Evaluation of working capital management
Subject: Business, Economics

Introduction

Working capital management implicates the administration of current assets as well as current liabilities. It is the main part of a firm’s short-term financial planning since it encompasses the management of cash, inventory and accounts receivable. Working capital management is most important for several reasons. The current assets of a typical manufacturing firm account for over half of its total assets. Excessive levels of current assets can easily result in a firm realizing a substandard return on investment. However, firms with too few currents assets may incur shortages and difficulties in maintaining smooth operations.

For small companies, current liabilities are the principal source of external financing. The fast growing but larger company also makes use of current liability financing. For these reasons the financial manager and stuff devote a considerable portion of their time to working capital matters. The management of cash, accounts receivable, accounts payable, accruals and other means of short term financing is the direct responsibility of the financial manager.

Through the survey I tried to find out how efficiently “Shakti Engineering Limited” manages their working capital.

Objective of The Report

The primary objective of this report is to fulfill the requirement of the BBA program. Another objective of the report is to prove my experience through internship program.

The specific objectives of this report are

  • Evaluation of working capital management
  • Evaluation of Liquidity position & working capital utilization
  • Analyzing the level of current assets with relation to current liabilities

 Scope of The Report

The report will focus on the practices of working capital management in Shakti Engineering Ltd. This report has been prepared on the basis of experience gathered during the period of internship. Most of the data used in the reporting of the study are from secondary sources. All the data related to the reporting requirements are not available due to confidential reservation practices for the benefit of the organization. There are very few similar organizations in our country. So I was not able to compare with other companies.

 Methodology

Two types of data are collected, one is primary data and second one is secondary data. Primary data were collected from the employees of the division in the branch while working there as an internee. And the details were collected from a number of secondary sources.

Primary data collection Process:

  • Face to face conversation with officers and staff

Secondary data collection Process:

  • Different file study.
  • Different books.

Analytical tools:

  • Microsoft excel was used to analyze the data.
  • Different tables and graphs were used to represent the analysis.

  Limitation

It is observable that almost all studies have some boundaries. During performing my work, I had to face some unavoidable limitations.

There were some confidential issues like financial issues, for which they were very strict and careful in revealing those information. Although they have provided all the possible information but there were some inadequacy of information.

Lack of enough materials like books, journals and other papers capture me for severe brainstorming during working this report.

About the Company

Shakti Engineering Limited was established in 1986. The primary objective of the Organization is to provide engineering, engineering-management and manufacturing services in various fields. The corporate operational spirit since inception – recognizing the sever resource constrains in the country has been “Progress through innovation and Efficiency.”

Company  Management

CXZS Mission Statement…

  • To be a Profitable Enterprise of International Standards,
  • Organized and run Professionally,
  • With High Efficiency.
  • Financial Growth of the Company must ensure a proportional improvement in long term financial prospects of the people working in the company.

Quality Assurance

To ensure the quality of products, the company follows a standard quality control system and maintains strict vigil throughout the production process. The company has promptly inspects of the quality of raw materials used at its manufacturing unit. Further the finished products are again scrutinized by the quality control inspection to prevent any sub standard product to reach the hands of the customer. In addition to it the company takes pride to acquire with the fact that the company has not received any complaints from the customers.

The Manufacturing Division

The Organization is manufacturing electrical equipment – mainly Distribution Transformers, Switchgear and PFI Plant. SEL has successfully designed and manufactured transformer in 11.415 KV 3 phase and 6.325.24 KV 1-phase ranges, besides other special transformers. The organization is recognized as manufacturer of transformer by all Power Supply Utilities in the country dealing with electric power systems.

The firm has attained capacity of manufacturing transformers from 5 kVA to 2 MVA of voltage up to 33 kV. The company has supplied more than 1000 transformers to Government, Semi-government Authorities and Private companies. The maintenance and repairing section of Shakti Engineering Limited has repaired nearly 2000 transformers.

Manufacture, supply and installation of High-tension switchgear, Low tension Switchgear and Power Factor Improvement (PFI) plant are also undertaken by the company.

Shakti Engineering Limited has manufactured and supplied voltage regulators, UPS, changeover switches, etc, and has provided services for installation and maintenance of thesecustomers.

Product Range

TransformerPhaseVolt-Amp (kVA)Primary to Secondary Voltage (kV)Frequency (Hz)
350 – 200011 / 0.41533 / 41550/60
15 – 756.35 / 0.2411 / 0.41550/60
HT Switch-gear (with VCB, LBS and SF6)Voltage (kV)Current (A)
11630 / 800 / 1250 / other
LT Switch-gear100 A to 8000 A
PFI plant10 kVAr to 2000 kVAr
IPGup to 1500 VA
Voltage Stabilizerup to 1000 kVA
Auto changeover switch 
Isolation and Other Special Transformersas per order

CDXSTelecommunication Division

Shakti Engineering Ltd is providing point-to-point Satellite Telecommunication Links through VSAT as representative of PAK DATACOM LIMITED, Pakistan. Till date such satellite telecommunication Links have been provided to USA, Singapore, Thailand and Hong Kong.

