What is working capital analysis

what is working capital analysis and also working capital management ratio analysis
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NealRexwal,Canada,Professional
Published Date:17-07-2017
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Chapter-5 • Introduction • Concept of Working Capital • Importance of Working Capital • Requirement of Working Capital • Working Capital Analysis of GSRTC Working Capital Analysis 5.1 INTRODUCTION In financial management, two important decisions are very vital and crucial. They are decision regarding fixed assets/fixed capital and decision regarding working capital/current assets. Both are important and a firm always analyzes their effect to final impact upon profitability and risk. Fixed capital refers to the funds invested in such fixed or permanent assets as land, building, and machinery etc. Whereas working capital refers to the funds locked up in materials, work in progress, finished goods, receivables, and cash etc. Thus, in very simple words, working capital may be defined as “capital invested in current assets.” Here current assets are those assets, which can be converted into cash within a short period of time and the cash received is again invested into these assets. Thus, it is constantly receiving or circulating. Hence, working capital is also known as circulating capital or floating capital. 5.2 CONCEPT OF WORKING CAPITAL There are two concepts of working capital. These are: 1. Gross working capital: (Total Current Assets) The gross working capital, simply called as working capital refers to the firm’s investment in current assets. Current assets are the assets, which can be converted into cash within an accounting year or operating cycle. Thus, Gross working capital, is the total of all current assets. It includes 1. Inventories (Raw materials and Components, Work-in-Progress, Finished Goods, Others) 2. Trade Debtors 3. Loans and Advance 4. Cash and Bank Balances 5. Bills Receivables. 6. Short-term Investment 80 Working Capital Analysis 2. Net Working Capital: (Total Current Assets – Total Current Liabilities) Net working capital refers to the difference between current assets and current liabilities. Current liabilities are those claims of outsiders, which are expected to mature for payment within an accounting year. Net working capital may be positive or negative. A positive net working capital will arise when current assets exceed current liabilities and a negative net working capital will arise when current liabilities exceed current assets i.e. there is no working capital, but there is a working capital deficit. It includes 1. Trade Creditors. 2. Bills Payable. 3. Accrued or Outstanding Expenses. 4. Trade Advances 5. Short Term Borrowings (Commercial Banks and Others) 6. Provisions 7. Bank Overdraft “Working Capital represents the amount of current assets that have not been 10 supplied by current, short term creditors.” “Gross working capital refers to the amount of funds invested in current assets that are employed in the business process while, Net Working Capital refers 11 to the difference between current assets and current liabilities.” “Working Capital is the excess of current assets that has been supplied by the 12 long-term creditors and the stockholders.” The two concepts of working capital, gross working capital and net working capital are exclusive. Both are equally important for the efficient management of working capital. The gross working capital focuses attention on two aspects How to optimize investment in current assets? and How should current assets be financed? While, net working capital concept is qualitative. It indicates the 10 James C. Van Horne & John M. Wachowicz, Jr. – “Fundamentals of Financial Management”, 11 M. Y. Khan & P K Jain, - “Financial Management – Text and Problems”, 12 Prasanna Chandra – “Financial Management – Theory and Practice” 81 Working Capital Analysis liquidity position of the firm and suggests the extent to which working capital needs may be financed by permanent sources of funds. 