A Reporton

of

Sultanate of Oman

Submitted by

R.Sasikumar

Course code : 406Register No: 32118

Enrollment No: 08008PF103

Under the Guidance ofProf. N. Aravindakshan

Submitted in partial fulfillment of the requirement

for the award of the degree of

ofM.G.UNIVERSITY

KOTTAYAM – KERALA

March – 2010

1

EXECUTIVE SUMMARY

This project is based on the study of working capital management in Arabian Industries LLC, An

insight view of the project will encompass – what it is all about, what it aims to achieve, what is its

purpose and scope, the various methods used for collecting data and their sources, including literature

survey done, further specifying the limitations of our study and in the last, drawing inferences from

the learning so far.

“Arabian Industries LLC” an Oman’s prestigious Engineering and Manufacturing Company; is a well

established engineering company. It is an Omani company which always maintained the highest

international standards of excellence through quality, technology and innovation. It has the ability to

provide the best in engineering and back up services for the petroleum and allied industries. The

company has ISO 9001-2000 certification and has executed projects in various Middle East countries.

It captured the various facets of the Oman economy in sectors ranging from maintenance,

manufacturing, fabrication and infrastructure, etc.

Working capital is the life-blood of all types of enterprises, manufacturing and trading both. It is

constantly required to buy raw materials for payment of wages and other day-to-day expenses.

Without adequate working capital, manufacturing operations will be crippled. It is a base on which all

the activities of business enterprise depend. The working capital management refers to the

management of working capital, or precisely to the management of current assets. A firm’s working

capital consists of its investments in current assets, which includes short-term assets— cash and bank

balance, inventories, receivable and marketable securities.

This project tries to evaluate how the management of working capital is done in Arabian Industries

LLC, through inventory ratios, working capital ratios, trends, computation of cash, inventory and

working capital, and short term financing. Working capital is primarily concerned with inventories

management, Receivable management, cash management & Payable management.

The objective of the company now is to increase the scale of its business by increasing its profits and

the turnover and also by venturing into new line of business. It is now targeting to be the World Class

Industrial Enterprise from the present status. It is striving to have a huge global base.

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AILLC/ADM/00101-2010 31ST March 2010

CERTIFICATE

This is to certify that Mr.Sasikumar.R. Register No.-32118 a IV th semester MBA student of

M.G.University - Kerala, has visited our Organization and conducted a study about it’s

Working Capital Management and he has successfully completed his Project works, during

the period from January to February 2010..

We wish all the best in his future endeavors.

Thanks with Regards,

Yours faithfully,

MaheshNair,

Finance Manager

Arabian Industries LLC.

CERTIFICATE3

This is to certify, that Mr. Sasikumar.R is a bonafide student of Polyglot Institute, Sultanate

of Oman, and is presently pursuing a Post Graduate Degree in Master of Business

Administration in Finance and marketing.

Under our guidance, he has submitted his project report titled “Working Capital

Management” of Arabian Industries LLC, in partial fulfillment of the requirement for the

summer internship project during the Post Graduate Degree in Master of Business

Administration studies.

This report has not been previously submitted as part of another degree or diploma of another

Business School or University.

Centre Co-Ordinator:

.

Place: Muscat, Sultanate of Oman

Date: 31st March 2010

DECLARATION

4

Prof. N. Aravindakshan

Dept. of Management

Polyglot Institute, Muscat,

Sultanate of Oman

Dr.K.Vijaya kumar

Polyglot Institute

I, Sasikumar.R., the undersigned, an MBA student of M.G.University, Kerala do

hereby declare that this report titled “Working Capital Management” of

ArabianIndustries LLC, under the guidance of Prof. N.Aravindakshan, Professor of

Finance and Accounting, Department of University Studies, Polyglot Institute, Sultanate of

Oman, submitted in partial fulfillment of the requirement for the summer

internship project during the Post Graduate Degree in Master of Business

Administration studies.

This is my original work and has not been previously submitted as a part

of another degree or diploma of another Business school or University.

The findings and conclusions of this report are based on my personal

study and experience, during the tenure of my summer internship.

Place: Muscat, Sultanate of Oman.

Date: 31st March 2010.

Counter signed:

Prof. N.Aravindakshan,

Dept. of University Studies,

Polyglot Institute,

Muscat, Sultanate of Oman.

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ACKNOWLEDGEMENT

I take this opportunity to thank various people, who all have helped me to complete successfully my

internship programme with a project at Arabian Industries LLC. I would like to express my gratitude

towards thanking the following people:

Prof. N.Aravindakshan: (Former Co-Ordinator, Institute of Management in Kerala, University of

Kerala, Kollam Centre:)

Prof. N Aravindakshan, guided me with his valuable suggestion. He was a source of

inspiration for me to complete the study and make this report on time and was instrumental in shaping

this report.

Dr.K Vijaya Kumar.(Centre Co-ordinator)

I am highly indebted to the centre co-ordinator Dr.. K.Vijaya Kumar, Department of Management

Studies for inspiring me and for his valuable guidance and assistance provided.

Mrs. Sindhu Divakaran

Mrs.Sindhu Divakaran, Faculty of Management Studies, Polyglot Institute, has also guided me with

her valuable suggestions and advice for making this report a good success.

Mr.P.O. Jabir - Operation Manager-Polyglot Institute, Sultanate of Oma,

I take this opportunity to express my sincere and whole hearted thanks to Mr.P.O.Jabir, Operation

Manager, and all the staff members of Polyglot Institute, Sultanate of Oman., for their tremendous

help and support during the period of my project study.

Mr. Mahesh Nair

I express my sincere gratitude to Mr.Mahesh Nair-Manager Finance-Arabian Industries LLC, for the

valuable advice and guidance extended to me for the completion and shaping of the dissertation.

Mr.Abdulkhadar Padiyath,

I wish to extend my sincere thanks to Mr.Abdulkhader Padiyath (Manager Finance -(Assistant), for

His help and support in shaping this report.

I also extend my sincere gratitude to all employees of Arabian Industries LLC, for their kind co-

operation and support for the completion of this report.

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TABLE OF CONTENTS

1. Executive Summary

2. Certificate from organization

3. Certificate from Guide

4. Declaration

5. Acknowledgement

6. List of Tables and Chart

Chapter No: Page No.

1. Introduction 1

1.1 Background of the study 2

1.2 Statement of Problem 3

1.3 Need and Importance of the study 3

1.4 Objectives of the study 4

1.5 Hypothesis 5

1.6 Methodology 5

1.7 Limitations of the study 8

1.8 Chapterization- 8

2 Manufacturing Industry in Oman-A Profile 9

2.1 Introduction 10

2.2 Present Scenario 10

2.3 Foreign Investment 12

2.4 Oman Economy – A Review 13

2.5 Major Diversification 14

2.6 Manufacturing industry in Oman 15

2.7 Infrastructure Industry for Crude Oil 15

2.8 Aim of Mfg. Industry inOman 16

2.9 The Scope of Oil and Gas Industry 17

3 A profile of Arabian Industries LLC 18

3.1 Introduction 19

3.2 Industry Profile 20

3.3 Subsidiary and Joint Venture 21

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3.4 Mission and Vision 24

3.5 Objectives and Goals 28

3.6 Product and Project Profiles 31

3.7 Financial Highlights 35

3.8 Literature Review 44

4 A Theoretical Perspective of Working Capital Management 50

4.1 Introduction 51

4.2 Need of Working Capital 56

4.3 Concept of Working Capital 56

4.4 Classification of Working Capital 59

4.5 Determinants of Working Capital 61

5 Research Methodology 65

5.1 Introduction 66

5.2 Scope of the Study. 67

5.3 Type of Data Collection 67

5.4 Objective of the Study 68

5.5 Scope and Limitation of the Study 69

6 Working Capital Level and Analysis 71

6.1 Working Capital Level 72

6.2 Working Capital Trend Analysis 73

6.3 Current Asset Analysis 76

6.4 Current liability Analysis 79

6.5 Changes of Working Capital 80

6.6 Operating Cycle 83

6.7 Working Capital Leverage 90

7 Analysis of Financial Statements 92

7.1 Introduction 93

7.2 Role of Ratio Analysis 93

7.3 Limitations of Ratio Analysis 94

7.4 Classification of WC Ratio 94

7.5 Efficiency Ratio 95

7.6 Liquidity Ratio 102

8

8 Working Capital Management-Finance and Estimation 109

8.1 Introduction 110

8.2 Receivables Management 110

8.3 Inventory Management 120

8.4 Cash Management 118

8.5 Working Capital – Finance and Estimation 124

8.6 Source of Working Capital 125

8.7 Estimation of working capital 128

9 Summary of Findings, Conclusion and Suggestions 130

9.1 Findings 131

9.2 Conclusions 132

9.3 Suggestions 133

BIBLIOGRAPHY

ABBREVIATION

9

LIST OF TABLES, AND FIGURES .

Sl. No. Description/name of the Table Table No. Page No.

1 Business Unit wise Performance-FBU 3-1 36

2 Business Unit wise Performance-MBU-TSU 3-2 36

3 Business Unit wise Performance-PDU 3-3 37

4 Business Unit wise Performance-EMU 3-4 37

5 Division Wise Performance 3-5 38

6 Financial Performance 3-6 38

7 Financial Summary 3-7 39

8 Cash Flow Analysis 3-8 41

9 Five Year Planned Turnover 3-9 41

10 Business Plan 3-10 43

11 Capital Expenditure 3-11 43

12 Size of Working Capital 6-1 72

13 Working Capital - Variance 6-2 74

14 Working Capital-size 6-3 74

15 Analysis of Current Asset and Liabilities 6-4 76

16 Current Asset - Size 6-5 76

17 Composition of Current Asset 6-6 77

18 Current Liabilities 6-7 79

19 Changes in Working Capital 6-8 82

20 Operating Cycle 6-9 89

21 Working Capital leverage 6-10 91

22 Working Capital Turnover Ratio 7-1 95

23 Inventory turnover 7-2 98

24 Debtors Turnover 7-3 100

25 Current Asset Turnover 7-4 101

26 Current Ratio 7-5 104

27 Quick Ratio 7-6 106

28 Absolute Liquid Ratio 7-7 108

29 Size of Receivable 8-1 111

30 Average Collection Period 8-2 112

31 Size of Inventory 8-3 115

32 Components of Inventory 8-4 115

33 Inventory turnover Ratio 8-5 117

34 Inventory Holding Period 8-6 117

35 Size and Index of Cash 8-7 121

36 Operating Cycle 8-8 123

37 Cash Conversion Cycle 8-9 127

38 Estimation of Working Capital 8-10 128

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LIST OF GRAPHS

Sl. No. Description-Name of Charts Chart No Page No.

1 Performance Review-FBU 3-1 36

2 Performance Review-MBU-TSU 3-2 36

3 Performance Review-PDU 3-3 37

4 Performance Review-EMU 3-4 37

5 Finance Performance- 3-5 39

6 Financial Summary 3-6 40

7 Cash Flow Analysis 3-7 41

8 Permanent Working Capital 4-1 59

2 Temporary Working Capital 4-2 60

9 Working Capital Index 6-1 73

10 Current Asset Index 6-2 77

11 Current Asset Component 6-3 78

12 Current Liability Index 6-4 79

13 Changes in Working Capital 6-5 82

14 Net Operating Cycle 6-6 89

15 Working Capital Leverage 6-7 91

16 Working Capital Turnover Ratio 7-1 96

17 Inventory Turnover Ratio 7-2 97

18 Receivable Turnover Ratio 7-3 100

19 Current Asset Turnover Ratio 7-4 101

20 Current Ratio 7-5 104

21 Quick Ratio 7-6 106

22 Cash and Bank to Current Liabilities 7-7 108

23 Receivable Index 8-1 111

24 Average Collection Period 8-2 112

25 Inventories Index 8-3 115

26 Components of Inventories 8-4 116

28 Inventory Turnover Ratio 8-5 117

29 Inventory Holding Period 8-6 118

30 Cash Index 8-7 121

31 Cash Conversion Cycle 8-8 123

12432 Cash Conversion Cycle 8-9 127

33 Estimation of Working Capital-2010 8-10 129

11

LIST OF DIAGRAMS

Sl. No Descriptions Page No.

1 Structure of Arabian Industries LLC 19

2 Corporate Objectives 28

3 AI LLC-Holding Company Structure 40

2 Determinants of Working Capital 64

6 Research Methodology 66

7 Research Methodology – Data to Action 70

8 Operating Cycle 84

9 Working Capital Cycle 87

10 Cash Conversion Cycle 122

12

13. BIBLIOGRAPHY

BOOKS REFERRED

1) Banarjee.A.K., Nair.R.K., Agarwal. V.K. – Organisational Behaviour

(2007) – Pragathi Publishers – Meerut

2) Gupta.R.L – Advanced Accountancy

(2006) – Sultan Chand and Sons

3) Khan M.Y. Jain P.K. – Financial Management

(2008) – Tata Mc Graw Hill Publishers – New Delhi

4) Maheshwari.Dr.S.N. – Management Accounting and Financial Control

(2006) – Sultan Chand and Sons – new Delhi

5) Maheshwari.Dr.S.N - Accounting for Management

(2005) – Sultan Chand and Sons

6) Pandey.I.M – Financial Management

(2008) – Vikas Publishing House – New Delhi

7) Sharma.R.K., Shashi K Gupta - Business Management

(2008) – Kalyani Publishers – Ludhiana.

REPORTS REFERRED

Financial Statement – (Annual Report for 2009)

Company Journals – Arabian Industries LLC.

Main Economic and Social Indicators – 2009 - Ministry of National Economy – Sultanate of

Oman.

13

AB breviation

AI LLC Arabian Industries LLC

AIM LLC Arabian Industries Manufacturing LLc

AIP LLC Arabian Industries Project LLC

AITS LLC Arabian Industries Technical Support LLC

APO Account Payable Outstanding

ARO Account Receivable Outstanding

BUH Business Unit Head

CCC Cash Conversion Cycle

CFO A US Magazine

CNC Computed Numerically Controlled

COO Chief Operating Officer

CPP Creditors payment Period

DCP Debtors Conversion Period

DSS Decision Support System

EPC Engineering, Procurement and Construction

FGCP Finished Goods Conversion Period

GCC Gulf Co-Operation Council

GOC Gross Operating Cycle

GWC Grows Working Capital

ICP Inventory Conversion Period

IOD Inventory Over Days

LLC Liability Limited Company

MBU Manufacturing Business Unit

MD Managing Director

NWC Networking Capital

PBU Project Business Unit

PDO Petroleum Development Oman

PWC Permanent Working Capital

QAQC Quality Assurance and Quality Control

RCP Receivable Conversion Period

RMCP Raw Material Conversion Period

TOR Turn Over Ratio

TWC Temporary Working Capital

WCC Working Capital Cycle

WCM Working Capital Management

WIPCP Work in Progress Conversion Period

14

15

CHAPTER - I

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1-BACKGROUND OF THE STUDY

2-STATEMENT OF PROBLEM

3-OBJECTIVES OF THE STUDY

4-HYPOTHESIS

5-METHODOLOGY

6-LIMITATIONS OF THE STUDY

7-STRUCTURE OF THE WORKS.