Since 1995, Shakti Engineering Limited has been working in the field of satellite telecommunication system. The first VSAT (Very Small Aperture Terminal) link was commissioned by the company as Bangladesh Representative of Pak Datacom Ltd.

Several international VSAT links connected to Hawaii, Singapore, Honk Kong and Bangkok and domestic links located between Dhaka, Chittagong, Khulna, Barisal and Sylhet have been provided by the company. SEL provides full after sales service and 24x7x365 network monitoring and maintenance.

Services

  •  Point to point VSAT link to Internet Service Providers (ISP) and Corporate Users
  • Point to Point and Point to MultipointRadio Links

Company Provides

  • Customized solution.
  • 24x7x365 network monitoring.
  • 24x7x365 network maintenance.
  • Quick Maintenance Service and network expansion.
  • Data circuit available from 64 kbps to 8 Mbps and Broad Band Radio up to 11 Mbps.
  • High Quality and wide footprint coverage through Loral Cyberstar(Agila 2 and other),
    Shin Satellite (Thaicom), Asiasat, Apstar, Intelsat.
  • Flexible packaging- Equipment, space segment, full circuit, half circuit basis as per
    customer choice.
  • Network availability of 99.8% and above.

 Partners & Associates

  • PAK Datacom Limited
  • Singapore Technologies Electronics
  • SHIN Satellite
  • Sing Tel
  • Radyne ComStream
  • GMI Pramac Group
  • Microelectronics Technologies inc.
  • LORAL Skynet
  • SUMAN
  • Nippon Steel
  • Mi-Cheng
  • Savita Chemicals

Cash Management

Cash is the important current asset for the operations of the business. Cash is the basic input needed to keep the business running on a continuous basis it is also the ultimate output expected to be realized by selling the service or product manufactured by the firm. The firm should keep sufficient cash, neither more nor less. Cash shortage will disrupt the firm’s operations while excessive cash will simply remain idle, without contributing anything towards the firm’s profitability. Thus a major function of the Financial Manager is to maintain a sound cash position.

Cash is the money which a firm can disburse immediately without any restriction. The term cash includes currency and cheques held by the firm and balances in its bank accounts. Sometimes near cash items, such as marketable securities or bank time deposits are also included in cash. The basic characteristics of near cash assets are that they can readily be converted into cash. Cash management is concerned with managing of:

  1.  Cash flows in and out of the firm
  2. Cash flows within the firm
  3.  Cash balances held by the firm at a point of time by financing deficit or inverting surplus cash.

Sales generate cash which has to be disbursed out. The surplus cash has to be invested while deficit cash has to be borrowed. Cash management seeks to accomplish this cycle at a minimum cost. At the same time it also seeks to achieve liquidity and control. Therefore the aim of Cash Management is to maintain adequate control over cash position to keep firm sufficiently liquid and to use excess cash in some profitable way.

The Cash Management is also important because it is difficult to predict cash flows accurately. Particularly the inflows and that there is no perfect coincidence between the inflows and outflows of the cash. During some periods cash outflows will exceed cash inflows because payment for taxes, dividends or seasonal inventory build up etc. On the other hand cash inflows will be more than cash payment because there may be large cash sales and more debtors’ realization at any point of time. Cash Management is also important because cash constitutes the smallest portion of the current assets, yet management’s considerable time is devoted in managing it. An obvious aim of the firm now-a-days is to manage its cash affairs in such a way as to keep cash balance at a minimum level and to invest the surplus cash funds in profitable opportunities. In order to resolve the uncertainty about cash flow prediction and lack of synchronization between cash receipts and payments, the firm should develop appropriate strategies regarding the following four facets of cash management.

1.Cash Planning: – Cash inflows and cash outflows should be planned to project cash surplus or deficit for each period of the planning period. Cash budget should prepared for this purpose.

2.Managing the cash flows: – The flow of cash should be properly managed. The cash inflows should be accelerated while, as far as possible decelerating the cash outflows.

3.Optimum cash level: – The firm should decide about the appropriate level of cash balances. The cost of excess cash and danger of cash deficiency should be matched to determine the optimum level of cash balances.

4.Investing surplus cash: – The surplus cash balance should be properly invested to earn profits. The firm should decide about the division of such cash balance between bank deposits, marketable securities and inter corporate lending.

The ideal Cash Management system will depend on the firm’s products, organization structure, competition, culture and options available. The task is complex and decision taken can affect important areas of the firm.