5.3 IMPORTANCE OF WORKING CAPITAL Working capital is one of the important measurements of the financial position. The words of H. G. Guthmann clearly explain the importance of working capital. “Working Capital is the life-blood and nerve centre of the business.” In the words of Walker, “A firm’s profitability is determined in part by the way its working capital is managed.” The object of working capital management is to manage firm’s current assets and 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 even be forced into bankruptcy. Thus, need for working capital to run day-to-day business activities smoothly can’t be overemphasized. 5.4 REQUIREMENTS OF WORKING CAPITAL There are no set rules or formula to determine the working capital requirements of the firms. A large number of factors influence the working capital need of the firms. All factors are of different importance and also importance change for the firm over time. Therefore, an analysis of the relevant factors should be made in order to determine the total investment in working capital. Generally the following factors influence the working capital requirements of the firm: • Nature and size of the business • Seasonal fluctuations • Production policy • Taxation • Depreciation policy • Reserve policy • Dividend policy • Credit policy: • Growth and expansion • Price level changes • Operating efficiency • Profit margin and profit appropriation 82 Working Capital Analysis 5.5 WORKING CAPITAL ANALYSIS OF GSRTC With a view to appraise working capital and liquidity position of GSRTC, the analysis has been made from the point of view of short term creditors, efficiency in the use of working capital, and investment in working capital. Short-term creditors are primarily interested in liquidity position or the short- term solvency of the firm while, the management is interested in efficient utilization of available working capital. The analysis throws the light on the following questions: 1. Will GSRTC be able to pay its current obligations promptly? 2. Can GSRTC effectively utilize the capital available? 3. Is the liquidity position of GSRTC improving? To evaluate the performance of working capital of GSRTC and answer above questions, three fold analyses are undertaken as shown under: A. An Analysis of Working Capital Trend in GSRTC B. An Analysis of Working Capital Efficiency in GSRTC C. An Analysis of Liquidity Position of GSRTC A. AN ANALYSIS OF WORKING CAPITAL TREND IN GSRTC The working capital trend analysis represents a picture of variations in current assets, current liabilities and working capital of GSRTC over a period of time. Trend Analysis is a tool of financial analysis where changes are compared to the base year, keeping the base year as 100. Such an analysis helps us to study upward / downward trends in current assets and current liabilities and its effect on working capital. The following analysis was carried out to find out working capital trend in GSRTC 1. Current Assets Trend Analysis 2. Current Liabilities Trend Analysis 3. Working Capital Trend Analysis 83 Working Capital Analysis 1. Current Assets Trend Analysis Table 5.1 Trend of Current Assets (per cent) (Base Year 1996-97) in GSRTC From 1996-97 to 2005-06 (Rs. in lacs) Sr. Stores & Loans & Sundry Cash on hand Current Year Trend No. Inventories Advances Debtors & at Bank Assets 1 1996-97 3206.85 2772.65 6097.06 6097.17 18173.73 100.00 2 1997-98 3162.64 3123.76 6424.94 4506.41 17217.75 94.74 3 1998-99 2801.50 3561.50 7355.53 4587.83 18306.36 100.73 4 1999-00 3140.78 4974.60 8002.04 12270.22 28387.64 156.20 5 2000-01 2859.94 7191.54 19006.32 5102.46 34160.26 187.97 6 2001-02 2453.05 5285.94 18086.62 3154.23 28979.84 159.46 7 2002-03 1801.37 1733.60 37310.12 2324.75 43169.84 237.54 8 2003-04 1752.53 2017.35 37833.77 3096.64 44700.29 245.96 9 2004-05 1996.32 2080.23 36799.49 4551.09 45427.13 249.96 10 2005-06 2534.39 3920.73 36023.43 6782.38 49260.93 271.06 Source: Computed from the annual reports and accounts of GSRTC, Ahmedabad. 