1.1 BACKGROUND OF THE STUDY.

“ THE MAJOR OBJECTIVE OF THIS STUDY IS FOR THE PROPER UNDERSTANDING OF THE WORKING CAPITAL OF ARABIAN INDUSTRIES LLC AND TO SUGGEST NECESSARY MEASURES TO OVERCOME THE SHORTFALLS IF ANY IN THE INDUSTRY. ”

The project undertaken is on “Working Capital Management of Arabian Industries LLC.”. It describes

about how the company manages its working capital and the various steps that are required in the

management of working capital. Cash is the lifeline of a company. If this lifeline deteriorates, so does

the company's ability to fund operations, reinvest and meet capital requirements and payments.

Understanding a company's cash flow health is essential to making investment decisions. A good way

to judge a company's cash flow prospects is to look at its Working Capital Management (WCM).

Working capital refers to the cash of a business requires for day-to-day operations or, more

specifically, for financing the conversion of raw materials into finished goods, which the company

sells for payment. Among the most important items of working capital are levels of inventory,

accounts receivable, and accounts payable. Analysts look at these items for signs of a company's

efficiency and financial strength.

The working capital is an important yardstick to measure the company’s operational and financial

efficiency. Any company should have a right amount of cash and lines of credit for its business needs

at all times. This project describes how the management of working capital takes place at Arabian

Industries LLC..

There are numerous instances in the history of business world where inadequacy of working capital

has led to business failures when a firm finds it difficult to meetings day to day affairs. Operating

expenses essential out lays may have to be postponed for want of funds, operating plans will go out of

gear & enterprise objectives on investment slumps the suppliers & creditors of the firm may have to

wait longer to raise their dues & will hesitate to extend further credit to the firm.

Thus efficient management of working capital in an important prerequisite for successful working of a

business concern it reduces the chances of business failure generates a felling of security and

confidence in the minds of personnel in the organization it assurance solvency of steady of the

organization.

1.2 STATEMENT OF PROBLEM

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In the management of working capital, the firm is faced with two key problems:

1. First, given the level of sales and the relevant cost considerations, what are the optimal amounts of

cash, accounts receivable and inventories that a firm should choose to maintain?

2. Second, given these optimal amounts, what is the most economical way to finance these working

capital investments? To produce the best possible results, firms should keep no unproductive assets

and should finance with the cheapest available sources of funds. Why? In general, it is quite

advantageous for the firm to invest in short term assets and to finance short-term liabilities.

Besides this followings are some other problem , a firm is facing. Through this study we try to find

answer for these problems.

1. What are root causes of working capital on business?

2. What are the major effects on accounts receivable?

3. What is the nature of relationship between working capital and capital employed

4. What steps should be taken to ensure that it effect on the profit of the firm will not be

negative?

5. How can working capital be managed?

6. What make up the working capital cycle?

7. How can debtors be controlled?

1.3 NEED AND IMPORTANCE OF THE STUDY.

1.This projects is helpful in knowing the companies position of funds maintenance and setting the

standards for working capital inventory levels, current ratio level, quick ratio, current asset turnover

level & size of current liability etc.

2. This project is helpful to the managements for expanding the dualism & the project viability &

present availability of funds.

3. This project is also useful as it combines the present year data with the previous year data and there

by it show the trend analysis, i.e. increasing fund or decreasing fund.

4. The project is done as a whole entirely. It will give overall view of the organization and it is useful

in further expansion decision to be taken by management.

1.4 OBJECTIVES OF THE STUDY

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The main objective of the study is to determine the effect of working capital on business profitability

which has to do with:-

1. Maintenance of working capital at appropriate level, and

2. Availability of ample funds as and when they are needed

To accomplishment of these two objectives, the management has consider the composition of current

assets pool. The working capital position sets the various policies in the business with respect to

general operations like purchasing, financing, expansion and dividend etc,

The subsidiary Objective of Working Capital Management is to provide adequate support for the

smooth functioning of the normal business operations of a company. This Objective can be sub-

divided into 2 parts:-

1. Liquidity

2. Profitability

1) Liquidity

The quantum of Investment in Current Assets has to be made in a manner that it not only meets the

needs of the forecasted sales but also provides a built in cushion in the form of safety stocks to meet

unforeseen contingencies arising out of factors such as delays in arrival of Raw Material, sudden

spurts in demand etc. Consequently, the investment in current assets for a given level of forecasted

sales will be higher if the management follows a conservative attitude than when it follows an

aggressive attitude. Thus, a company following a conservative approach is subject to a lower degree

of risk than the one following an aggressive approach. Further, in the former situation the high

amount of Investment in Current Assets imparts greater liquidity to the company than under the latter

situation wherein the quantum of investment in Current Asset is less. This aspect exclusively covers

the liquidity dimension of Working Capital.

2) Profitability

Once we recognize the fact that the total amount of financial resources at the disposal of a company is

limited and these can be put to alternative uses, the larger the amount of investment in current assets,

the smaller will be the amount available for investment in other profitable avenues at hand with the

company. A conservative approach in respect of Investment in Current Assets leaves fewer amounts

for other Investments than an aggressive approach does.

1.5 HYPOTHESIS

19

Hypothesis is a conjectural statement of the relationships between two or more variables. It is testable,

tentative problem explanation of the relationship between two or more variables that create a state of

affairs or phenomenon.E,C, Osuola said hypothesis should always be in declarative sentence form,

and they should relate to them generally or specially variable to variables.

Hypothesis thus:-

1. Explain observed events in a systematic manner

2. Predict the outcome of events and relationships

3. Systematically summarized existing knowledge.

In essence, there exist null hypothesis set up only to nullify the research hypothesis and the alternative

hypothesis, for the purpose of the study. For the efficiency of the study, the hypothesis is as follows:

H 0

1. Working capital does not help the business concern in maintaining the goodwill

2. Working capital does not create an environment of security, confidence, and overall

efficiency in a business

H 1

1. Working capital helps the business concern in maintaining the goodwill.

2. Working capital creates an environment of security, confidence, and overall efficiency in business.

1.6 METHODOLOGY

Methodology may be a description of process, or may be expanded to include a philosophically

coherent collection of theories, concepts or ideas as they relate to a particular discipline or field of

inquiry. This project requires a detailed understanding of the concept – “Working Capital

Management”. Therefore, firstly we need to have a clear idea of, what is working capital, how it is

managed in Arabian Industries LLC, what are the different ways in which the financing of working

capital is done in the organization etc.

20

To recognize the various type of information which are necessary for the study of working capital

management.

The management of working capital involves managing inventories, accounts receivable and

payable and cash. Therefore one also needs to have a sound knowledge about cash

management, inventory management and receivables management.

Then comes the financing of working capital requirement, i.e. how the working capital is

financed, what are the various sources through which it is done.

And, in the end, suggestions and recommendations on ways for better management and

control of working capital are provided.

Collection of data from various department of AILLC to analyze the working capital management of

the firm.

1.6.1 COLLECTION OF DATA

There are several ways of collecting both data-Primary and Secondary datas, which differ

considerably in context of money, cost, time and other sources at the disposable of the researcher.

There are two types of data:

· Primary data

· Secondary data

1-Primary Data

Definition:-

The first handed information/Fresh data collected through various methods is known as primary data.

In respect of primary data which the researchers are directly collects data that have not been

previously collected.

The primary data was gathered through personal interaction with various functional heads and other

technical personnel. Some information was also collected by observation.

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2-Secondary Data :

Definition:-

The data which have been already collected & comprised for another purpose. Secondary data

was collected various reports, annual reports, documents charts, management information systems, etc

in AI LLC, And also collected various magazines, books, newspapers etc.

The analysis of the information gathered has been made on the basis of the clarifications sought

during the personal discussions with the concerned people and perception during the personal visits to

the important areas of services.

In marking observations identifying problems and suggesting certain remedies such emphasis was

given on the basis of opinions gathered during the personal discussions and with the personal

experience gained during the academic study of M.B.A course.

1.6.2 TOOLS EMPLOYED

The data presentation tools are mainly mathematical tools, Tables and Charts are used for this study.

The most important parts of tools include;

a) Table numbers

b) Title of the table

c) Caption

d) Stub or the designation of the rows and columns

e) The body of the table

f) The head note or prefatory note or explanatory just before the title.

g) Source note, which refers to the literally or scientific source of the table has observed that a

table has the following merits over a prose information that;

h) A table ensures an easy location of the required figure;

i) Comparisons are easily made utilizing a table than prose information;

j) Patterns or trends within the figures which cannot be visualized in the prose information can

be revealed and better depicted by a table; and a table is more concise and takes up a less

space than a prose formation:

1.6.3 TIME SPAN

A period of six year i.e. 2004-2009 has been taken for the study.

22

1.7 LIMITATIONS OF THE STUDY.

The following are the various limitations involved in the study.

.

1. The study in limited 4 years (2004-2005) to (2005-2006) performance of the company.

2. The data used in this study have been taken from published annual report only.

3. This study in conducted within a short period. During the limited period the study may not be

retailed, full fledged and utilization in all aspects.

4. Financial accounting does not take into account the price level changes.

5. We cannot do comparisons with other companies unless and until we have the data of other

companies on the same subject.

6. Only the printed data about the company will be available and not the back–end details.

7. Future plans of the company will not be disclosed to us.

8. Lastly, due to shortage of time it is not possible to cover all the factors and details regarding the

subject of study.

1.8 CHAPTERIZATION

This research work is to be organized in nine chapters as follows:

Chapter – 1 - Introduction

Chapter-II - Manufacturing Industry in Oman – A profile

Chapter-III - Arabian Industries LLC-A Profile

Chapter-IV - A Theoretical Perspective of Working Capital Management

Chapter – V - Research methodology

Chapter VI - Analysis of Working Capital Level

Chapter VII - Analysis of Financial Statement

Chapter – VIII - Management of working capital and it’s Financing and Estimation

Chapter – IX - Findings, Conclusion and Recommendations

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CHAPTER – II

2.1 OMAN PETROLEUM INDUSTRY - INTRODUCTION

24

1-Introduction

2-Present Scenario

3-Foreign Investment

4-Oman Economy

5-Major Diversification

6-Oman Industry- An over view

7-ManufacturingIndustry in Oman

8-The Scope of Oil and Gas Industry.

Oman's petroleum deposits were discovered in 1962, decades after most of those of its neighbours.

Moreover, Oman's oil fields are generally smaller, more widely scattered, less productive, and more

costly per barrel than in other Persian Gulf countries. The average well in Oman produces only around

400 barrels per day (bbl/d), about one-tenth the volume per well of those in neighboring countries. To

compensate, Oman uses a variety of enhanced oil recovery (EOR) techniques. While these raise

production levels, they increase the cost.

According to the 2008 BP Statistical Energy Survey, Oman had proved oil reserves of 5.572 billion

barrels at the end of 2007, the bulk of which are located in the country's northern and central regions.

The largest and traditionally most reliable fields are in the north. These fields, which include Yibal

(the biggest), Fahud, al-Huwaisah, and several others, are now mature and face future declines in

production. In spite of declining production, Oman remains a significant non-

OPEC oil exporter. According to the 2008 BP Statistical Energy Survey, Oman produced an average

of 717.8 thousand barrels of crude oil per day in 2007, 0.9% of the world total and a change of -4.6 %

compared to 2006./P> /P>Oman exports significant amounts of liquefied natural gas and, according to

the 2008 BP Statistical Energy Survey, had 2007 proved natural gas reserves of 0.69 trillion cubic

metres and 2007 natural gas production of 24.1 billion cubic metres./P> .

2.2 PETROLEUM INDUSTRY – PRESENT SCENARIO.

The petroleum industry forms the backbone of Oman's economy. Over the past three decades, the oil

reserve has helped the Sultanate move from strength to strength economically. But can Oman depend

wholly on its natural resources or it needs to diversify into other areas to sustain and bolster its

economy is an important question mark.

25

The oil price slump in 1998-99 forced Oman to take steps to diversify and put greater emphasis on

other industries, such as tourism and liquid natural gas. Oman's Basic Statute of the State expresses in

Article 11 that "The National Economy is based on justice and the principles of a free economy."

Recent official statistics reveal that the oil sector's share in the GDP has risen to 49 per cent in 2005

from 42.2 per cent in 2004. According to the 2006 annual report of the Central Bank of Oman (CBO),

"The fiscal position remained strong in 2005, with the fiscal recording a surplus of about 2.6 per cent

of GDP. As against a budgeted deficit of RO540 million in 2005, there was a net surplus of RO303

million."

Revenues from the petroleum sector rose 44.3 per cent in 2005. Non-oil revenues rose 9.2 per cent,

driven by a strong 17.8 per cent growth in non-oil industrial activities. The average price of Omani

crude was about US $50.26 per barrel in 2005, representing a 46 per cent rise over the average price

of US $34.42 in 2004. As a result, the share of oil and gas sector in the GDP, exports and net

government revenue rose to 49 per cent, 84.2 per cent and 79 per cent, respectively, in 2005. After a

period of subdued inflation, 2004 saw signs of minor rise in prices, which persisted in 2005.

Consumer price inflation rose from 0.7 per cent in 2004 to 1.9 per cent in 2005. But the Sultanate's

inflation at 2.3 per cent was still lower than the average inflation in advanced countries in 2005.

A VIEW OF OIL DRILLING AREA

A close look at the June 1995 “Vision Conference: Oman 2020” reveals that a lot of strategic planning

went into the formulation of initiatives aimed at securing Oman's future prosperity and growth. These

include:-

26

To have economic and financial stability.

To reshape the role of the government in the economy and to broaden private sector

participation.

To diversify the economic base and sources of national income.

To globalise the Omani economy.

To upgrade the skills of the Omani workforce and develop human resources.

It is expected that by 2020 the economy will not be reliant on oil, but rather diversified into non oil

sectors, raising higher levels of savings and investments. Studies reveal that the crude oil sector's

share of GDP is estimated to drop to 9 per cent in 2020, compared with 41 per cent in 1996. Also, the

gas sector is expected to contribute around 10 per cent to GDP, compared with less than 1 per cent in

1996, while the non-oil industrial sector's contribution is expected to increase from 7.5 per cent to 29

per cent.

2.3 INCENTIVES FOR FOREIGN INVESTMENT

In a bid to reinforce the existing set-up as well as make room for further development in the

petroleum sector, the government has undertaken a string of measures to provide incentives to foreign

investors. These include:

1. Tax exemption for five years (sometimes renewable for a further five years) for industrial

enterprises which contribute to Oman's economy.

2. Foreign investors allowed to hold 49 per cent of equity, which could be increased in

mitigating circumstances.

3. Concessional financing may be arranged through the Ministry of Commerce and Industry and

Oman Development Bank.

4. A clear and efficient legal network which offers advice on company law, copyright law,

arbitration and agency law.

5. A diverse economy which encourages privatisation of infrastructure and services.

6. Price stability, with an inflation rate of not more than 1 per cent since 1992.

7. Stable currency with full convertibility.

8. No personal income tax and no foreign exchange controls.

9. Tax and import duty exemptions.

10. Interest-free long-term loans to partly foreign-owned industrial and tourism projects.

27

Foreign business participation in Oman is encouaged provided the company is established in

accordance with the Foreign Business and Investment Law of 1974. Foreign companies are formed as

an incorporation of a local company or other commercial entity. They may also exist as a branch

office, a consultancy or by appointing a commercial agent, ensuring that the company only supplies

services and/or goods to be imported into the Sultanate.

PDO – HEAD QUARTERS

Airline and shipping offices as well as companies with occasional business are not governed by the

Foreign Business and Investment Law. Potential businesses should supply the company's articles of

incorporation and other pertinent information when applying for authorisation to the Foreign Capital

Investment Committee at the Ministry of Commerce and Industry.