Functions of Cash Management:

Cash Management functions are intimately, interrelated and intertwined Linkage among different Cash Management functions have led to the adoption of the following methods for efficient Cash Management:

  • Use of techniques of cash mobilization to reduce operating requirement  of cash
  • Major efforts to increase the precision and reliability of cash forecasting.
  • Maximum effort to define and quantify the liquidity reserve needs of the firm.
  • Development of explicit alternative sources of liquidity
  • Aggressive search for relatively more productive uses for surplus money assets.

The above approaches involve the following actions which a finance manager has to perform.

1. To forecast cash inflows and outflows

2. To plan cash requirements

3. To determine the safety level for cash.

4. To monitor safety level for cash

5. To locate the needed funds

6. To regulate cash inflows

7. To regulate cash outflows

8. To determine criteria for investment of excess cash

9. To avail banking facilities and maintain good relations with bankers

Motives for holding cash:

There are four primary motives for maintaining cash balances:

1. Transaction motive

2 .Precautionary motive

3. Speculative motive

4. Compensating motivess

Transaction Motive: This motive refers to the holding of cash in order to meet the day-to-day expenses of the business. These transactions including purchase of raw material, packing materials, wages, operating expenses, taxes, dividend etc. (1) since the timing of cash inflows and the cash outflows differ significantly, a minimum cash balance is required. At the same time, there is regular inflow of cash from sales proceeds, income from investments etc. But inflows and outflows-of cash do not perfectly coincide. (2) Sometimes the firm has surplus cash in certain periods, which the firm invests in easily marketable securities. These are sold and cash realized when need for payment arises in business. (3) Some firms keep cash on hand to meet some anticipated payments. It may invest such surplus cash in such a way that it will mature when anticipated payment is to be made. (4) The company is also required to keep some cash on hand to make regular annual payments, e.g. once in a year, cash is needed to pay dividend. Similarly, advance tax is payable every three months for which a firm is required to hold some cash. Here again it can be invested in short term marketable securities.

Precautionary Motive: This motive for holding cash refers to maintaining a cash balance to meet unexpected contingencies, which may arise as a result of

  1.  Uncontrollable circumstances, such as floods, strikes, earthquakes etc.
  2. Sharp increase in the cost of materials, labor etc.
  3. Unexpected delay in collection of accounts receivables.

Thus precautionary balance is required to meet unforeseen contingencies. If the event for which cash balance is kept is more unpredictable, the larger would be the cash needed. If there has been a careful planning, less cash would be required.

If the firm has a good prestige in the market, it can borrow from banks or from other sources at a short notice, it will require less cash to be maintained for contingencies. Insurance against some of the risks may also come to the help, in the sense that money can be recovered from insurance company and so less cash may be maintained. But no cut and dried formula can be suggested. Conditions would differ from industry to industry and also from firm to firm. It is for the finance manager to determine the cash to be held looking to the circumstances available. Generally such cash is held in the form of marketable securities, so that it can earn some return.

 Speculative Motive: It refers to the desire of a firm to keep cash to take advantage of profitable opportunities, which are outside the normal course of business. It helps to take advantage of

  •  Purchasing raw materials at reduced prices by availing the benefits of cash discount.
  • Speculating on interest rate movements etc.

The holding of cash for speculative motive by a business firm is debatable. It is believed that business firms should not indulge in speculative transactions, as it involves risks that can put firm in trouble. Another viewpoint is that surplus cash, if any, should also be invested in sound securities, so that it earns some return. Such transactions made at times will raise the profitability of business. However, it requires caution, foresight and skill. Hence, the best way is not to hold cash for speculative motive.

Compensating Motive: Banks provide different types of services to the firms, e.g. clearance of cheque, transfer of funds etc. against a nominal fee or commission. Generally, clients (firms) are required to maintain a minimum cash balance at the bank which cannot be utilized by them for transaction purpose. The bank can use the same for generating returns. To get compensated for free services, they provide to customers, the banks require the clients to always keep a bank balance sufficient to earn a return equal to the cost of services. Such balances are called compensating balance.

Cash Management Objectives

The Basic objective of cash management is two fold:

(a)  To meet the cash disbursement needs (payment schedule);

(b)  To minimize funds committed to cash balances. These are conflicting and mutually contradictory and the task of cash management is to reconcile them.

Meeting the payments schedule: – A basic objective of the cash management is to meet the payment schedule, i.e. to have sufficient cash to meet the cash disbursement needs of the firm. The importance of sufficient cash to meet the payment schedule can hardly be over emphasized. The advantages of adequate cash are : (i) it prevents insolvency or bankruptcy arising out of the inability of the firm to meet its obligations; (ii) the relationship with the bank is not strained; (iii) it helps in fostering good relations with trade creditors and suppliers of raw materials, as prompt payment may also help their cash management; (v) it leads to a strong credit rating which enables the firm to purchase goods on favorable terms and to maintain its line of credit with banks and other sources of credit; (vi) to take advantage of favorable business opportunities that may be available periodically; and (vi) finally the firm can meet unanticipated cash expenditure with a minimum of strain during emergencies, such as strikes , fires or a new marketing campaign by competitors.