84 Working Capital Analysis Chart 5.1 Relative Share of Current Assets in GSRTC Cash on Hand and at Bank 16% Sundry Debtors 65% Stores and Inventories 8% Loans and Advances 11% Stores and Inventories Loans and Advances Sundry Debtors Cash on Hand and at Bank 85 Working Capital Analysis Chart 5.2 Temporal Change in Current Assets of GSRTC From 1996-97 to 2005-06 300.00 250.00 200.00 150.00 100.00 50.00 0.00 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 Year Current Assets 86 Current Assets Average Current Assets Working Capital Analysis Table 5.2 Average Current Assets in GSRTC From 1996-97 to 2005-06 (Rs. in lacs) Average No Particular Percentage Amount 1 Stores and Inventories 2570.00 08 2 Loans and Advances 3666.20 11 3 Sundry Debtors 21293.93 65 4 Cash on Hand and at Bank 5247.32 16 Total 32777.45 100 Table 5.2 and Chart 5.1 reveal that current assets in GSRTC include four main components. From above data, it is apparent that stores and inventories (stock in hand, stores and loose parts, material adjustment ledger, work in progress etc.) have the minimum share of 8% in the current assets of the corporation, whereas, sundry debtors (income earned but not received, interest due but not received, debts from other corporations etc.) have the biggest contribution of around 65% to the current assets. Thus, current assets of GSRTC mainly comprise of sundry debtors. As such, the trend of current assets is largely followed by the trend of sundry debtors in GSRTC. Table 5.1 and Chart 5.2 reveal that current assets in GSRTC show an increasing trend except in the year 1997-98 and 2002-03. It ranged between 94.69 per cent in the year 1997-98 and 271.06 per cent in the year 2005-06 with an average trend of current assets to be 180.36. Though, current assets in GSRTC show an increasing trend during the study period, it was lower than average trend in current assets up to the year 87 Working Capital Analysis 1999-00. Then after, it was higher than average current assets trend till the ending year of the study period. As presented in Chart 5.3 a sudden hype in the current assets is encountered during the year 1999-00 (39.68% increase in the level of Loans and Advances and 167.45% in Cash on Hand and at Bank in comparison to last year). The possible reasons behind these may be: 1. Excessive advanced payment of Income Tax around Rs. 2, 27,710 during the year. 2. An advanced payment made towards a number of purchase orders worth Rs. 3643.00 lacs placed during the year. 3. Security deposits (5% to 10% of amount of tender) received against limited and open tenders from various suppliers and manufacturers. 4. Cash received around Rs. 720.77 lacs from the sell of scrap vehicles and materials through a number of auctions done by central workshop, Ahmedabad. 5. An increase in the Equity Capital (around Rs. 2500 lacs), Loan (around Rs. 33244.53 lacs), Fund (around Rs. 5966.11 lacs), Provisions (around Rs. 5592.57 lacs) during the year. As presented in Chart 5.2 a sudden hype in the current assets is also encountered during the year 2002-03 (106.29% increases in sundry debtors in comparison to last year). The possible reasons behind these may be: 1. During the year, provisions of reimbursement to be received from Government on account of loss due to Student Concession, un-economic routes, city services etc. worked out. 2. During the year the corporation has created casual contracts. However, casual contract kms. Operated decreased from lacs 67.14 to 65.03 lacs but the revenue increased by around Rs. 643.87 lacs due to the revised rates of casual contracts during the year. 88 Working Capital Analysis 2. Current Liabilities Trend Analysis Table 5.3 Trend of Current Liabilities (per cent) (Base Year 1996-97) in GSRTC From 1996-97 to 2005-06 (Rs. in lacs) O/S Debt Diff. In Sr. Revenue Provident Outstanding Current Year for Capital Gratuity closing Provisions Trend No. Liabilities Fund Interest: Liability Expenditure stores 1 1996-97 2519.05 24208.03 0.00 0.00 0.00 107.52 1651.68 28486.29 100.00 2 1997-98 3148.00 43132.21 0.00 56.81 0.00 201.50 2194.47 48733.00 171.08 3 1998-99 1807.11 52818.60 0.00 0.00 0.00 311.71 2554.79 57492.22 201.82 4 1999-00 1404.95 78488.14 9.48 0.00 0.00 423.36 3037.80 83363.73 292.65 5 2000-01 3543.96 106102.77 34.39 0.00 0.00 535.02 5405.75 115621.90 405.89 6 2001-02 1919.22 117768.47 0.63 0.00 308.01 646.67 3134.71 123777.72 434.52 7 2002-03 2684.10 27639.46 1873.51 40.41 3827.14 758.33 34.51 36857.45 