2.4 OMAN ECONOMY AND PETROLEUM INDUSTRY – A REVIEW

According to the CBO annual report, the improved macroeconomic environment has been reflected in

the upgrading of the Sultanate's rating by Moody's from Baa2 to Baa1 in October 2005. In January

2006, Standard and Poor's also reaffirmed their local and foreign currency sovereign credit ratings for

Oman at "A-/A-2" and "BBB+/A-2", respectively, with a "stable" outlook. It may be noted that the

government debt as a percentage of GDP continued to decline and, by the end of 2005, fell to 8.6 per

cent.

The most striking aspect of the developments in the banking system in 2005 relates to the surge in

profits. Net profits of banks rose from RO79.4 million in 2004 to RO123.2 million in 2005 while net

foreign assets of commercial banks rose by 127.9 per cent, from RO256.6 million in 2004 to RO584.9

million in 2005.The current account (comprising trade, services, income and transfers) showed a

surplus of RO1813 million in 2005 as against RO219 million in 2004. The trade account, reflecting

the excess of export earnings over merchandise imports, showed a high surplus of RO4100 million in

2005 as against a surplus of RO2118 million in 2004.

28

The nominal GDP, exports and government revenue are expected to benefit further from the

favourable oil price scenario in 2006. This favourable phase provides an opportune time to use the

surplus oil revenue in diversifying the economy. Greater openness to trade and foreign investment,

phased implementation of the privatisation programme of the government, and reversing the declining

trend in oil production will help strengthen the growth impulses in the economy.

In 2002, the petroleum ministry took big steps to encourage international companies to invest in

abandoned concession onshore and offshore areas. Oil and Gas Minister Dr. Mohammed Bin Hamad

al-Rumhi had then called on Petroleum Development Oman (PDO) and international companies

operating in oil and gas exploration and production to continue their efforts to discover new fields and

improve extracting methods and techniques.

The minister upheld his ministry's resolve to provide necessary infrastructure and the government

constructed three pipelines to transport gas from the central region to Sur, Sohar and Salalah for

existing industrial estates and power plants.

The transported gas was to be used to operate power plants in Salalah and Barka, and petrochemical,

aluminum, cement factories, oil refinery and other industries in Sohar and Raysut industrial estates.

With the new infrastructure in place, the scene has improved significantly. Foreign investors are now

keen on joint ventures in these regions.

2.5 ECONOMY ON THRESHOLD OF MAJOR DIVERSIFICATION

When His Majesty Sultan Qaboos Bin Said assumed power in 1970, he embarked on his vision of

putting the Sultanate on a progressive path of making the country economically stable. He left the

doors open for other countries to join hands with the local government in constructing Oman into a

nation that would stride comfortably into the 21st century.

In his zeal for economic development and modernization, he launched a programme to built and

expand the country's almost non-existent infrastructure. As the 70s rolled on, the country achieved

substantial progress in developing physical and social infrastructure. New roads, a new deepwater

port, an international airport, electricity-generating plants, schools, hospitals and low-cost housing

were built from money that came exclusively from oil receipts.

29

2.6 THE MANUFACTURING INDUSTRY - AN OVERVIEW

The manufacturing sector is part of the goods-producing industries super sector group. The

Manufacturing sector comprises establishments engaged in the mechanical, physical, or chemical

transformation of materials, substances, or components into new products. Establishments in the

Manufacturing sector are often described as plants, factories, or mills and characteristically use

power-driven machines and materials-handling equipment. However, establishments that transform

materials or substances into new products by hand or in the worker's home and those engaged in

selling to the general public products made on the same premises from which they are sold, such as

bakeries, candy stores, and custom tailors, may also be included in this sector. Manufacturing

establishments may process materials or may contract with other establishments to process their

materials for them. Both types of establishments are included in manufacturing.

. The manufacturing industry - the powerhouse driving many economies - has been reeling under the

most challenging time in its history. Manufacturers are striving to be more innovative, compete

globally, and expand and market their products to emerging markets worldwide. Intense pressure to

reduce costs and the need to effectively manage a complex supply chain have manufacturers shifting

their production bases and spreading out operations well beyond their home grounds. This course

provides an overview of the manufacturing industry. It first examines the state of affairs in the

manufacturing industry, including its subsectors, key players, and trends. The course then reflects on

the main issues and challenges facing the industry, and, finally, it examines strategic solutions that

successful companies are employing to overcome these challenges.

2.7 INFRASTRUCTURE INDUSTRY FOR CRUDE AND GAS EXPLOITATION

The depletion of the sultanate's crude oil reserves accelerated the government's bid to increase the use

of gas in electric power generation and industry. In the early 1970s, the sultanate began to use gas in

electric power generation. Gas pipelines were laid, and generators were converted from diesel to gas.

This was done in the Muscat metropolitan area just before the second oil price shock despite

resistance by importers of diesel. Plans were to increase gas use by extending the government gas grid

linking the south and the east to the north. Power generation facilities north of Muscat in 1992 were

using gas as a feedstock, and plans were to increase gas-fired units elsewhere. Although the

government has promoted the industrial use of gas, oil firms remain the principal consumers, using a

total of 8.5 million cubic meters per day of associated gas. Gas is required for re-injection,

compression fuel, and power generation to support facilities at producing fields.

30

This is likely to continue in the short term, given the slow pace of switching industrial use from

petroleum. The government's focus in the 1990s on exploiting natural gas reserves and increasing

output to meet rising demand complements its priority in maintaining current oil output levels. It

seeks to do this without depleting crude reserves by using gas produced in association with oil output

for reinjection at mature fields to increase production and, by substituting gas for oil, to release

greater volumes of crude oil for export.

OFFSHORE OIL RIG

The Sultanate’s industrial strategy is multi-pronged. Besides utilising locally available natural

resources such as oil, gas and minerals, it aims at diversification of products for local consumption as

well as exports. While industrial projects based on fossil fuels and their derivates provide tremendous

impetus to the economic development of a country, small and medium units play a supportive but

significant role in the industrialization process. Mega projects like oil refineries and their downstream

industries and steel mills require massive investments whereas medium and small units could be set

up with less capital in areas where indigenously available resources could be made use of.

2.8 THE AIM OF THE MANUFACTURING INDUSTRY IN OMAN.

To achieve an average annual growth of 14,3 % in domestic product of manufacturing

industry.

To increase the manufacturing industry exports at an annual average growth rate of 18, 2%.

To achieve regional equilibrium in industrial development.

To transfer and domesticate foreign and local capital in the industrial sector.

To develop educational syllabus and introduce industry subject for trade orientation with its

different aspects as a basic subject in all educational stages.

To reduce cost of the industrial production and develop the competitiveness of industrial

products.

To provide the infrastructure services of the industry.

31

Despite a sharp fall in average oil prices in 2009, the Omani govt. has managed to keep it’s fiscal

amount close to balance. Oman’s economy has navigated through the global economic crisis in

relatively good shape. Although country’s real non oil growth fell sharply in 2009, it remained in

positive territory. Oman’s financial sector was less affected by the global economic crisis and the

countries modest level of indebtedness has limited it’s external vulnerability.

2.9 THE SCOPE OF OIL AND GAS INDUSTRY IN OMAN – AN OVERVIEW

The continued growth in demand and an industry struggling to meet this voracious demand have

pushed oil prices to an all-time high. Big oil companies, even while investing heavily in exploration,

technology, operational improvement, and research and development, are still left with huge surpluses

in an industry so far known only as a modest return. In reality, there has never been a more

challenging time for the oil and gas industry. While oil companies face tough challenges in finding

new sources of oil and gas to replace the old ones, the emerging oil demand and supply equation

renders some of the world's most powerful nations increasingly dependent on some of the world's

most unstable regions.

As a result, companies are applying advanced technologies and improved processes to meet growing

demand, as well as working to keep abreast of the constantly shifting geopolitical landscape so critical

to success in this sector. This course provides a high-level view of the industry environment,

including its scope and structure, and navigates learners through relevant business and regulatory

issues. Also examined are the forces shaping this industry, its key players, business drivers and

challenges, and the strategic solutions for these challenges? A report on the state of affairs in the oil

and gas industry and analysis based insights are also presented. The overall purpose of this course is

not to make learners industry experts, but to help them get a feel of the industry and learn some of the

winning strategies the key players are successfully applying.

CRUDE OIL DRILLING

32

CHAPTER - III

3.1 INTRODUCTION TO ARABIAN INDUSTRIES LLC

33

1-Introduction

2-Industry Profile

3-Subsidiary and Joint Venture

4-Mission and Vision

5-Objectives and Goals

6-Product and Project Profiles

7-Financial Highlights

8-Literature Review

Arabian Industries LLC is a leading engineering company catering to the needs of the energy sector

for the MENA region. It has facilities and expertise to meet the varied client needs of the Oil/Gas and

other energy sectors in the production, Processing and delivery phases. Started in 1991 in The

Sultanate of Oman, they have grown steadily and won many accolades and appreciations. The most

prestigious achievement is the Year 2008 “His Majesty Cup award for best five factories”. Their

commitment to the job, quality of work, earnestness to provide Total Solutions and desire to surpass

client expectations has consistently earned repeat business from their esteemed clients. These qualities

enable them to compete in international markets and succeed.

Arabian Industries LLC – Company Structure

“Arabian Industries LLC” is an Oman’s Prestigious Engineering and Manufacturing Company;

established in the year 1991, is a well established engineering company. It is 100% Omani company

Arabian Industries LLC

(Holding Company)

Arabian IndustriesProject LLC

Arabian IndustriesManufacturing LLC

Arabian IndustriesTechnical Support LLC

Arabian Industries Joint Venture

34

which always maintained the highest international standards of excellence through quality, technology

and innovation. It has the ability to provide the best in engineering and back up services for the

petroleum and allied industries. The company has ISO 9001-2000 certification and has executed

projects in various Middle East countries. It captured the various facets of the Oman economy in

sectors ranging from maintenance, manufacturing, fabrication and infrastructure, etc.

“Arabian Industries LLC and its subsidiaries are committed to become one of the leading companies

providing complete solutions to the energy sector by enhancing customer satisfaction, strengthening

employee & supplier relations and continually improving its product & services through the Quality

Continuous Improvement, Enhancing Employees Safety, Providing proper resources & suitable

working environment, achieving national development and improving profitability and budget”.

3.2 PROFILES OF ARABIAN INDUSTRIES LLC.

Arabian Industries LLC is a leading engineering company catering to the needs of the energy sector

for the MENA region with active participation in Oman’s Hydrocarbon, Petrochemical and Energy

Sector industries. .. Started in 1991 in The Sultanate of Oman, they have grown steadily and won

many accolades and appreciations. Arabian Industries LLC clientele include all major operating

companies in Oman including Petroleum Development Oman /Shell, Oman Gas Company, Occidental

of Oman, Occidental Mukhaizna, Oman Refinery and other Omani Oil, Gas, Water and Process

Sector clients.

The Company posted a growth of approximately 200% during the period from 1991 to 2009 and is

currently rated one of the leading EPC Contractors in the Region. Their commitment to the job,

quality of work, earnestness to provide Total Solutions and desire to surpass client expectations has

consistently earned repeat business from their esteemed clients. These qualities enable them to

compete in international markets and succeed.

Arabian Industries LLC, is currently executing a number of major contracts in Oman for

activities, which include Greenfield and Brownfield EPC & CME&I Construction Contracts for

Facilities, Pipelines and Process Plant, Long Term Maintenance Contracts for Oil & Gas facilities,

Pipeline Integrity Management Services including rehabilitation and routine / planned maintenance of

cross country pipelines and Environmental Services.

Arabian Industries LLC, owns one of the biggest fleet of plant and equipment amongst the oil and gas

sector contractors in Oman and directly employs approximately 2500 multi-disciplined experienced

35

staff personnel. Apart from the Head Office located at Al Khuwair House, various site, Arabian

Industries LLC, currently have a Project Coordination office, Staff Camp, Fabrication Shop, Vehicle

Maintenance Workshop and other related facilities in Rusayl, Sultanate of Oman. These are in

addition to on-site offices, accommodation, workshops and warehouses throughout its operating areas

in the Country.

Arabian Industries LLC, is one of the first companies in the Sultanate of Oman to have ISO 9002

Quality System Certification of Compliance for its entire scope of activities. This System was updated

to ISO 9001 in the year of 2000. The  The Company’s Health, Safety, Environmental & Waste

Management standards are one of the most effective amongst the Omani contracting community with

a number of major milestone achievements to its credit.

3.3 SUBSIDIARY COMPANIES & JOINT VENTURES

SUBSIDIARY COMPANIES

1. ◙ ARABIAN INDUSTRIES MANUFACTURING LLC

Arabian Industries Manufacturing Co. LLC (AIM) (a subsidiary of Arabian Industries LLC), is the

manufacturing division providing complete solutions for engineering, procurement and fabrication of

equipments to cater to clients in the Oil & Gas, Petrochemicals, Power , Fertilizer, Chemicals, and

Refinery industries..

2. ◙ ARABIAN INDUSTRIES PROJECTS LLC

36

Arabian Industries Projects LLC (AIP), a subsidiary of Arabian Industries LLC, is the Projects

Division providing Engineering, Procurement, Construction and commissioning services, to cater to

clients in the Oil & Gas, Petrochemicals, Power, Fertilizer, Chemicals and Refinery Industries.

3. ◙ ARABIAN INDUSTRIES TECHNICAL SUPPORT LLC

Arabian Industries Technical Support LLC (AITS), a subsidiary of Arabian Industries LLC, is a

provider of total maintenance solutions under one roof to cater to clients in the Oil & Gas,

Petrochemicals, Power, Fertilizer, Chemicals and Refinery Industries.

JOINT VENTURES

Arabian Industries LLC has entered into a JV with two foreign companies. They are listed below.

1. WORLEY PARSONS –ARABIAN INDUSTRIES J.V. (WPAI J.V.)

The WPAI - J.V. was formed between Arabian Industries LLC. and Worley Parsons (Oman) during

the middle of 2005 as a framework to cater to the Engineering, Maintenance and Construction

contract for Petroleum Development of South Oman, awarded by PDO. This is a five year contract

which can be extended to 7 years.

2. NORM PROJECT J.V.

This is another J.V. formed between Arabian Industries LLC. and an International institution

(specializing in the treatment of radioactive contamination). NORM stands for “Naturally

Occurring Radioactive Materials” which are found in the PDO sites during production of Oil from

oil-wells.. This entails suitable investments in setting up decontaminating facilities and developing the

required infrastructure in PDO sites for the said purpose.

CREDENTIALS OF ARABIAN INDUSTRIES LLC.

37

ASME ‘U’, 'U2' ‘S’ & ‘R’ Stamps: For the manufacture and repair of Pressure Vessels at

their state-of-art facilities at Rusayl & Sohar work centre.

Society is their cradle so they need to preserve and enrich it; Customers are their Patrons so

they need to honor their commitments with them;

The employees are their biggest assets, so they need to nourish and help them grow.

3.4 CORPORATE PHILOSOPHY

A corporate philosophy is — Creating Jobs, Adding Value to the Individual, and Contributing to

Society inspires Temp Holdings to become a company that helps people fulfill their dreams and find

happiness through work. Based on this philosophy, Arabian Industries LLC, will enter the future as a

trusted and reliable company throughout Oman and the rest of the world. We will also pursue business

activities that emphasize corporate social responsibility (CSR) in order to contribute to a better

society.