Minimizing funds committed to cash balances: – The second objective of cash management is to minimize cash balances. In minimizing cash balances two conflicting aspects have to be reconciled. A high level of cash balance will, ensure prompt payment together with all the advantages, but it also implies that large funds will remain idle ultimately results less to the expected. A low level of cash balances, on the other hand, may mean failure to meet the payment schedule that aim of cash management should be to have an optimal amount of cash balances

Elements of a Cash Management System

The basic premise of sound cash management is to ensure that cash inflows  and outflows are effectively controlled and utilized. To effectively control cash flow, institutions must implement adequate cash management techniques to expedite cash collections and check clearing in order to access and use the funds. Institutions must also develop cost-effective disbursement mechanisms for transferring funds. The board and management are ultimately responsible for selecting the best collection and payment mechanisms as well as adopting appropriate oversight and review guidelines, operating policies and procedures, and audit requirements. In some cases, institutions may deploy other financial institutions and organizations for cash management related services that can be performed more economically or efficiently. Such services include transfer and payment of funds, collection and concentration of funds, sweep account services, information reporting, and so on.

Collection – An important component of the cash management function is the collection of funds. This process involves speeding up the conversion of receipts into available funds. By minimizing the float time associated with collection of accounts receivable and extending the float on the accounts payable side, institutions can more effectively manage cash. Hence, institutions should effectively develop a system to collect payments from customers.

Concentration – This is the movement of funds from outlying depository locations to a central bank account, commonly called a concentration account, where the funds can be more efficiently used. The most frequently used methods for concentration are depository transfer checks (DTCs), electronic depository transfers (EDTs), and wire transfers. A DTC is an unsigned paper instrument payable only to the bank of deposit for credit to a specific account. Instead of writing and depositing checks to concentrate funds, an institution instructs a concentration bank to prepare DTCs drawn for deposit into the concentration account. After a DTC is deposited, it clears in the same manner as a regular check. An EDT is simply an electronic version of the paper DTC (also known as an ACH-DTC) and is normally more cost-effective. Wire transfers may also be used for concentration but is the most expensive method. They are generally used when the amounts are large enough to justify their cost and where funds are immediately needed.

Disbursement – This involves controlling the release and timing of outgoing funds. Various disbursement techniques are available for institutions to effectively manage the disbursement process. These include checks, zero balance accounts, controlled disbursement, payable through drafts, and electronic disbursement methods.

  • Checks Checks are still the most frequently used payment instrument for bill paying and provide the payor with disbursement float. However, technological advances have increased the sophistication of check fraud. These technological advances include color copiers, high-resolution laser printers, and hand-held document scanners for use with a personal computer. Electronic payments methods help prevent check fraud by eliminating the check. Without a negotiable instrument, the counterfeiter has nothing to alter or copy. Furthermore, electronic payments (e.g., ACH) also offer strong cost savings potential by eliminating check printing costs, postage for mailing checks, and bank fees associated with check processing, account reconcilement, and check fraud prevention services.
  • Zero Balance Accounts (ZBAs) – A ZBA is a disbursement account on which checks are written even though the balance in the account is zero. A transfer of funds from the institution’s master account covers the checks. Funding of the ZBA account is automatic and involves only an accounting entry by the bank. Credits and debits are posted just before the close of business when a credit from the master account is posted to bring the balance back to zero. If there is a credit balance in the ZBA account, the ZBA will be debited and a credit made to the master account.
  • Controlled Disbursement – Another method used to minimize balances in disbursement accounts is controlled disbursement. This is a bank service that provides same-day notification, usually by mid-morning, of the dollar amount of checks that will clear against the controlled disbursement account that day. The disbursement bank receives information from the local Federal Reserve Bank early in the morning so that the checks can be sorted and the institution notified of its funding requirement.
  • Payable Through Drafts (PTDs) – A PTD is a payment instrument resembling a check that is drawn against the payor, not the bank, and on which the payor has a period of time to honor or refuse payment. PTDs are used frequently to fund loans on capital items purchased by the borrower (e.g., equipment or livestock). The use of drafts gives the institution an added measure of disbursement control and additional time to ensure that all terms have been met or expenditures authorized. Electronic PTDs are simply ACH debits to an institution’s account in which the institution is notified in time to pay or reject each item. They are used for similar purposes as paper PTDs.
  • Electronic Disbursements – As with collection and concentration systems, disbursements can also be made electronically. As indicated previously, funds operated by wire transfers are moved almost instantaneously, thereby reducing float time, but are a costly way to disburse funds compared to checks and ACH transactions. Image technology can also be used to facilitate the processing of payments. This technology allows paper documents (e.g., checks) to be scanned and converted to digital information. The images may be transmitted to a computer and stored there, or sent to a fax machine. The increasing use of electronic commerce and potential cost savings are expected to stimulate growth in electronic payment systems as discussed in the following section.

