer to customer.The credit evaluation procedure of the individual accounts should involve the following steps:
(i) Credit Information:
The first step will be to gather credit information about the customers. This information should be adequate enough so that proper evaluation about the financial position of the customers is possible. This type of investigation can be undertaken only upto a certain limit because it will involve cost. The cost incurred and the benefit from reduced bad debt losses will be compared. The cost of collecting information should, therefore, be less than the potential -profitability. The information may be available from financial statements credit rating agencies, reports from banks, firms records etc.

(ii) Credit Investigation:
After having obtained the credit information, the firm will get an idea regarding matters which should be further investigated. The factors that affect the extent and nature of credit investigation of an individual customer are:

The type of customer, whether new of existing
The Customer’s business line background and the related trade risks
The nature of the product perishable or seasonal
Size of customer’s order and expected further volumes of business with him
Company’s credit policies and practices.

(iii) Credit Limit: A credit limit is a maximum amount of credit which the firm will extend at any point of time. The finance manager will match the creditworthiness of the customers with the credit standards of the company. The decision on the magnitude of credit will depend upon the amount of contemplated sale and the customer’s financial strength. The credit limit must be reviewed periodically.

(iv) Collection Procedure: The concern should follow a well laid down collection policy and procedure to collect dues from its customers. The concern should devise procedures to be followed when accounts become due after the expiry of credit period. The collection policy be termed as strict and lenient. A strict policy of collection will involve more efforts on collection. Such a policy will enable early collection of dues and will reduce bad debt losses. A rigorous collection policy will involve increased collection costs. A linient policy may increase the debt collection period and more bad debt losses.

(3) Control of Receivables: A firm needs to continuously monitor and control its receivable to ensure the success of collection efforts. Two traditional methods of evaluating the management of receivable are:

Average collection period
Aging schedule.

The average collection Period = The average collection period so calculated is compared with the firm’s stated credit period to judge the collection efficiency. The aging schedule breaks down receivables according to the length of time for which they have been outstanding. The aging schedule provides more information about the collection experience.

Question 6.
Discuss the preparation of Ageing Schedule and Debtors Turnover Ratio.
Answer:
Ageing Schedule:
Ageing schedule is a table that classifies accounts receivable and payables according to their dates. It helps in managing cash and analyzing payments. An aging schedule is a way of finding out if customers are paying their bills within the credit period prescribed in the company’s credit terms.

The typical accounts receivable aging schedule consists of 6 columns:

Column 1 lists the name of each customer with an accounts receivable balance.
Column 2 lists the total amount due from the customers listed in Column 1.
Column 3 is the “current column.” Listed in this column are the amounts due from customers for sales made during the current month.
Column 4 shows the unpaid amount due from customers for sales made in the previous month. These are the customers with accounts 1 to 30 days past due.
Column 5 lists the amounts due from customers for sales made two months prior. These are customers with accounts 31 to 60 days past due.
Column 6 lists the amount due from customers with accounts over 60 days past due.

Debtors Turnover Ratio:
A concern may sell goods on cash as well as on credit. Credit is one of the important elements of sales promotion. The volume of sales can be increased by following a liberal credit policy.
Debtors/Receivables Turnover = \(\frac{\text { Net Credit Annual Sales }}{\text { Average Trade Debtors }}\)
= No. of times
Trade Debtors = Sundry debtors + Bills Receivables
Debtors should always be taken to gross value. No provision for bad and doubtful debts be deducted from them. Generally, the higher the value of debtors turnover the more efficient is the management of debtors/sales or more liquid are the debtors.

Practical Problems

Question 1.
From the following information, calculate the operating cycle in days and the amount of working capital required.
Period covered – 365 days
Total cost of production – ₹ 22,000
Total cost of sales – ₹ 24,000
Raw materials consumption – ₹ 9,200
Average debtors outstanding – ₹ 1,000
Credit sales for the year – ₹ 30,000
Value of average stock maintained:
Raw materials – ₹ 680
“Work in progress – ₹ 760
Finished goods – ₹ 560
Note: Amount given represent lakhs.

Question 2.
Prepare an estimate of working capital requirement from the following date of a trading concern.
(a) Projected annual sales – 80,000 units
(b) Selling price – ₹ 8 per unit
(c) Percentage of profit – 20%
(d) Average credit period allowed to debtors – 10 weeks
(e) Average credit period allowed by suppliers – 8 weeks
(f) Average stock holding in terms of sales requirement – 10 weeks
(g) Allow 20% for contingencies.

Question 3.
Calculate the working capital requirement from the following information.

Question 4.
A proforma a cost sheet of a company provides the following particulars.
Elements of cost – Amount per Unit
Materials – 50%
Direct labour – 15%
Overheads – 15%
The following further particulars are available
(a) It is proposed to maintain a level of activity of 6,00,000 units.
(b) Selling price is 20 per unit
(c) Raw materials are expected to be in stores for an average of 2 months
(d) Materials will be in process, an average of one month
(e) Finished goods are required to be in stock for an average of 2 months
(f) Credit allowed to debtors is three months
(g) Credit allowed to supplier is two months.

Question 5.
A cost sheet of a company provides you the following information.
Elements of cost – Amount per Unit
Materials – 80
Direct labour – 30
Overheads – 60
Total cost – 170
Profit – 30
Selling price – 200
The following further particulars are available.
(a) Raw materials are in stock for one month (avg)
(b) Raw materials are in process on an average for half a month.
(c) Finished goods are in stock on an average for one month
(d) Credit allowed by supplier one month.
(e) Lag in payment of overheads is one month
(f) Lag in payment of wages is 1 1/2 weeks.
(g) 1/4th output is sold against cash.
(h) Cash in hand and at bank is expected to be ₹ 1,25,000.
(i) Credit allowed to customers 2 months.
You are required to prepare a statement showing the working capital needed to finance level of activity of 2,08,000 units of production.

Question 6.
What are the different methods of calculating EOQ?

Question 7.
Find out the EOQ from the following.

Question 8.
Give the meaning of EOQ and claculate EOQ from the following:
Monthly consumption 1,500 units
Ordering cost ₹ 50 per order
Inventory carrying cost per month per units ₹ 0.60.

Question 9.
Find out E.O.Q. from the following Annual usage 4000 units, cost of material per units ₹ 2, cost of placing and receiving one order ₹ 5 Annual carrying cost of one unit : 8% inventory value.