1 Creating Jobs

Arabian Industries LLC, creates various types of employment by examining working arrangements,

working environment, job content, and conditions of employment

2 Contributing to society

Arabian Industries LLC, contributes to society’s betterment by creating jobs and developing effective

human resources

3 Adding Value to the individual

Arabian Industries LLC, supports people who want to improve themselves through their work,

regardless of age, sex, or nationality.

3.4.1 CORPORATE MISSION AND VISION

38

Overview

Arabian industry is a leading EPC Contracting Company, specialized in design, engineering,

project construction, fabrication, and testing activities in Oil and Gas, Refineries,

Petrochemicals and Power sectors.

1 Mission

To achieve market leadership through excellence in the quality of product and services by adopting

state of the art technologies and innovative management approaches aim towards customer

satisfaction.

2 Vision

39

Arabian Industries LLC is committed to providing their clients with the best possible service and

results at a competitive price, without compromising on quality, health, safety, environment,

business ethics or welfare of their staff. “As a recommended supplier, and a preferred employer, AI

LLC is meeting the objectives and needs of their clients & employees.”

3 Policy

Arabian Industries LLC and its subsidiaries are committed to become one of the leading company

providing complete solutions to the energy sector by enhancing customer satisfaction, strengthening

employee & supplier relations and continually improving its product & services.

4 Strength

40

Integrity in diversity. Though their business expands to diverse sectors they still abide by their

vision & policy and maintain integration of their Quality management system and consistency of

operations through empowerment, motivated & dedicated peers and strong leadership

5 Approach

AILLC is a customer-focused organization nurturing the culture of internal-customers & external-

customers through out the organization. They achieve this through team-building, supply chain

management and continual training & development of their employees.

6-Credentials

41

AI LLC’s quality management system established since 1996 has been certified to ISO 9001 –

2000. Their pressure equipments manufacturing facilities are accredited by ASME for U, U2, S and

R stamps. Oil & Gas field equipments manufacturing facilities are certified by API for conformance

to 6A, 6D and 16A requirements.

3.5 CORPORATE OBJECTIVE

1 A To be of service to the nation and to contribute effectively to its economic well being and

growth through the production, supply and marketing of infrastructure facilities to Petroleum

Production and it’s allied industries in Sultanate of Oman.

2 To sustain and improve its pioneering role in the development of engineering and technology

in manufacturing industry through continuous research and development.

3 To improve productivity and maintain high standards of quality and adopt effective measures

for controlling cost in all aspects.

4. To ensure for its customers the availability of its products and services on reasonable terms,

for its shareholders a fair return on capital invested and, for itself, development of adequate

internal resources for continual growth and expansion.42

CORPORATE OBJECTIVE

3.5.1 CORPORATE GOALS

1 To achieve a net profit of OMR: One Million per year with a turnover of OMR: 100 Million by

the year of 2010

2. To focus on cost reduction and technology up gradation in order to become competitive in each

line of business.

3. To constantly innovate and develop new technology and services to satisfy customer

requirements.

4. To invest in new business lines, where profit can be made on sustainable basis over the long te

rm.

5. To compete through speed, agility and flexibility in recognizing and capturing opportunities in

existing markets.

6.

CORPORATE GOALS

3.5.2 QUALITY PERFECTIVE

43

A dedicated team of Quality Assurance and Quality Control Engineers (lead by the Company’s

QA/QC Manager and Quality Systems Engineer) supports the implementation and monitoring of

Quality Management of the Company.  All departments in the Company are certified to ISO 9001 and

regular internal and external audits are conducted to check the compliance and renewal of certificate.

ISO 9001:2000 requires that an organization’s quality policy provide a framework for reviewing the

company’s quality objectives. The policy should give an overall direction for the organization, and its

objectives should flow in that direction. But because of outside forces such as customer requirements

and market environments, business conditions can change. If this happens, the alignment between

quality policy and objectives can become off-centered. So, the standard requires that management

periodically review changes to both the policy and objectives. An organization’s objectives must be

measurable and its quality management system processes designed to meet those objectives.

3.5.3 MAJOR CLIENTS OF ARABIAN INDUSTRIES LLC

Since the company began operations in 1991, it has successfully executed numerous projects for

clients within the Gulf region. It includes some of the most reputed industrial entities like:-

In achieving the objectives of Centre, they promise to:

44

Attending clients promptly and courteously

Respond to complaints/suggestions from the clients within a reasonable time

Continuously evaluate the effectiveness of company’s programmes

Provide timely support to staff and workers of the firm.

Generate Performance report every two weeks after launching the project works.

Provide technical advice to the clients on various issues.

MAJOR CLIENTS

1. Petroleum Development Oman LLC (PDO)

2. Sohar Aluminium Company LLC (SAC)

3. Oman Refinery Company LLC (ORC)

4. Oman Gas Company LLC (OGC)

5. Occidental Oman LLC

6. Qatar Petroleum (QP)

7. Oman LNG LLC

8. Daleel Petroleum LLC

9. Enerflex Systems Pty Ltd

10. Petrofac Engineering & Construction Ltd

11. Japan Gas Corporation

12. Hanover Company ,USA

Major Clients

3.6 PRODUCT AND PROJECT PROFILES

45

AI LLC offers complete engineering and maintenance management services under one roof. By

optimizing its experience and technical know-how, the company provides complete assistance on

following matters

A project is a series of activities aimed at bringing about clearly specified goals within a defined time-

period and with a defined budget.

A project has: a primary target group and final beneficiaries, clearly defined coordination,

management and financing arrangements, a monitoring and evaluation system financial and

economic analysis, showing that benefits will exceed costs.

3.6.1 MAJOR PROJECTS OFFERED BY ARABIAN INDUSTRIES LLC

1. Projects and Construction (Including EPC)

2. Service Contracts

3. Civil & Building Works

4. Workshop Fabrication

5. Tank Fabrication, Construction & EPC Services

6. High Density Polyethylene Pipe Lining

7. Maintenance & Process Plant Turnaround Services 

8. Aluminum Component Fabrication & Installation Services

3.6.2 Major Projects & Products details

46

1

Project C31/0606: Engineering and Maintenance Contract (EMC

JV Partner Worley Parsons

Project Value US$ 240 million

2

Name of Project DCME & I Engineering Service Contract No. C-680046,

Type of Contract Main sub-contractor for complete mechanical works

Approximate Value US$ 40 million (Mechanical)

3

Name of Project Fahud Steam Injection Project

Type of Contract EPC Lump sum

Project Value US$ 143 million

4

Project C31/1097: Hubara -Saih Rawl - 132 kv Overhead line,

Type of Contract EPC , Lump sum

Project Value US$ 38 million

5

Name of Project Barik Central Gathering Station Construction

Type of Contract Sole Construction Contractor

Project value US $ 11.3 Million

6

Name of Project Yibal Brownfiled Expansion – C-980033

Type of Contract Sole Construction Contractor Lump sum

Project value US $ 16 Million

7

Name of Project Security Upgrade in Oman LNG

Type of Contract Sub contractor

Project value USD.1 3.51 million

8

Name of Project Additional AR Pipeline Construction work

Type of Contract Main Contractor

Project value US $ 1 2.5 Million

3.6.3 MAJOR ACHIEVEMENTS

1-Engineering capabilities

47

Mechanical design of process equipments like pressure vessels, heat exchangers, separators,

Design of Shop and site Storage tanks as per international standards API 650, 653, EN 14015

Design of direct and indirect heaters, fuel gas treatment plants

Packages: PV Elite, Stadd Pro, AUTOCAD and piping software’s

Regular association with reputed international process owners and licensors in the Oil & Gas,

Refinery and Petrochemical industry for the design of equipment internals.

2-Welding and joining technology

Core competency and expertise in welding and joining technology of all construction metals,

especially in DSS,CRA and special alloy steels

Qualified for a wide range of welding procedures up to 200 mm thickness

SMAW /SAW/GTAW/FCAW/MIG facilities

Strip cladding and special weld metal overlays

GRP piping fabrication and bonding facilities

3-Testing

Hydro/pneumatic testing bays and facilities

RT/MT/UT/PT/PWHT/PMI and other NDT facilities

PWHT facilities by Internal and external firing methods

Local stress relieving facilities by electrical methods

Gas fired PWHT furnaces adjustable to equipment sizes.

4-Major Services Offered

Maintenance of Static Equipments

Maintenance of Heat Exchangers including Tube Cleaning, Re-tubing and Plugging

Maintenance, Overhauling and Monitoring of Compressors, Pumps, and Turbines ..

Maintenance and Overhauling of Oilfield Equipments;

Design, fabrication, erection and commissioning of oil and petroleum storage tanks,

MAJOR ACHIEVEMENTS

48

3.7 FINANCIAL HIGHLIGHTS FOR 2009

[ SOURCE: COMPANY REPORT ]

49

FINANCIAL PERFORMANCE REVIEW 2009

BUSINESS PLAN – 2010

New project inflows (excluding EMU) at RO 41.58 million for the year 2008 vis-à-vis RO

20.977 million in the year 2008 – 103.4% growth year on year.

Backlog of works at RO 40.216 million as at December 2008 (of which RO 37.352 million is

expected to be executed in 2009) against RO 9.98 million as at December 200 – 347.2%

growth year on year.

Projected Gross Sales at RO 42.70 million in 2008 vis-à-vis RO 38.14 million in the previous

year – 113.44% growth year on year

Forecasted Net Profit Before Tax at RO 5.33 million in 2008 as against RO 3.58 million in

the previous year – 59.8% growth over 2008.

BUSINESS UNITS

1. FABRICATION BUSINESS UNIT

2. TECHNICAL SUPPORT UNIT

3. PROJECT DEVELOPMENT UNIT

4. ENGINEERING MAINTENANCE UNIT

3.7.1 PERFORMANCE REVIEW FOR 2009

Fabrication Business Unit

50

Chart-3-1- PERFORMANCE REVIEW FOR 2009-FABRICATION BUSINESS UNIT

9004

6841

8204

5749

800

1092

0

2000

4000

6000

8000

10000

12000

14000

16000

Revenue Cost Margin

Performance Review-MBU

ForecastedDec'08

Planned

Table-3-1-Performance Review-FBU Value in RO, 000

Revenue Cost Margin

Planned 10084.48 9188.48 896

Forecasted Dec'08 7661.920 6438.88 1223

Margins were better than the original business plan based in spite of a lower turnover as the

contracts were taken at better margins.

3.7.2 Performance Review for 2009

Technical Support Unit

Chart-3-2- Performance Review for 2009-Technical Support Unit

1502

1098 1066

704

435 394

0

200

400

600

800

1000

1200

1400

1600

Revenue Cost Margin

PERFORMANCE REVIEW-MBU-ITS

Planned

ForecastedDec'08

Table-3-2-Performance Review-Technical Support Unit Values in OMR

Revenue Cost Margin

Planned 1727 1225 487

Forecasted Dec'08 1229 810 453

Better marketing strategy and business tie-up’s have been planned for the year 2009 to have a

better turnover to counter the underperformance in terms of planned revenue by this Business

Unit.

3.7.3 Performance Review for 2009 of Projects Development Unit

Chart-3-3- Performance Review for 2009-PDU

51

12489

5618

11032

4400

1457

1218

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Revenue Cost Margin

PERFORMANCE REVIEW-2008-PBU

ForecastedDec'08

Planned

Table-3-3-Performance Review-PDU Values in OMR

Revenue Cost Margin

Planned 14363 12686 1676

Forecasted Dec'08 6460 5060 1400

Smaller Contracts were executed under this business with higher profit margin as the carry

forward jobs from 2007 to 2008 were limited. However the firm expects a better turnover in

the year 2009 based on a healthy order book for the year ended 2008.

3.7.4 Performance Review for 2009 Engineering Maintenance Unit

Chart-3-4- Performance Review for 2009-EMU

22000

24569

1944921287

2550 3282

0

5000

10000

15000

20000

25000

Revenue Cost Margin

PERFORMANCE REVIEW-EMC(jv)

Planned

ForecastedDec'08

Table-3-4-Performance Review-EMU Values in OMR

Revenue Cost Margin

Planned 25300 22366 2932

Forecasted Dec'09 28254 24480 3774

Engineering Maintenance Contract has delivered results better than expected.

3.7.5 Forecasted Revenue for 2009

(Figures of 2008 are based on forecast)52

Planned T/O RO 51.75million Anticipated Turnover for 2008 RO 44.85 million

Planned Profit RO 5.55 million Anticipated Profit for 2008 RO 5.55 million

Net Profit Margin target 10.45% Anticipated Net Profit Margin for 2009 14.5%.

Table—3-5 Division Wise Performance

Turnover Planned Forecasted-2009

Fabrication 10,354,829 7,867,448

Technical 1,727,767 1,262,931

Projects 14,362,451 6,460,212

EMU Division 25,300,000 28,254,687

Total 51,745,047 43,845,278

Cost - -

Fabrication 9,434,365 6,611,701

Technical 1,226,996 809,529

Projects 12,687,019 5,059,821

EMU Division 22,367,418 24,480,246

Total 45,715,798 36,961,296

Overhead 986,375 997,875

Directors Fees 353,002 412,039

Net Profit Before Tax 4,689,873 5,474,238

Business Plan 2010

1 Complete the construction works.

2 New Office block.

3 New lease land at Industrial Estate.

4 New land acquired will use to setup facility for new projects.

5 Open offices in other GCC countries.

3.7.6 Financial Performance 2002 to 2009

Table-3-6-Financial Performance

2002 2003 2004 2005 2006 2007 2008 2009

Turnover 4216 5455 4900 6928 11280 25000 39166 43845

Net Profit after tax 555 184 145 125 285 1695 2649 5095

Net Worth (1591) (633) 571 1501 1785 4136 5241 8555

Chart-3-5-Financial Performance

53

-5000

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

2002 2003 2004 2005 2006 2007 2008 2009

FINANCIAL SUMMARY

Turnover

Net Profit aftertax

Net Worth

FINANCIAL SUMMARY ASSETS & LIABILITIES

The total Assets (Fixed and Current) as on 31st Dec.2009 RO 3.5 million

Total Liabilities (Long Term & Current) as on 31st Dec .2009 RO 2.5 million

Equity and accumulated Reserves as on 31st Dec. 2009 RO 1 million

3.7.7 Future Financial Planning

1. Approval of Capital Expenditure for OMR- 3 million

2. Approval of acquisition of Proposed Land and Building at Salalah.

3. Proceed with the setup of representation Office in all GCC Countries.

4. Raise the Share Capital to RO 5 Million in the year 2010.

5. Payment of Dividend of 75% proposed share holders

Table 3-7-Financial Summary

2005 2006 2007 2008 2009

TURNOVER 1748 2227 3163 4720 4231

NET PROFIT 6 65 111 389 445

Chart-3-6 Financial Summary

54

OBJECTIVES FOR 2010

Executing jobs in hand in line with schedule & budgets

Secure at least 5 projects in the range of 30 Million USD under EMU.

Achieve a net profit of RO 6.5 Million (before tax and after adjustment of Management fees)

Expand client base especially for the Fabrication Shop.

Buildup strong management at various levels to meet the Company long term objectives.

3.7.8 FIVE YEAR PLANNED TURNOVER

55

ARABIAN INDUSTRIES HOLDING COMPANY STRUCTURE

ARABIAN INDUSTRIES LLCHOLDING CO.