Electronic Payment Systems – The growing use and the reliance on the electronic transfer of funds expose an institution to additional risk in the management of cash. Each day, the institution’s customers may make thousands of payments that result in the transfers of balances among the institutions, depository banks, and Federal Reserve Banks. In addition, institutions make their own payments in connection with carrying out their business. Because of electronic commerce, information moves faster and with greater accuracy. Consequently, the access and speed capabilities can magnify risk in an electronic environment. Since cash is a highly liquid asset, it can be easily transferred, concealed, and converted into other assets. For these reasons, institutions must have an adequate and effective information system (IS) in place. Coordination with IS examiners will be necessary to comprehensively evaluate an institution’s electronic environment. While the range of electronic funds transfer may vary from institution to institution, the most common types of electronic payment systems include the following.

  • Automated Clearinghouse (ACH) System – The ACH system was developed as an electronic alternative to checks. It comprises a network of regional associations, interbank associations, and private sector processors. The Federal Reserve is the principal ACH operator, and the majority of financial institutions are members of an ACH association. In an ACH transaction, payment information is processed electronically instead of manually, thereby increasing reliability, efficiency, and cost-effectiveness. Institutions can make both credit and debit transactions with an ACH. In addition, an ACH transaction is capable of transferring more information about a payment than is possible with a check. Transactions are settled 1 or 2 business days after the payment information is entered into the payment system. In general, ACH payments can be used in place of more costly wire transfers when the amounts are known at least 1 day in advance.
  • FedWire – The FedWire is the Federal Reserve funds transfer system. It is a real-time method of transferring immediate funds and supporting information between two financial institutions using their respective Federal Reserve accounts. The system is reliable and secure but relatively expensive for institutions compared to checks and ACH transactions. The FedWire functions as both a communication (i.e., clearing) and a settlement facility. The FedWire service may be accessed by direct computer interface or off-line by telephone through a personal computer based electronic delivery system named FedLine. Funds are moved almost instantaneously once the originating bank has received the request. The transaction is final and irrevocable once the originating bank has sent the funds and the Federal Reserve confirms receipt. In the event of the sending bank’s failure to settle, the Federal Reserve guarantees the transferred funds to the receiving bank. Therefore, there is no settlement risk to the recipient of a FedWire transfer. Nevertheless, other types of risk associated with the FedWire funds transfer method include potential loss because of errors, omissions, and fraud.
  • Clearinghouse Interbank Payments System (CHIPS) – This is a funds-transfer network owned and operated by the New York Clearinghouse Association to deliver and receive United States (U.S.) dollar payments between domestic or foreign banks that have offices located in New York City. CHIPS was established to substitute electronic payments for paper checks arising from international dollar transactions, such as Eurodollar investments or foreign exchange contracts. The network is composed of a small number of settling participants (large U.S. chartered banks that settle end-of-day balances between each other) and a larger number of non-settling participants who maintain accounts with one of the settling banks. Unlike FedWire funds transfers, CHIPS transfers are not settled at the time the payment instructions are delivered. Instead, the transfers are settled at the end of the day through a net settlement arrangement established with the Federal Reserve Bank of New York.
  • Society for Worldwide Interbank Financial Telecommunications (SWIFT) – This is a nonprofit cooperative of member banks serving as a worldwide interbank telecommunications network based in Brussels, Belgium. It is the primary message system employed by financial institutions worldwide to transmit either domestic or international payment instructions. Unlike electronic funds transfer systems, SWIFT only provides instructions to move funds. Messages are transferred requesting debits and credits and other types of messages to correspondent accounts. SWIFT does not have a settlement mechanism. Settlement occurs through FedWire, CHIPS, or other means.

Complete elimination of risk from electronic funds transfer is an impossible task. However, the increasing use of electronic transfer activities makes it essential that each System institution clearly understands the risks inherent in these activities and be aware of the methods for possibly reducing these risks to an acceptable level. The next section provides a brief discussion of some of the sources of risk involved in the overall cash management operations.

Evaluation Of Cash Management Performances

One of the most important jobs of the Finance Manager is to maintain sufficient liquidity to enable the firm to pay off its obligations when they fall due. To test a firm’s liquidity and solvency we commonly use current and quick ratios. Traditionally 2:1 current ratio and 1:1 quick ratio are taken as satisfactory standards for the purpose. The former indicates the extent of the soundness of the current financial position of a firm and the degree of safety provided to the creditors, the later signifies the ability of a firm to settle all its current obligations on a particular date.