129.39 8 2003-04 7553.50 24975.68 2466.53 30.47 1340.28 869.99 23.64 37260.09 130.80 9 2004-05 6860.79 26944.98 2831.17 0.00 5892.85 981.64 23.01 43534.44 152.83 10 2005-06 8472.94 30824.10 1954.14 0.00 17423.82 1093.24 57.99 59826.23 210.02 Sorce: Computed from the annual reports and accounts of the GSRTC, Ahmedabad 89 Working Capital Analysis Chart 5.3 Relative Share of Current Liabilities in GSRTC Gratuity 1% Difference in Closing Stores 0% Provident Fund 5% Outstanding Interest 1% Provisions 3% Revenue Liabilities 84% O/S Debt for Capital Expenditure 6% O/S Debt for Capital Expenditure Revenue Liabilities Gratuity Difference in Closing Stores Provident Fund Outstanding Interest Provisions 90 Working Capital Analysis Chart 5.4 Temporal Change in Current Liabilities of GSRTC From 1996-97 to 2005-06 500.00 450.00 400.00 350.00 300.00 250.00 200.00 150.00 100.00 50.00 0.00 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 Year Current Liability Average Current Liablity 91 Current Liability Working Capital Analysis Table 5.4 Average Current Liabilities in GSRTC From 1996-97 to 2005-06 (Rs in lacs) No Particular Avg. Amount Percentage 1 O/S Debt for Capital Expenditure 3991.36 06 2 Revenue Liabilities 53290.24 84 3 Gratuity 916.98 1 4 Difference in Closing Stores 12.77 0 5 Provident Fund 2879.21 5 6 Outstanding Interest 592.90 1 7 Provisions 1811.84 3 Total 63495.31 100 Table 5.4 and Chart 5.3 reveal that current liabilities in GSRTC include seven main components. From the above data, it is apparent that difference in closing stores is almost negligible in the current liabilities of the corporation, whereas, revenue liability has the biggest contribution of around 84% to the current liabilities. Thus, current liability of GSRTC mainly comprises of revenue liability. As such, the trend of current Liabilities is largely followed by the trend of revenue liabilities in GSRTC. Table 5.3 and Chart 5.4 reveal that current liabilities in GSRTC show an increasing trend, except in the year 2002-03. It ranged between 100 per cent in the year 1996-97 and 434.52 per cent in the year 2001-02 with an average trend of current liabilities to be 222.90. Though, current liabilities in GSRTC show an increasing trend during the study period, it was lower than average trend in current liabilities except in the year 1999-00 to 2001-02. As presented in Chart 5.4 current liabilities show a huge fall in the year 2002- 03 because during the year corporation has decreased current liabilities, (76.51% decrease in the level of revenue liabilities around Rs. 90129.01 lacs as well as 98.90% decrease in the provisions around Rs. 3100.20 lacs, in comparison to last year, this decrease may be due to decrease in staff cost & super annuation (as decrease in staff), taxes, depreciation, traffic, stationary, lease rent, uniform, electric power, clothing interest etc. 92 Working Capital Analysis 3. Working Capital Trend Analysis Table 5.5 Trend of Working Capital (per cent) (Base Year 1996-97) in GSRTC From 1996-97 to 2005-06 (Rs. in lacs) Current Current Adding Constant Working Capital Working Capital Sr. No. Year Assets Liabilities (CA-CL) Value 94797.89 Trend 1 1996-97 18173.74 28486.29 -10312.55 84485.34 100.00 2 1997-98 17208.37 48733.00 -31524.63 63273.26 74.89 3 1998-99 18306.37 57492.22 -39185.85 55612.04 65.82 4 1999-00 28387.64 83363.73 -54976.09 39821.80 47.13 5 2000-01 34160.26 115621.90 -81461.64 13336.25 15.79 6 2001-02 28979.83 123777.72 -94797.89 0.00 0.00 7 2002-03 43169.83 36857.45 6312.38 101110.27 119.68 8 2003-04 44700.29 37260.09 7440.20 102238.09 121.01 9 2004-05 45427.13 43534.44 1892.69 96690.58 114.45 10 2005-06 49261.00 59826.23 -10565.23 84232.66 99.70 Average 32777.45 63495.31 -30717.86 94213.17 75.85 Source: Computed from the annual reports and accounts of the GSRTC, Ahmedabad 93 Working Capital Analysis Chart 5.5 Current Assets and Current Liabilities in GSRTC From 1996-97 to 2005-06 140000 120000 100000 80000 60000 40000 20000 0 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 Year Current Assets Current Liabilities 94 Current Assets Current Liabilities Working Capital Analysis Chart 5.6 Temporal Change in Working Capital of