PROJECT UNIT FABRICATION UNIT TECHNICAL UNIT

ARABIAN INDUSTRIES PROJECT LLC

ARABIAN INDUSTRIESMANUFACTURING CO. LLC

ARABIANINDUSTRIESTECHNICAL SUPPORT LLC

EMU NORMS

NORMARABIAN INDUSTRIES JV

PARSON-ARABIANINDUSTRIES - JV

FINANCIAL SUMMARY

1748

2227

3163

4720

4231

6

65

111

389

445

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

2005 2006 2007 2008 2009

YEARS

VA

LU

ES

0

50

100

150

200

250

300

350

400

450

500

TURNOVER

NET PROFIT

Table-3-8-Future Plan

Value in RO Million

BUSINESS UNIT 2010 2011 2012 2013 2014

Engineering Maintenance Contract 20.000 25.000 25.000 25.000  25.000 

Arabian Industries Manufacturing 10.000 13.000 15.000 18.000 20.000

Arabian Industries Technical Support 2.500 3.000 3.500 4.000 5.000

Arabian Industries Projects 30.000 35.000 40.000 45.000 50.000

Total 62.500 75.000 83.500 92.000 100.000

Chart-3-7 - Cash Flow Analysis

CASH FLOW 2009

0

100000

200000

300000

400000

500000

600000

JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC

MONTHS

CA

SH

IN

FLO

W

Series2

Table – 3-9 Cash Flow Analysis

Jan/10 Feb/10 Mar/10 Apr/10 May/10 Jun/10

301900.3 511660.3 352984.5 289537.8 225635.8 179465.6

Jul/10 Aug/10 Sep/10 Oct/10 Nov/10 Dec/10

143654.6 90899.45 192841.2 278427.7 347378.2 571331.5

56

CASH FLOW ANALYSIS – 2009

CASH FLOW FORECAST FOR THE YEAR 2009 CURRENCY IN OMANI RIYAL

PERT. JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC

Projects Division 920,000 920,000 920,000 920,000 920,000 1,012,000 1,012,000 1,012,000 1,012,000 1,012,000 1,012,000 1,012,000

Manufacturing

Division345,000 345,000 345,000 345,000 345,000 379,500 379,500 379,500 379,500 379,500 379,500 379,500

Maintenance

Division172,500 172,500 172,500 172,500 172,500 172,500 189,750 189,750 189,750 189,750 189,750 189,750

NORM Contract 540,499 405,374 270,250 #VALUE! 0 0 0 0 0 0 0 0

Engineering &

Maintenance

Contract

5,060,000 5,060,000 5,060,000 5,060,000 5,060,000 5,060,000 5,060,000 5,060,000 5,692,500 5,692,500 5,692,500 6,325,000

Total Inflow

( collection from

contract

Receivables)

7,037,999 6,902,874 6,767,750 6,497,500 6,497,500 6,624,000 6,641,250 6,641,250 7,273,750 7,273,750 7,273,750 7,906,250

Salary & Wages

(excluding

Gratuity)

1,446,953 1,461,422 1,476,037 1,623,640 1,623,640 1,639,877 1,656,275 1,672,838 1,689,566 1,706,462 1,723,527 1,740,762

Suppliers / Sub

Contractors -

Creditors LC &

LTR

4,926,599 4,832,011 4,737,425 4,548,250 4,548,250 4,636,800 4,648,875 4,648,875 5,091,625 5,091,625 5,091,625 5,534,375

Other Expenses

(including Fuel +

Vehicle

ministrative

Overheads)

211,140 207,086 203,033 194,925 194,925 198,720 199,238 199,238 218,213 218,213 218,213 237,188

Income Tax 25,000

Bank Charges &

Bank Interest Cost44,249 42,880 43,967 44,419 44,873 45,059 45,327 45,708 45,058 44,518 44,089 42,626

Total Out Flow 6,628,940 6,543,400 6,776,711 6,411,234 6,411,688 6,520,456 6,549,715 6,566,659 7,044,462 7,060,817 7,077,453 7,554,950

Net Inflow / Out

Flow409,058 359,474 -8,961 86,266 85,812 103,544 91,535 74,591 229,288 212,933 196,297 351,300

MONTH 10-Jan 10-Feb 10-Mar 10-Apr 10-May 10-Jun 10-Jul 10-Aug 10-Sep 10-Oct 10-Nov 10-Dec

Opening Balance -107,158 152,186 361,946 203,271 139,824 75,922 52,119 16,308 -36,447 65,495 151,081 220,032

Inflow 7,037,999 6,902,874 6,767,750 6,497,500 6,497,500 6,624,000 6,641,250 6,641,250 7,273,750 7,273,750 7,273,750 7,906,250

Outflow 6,628,940 6,543,400 6,776,711 6,411,234 6,411,688 6,520,456 6,549,715 6,566,659 7,044,462 7,060,817 7,077,453 7,554,950

Surplus / (deficit) 301,900 511,660 352,984 289,538 225,636 179,466 143,655 90,899 192,841 278,428 347,378 571,332

57

BUSINESS PLAN - 2010

Table-3-10-Business Plan

Business Unit Planned VOWD Planned Cost Planned Margin

Arabian Industries Fabrication Unit8,945,451 7,737,077 1,208,374

Arabian Industrial Maintenance Unit1,614,118 1,161,660 452,457

Arabian Industries Projects Unit29,690,189 26,765,988 2,924,202

EMU23,000,002 19,872,181 3,127,822

Total63,249,760 55,536,905 7,712,855

Overhead1,220,241 -1,220,241

Management Fees454,483 -454,483

Net Profit before Tax4,528599 6,038,131

3.7.9 CAPITAL EXPENDITURE

Table-3-11-Capital Expenditure

Business Unit Amount in RO

ARABIAN INDUSTRIES MANUFACTURING UNIT 1,018,613

INVESTMENT – AIR COOLERS INTL 517,500

ARABIAN INDUSTRIES TECHNICAL SUPPORT UNIT 572,355

INVESTMENT IN NEW TECHNOLOGY 697,475

ARABIAN INDUSTRIES PROJECT DEVELOPMENNT UNIT 616,613

NEW PROJECT 2,535,893

ENGINEERING MAINTENANCE UNIT 718,520

CORPORATE 46,000

TOTAL 6,722,968

FUTURE PROJECT

Investment in proposed project OMR 6 Million

Equivellant to USD#15,463,917.00

FINANCING PROPOSED FOR THE CAPITAL EXPENDITURE

Total Capital Expenditure planned for 2010 6,000,000

Term Loan for New Project-1 2,500,000

Term loan for New Project 2 3,000,000

Term loan for New project 3 1,500,000

Balance financed by Cash generated from operations 500,000

3.7.10 FUTURE PROPOSALS 58

Approval of Capital Expenditure RO 6,000,000

Approval of acquiring of shares in new company.

Proceed with the setup of representation Office in all GCC countries

Raise the Share Capital to RO 5 Million by allocating RO 500,000 from the profits of year 2010.

Approval of payment of Management fees to CMD 10% of Net Profit before tax.

Adjust the management fees payable to directors with the amounts receivable from sister co.

Payment of Dividend of RO 5,000,000/ to the members by 31st March 2010.

3.8 LITERATURE REVIEW - AN OVER VIEW

“A literature review is an essay or is part of the introduction to an essay, research report, or thesis.

It provides an overview and critical analysis of relevant published scholarly articles, research

reports, books, theses etc on the topic or issue to be investigated. A detailed guide to the literature

review is available on the Language and Learning services website. Literature search: A

systematic and exhaustive search for published material on a specific topic.”

It discusses published information in a particular subject area, and sometimes information in a

particular subject area within a certain time period. It is a summary of research that has been 59

published about a particular subject. It provides the reader with an idea about the current situation

in terms of what has been done, and what we know. Sometimes it includes suggestions about what

needs to be done to increase the knowledge and understanding of a particular problem.

It gives an overview of what has been said, who the key writers are, what are the prevailing

theories and hypotheses, what questions are being asked, and what methods and methodologies

are appropriate and useful. As such, it is not in itself primary research, but rather it reports on

other findings. Literature reviews can give you an overview or act as a stepping stone. It also

provide a solid background for a research paper's investigation.

A LITERATURE REVIEW MUST DO THESE THINGS:

be organized around and related directly to the thesis or research question you are developing

synthesize results into a summary of what is and is not known

identify areas of controversy in the literature

formulate questions that need further research

Structuring a literature review

It is often difficult to decide how to organize the huge amount of information you have

collected.

The structure of each dissertation will be different but there are some general principles and

these are really the guidelines you should use for any piece of academic writing.

Structuring a literature review

Introduction to the literature review

Main part

Conclusions

A literature review is a piece of discursive prose, not a list describing or summarizing one piece of

literature after another.

It's usually a bad sign to see every paragraph beginning with the name of a researcher. Instead,

organize the literature review into sections that present themes or identify trends, including

relevant theory.

3.9 ABSTRACT OF LITERATURE REVIEW

60

The current study contributes to the literature by examining impact of working capital management on

the operating performance and growth of new public companies. The study also sheds light on the

relationship of working capital with debt level, firm risk, and industry. Using a sample of a

manufacturing, the study finds a significant positive association between higher levels of accounts

receivable and operating performance. The study further finds that maintaining control (i.e. lower

amounts) over levels of cash and securities, inventory, fixed assets, and accounts payables appears to

be associated with higher operating performance, as well. We find that the firms which are

experiencing unusually high growth tend not to perform as well as those with low to moderate growth.

Further firms which are experiencing high growth tend to hold higher levels of cash and securities,

inventory, fixed assets, and accounts payables. These findings tend to suggest that firms are willing to

sacrifice performance (accept low or negative operating returns) to increase their growth levels. The

higher level of growth is also associated with higher operating and financial risk. The findings of this

study suggest that perhaps the firms should stay more focused on their operating performance than on

maintaining high growth levels.

3.10 INTRODUCTION AND LITERATURE REVIEW

Working capital policy refers to the firm's policies regarding 1) target levels for each category of

current operating assets and liabilities, and 2) how current assets will be financed. Generally good

working capital policy (i.e. under conditions of certainty) is considered to be one in which holdings of

cash, securities, inventories, fixed assets, and accounts payables are minimized.

The level of accounts receivables should be used as a means of stimulating sales and other

income. Previous literature on working capital management has found a negative association, overall,

between level of working capital and operating performance as measured by operating returns and

operating margins (Peterson and Rajan, 1997). Under conditions of certainty (i.e. sales, costs, lead

times, payment periods, and so on, are known), firms have little reason to hold more working capital

than a minimum level.

3.11 AN ANALYSIS OF WORKING CAPITAL MANAGEMENT RESULTS ACROSS INDUSTRIES :-

61

INTRODUCTION

The importance of efficient working capital management (WCM) is indisputable. Working capital is

the difference between resources in cash or readily convertible into cash (Current Assets) and

organizational commitments for which cash will soon be required (Current Liabilities). The objective

of working capital management is to maintain the optimum balance of each of the working capital

components.

Business viability relies on the ability to effectively manage receivables, inventory, and payables.

Firms are able to reduce financing costs and/or increase the funds available for expansion by

minimizing the amount of funds tied up in current assets. Much managerial effort is expended in

bringing non-optimal levels of current assets and liabilities back toward optimal levels. An optimal

level would be one in which a balance is achieved between risk and efficiency.

A recent example of business attempting to maximize working capital management is the

recurrent attention being given to the application of Six Sigma® methodology. When used to identify

and rectify discrepancies, inefficiencies and erroneous transactions in the financial supply chain, Six

Sigma® reduces Days Sales Outstanding (DSO), accelerates the payment cycle, improves customer

satisfaction and reduces the necessary amount and cost of working capital needs. There appear to be

many success stories, including Jennifer Towne’s (2002) report of a 15 percent decrease in days that

sales are outstanding, resulting in an increased cash flow of approximately 2 million dollars at

Thibodaux Regional Medical Center. Furthermore, bad debts declined from 3.4 million dollar to o

600,000 dollar.

Even in a business using Six Sigma® methodology, an “optimal” level of working capital

management needs to be identified. Industry factors may impact firm credit policy, inventory

management, and bill-paying activities. Some firms may be better suited to minimize receivables and

inventory, while others maximize payables. Another aspect of “optimal” is the extent to which poor

financial results can be tied to sub-optimal performance. Fortunately, these issues are testable with

data published by CFO magazine (Mintz and Lazere 1997; Corman 1998; Mintz 1999; Myers 2000;

Fink 2001), which claims to be the source of “tools and information for the financial executive,” and

are the subject of this research.

The following section presents a brief literature review. Next, the research method is described,

including some information about the annual Working Capital Management Survey published by

CFO magazine. Findings are then presented and conclusions are drawn.

62

Many researchers have studied working capital from different views and in different

environments. The following are some useful research:

3.12 RELATED LITERATURE

The importance of working capital management is not new to the finance literature. Over twenty years

ago, Largay and Stickney (1980) reported that the then-recent bankruptcy of W.T. Grant, a nationwide

chain of department stores, should have been anticipated because the corporation had been running a

deficit cash flow from operations for eight of the last ten years of its corporate life. As part of a study

of the Fortune 500’s financial management practices. Following are the important views of scholars

about working capital management.

1 GILBERT AND REICHERT (1995 ) :

Find that accounts receivable management models are used in 59 percent of these firms to improve

working capital projects, while inventory management models were used in 60 percent of the

companies. More recently, Farragher, Kleiman and Sahu (1999) find that 55 percent of firms in the

S&P Industrial index complete some form of a cash flow assessment, but did not present insights

regarding accounts receivable and inventory management, or the variations of any current asset

accounts or liability accounts across industries. Thus, mixed evidence exists concerning the use of

working capital management techniques. Theoretical determination of optimal trade credit limits are

the subject of many articles over the years (e.g., Schwartz 1974; Scherr 1996), with scant attention

paid to actual accounts receivable management. Across a limited sample,

2 WEINRAUB AND VISSCHER (1998) :

Observe a tendency of firms with low levels of current ratios to also have low levels of current

liabilities. Simultaneously investigating accounts receivable and payable issues, Hill, Sartoris, and

Ferguson (1984) find differences in the way payment dates are defined. Payees define the date of

payment as the date payment is received, while payers view payment as the postmark date. Additional

WCM insight across firms, industries, and time can add to this body of research. Maness and Zietlow

(2002, 51, 496) presents two models of value creation that incorporate effective short-term financial

management activities. However, these models are generic models and do not consider unique firm or

industry influences. Maness and Zietlow discuss industry influences in a short paragraph that includes

the observation that, “An industry a company is located in may have more influence on that

company’s fortunes than overall GNP” (2002, 507).

63

3 ELJELLY, 2004 :

Elucidated that efficient liquidity management involves planning and controlling current assets and

current liabilities in such a manner that eliminates the risk of inability to meet due short-term

obligations and avoids excessive investment in these assets. The relation between profitability and

liquidity was examined, as measured by current ratio and cash gap (cash conversion cycle) on a

sample of joint stock companies in Saudi Arabia using correlation and regression analysis.

The study found that the cash conversion cycle was of more importance as a measure of liquidity than

the current ratio that affects profitability. The size variable was found to have significant effect on

profitability at the industry level. The results were stable and had important implications for liquidity

management in various Saudi companies. First, it was clear that there was a negative relationship

between profitability and liquidity indicators such as current ratio and cash gap in the Saudi sample

examined. Second, the study also revealed that there was great variation among industries with

respect to the significant measure of liquidity.

4 BERGAMI ROBERT (2007 ) :

Analysis that that international trade transactions carry inherently more risk than domestic trade

transactions, because of differences in culture, business processes, laws and regulations. It is therefore

important for traders to ensure that payment is received for goods dispatched and that the goods

received and paid for comply with the contract of sale. One effective way of managing these risks has

been for traders to rely on the letter of credit as a payment method. However for exporters in

particular, the letter of credit has presented difficulties in meeting the compliance requirements

necessary for the payment to be triggered.