Current ratio

YearCurrent AssetsCurrent LiabilitiesCurrent Ratio
2005-06140484846350217004.01
2006-07165586200447562763.70
2007-08212736000787455602.70
2008-093016360001121838002.69
2009-10250046900901196432.77

The above chart is showing that the current ratio is decreasing. Although it is over 2:1 in the 5 years study period. So, I can say that the company has very sound position regarding liquidity.

Quick Ratio

YearQuick Ratio
2005-062.52
2006-072.19
2007-081.46
2008-091.57
2009-101.73
2009-10 

The above chart is showing that the quick ratio is decreasing during the 5 years study period. Traditionally 1:1 quick ratio is taken as satisfactory standards for the purpose. The quick ratio is over 1:1 in the 5 years study period. So, I can say that the company has very sound position regarding liquidity.

 Management of  Inventory

Inventories are the stock of the product made for sale by the company or semi finished goods or raw materials. Inventory of finished goods which are ready for sale is required to maintain smooth marketing operation. The inventory of raw material and work in progress is required in order to maintain an unobstructed flow of material in the production line. These inventories serve as a link between the production and consumption of goods.

The aspect of management of inventory is especially important in respect to the fact that in country like Bangladesh, the capital block in terms of inventory is about 70% of the current assets. It is therefore, absolutely imperative to manage efficiently and effectively in order to avoid unnecessary investment in them. Although to maintain low inventories may prove to be profitable but to maintain very low inventories may prove risky on the contrary.

This aspect of management if tackled in a proper way may prove to be a boon its effective and efficient management would result in the maintaining of optimum level of inventories. At this level the profitability of the organization will not be jeopardized at the cost of inventory.

Now from the above stated facts it is clear that maintaining of optimum level of inventory involves huge cost, so why should keep the inventories at all. Basically there are three main reasons for which inventories are stocked and they are:-

Transaction Motive: This motive lays emphasis on maintaining of inventories in order to maintain a smooth and unobstructed supply of materials for the sales and production operations.

Precautionary Motive: This motive emphasizes on the stocking goods in order to guard against the uncertainties of future i.e. unpredictable changes in the forces of demand, supply and other forces.

Speculative Motive:   This motive influences the decisions regarding the increase or decrease in the level of inventory in order to take advantage of price fluctuations.

A company should maintain adequate stock of materials for a continuous supply to the factory for an uninterrupted production. It is not possible for a company to procure raw material instantaneously whenever needed. A time lag exists between demand and supply of material. Also, there exists an uncertainty in procuring raw material in time at many occasions. The procurement of materials may be delayed because of factors beyond company’s control e.g. transport disruption, strike etc. Therefore, the firm should keep a sufficient stock of raw material at a time to have streamline Other factors which may incite us to keep stock of inventories is the quantity discounts, expected rise is price.

The work in process inventory builds up because of the production cycle. Production cycle is the time span between the introduction of raw material in to the production and the emergence of finished goods at the completion of production cycle. Till the production cycle completes, the stock of work in process has to be maintained.

Efficient firms constantly try to make the production cycle smaller by improving their production techniques.

The stock of finished goods has to be held because production and sales are not instantaneous. A firm can not produce immediately when goods are demanded by customers. Therefore to supply finished goods on regular basis, their stock has to maintain for sudden demand of customers, in case the firm sales are seasonal in nature, substantial finished goods inventory should be kept to meet the peak demand. Failure to supply products to customer, when demanded, would mean loss of the firm’s sales to the competitors.

Major Raw Material used by the Company:

Sl noParticularsAnnual usageDailyUsageSafetyStockLead time in days% of product used for production
1Copper200 tons5001ton1420
2stamping materials300tons8333 tons1430
3stator frames4800pieces10 pieces300 pieces3020
4CE & NC covers9600 pieces20 pieces250 pieces1410
5IP coils72000 pieces200 pieces500 pieces1405
6Rubber500 kg2 kg50 kg156+7+8+9=15
7Nuts and bolts1000 kg4 kg100 kg14
8Washers500 kg2 kg50 kg14
9M/S component20001025014

ABC system of segregation of inventory at “Shakti Engineering Ltd”.

Group A materialsGroup B materialsGroup C materials
Copperstator framesRubber materials
stamping materialsStill keysNuts & bolts
CE & NC covers Washers
IP coils M/S components

Analysis

  1. From above table clearly showing the classification of materials in to three groups
  2.  materials are Copper, stamping materials, CE & NC covers, IP coils
  3. Stator frames, still keys
  4. Rubber materials, Nuts & bolts, Washers, M/S Components

From the above analysis I can interpret that SEL adopted ABC technique based on Costs and usage and it is using to maintain the inventory in warehouse it reduces the damages of goods in warehouse so it increases quality of production and same time it gives information about re ordering point order delivery period.