GSRTC From 1996-97 to 2005-06 140.00 120.00 100.00 80.00 60.00 40.00 20.00 0.00 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 Year Working Capital Average Working Capital 2 per. Mov. Avg. (Working Capital) 95 Working Capital Average Working Capital Working Capital Analysis Chart 5.5 reveals that, in GSRTC, current liabilities are greater than current assets during the whole study period except in the year 2002-03, 2003-04 and 2004-05. From the data presented in Table 5.5, it is apparent that difference between current liabilities and current assets is minimum around 18.35% (45427.13 – 43534.44) in the year 2004-05, whereas, highest around 919.25% (28979.83 – 123777.72) in 2001-02. Working capital is negative in major years of the study period except in the year 2002-03, 2003-04 and 2004-05. Thus, current Liability of GSRTC is normally higher than its current Assets. Table 5.5 and Chart 5.6 indicate that working capital in GSRTC show decreasing trend except in the years 2002-03 and 2003-04. It ranged between –919.25 per cent in the year 2001-02 and 72.15 per cent in the year 2003-04 with an average trend of working capital -297.87. Though, working capital in GSRTC show decreasing trend during the study period, it was higher than average trend except in the year 2002-03, 2003-04 and 2004-05. As a whole, it may be concluded that working capital trend is positive from the year 2002-03, as current assets are higher than current liabilities from that year. B. EFFICIENCY ANALYSIS OF GSRTC Efficiency analysis examines how efficiently different working capital components are used in an enterprise. Working capital may have various components. Efficient turnover of these components results into higher efficiency which in turn results into higher profitability. In GSRTC, to measure efficiency in the utilization of working capital following ratios have been calculated: 96 Working Capital Analysis 1. Working Capital Turnover Ratio 2. Debtors Turnover Ratio 3. Creditors Turnover Ratio 1. Working Capital Turnover Ratio The working capital is required for the smooth running of day to day operations of the business. Hence, it has utmost importance in analysing business operation both internally and externally. Inadequacy or mismanagement of working capital leads towards business failure. The working capital of a company is the life blood which flows through the veins and arteries of the structure. as like the lacking or slow down of blood results into a death, the lacking or slow down of working capital results into a death of financial body (brain - management and muscles – personnel) of a business and becomes just junk. The Working Capital Turnover Ratio is one of the best measures to analyse the efficiency of a firm in managing its working capital. It is figured as shown below: Net Sales (Net Revenue) Working Capital Turnover Ratio = Working Capital As GSRTC is a service sector, net sales is replaced by net revenue. Moreover, in the present study, working capital is taken as the excess of current assets over current liabilities. The faster the working capital turnover, the lower is the total investment and is greater the profit. However, a very high turnover of working capital may, in some cases, denote deficiency of working funds for the given volume of business, which ultimately adversely affects the profitability. 97 Working Capital Analysis Table 5.6 Working Capital Turnover Ratio (times) in GSRTC From 1996-97 to 2005-06 (Rs. in lacs) Working Sr. no. Year Net Revenue Ratio Capital 1 1996-97 80868.41 -10312.55 -7.84 : 1 2 1997-98 86208.27 -31524.63 -2.73 : 1 3 1998-99 94939.69 -39185.85 -2.42 : 1 4 1999-00 107233.27 -54976.09 -1.95 : 1 5 2000-01 124854.28 -81461.64 -1.53 : 1 6 2001-02 122666.38 -94797.89 -1.29 : 1 7 2002-03 130824.01 6312.38 20.72 : 1 8 2003-04 141540.43 7440.20 19.02 : 1 9 2004-05 137070.71 1892.69 72.42 : 1 10 2005-06 143016.76 -10565.23 -13.54 : 1 Average 116922.22 -30717.86 8.09 S D 23099.90 36598.77 25.05 C V % 19.76 -119.14 309.83 Compound Annual 10.49 7.70 5.61 Growth Rate % Source: Computed from the annual reports and accounts of the GSRTC, Ahmedabad 98

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