The current rules that govern letter of credit transactions(UCP 500) have been under review for the

past three years and an updated set of rules (UCP 600) is expected to be introduced on 1July 2007.

This paper focuses on the changes mooted for 2007and compares these main issues with the existing

rules and other associated guidelines and regulations governing this method of payment. This paper

considers the implication to changes of letter of credit transactions and the sharing of risk. Firstly the

paper provides some background to letters of credit, then comments on existing literature and models,

and subsequently an analysis of the most important changes to the existing rules, before reaching a

conclusion. The conclusion is that the UCP 600 have not paid enough consideration to traders and

service providers and are likely to engender an environment of uncertainty for exporters in particular.

64

CHAPTER 4

65

1-INTRODUCTION

2-NEED OF WORKING CAPITAL

3-CONCEPT OF WORKING CAPITAL

4-CLASSIFICATION OF WORKING CAPITAL

5-DETERMINANTS OF WORKING CAPITAL

4.1 INTRODUCTION- WORKING CAPITAL MANAGEMENT

“Working capital occupies a peculiar position in the capital structure of a company. The decision as

to the adequacy of working capital is a complicated and yet a very important decision”.

Working capital is the life-blood of all types of enterprises, manufacturing and trading both. It is

constantly required to buy raw materials for payment of wages and other day-to-day expenses.

Without adequate working capital, manufacturing operations will be crippled. For trading enterprises,

the capacity to stock a variety of goods for sale depends upon its working capital. It is a base on which

all the activities of business enterprise depend.

Many companies still under estimate the importance of working capital management as a lever for

freeing up cash from inventory, accounts receivable, and accounts payable. By effectively managing

these components, companies can sharply reduce their dependence on outside funding and can use the

released cash for further investments or acquisitions. This will not only lead to more financial

flexibility, but also create value and have a strong impact on a company’s enterprise value by

reducing capital employed and thus increasing asset productivity.

High working capital ratios often mean that too much money is tied up in receivables and inventories.

Typically, the knee-jerk reaction to this problem is to apply the “big squeeze” by aggressively

collecting receivables, ruthlessly delaying payments to suppliers and cutting inventories across the

board. But that only attacks the symptoms of working capital issues, not the root causes. A more

effective approach is to fundamentally rethink and streamline key processes across the value chain.

This will not only free up cash but lead to significant cost reductions at the same time.

Only those enterprises which have adequate working capital can survive in times of depression. The

investment in raw materials becomes long- term investments during depression and cash flow declines

due to fall in sale. In such circumstances only enterprises with adequate working capital can survive.

Excessive working capital is equally unprofitable. The extra working capital is not utilized in business

operations and earns no profit for the firm. It results in unnecessary accumulation of inventories,

leading to inventory mishandling, waste, theft etc. The abundance of working capital would lead to

waste and inefficiency

Shortage of working capital funds renders the firm unable to avail attractive credit opportunities etc.

The firm loses its reputation when it is not in a position to honor its short term obligations. As a result,

the firm faces tight credit terms. It stagnates growth.

66

Definition:-

1.According to Guttmann & Dougall:-

“Working capital is defined as current assets minus current liabilities”.

A positive position means that a company is able to support its day-to-day operations. i.e. to serve

both maturing short-term debt and upcoming operational expenses.

2. According to Park & Gladson:-

“The excess of current assets of a business (i.e. cash, accounts receivables, inventories) over current

items owned to employees and others (such as salaries & wages payable, accounts payable, taxes

owned to government)”

“Working capital like many other accounting terms and financial terms has been used by different

people in different senses.”

One school of thought believes that, as all capital resources available to a business organization –

From shareholders, bondholders, and creditors (secured and unsecured) works up in the business

activities to generate revenues and facilitate future expansion and growth; they are to be considered as

‘working capital’.

Another school of thought links working capital with current assets and current liabilities.

According to them, the excess of current assets over current liabilities is to be rightly considered as

the working capital of a business organization.

According to “Shubin” working capital is “the amount of funds necessary to cover the cost of

operating the enterprise. Working capital in a going concern is a revolving (circulating fund), it

consists of cash receipts from sales which are used to cover the cost of current operations.

“Circulating capital means current assets of the company that are changed in the ordinary course of

business from one form to another, as for example from cash to inventories, inventories to receivables

and receivables to cash.”

“Working capital is descriptive of that capital which is not fixed. But, the more common use of

working capital is to consider it as the difference between the current assets and the current

liabilities”. Current assets and current liabilities are assets and liabilities which arise in the course of

business. The WC demonstrates the amount of liquid assets that are available to sustain and build the

business by measuring company’s efficiency and short-term financial health. As such, it carries great

value to those who might be interested in investing in business or even purchasing it.

67

Working capital, also known as net working capital, is a measurement of a business’s current

assets, after subtracting its short-term liabilities, typically short term. Sometimes referred to as

operating capital, it is a valuation of the assets that a business or organization has available to manage

and build the business. Generally speaking, companies with higher amounts of working capital are

better positioned for success because they have the liquid assets that are essential to expand their

business operations when required.

Characteristics of Working Capital

Working capital is the life blood and nerve centre of a business. Just as circulation of blood is

essential in the human body for maintaining life, working capital is very essential to maintain the

smooth running of a business. No business can run successfully with out an adequate amount of

working capital.

The features of working capital distinguishing it from the fixed capital are as follows:

1 Short term Needs:

Working capital is used to acquire current assets which get converted into cash in a short period. In

this respect it differs from fixed capital which represents funds locked in long term assets. The

duration of the working capital depends on the length of production process, the time that elapses in

the sale and the waiting period of the cash receipt.

2 Circular Movement:

Working capital is constantly converted into cash which again turns into working capital. This process

of conversion goes on continuously. The cash is used to purchase current assets and when the goods

are produced and sold out; those current assets are transformed into cash. Thus it moves in a circular

away. That is why working capital is also described as circulating capital.

3 An Element of Permanency:

Though working capital is a short term capital, it is required always and forever. As stated before,

working capital is necessary to continue the productive activity of the enterprise. Hence so long as

production continues, the enterprise will constantly remain in need of working capital. The working

capital that is required permanently is called “permanent or regular working capital”.

68

4 An Element of Fluctuation:

Though the requirement of working capital is felt permanently, its requirement fluctuates more widely

than that of fixed capital. The requirement of working capital varies directly with the level of

production. It varies with the variation of the purchase and sale policy; price level and the level of

demand also. The portion of working capital that changes with production, sale, price etc. is called

“variable working capital”.

5 Liquidity:

Working capital is more liquid than fixed capital. If need arises, working capital can be converted into

cash within a short period and without much loss. A company in need of cash can get it through the

conversion of its working capital by insisting on quick recovery of its bills receivable and by

expediting sales of its product. It is due to this trait of working capital that the companies with a larger

amount of working capital feel more secure.’

6 Less Risky:

Funds invested in fixed assets get locked up for a long period of time and can not be recovered easily.

There is also a danger of fixed assets like machinery getting obsolete due to technological

innovations. Hence investment in fixed capital is comparatively more risky. As against this,

investment in current assets is less risky as it is a short term investment. Working capital involves

more of physical risk only, and that too is limited. Moreover, working capital gets converted into cash

again and again; therefore, it is free from the risk arising out of technological changes.

7 Special Accounting System not needed:

Since fixed capital is invested in long term assets, it becomes necessary to adopt various systems of

estimating depreciation. On the other hand working capital is invested in short term assets which last

for one year only. Hence it is not necessary to adopt special accounting system for them.

Among the most important items of working capital are levels of inventory, accounts receivable, and

accounts payable. Working capital can be expressed as a positive or a negative number.

“When a company has more debts than current assets, it has negative working capital; When

current assets outweigh debts, a company has positive working capital”.

69

A company will try to manage cash by:

Identifying the cash balance that allows it to meet day-to-day expenses but minimizes the cost

of holding cash;

Finding the level of inventory that allows for continuous production but lessens the

investment in raw materials and reduces reordering costs;

Identifying the appropriate source of financing, given the cash-conversion cycle.

It may be necessary to use a bank loan or overdraft. However, inventory is preferably financed by

credit arranged with the supplier. If a company is not operating efficiently, this will show up as an

increase in the working capital. This can be judged by comparing the amounts of working capital from

one period to another. Slow collection and inventory turnover may signal an underlying problem in

the company’s operations.

Advantages

Proper management of working capital gives a firm the assurance that it is able to continue its

operations and that it has sufficient cash flow to satisfy both maturing short term debt and upcoming

operational expenses.

Disadvantages

If a company’s current assets do not exceed its current liabilities, then it may run into trouble paying

back creditors in the short term.

A declining working-capital ratio over a longer time period could also be a red flag that merits further

analysis. For example, it could be that the company’s sales volumes are decreasing and, as a result, its

accounts receivable are diminishing.

70

FACTORS INFLUENCING WORKING CAPITAL

4.2 NEED OF WORKING CAPITAL

Working capital is among the many important things that contribute to the success of a business.

Without it, a business may cease to function properly or at all. Not only does a lack of working capital

render a company unable to build and grow, but it may also leave a company with too little cash to

pay its short-term obligations. Simply put, a company with a very low amount of working capital may

be at risk of running out of money.

When a company has too little working capital, it can face financial difficulties and may even be

forced toward bankruptcy. This is true of both very small companies and billion-dollar organizations.

A company with this problem may pay creditors late or even skip payments. It may borrow money in

an attempt to remain afloat. If late payments have affected the company’s credit rating, it may have

difficulty obtaining a loan at an affordable interest rate.

The need for working capital gross or current assets cannot be over emphasized. As already

observed, the objective of financial decision making is to maximize the shareholders wealth. To

achieve this, it is necessary to generate sufficient profits can be earned will naturally depend upon the

magnitude of the sales among other things but sales can not convert into cash. There is a need for

working capital in the form of current assets to deal with the problem arising out of lack of immediate

realization of cash against goods sold. Therefore sufficient working capital is necessary to sustain

sales activity. Technically this is refers to operating or cash cycle.

4.3 CONCEPT OF WORKING CAPITAL

There are two concepts of working capital:

1.     Gross working capital

2.     Net working capital

Grossw Working Capital

“The gross working capital is the capital invested in the total current assets of the

enterprises. Current assets are those Assets which can convert in to cash within a short

period normally one accounting year.”

71

Constituents of Current Assets.

Current assets are assets which are expected to be sold or otherwise used within one fiscal year.

Typically, current assets include cash, cash equivalents, accounts receivable, inventory, prepaid

accounts which will be used within a year, and short-term investments.

1 Cash in hand and cash at bank

2 Bills receivables/Sundry debtors

3 Short term loans and advances.

4 Inventories of stock as:

4.1 Raw material

4.2 Work in process

4.3 Stores and spares

4.4 Finished goods

5 Temporary investment of surplus funds.

6 Prepaid expenses

7 Accrued incomes.

8 Marketable securities.

Net Working Capital

“In a narrow sense, the term working capital refers to the net working capital. Net

working capital is the excess of current assets over current liability”

“NET WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES.”“NET WORKING CAPITAL = CURRENT ASSETS – 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 and include creditors, bills payable and outstanding expenses. Net working capital

can be positive or negative

Constituents of Current liabilities

Current liabilities are considered as liabilities of the business that are to be settled in cash within the

fiscal year. Current liabilities include accounts payable for goods, services or supplies, short-term

loans, long-term loans with maturity within one year, dividends and interest payable, or accrued

liabilities such as accrued taxes.

72

1. Accrued or outstanding expenses.

2. Short term loans, advances and deposits.

3. Dividends payable.

4. Bank overdraft.

5. Provision for taxation, if it does not amount to appropriation of profit.

6. Bills payable.

7. Sundry creditors.

The gross working capital concept is financial or going concern concept whereas net working capital

is an accounting concept of working capital. Both the concepts have their own merits.

The gross concept is sometimes preferred to the concept of working capital for the following reasons:

1.     It enables the enterprise to provide correct amount of working capital at correct time.

2.     Every management is more interested in total current assets with which it has to operate then the

source from where it is made available.

3.     It take into consideration of the fact every increase in the funds of the enterprise would increase

its working capital.

4.     This concept is also useful in determining the rate of return on investments in working capital.

The net working capital concept, however, is also important for following reasons:

1. It is qualitative concept, which indicates the firm’s ability to meet to its operating expenses

and short-term liabilities.

2. IT indicates the margin of protection available to the short term creditors.

3. It is an indicator of the financial soundness of enterprises.

4. It suggests the need of financing a part of working capital requirement out of the permanent

sources of funds.

Working capital, on the one hand, can be seen as a metric for evaluating a company’s operating

liquidity. A positive working capital position indicates that a company can meet its short-term

obligations. On the other hand, a company’s working capital position signals its operating efficiency.

Comparably high working capital levels may indicate that too much money is tied up in the business.

The most important positions for effective working capital management are inventory, accounts

receivable, and accounts payable. Depending on the industry and business, prepayments received

from customers and prepayments paid to suppliers may also play an important role in the company’s

cash flow. Excess cash and no operational items may be excluded from the calculation for better

comparison.

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4.4 CLASSIFICATION OF WORKING CAPITAL

Working capital may be classified in to ways:

On the basis of concept.

On the basis of time.

On the basis of concept working capital can be classified as gross working capital and net

working capital. On the basis of time, working capital may be classified as:

Permanent or fixed working capital.

Temporary or variable working capital

A-Permanent OR Fixed Working Capital.

The operating cycle is a continuous feature in almost all the going concerns and therefore creates the

need for working capital and their efficient management. However the magnitude of working capital

required will not be constant, but will fluctuate. At any time, there is always a minimum level of

current assets which is constantly and continuously required by a business unit to carry on its

operations. This minimum amount of current assets, which is required on a continuous and

uninterrupted basis, is after referred to as fixed or permanent working capital. This type of working

capital should be financed (along with other fixed assets) out of long term funds of the unit. However

in practice, a portion of these requirements also is met through short term borrowings from banks and

suppliers credit.

Chart 4-1 Permanent Working Capital

Y

ValuePermanent Current Asset

O XTime

Permanent Working Capital

74

The amount of Current Assets require to meet a firms long term minimum needs

The amount of current assets required to meet a firm’s long-term minimum needs are called

Permanent current assets.

For e.g., In a manufacturing unit, basic raw materials required for production has to be available at all

times and this has to be financed without any disturbance.

B-Temporary OR Variable Working Capital.

Any amount over and above the permanent level of working capital is variable, temporary or

fluctuating working capital. This type of working capital is generally financed from short term sources

of finance such as bank credit because this amount is not permanently required and is usually paid

back during off season or after the contingency. As the name implies, the level of fluctuating working

capital keeps on fluctuating depending on the needs of the unit unlike the permanent working capital

which remains constant over a period of time.

The Temporary or Variable working capital is the amount of working capital which is required to

meet the seasonal demands and some special exigencies. Variable working capital can further be

classified as Seasonal Working Capital and Special Working Capital. The capital required to meet the

seasonal need of the enterprise is called seasonal working capital. Special working capital is that part

of working capital which is required to meet special exigencies such as launching of extensive

marketing for conducting research, etc.

Temporary working capital differs from Permanent working capital in the sense that is required for

short periods and cannot be permanently employed gainfully in the business.