Table shows percentage wise Costs incurred for raw materials

Particulars% of cost
Copper30%
Stamping25%
Mild still15%
Others30%

 Analysis

Above pie diagram is showing the cost incurred for the different raw materials.  Company is spending 30% on Copper, 25% on Stamping, 15% Mild still, 30% on others.

Organization is spending more money on getting the raw materials of Copper, Stamping and Mild still from different vendors. And it helps to maintain safety stock in unit.

Table shows lead time of raw materials

ParticularsLead time in days
Copper14
stamping materials14
stator frames30
CE & NC covers14
IP coils14
Rubber15
Nuts and bolts14
Washers14
M/S component14

Analysis:

The graph shows that SEL gets Copper within 14 days of ordering, Stamping materials within 14 days, Stator Frames within 30 days, CE & NC Covers within 14 days, IP Coils within 14 days, Rubber within 15 days, Nuts and Bolts within 14 days, Washers within 14 days and M/S components within 14 days of ordering

It can be interpreted as procuring of Stator Frames is consuming more time and the company has to concentrate on this and should try to reduce the Lead time of procurement of Stator Frames. If lead time is high it’s indirectly effects to dispatching of goods and sales.

Calculations

Table shows the re order point of raw materials

ParticularsRe ordering point
Copper8000  (in KGs)
Stamping materials11662  (in KGs)
Stator frames600  units
CE & NC covers530 units
IP coils7800 units

 

 

 

Analysis

Above graph is showing the reordering of raw materials to the vendors. When copper reaches to the 8000Kgs , Stamping materials reaches 11662Kgs, Stator frames reaches 600 units, CE & NC reaches to 530 units and IP coils reaches to 7800 units. The company will go for re order.

Reordering point plays key role to maintain the stock in proper order to avoid the out of stock in the company.

Evaluation Of Inventory Management:

Inventory Conversion Period

YearInventorySales/365Days
2005-0652307640586849.3289
2006-0767776634657479.45103
2007-0898058000910684.93107
2008-20091250343201132054.8110
2009-1094469774938438.36100

 Analysis

The graph is showing that in 2005-06 inventory conversion period was 89 days. It was increasing in the 5 years study period. It shows that the stock retention period is on fluctuating trend.

Inventory Turnover Ratio

YearSalesInventoryRatio
2005-06214200000523076404.09
2006-07239980000677766343.54
2007-08332400000980580003.39
2008-20094132000001250343203.30
2009-10342530000944697743.63

 Analysis

Inventory turnover ratio is generally regarded as indicator of inventory efficiencies. It establishes a relationship between the total sales during a period and average inventory hold to meet that quantum. In 2005-06 it was 4.09 it shows very slow moving of inventory. But during the 5 years study period it was in decreasing trend.

Management Of Receivables

Trade credit, the tool which as a bridge for movement of goods through production and distribution stages to customer, is a force in the present day business and a essential device. Trade credit is granted with a motive of protecting the sale from ones, competitors and attaching more of the potential customers. Trade credit is said to be extended to a customer when a firm sell its services or goods and does not receive the payment for them immediately. Thus trade credit creates receivable which refer to the amount which a firm is expected to collect in near future.

Aspects of Credit Policy:

The important aspects of credit policy should be identified before establishing an optimum credit policy. The important decision variables of the credit policy are:

Credit terms are the conditions or stipulations under which the firm extends credit. The terms and conditions can be clubbed according to the period for which they are extended and according to the amount of discount offered thereby there are two important components of trade credit namely cash period and cash discounts. Credit terms can be effectively used as a tool to boost sales. The most desirable credit terms which increases the overall profitability of the firm, should be offered to the customers cost benefit trade off between credit terms should be done to choose the best one.
The time duration for which the credit is extended to the customers is referred to as credit period. Usually the credit period of the firm is governed by the industry norms, but firms can extend credit duration to stimulate its sales.
Cash discounts are the offer made by the firm to customer to pay less if the required amount is paid earlier. The cash discount terms indicate the rate of discount and the period for which discount has been offered. If the customer does not avail this offer, he is expected to make the payment by the due date.

The credit standards followed by the firm have an impact on sales and receivable. The sales and receivable levels are likely to be high if the credit standards of the firm are relatively loose. In contrast, if the firm has relatively tight credit standards, the sales and receivable are expected to be low. The credit standards are governed by various aspects such as the willingness of the customer to pay, the ability of the customer to pay in the economic conditions etc.