Chart 1-2 Temporary Working Capital

Y

Temporary current assets

Value

Permanent Working Capital

Time

Temporary Working Capital

75

The amount of Current Asset required

to meet short term minimum needs

4.5 DETERMINANTS OF WORKING CAPITAL

Working capital management is an indispensable functional area of management. However the total

working capital requirements of the firm are influenced by the large number of factors. It may

however be added that these factors affect differently to the different units and these keep varying

from time to time. In general, the determinants of working capital which are common to all

organizations can be summarized as under:

Nature of Business

This is one of the main factors. Usually in trading businesses the working capital needs are higher as

most of their investment is concentrated in stock or inventory. Manufacturing businesses also need a

good amount of working capital to meet their production requirements. Whereas, those companies

that sell services and not goods, on a cash basis require least working capital because there is no

requirement on their part to maintain heavy inventories.

Size of Business

In very small company the working capital requirement is quit high due to high overhead, higher

buying and selling cost etc. as such medium size business positively has edge over the small

companies. But if the business start growing after certain limit, the working capital requirements may

adversely affect by the increasing size.

Credit Terms / Credit Policy

Some time due to competition or custom, it may be necessary for the company to extend more and

more credit to customers, as result which more and more amount is locked up in debtors or bills

receivables which increase the working capital requirement. On the other hand, in the case of

purchase, if the credit is offered by suppliers of goods and services, a part of working capital

requirement may be financed by them, but it is necessary to purchase on cash basis, the working

capital requirement will be higher.

Credit terms greatly influence working capital needs. If terms are:

buy on credit and sell by cash, working capital is lower

buy on credit and sell on credit, working capital is medium

buy on cash and sell on cash, working capital is medium

buy on cash and sell on credit, working capital is higher.

Prevailing trade practices and changing economic condition do generally exert greater influence

on the credit policy of concern. A liberal credit policy if adopted more trade debtors would result and

when the same is tightened, size of debtors gets slim.

76

Credit periods also influence the size and composition of working capital. When longer credit period

is allowed to debtors as against the one extended to the firm by its creditors, more working capital is

needed and vice versa.

Collection policy is another influencing factor. A stringent collection policy might not only deter

away some credit customers, but also force the existing customers to be prompt in settling dues

resulting in lower level of working capital. The opposite holds well with a liberal collection policy.

Collection procedure also influences the working capital needs. A decentralized collection of dues

from customers and centralized payments to suppliers shall reduce the size of working capital.

Centralized collections and centralized payments would lead to moderate level of working capital. But

with centralized collections and decentralized payments, the working capital need would be the

highest.

Seasonality

Seasonality of Production

Agriculture and food processing and preservation industries have a seasonal production. During

seasons, when production activities are in their peak, working capital need is high.

Seasonality in supply of raw materials

This also affects the size of working capital. Industries that use raw materials which are available

during seasons only, have to buy and stock those raw materials. They cannot afford to buy these items

in a phased way, since either supplies would get reduced or prices would be higher. Also, from the

point of view of quality of raw materials, it pays to buy in bulk during the seasons. Hence the high

level of working capital needed when season exists for raw materials.

Seasonality of demand for finished goods

In case of products like umbrella, rain-coats and other seasonal items, the demand is high during peak

seasons. But the production of these items has to be continuous throughout the year to meet the high

demand during peak seasons. Thus, working capital requirement would be higher.

“Since Arabian Industries LLC is a contracting company, the above mentioned seasonal factors

do not affect its operation or its business cycle. “

Business Trade Cycle

Trade cycle refers to the periodic turns in business opportunities from extremely peak levels, via a

slackening to extremely tough levels and from there, via a recovery phase to peak levels, thus

completing a business cycle. There are 4 phases of trade cycle.

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Boom Period – more business, more production, more working capital.

Depression period – less business, less production, less working capital.

Recession period – slackening business, stock pile-up, more working capital.

Recovery period – recouping business, stock speedily converts to sales, less working capital.

Inflation

Under inflationary conditions generally working capital increases, since with rising prices demand

reduces resulting in stock pile-up and consequent increase in working capital.

Length of Production cycle

The time lapse between feeding of raw material into the machine and obtaining the finished goods out

from the machine is what is described as the length of manufacturing process. It is otherwise known

as conversion time. Longer this time period, higher is the volume and value of work-in-progress and

hence higher the requirement of working capital and vice versa.

System of Production process

If capital intensive, high-technology automated system is adopted for production, more investment in

fixed assets and less investment in current assets are involved. Also, the conversion time is likely to

be lower, resulting in further drop in the level of working capital. On the other hand, if labor intensive

technology is adopted, less investment in fixed assets and more investment in current assets which

would lead to higher requirement of working capital.

Growth and expansion plans

Growth and expansion industries need more working capital than those that are static.

Profitability

The profitability of the business may be vary in each and every individual case, which is in turn its

depend on numerous factors, but high profitability will positively reduce the strain on working capital

requirement of the company, because the profits to the extend that they earned in cash may be used to

meet the working capital requirement of the company.

78

Operating efficiency

If the business is carried on more efficiently, it can operate in profits which may reduce the strain on

working capital; it may ensure proper utilization of existing resources by eliminating the waste and

improved coordination etc.

Apart from the above factors, dividend policy, depreciation policy, price level changes, operating

efficiency and government regulations also influence the level and the size of working capital.

InflationInflation Business

Trade cycle

Business Trade cycle

SeasonalitySeasonality

ProfitabilityProfitability

Credit term or Credit policyCredit term or

Credit policySize of the BusinessSize of the

Business

Operating efficiencyOperating

efficiency

Nature of the

BusinessNature of

the Business

System of Production

processSystem of Production

process

Length of Production

cycleLength of Production

cycle

WORKINGCAPITALWORKING

CAPITAL

79

CHAPTER – V

80

1) INTRODUCTION

2) SCOPE OF THE STUDY

3) TYPES OF DATA COLLECTION

4) OBJECTIVE OF STUDY

5) LIMITATIONS OF STUDY

5.1 RESEARCH METHODOLOGY - INTRODUCTION

Research Methodology is a purposeful, precise and systematic search for new knowledge, skills,

attitudes and values, or for the re-interpretation of existing knowledge, skills, attitudes and values.

Research methodology is a way to systematically solve the research problem. It may be understood as

a science of studying now research is done systematically. In that various steps, those are generally

adopted by a researcher in studying his problem along with the logic behind them.

Data collection is important step in any project and success of any project will be largely depend upon

now much accurate you will be able to collect and how much time, money and effort will be required

to collect that necessary data, this is also important step.

Various Steps for Research Methodology

This project requires a detailed understanding of the concept – “Working Capital Management”.

Therefore, firstly we need to have a clear idea of what is working capital, how it is managed in AI

LLC, what are the different ways in which the financing of working capital is done in the company.

The management of working capital involves managing inventories, accounts receivable and payable

and cash. Therefore one also needs to have a sound knowledge about cash management, inventory

management and receivables management.

Then comes the financing of working capital requirement, i.e. how the working capital is financed,

what are the various sources through which it is done.

And, in the end, suggestions and recommendations on ways for better management and control of

working capital are provided.

81

5.2 SCOPE OF THE STUDY

This project is vital to us in a significant way. It does have some importance for the company too.

These are as follows:–

This project will be a learning device for the finance student.

Through this project we would study the various methods of the working capital management.

The project will be a learning of planning and financing working capital.

The project would also be an effective tool for credit policies of the companies.

This will show different methods of holding inventory and dealing with cash and receivables.

This will show the liquidity position of the company and also how do they maintain a

particular liquidity position.

5.3 TYPES OF DATA COLLECTION

There are two types of data collection methods available.

1. Primary data collection

2. Secondary data collection

5.3.1 Primary data collection method

Primary data is the data which the researcher collects through various methods like

interviews, surveys, questionnaires etc, to support the secondary data. Some advantages and

disadvantages of primary data are as follows:

5.3.2 Secondary data collection method

Secondary data is data collected by someone other than the user. Common sources of

secondary data for social science include censuses, surveys, organizational records and data

collected through qualitative methodologies or qualitative research. Primary data, by contrast,

are collected by the investigator conducting the research.

82

This project is based on primary data collected through personal interview of head of Finance

Department, head of Statistical Quality Control department and other concerned staff member of

finance department. But primary data collection had limitations such as matter confidential

information thus project is based on secondary information collected through four years annual report

of the company, supported by various books and internet sides. The data collection was aimed at

study of working capital management of the company.

Project is based on:

Financial Report of Arabian Industries LLC – 2004-2005-2006-2007-2008-2009

5.4 OBJECTIVES OF THE STUDY.

This research is focusing on working capital management and its effects on profitability for a sample

of Omani firm. Study of the working capital management is important because unless the working

capital is managed effectively, monitored efficiently planed properly and reviewed periodically at

regular intervals to remove bottlenecks if any the company can not earn profits and increase its

turnover. With this primary objective of the study, the following further objectives are framed for a

depth analysis.

5.4.1 The Main objectives of the studies are:

1. To study the way and means of working capital finance of the company.

2. To estimate the operating cash cycle and working capital requirement of the company.

3. To establish a relationship between Working Capital Management and Profitability over a

period of five years of the company..

4. To find out the effects of different components of working capital management on

Profitability

5. To establish a relationship between the two objectives of liquidity and profitability of the

Omani firm.

6. To find out the relationship between debt used by Arabian Industry LLC and its Profitability

7. To draw conclusion about relationship of working capital management and profitability of

the company.

8. To study the optimum level of current assets and current liabilities of the company.

9. To study the liquidity position through various working capital related ratios.

10. To study the working capital components such as receivables accounts, cash management,

Inventory position

83

5.4.2 Analysis Used in Study : Descriptive analysis .

Descriptive Statistics are used to describe the basic features of the data in a study. They provide

simple summaries about the sample and the measures. Together with simple graphics analysis,

they form the basis of virtually every quantitative analysis of data. With descriptive statistics you

are simply describing what is, what the data shows

5.4.3 Research Design

STEP 1 - To study the Financial Statement of Arabian Industries LLC

STEP 2 – Data Analysis of working capital through Estimation of Working Capital.

STEP 3 – Analysis of Inventory Management of Arabian Industries LLC.

STEP 4 – Comparison of base year data’s with previous years datas.

5.4.4 Data Collection

5.4.4.1 The information is collected through the Primary Source like:-

Interviewing the employees of the department.

Getting information from MIS department.

Discussion with the head of the Finance department and Procurement department.

5.4.4.2 The Data was collected from following Secondary Sources like:-

Corporate department

Procurement department

Finance department

Logistic Department

5.5 SCOPE AND LIMITATIONS OF THE STUDY

5.5.1 Scope of the study

The scope of the study is identified after and during the study is conducted. The study of working

capital is based on tools like trend Analysis, Ratio Analysis, working capital leverage, operating

cycle etc. Further the study is based on last 5 years Annual Reports of ArabianIndustries LLC,

And even factors like competitor’s analysis, industry analysis were not considered while

preparing this project.

84

5.5.2 Limitations of the study

Following limitations were encountered while preparing this project:

1) Limited data:-

This project has completed with annual reports; it just constitutes one part of data collection i.e.

secondary. There were limitations for primary data collection because of confidentiality.

2) Limited period:-

This project is based on five year annual reports. Conclusions and recommendations are based on

such limited data. The trend of last five year may or may not reflect the real working capital

position of the company

3) Limited area:-

Also it was difficult to collect the data regarding the competitors and their financial information.

Industry figures were also difficult to get.

RESEARCH METHODOLOGY – DATA TO ACTION

85

Chapter VI

86

1) Working capital level.2) Working capital trend analysis.3) Current assets analysis.4) Current liability analysis.5) Changes of working capital6) Operating cycle7) Working capital leverage

1.1 Working Capital level

The guiding principle for working capital is called the hedging principle or principle of self-

liquidating debt or matching principle (different from the matching principle used in measuring

accounting profit).

It is an accepted belief in business that the term of a funding arrangement must match the term of the

investment itself. This means that any funds used for short-term assets or purposes should be financed

from short-term sources. Likewise investments in long term-assets should be funded from long-term

sources.

Therefore a key criterion for acquiring additional finance is matching up the life of the assets acquired

with the term of the loan or other method of funding. For example, the buying of an unusually large

quantity of inventory should be financed by a loan, or credit, with a repayment period of less than one

year.

The level of any long-term assets funded by short-term debt shows the firm's level of 'aggression' in

its financing policy. Although this type of action may increase profits (due to the lower cost of short-

term debt) it greatly increases the risk of cash shortages if short-term financing can't be renewed.

Table 6.1- Size of Working Capital

SOURCE: COMPANY REPORT

EXTRACTED FROM AUDITED BALANCE SHEET OF ARABIAN INDUSTRIES LLC

2004 2005 2006 2007 2008 2009

CURRENT ASSET            

Bank Balances

45,595 1

96,786

67,900 5

62,828 1

43,351 1,892,

372

Trade Debtors 2,18

8,348 2,92

1,799 7,70

2,727 12,54

3,178 20,19

4,201 13,437,

981

Inventory 1

12,639 4

59,404 1

60,412 3

73,118 5

63,989 724,

145

Work in Progress 1,75

8,719 2,14

2,770 2,77

3,635 1,27

5,523 1,42

2,625 2,274,

690

Dues from Related Parties -

-

214,325

191,658

316,956

4,632,789

Other Receivables 3

49,388

52,319 7

25,857 5

12,228 3

36,700 99,

243

TOTAL CURRENT ASSETS 4,45

4,689 5,77

3,078 11,64

4,857 15,45

8,533 22,97

7,822 23,061,

219

  -

-

-

-

-

-

CURRENT LIABILITIES -

-

-

-

-

-

Short-term Borrowings 3

40,867 9

00,676 2,04

9,745 -

2,015,753

553,812

Current Portion of Long Term loan 1

47,493 1

84,717 4

98,801 1,43

6,567 1,50

3,569 2,188,

446

Trade Creditors 1,17

1,301 3,01

3,726 5,15

4,023 6,84

0,688 10,29

3,795 6,186,

854

Dues to Related Parties 4

49,842

2,043

23,504

31,073 1,49

9,973 420,

900

Provisions - Tax -

27,422

182,064

175,183

402,530

922,451

Other Payables 1,21

7,574 1,53

3,552 3,48

9,970 6,65

2,454 6,94

8,035 5,588,

569

TOTAL CURRENT LIABILITIES 3,32

7,077 5,66

2,135 11,39

8,106 15,13

5,965 22,66

3,655 15,861,

031

87

NET WORKING CAPITAL - (A-B) 1,127,612 110,943 246,751 322,568 314,167 7,200,188

1.2 WORKING CAPITAL TREND ANALYSIS

Trend analysis is an improvement over the year to year analysis. When a comparison of Financial

Statements covering more than 3 years is undertaken, the year to year analysis becomes cumbersome.

In trend analysis, the changes are calculated for several successive years instead of two or three years.

Therefore the trend analysis is a company's financial position over a long period of time. Trend

analysis is important as it may point to basic changes in the nature of business and also helps in

drawing meaningful conclusions regarding the operating performance over several years and the

financial position of the enterprise. It is based on the idea that what has happened in the past gives an

idea of what will happen in the future.

In working capital analysis the direction at changes over a period of time is of crucial importance.

Working capital is one of the important fields of management. It is therefore very essential for an

annalist to make a study about the trend and direction of working capital over a period of time. Such

analysis enables as to study the upward and downward trend in current assets and current liabilities

and it’s effect on the working capital position.

In the words of S.P. Gupta “The term trend is very commonly used in day-today conversion trend,

also called secular or long term need is the basic tendency of population, sales, income, current

assets, and current liabilities to grow or decline over a period of time”.