The need to collect the payments early gave rise to a policy regarding it, called as the collection policy. It aims at the speed recovery from slow payers and reduction of bad debts losses. The firm has to very cautious while it goes in for collection from slow payers. The various aspects such as willingness, capabilities, and external conditions should be taken care of before you go in collection procedure. The optimum collection policy will maximize the profitability and will be consistent with the objective of maximizing the value of the firm.

 Performance Evaluation Of Receivables Management

Average collection period explains how many days of credit, a company is allowing to the customer, a higher collection period indicates towards a liberal and inefficient credit and collection performances shorter the collection period the better the credit management and liquidity of accounts receivable.

Average collection period

YearDays
2005-0644
2006-0751
2007-0845
2008-0963
2009-1047

The above graph is showing that average collection period of receivable is in fluctuating trend during the 5 years study period. It was 63 days in the year 2008-09. It shows the collection period of receivable is too high. The collection period of debtors should be kept at lowest level for the reduction in cost of capital and better productivity

Management Of  Payables

A substantial part of purchase of goods and services in business are on credit terms rather than against cash payment. While the supplier of goods and services tends to perceive credit as a lever for enhancing sales or as a form of non-price instrument of competition, the buyer tends to look upon it as a loaning of goods or inventory. The supplier’s credit is referred to as Accounts payable, Trade Credit, Trade Bill, Trade Acceptance, commercial drafts of bills payable depending on the nature of the credit.

Determinants Of Trade Credit

Size of the firm:

Smaller firms have increasing dependence on trade credits as they find it difficult to obtain alternative sources of finance as easily as medium or large sized firms. At the same time, larger firms that are less vulnerable to adverse turns in business can command prompt credit facility from supplier, while smaller firms may find it difficult to sustain creditworthiness during periods of financial strain and may have reduced access to credit due to weak financial position.

Industrial Credits:

Different categories of industries or commercial enterprises show varying degree of dependence on trade credit

Nature of Product:

Products that sell faster or which have higher turnover may need shorter term credit. Products with slower turnover take longer to generate cash flows and will need extended credit terms.

Financial Position of Seller:

The financial position of the seller will influence the quantities and periods of credits he wishes to extend. Financially weak suppliers will have to be strict and operate on higher credit terms to buyers. Financially stronger suppliers, on the other hand, can dictate stringent credit terms but may prefer to extend liberal credit so long as the transactions provide benefits in excess of the costs of extending credit.

Financial position of the buyer:

Buyer’s creditworthiness is an important factor in determining the credit quantum and period. It may be logical to expect large buyers not to insist on extending credit terms for small suppliers with weak bargaining power. Where goods are supplied on a consignment basis, the supplier provides extra finance for the merchandise and pays commission to consignee for the goods sold.

Cash discounts:

Cash discount influences the effective length of credit. Failure to take advantage of the cash discount could result in the buyer using the funds at an effective rate of interest higher than the alternative sources of finance available.

Degree of risk:

Estimates of credit risk associated with the buyer will indicate what credit policy is to adopt the risk may be with reference to the buyer’s financial standing or with reference to the nature of the business the buyer is in.

 Evaluation of Payables Management

 Average Payment Period

YearDays
2005-0612
2006-0713
2007-0813
2008-0915
2009-1020

Table shows that the minimum average payment period is 12 days and maximum is 20 days. The payment period of creditors should be kept at highest level for the reduction in cost and better productivity Table reveals the increasing trend in average payment period which is good for the company.

Findings

  • The company is in a sound position regarding liquidity. In the 5 years study period its current ratio is over 2:1 and quick ratio is over 1:1.
  • The company uses ABC techniques to maintain its inventory efficiently and to get information about reordering point.
  • The inventory conversion period is too high of the company. It is in increasing trend. It is not good for the company.
  • Inventory turn over ratio is too high. It shows very slow moving of inventory.
  • The average collection period of receivable is too high. I t increases the cost of capital.
  • The average payment period of payables is too low. The company pays its payables too earlier.

Recommendation

  • The inventory conversion period is too high of the company. It is in increasing trend. The company should take possible initiatives to reduce its inventory conversion period.
  • The company should keep its inventory turnover ratio in a lower point.
  • To reduce cost of capital the company should take proper steps to keep receivable collection period in a lower point.
  • The company should take the advantages of deferral payments of payables.

Internship Experience

As an intern student of EasternUniversity I worked in Shakti Engineering Ltd. for three months limited period. In this limited period of time I have learned many things and most importantly it was the first introduction to the corporate world. I also learned

  • How to work in stressful situation as well as work with responsibilities.
  • How manage the time properly.
  • About the organizational behavior.
  • How to interact with the seniors and co-workers.
  • About the application of theoretical knowledge in real business environment.
  • How to keep records of different activities in a organization.

At sum up, I can say that the internship period was very inspiring for me.DXSC

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