According to R.C.Galeziem “The trend is defined as smooth irreversible movement in the series.

It can be increasing or decreasing.”

Emphasizing the importance of working capital trends, Man Mohan and Goyal have pointed out that

“analysis of working capital trends provide as base to judge whether the practice and privilege policy

of the management with regard to working capital is good enough or an important is to be made in

managing the working capital funds.

Further, any one trend by it self is not very informative and therefore comparison with Illustrated their

ideas in these words, “An upwards trends coupled with downward trend or sells, accompanied by

marked increase in plant investment especially if the increase in planning investment by fixed interest

obligation”

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One of the main goals of trend analysis is to forecast future values of the series. It allows a researcher

to look at a pattern of change over a long period of time rather than at a single discrete point in time or

over a short time so that better conclusions can be drawn.

Table 6.2 – Working Capital Variance Analysis.

ANALYSIS OF VARIANCE OF WORKING CAPITAL

YEARS 2004 2005 2006 2007 2008 2009

TOTAL CURRENT ASSETS 4,454,689 5,773,078 11,644,857 15,458,533 22,977,822 23,061,219

TOTAL CURRENT LIABILITIES 3,327,077 5,662,135 11,398,106 15,135,965 22,663,655 15,861,031

NET WORKING CAPITAL - (A-B) 1,127,612 110,943 246,751 322,568 314,167 7,200,188

W-C VARIATION –in % 100% 9.84% 21.88% 28.61% 27.86% 638.53%

(“Index    =             100 X Index Year Amount / Base Year Amount”)

Chart-6.1- Working capital index

WORKING CAPITAL INDEX

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

2004 2005 2006 2007 2008 2009

YEARS

VA

LUE

TOTAL CURRENTASSETS

TOTAL CURRENTLIABILITIES

NET WORKINGCAPITAL - (A-B)

W-C VARIATION –in%

Table 6.3-Working capital size

ANALYSIS OF VARIANCE OF WORKING CAPITAL

YEARS 2004 2005 2006 2007 2008 2009

TOTAL CURRENT ASSETS 4,454,689 5,773,078 11,644,857 15,458,533 22,977,822 23,061,219

TOTAL CURRENT LIABILITIES 3,327,077 5,662,135 11,398,106 15,135,965 22,663,655 15,861,031

NET WORKING CAPITAL - (A-B) 1,127,612 110,943 246,751 322,568 314,167 7,200,188

W-C VARIATION –in % 100% 9.84% 21.88% 28.61% 27.86% 638.53%

The computation of a series of Index Numbers requires the choice of a base year that will for

all times have an index number of 100. The base period should be a normal year with regard to

business conditions, since the base year used as a reference should be representative. Generally, the

earliest year is selected as a base year. However, where the earliest year is selected as the normal year

89

then another year is chosen. All Index numbers are computed with reference to the base year using

this formula

1.2.1 OBSERVATIONS

It was observed that major source of liquidity problem is the mismatch between current payments and

current receipts from the Comparison of funds flow statements of AI LLC for six years. It was

observed that in the year 2005 current assets increased by around 29.6% compared to 2004 and

current liabilities increased by 70.18% which affect as working capital reduced by 9.84% in the year

2005 compared to 2004.because the net working capital was OMR 1,127,612/- in 2004 but in 2005 it

was reduced to OMR 110,943/- in the year 2005 due to the increase in current liability of 70%

compared to 2004. In 2004 current liability was OMR 3,327,077, where as in 2005 it was increased by

OMR 2,335,058/-; a total liability of OMR 5,662,135/- in 2005.

In the year 2006, 2007, 2008 a tremendous increase we can see in current liability by 172.4%,

112.35%, and 226.26% res. and current asset also increased accordingly compared to 2004 like

131.8%, 85.61% and 168.79% during the year 2006, 2007, 2008. In the year 2009 we can see the

growth of current asset is very less compared to 2004 with a percentage of only 1.87% where as in the

current liability we can see there is a slop of -2004.46% compared to 2004, where as an increase in

current asset for 73.478% compared to 2004 and a good nest asset (WC reserve) is with the firm for

an increased percentage of 638.53% in the year 2009.

The position of working capital is very good in 2009 because the bank balance in 2008 was only

143,351/- OMR where as in 2009 it is increased to OMR 1,892,372/-; ie. 1220% compared to 2008,

which is quite good and also we can see that there is receivable from related parties is 4,632,789/- in

the year 2009, where as in 2008 it was only OMR 316,956/-; that means an increase is for 1361% in

the year 2009 compared to 2008. That means the fund position is quite good for 2009.

While compared to 2004 current assets have been increased by 417.68% and current liabilities have

been increased by 376.73%. But compared to 2008 and 2009 there is a short fall of -30.02% in current

liabilities, where as an increase in current asset is only an increase of .36%. The bank balance is

increased to OMR 1,892,372/- in 2009 from OMR 143,351/- in the year 2008.It shows that

management is using only it’s own fund for the short term requirements and WC has been increased

90

to OMR 7,200,186/- in the year 2009-A growth of 638.53%. This two together pushed down the net

working capital to the present level. The increase in working capital is a clear indication that the

company is utilizing its own funds and resources with efficiency.

Table 6.4 –Variance Analysis of Current Asset and Current Liability.

OBSERVATION OF WORKING CAPITAL            

YEARS 2004 2005 2006 2007 2008 2009

TOTAL CURRENT ASSETS 529853 686666 1385071 1838680 2733045 2742964

YEARLY VARIATION 100 156813 698405 453609 894365 9920

GROWT COMPARED TO 2004 100 29.60 131.81 85.61 168.79 1.87

YEARLY GROWTH IN % 100 29.60 101.71 32.75 48.64 0.36

             

TOTAL CURRENT LIABILITIES 395732 673470 1355722 1800313 2695677 1886554

YEARLY VARIATION 395732 673470 1355722 1800313 2695677 1886554

GROWTH COMPARED TO 2004 100 70.18 172.40 112.35 226.26 (204.46)

YEARLY GROWTH IN % 100 70.18 101.30 32.79 49.73 (30.02)

NET WORKING CAPITAL - (A-B) 134121 13196 29349 38367 37368 856410

WORKING CAPITAL SIZE 100 9.84 21.88 28.61 27.86 638.53

TOTAL CURRENT ASSETS 100 156812.76 855218.25 1308827.295 2203192.035 2213111.565

VARIATION COMPARED TO 2004 100 29.6 161.41 247.02 415.81 417.68

TOTAL CURRENT LIABILITIES 100 277738.2 959990.265 1404581.445 2299945.455 1490822.82

VARIATION COMPARED TO 2004 100 70.18 242.59 354.93 581.19 376.73

1.3 CURRENT ASSETS

A balance sheet item which equals the sum of cash and cash equivalents, accounts receivable,

inventory, marketable securities, prepaid expenses, and other assets that could be converted to cash in

less than one year. A company's creditors will often be interested in how much that company has in

current assets, since these assets can be easily liquidated in case the company goes bankrupt. In

addition, current assets are important to most companies as a source of funds for day-to-day

operations.

Table 6.5-Current Asset Size

CURRENT ASSET            

  2004 2005 2006 2007 2008 2009

CURRENT ASSET - A            

Bank Balances / Deposits

46,198 19

9,387 6

8,798 5

70,267 145,245

1,917,381

Trade Debtors (Net of Provisions) 2,2

17,269 2,96

0,413 7,80

4,526 12,7

08,947 20,461,085

13,615,576

Inventory 1

14,127 46

5,475 16

2,532 3

78,049 571,443

733,715

Work in Progress 1,7

81,962 2,17

1,088 2,81

0,291 1,2

92,380 1,441,426

2,304,752

Dues from Related Parties -

-

217,158

194,191

321,144

4,694,015

Other Receivables 3

54,006 5

3,010 73

5,450 5

18,997 341,150

100,555

91

TOTAL CURRENT ASSETS 4,5

13,561 5,84

9,374 11,79

8,754 15,6

62,831 23,281,494

23,365,993

CURRENT ASSET INDEX 100 129.60 261.41 347.02 515.81 517.68

Chart 6.2- Current Asset Index.

1.3.1

Composition of current assets

Analysis of current assets components enable one to examine in which components the working

capital fund has locked. A large tie up of funds in inventories affects the profitability of the business

or the major portion of current assets is made up cash alone, the profitability will be decreased

because cash is non earning asset

Table 6.6-Composition of Current Assets

CURRENT ASSET COMPOSITION           

  2004 2005 2006 2007 2008 2009

CURRENT ASSET - A            

Bank Balances 1.02 3.41 0.58 3.64 0.62 8.21

Trade Debtors 49.12 50.61 66.15 81.14 87.89 58.27

Inventory 2.53 7.96 1.38 2.41 2.45 3.14

Work in Progress 39.48 37.12 23.82 8.25 6.19 9.86

Dues from Related Parties - - 1.84 1.24 1.38 20.09

Other Receivables 7.84 0.91 6.23 3.31 1.47 0.43

CURRENT ASSET INDEX 100 100 100 100 100 100

Chart 6.3- Current Asset Components92

100 129.60

261.41347.02

515.81 517.68

0

100

200

300

400

500

600

VALUE

2004 2005 2006 2007 2008 2009

YEAR

CURRENT ASSET INDEX

CURRENTASSETINDEX

1.3.2

Observations

It was observed that the size of current assets is increasing with increases in the sales. The excess of

current assets is showing positive liquidity position of the firm but it is not always good because

excess current assets then required, it may adversely affects on profitability.. We can see in each year

there is tremendous growth in current asset. Compared to 2007 the growth in current asset in 2008,

there is a growth of 48.64%, where as in 2009 the growth rate is only .36%. The reason is that the

debtors receivable in 2008 is 20,461,085 but in 2009 it has been reduced to 13,615,576/-, a drop of

OMR 6,845,509/- ie. 33.46%. These shows that the a good cash collection from receivables in 2009

which shows a good working capital reserve of OMR 6,845,509/- which used to pay back the current

liabilities of sundry creditors, other payables and due to related parties.

Compared to 2008 in 2009 the bank balance also increased to OMR 1,917,381/-from OMR 145,245/-

in the year 2008. Cash balance of the company increased in the year 2009 because company had done

good in it’s collection process, which provides a good financial position in 2009. Current assets

components show sundry debtors are the major part in current assets it indicates that the efficiency in

collection management. Over investment in the debtors may affects liquidity of firm for that company

has raised funds from other sources like short term loan which incurred the interest. Other main

achievement is that, if we compare the purchase level with inventory, we can see that inventory level

is not increased as compared to the volume of purchase. But same time we can see that the receivable

from related parties and work in progress has been increased substantially. These show the proper

utilization of materials and resources.

1.4 Current liabilities

93

0%

20%

40%

60%

80%

100%

VA

RIA

TIO

N IN

%

2004 2005 2006 2007 2008 2009

YEARS

CURRENT ASSET COMPOSITION

Other Receivables

Dues from RelatedParties

Work in Progress

Inventory

Trade Debtors (Netof Provisions)

Bank Balances /Deposits

Current liabilities are debts, accounts payable, interest due, trade credit, loans, and other obligations

that are due and payable within one year. Current liabilities are calculated and identified on a

business' balance sheet. Current liabilities as a total are information that is used as one measure of the

financial condition of a company, especially in association with current assets to calculate the level of

working capital.

Table 6.7-Current liabilities size

  2004 2005 2006 2007 2008 2009

CURRENT LIABILITIES - B            

Short-term Borrowings 345,371 912,579 2,076,834 0 2,042,393 561,131

Current Portion of Long Term Debt 149,443 187,158 505,393 1,455,553 1,523,440 2,217,368

Trade Creditors 1,186,780 3,053,555 5,222,137 6,931,094 10,429,836 6,268,619

Dues to Related Parties 455,788 2,070 23,814 31,484 1,519,796 426,463

Provisions - Tax 0 27,784 184,470 177,498 407,850 934,642

Other Payables 1,233,665 1,553,819 3,536,092 6,740,372 7,039,860 5,662,426

TOTAL CURRENT LIABILITIES 3,371,047 5,736,965 11,548,742 15,336,000 22,963,175 16,070,649

VARIATION IN CURRENT

LIABILITIES IN % 100.000 170.183 342.586 454.933 681.188 476.726

Chart 6.4- Current Liability Index

Observations

94

VARIATION IN CURRENT LIABILITIES

100

170.183

342.586

454.933

681.188

476.7258

0

100

200

300

400

500

600

700

800

2004 2005 2006 2007 2008 2009

YEARS

VA

RIA

TIO

N

VARIATIONINCURRENTLIABILITIES

Current liabilities show a tremendous growth till 2008, because company creates the credit in the

market by good transaction. To get maximum credit from supplier which is profitable to the company

it reduces the need of working capital of firm. As the current liability increase in the year 2007, 2008

by 455% and 682 % res. it increases the working capital size in the same year. But subsequently it the

liability has been reduced to 477%. But due to the good collection process the change in working

capital is not affected much and the company enjoyed good credit terms over creditors which may

include indirect cost of credit terms. From the graph we can see that the requirementof working

capital has been increased drastically during the year 2006-2007-2008and it has been paid and cleared

n 2009, and still the firm is having a good reserve in it’s working capital. This shows the efficiency in

it’s collection policy.

1.5 Changes in working capital

The excess of current assets over current liabilities is referred to as the company’s working capital.

The difference between the working capital for two given reporting periods is called the change in

working capital.

1.5.1 Benefit

Changes in working capital is included in cash flow from operations because companies typically

increase and decrease their current assets and current liabilities to fund their ongoing operations.

When a company increases its current assets, it’s a cash outflow: The company had to shell out money

to buy the extra assets. Likewise, when a company increases its current liabilities, it’s a cash inflow:

The added liabilities, such as short-term debt, provide money. Changes in working capital simply

shows the net affect on cash flows of this adding and subtracting from current assets and current

liabilities. When changes in working capital is negative, the company is investing heavily in its

current assets, or else drastically reducing its current liabilities. When a change in working capital is

positive, the company is either selling off current assets or else raising its current liabilities.

1.5.2 Origin

95

This information is found in the Statement of Cash Flow of the company’s financial statement.

1.5.3 For the Processing:

For many growing companies, changes in working capital is a little like capital spending: It’s money

the company is investing—in things like inventory—in order to grow. To get a true picture of the cash

a company is generating before investment, one can add back changes in working capital to cash flow

from operations. Another point: A negative value for changes in working capital could mean the

company is investing heavily in growth, or that something’s gone wrong. If a company is having

trouble selling its goods, inventories will balloon, and changes in working capital will turn sharply

negative.

There are so many reasons to changes in working capital as follows:-

1. CHANGES IN SALES AND OPERATING EXPANSES:-

The changes in sales and operating expanses may be due to three reasons

A) There may be long run trend of change e.g. The price of row material say steel may constantly

raise necessity the holding of large inventory.

B) Cyclical changes in economy dealing to ups and downs in business activity will influence the level

of working capital both permanent and temporary.

C) Changes in seasonality in sales activities

2. Policy changes:-

The second major case of changes in the level of working capital is because of policy changes

initiated by management. The term current assets policy may be refined as the relationship between

current assets and sales volume.

3. Technology changes:-

The third major point if changes in working capital are changes in technology because change sin

technology to install that technology in our business more working capital is required

A change in operating expanses rise or full will have similar effects on the levels of working

following working capital statement is prepared on the base of balance sheet of last two year.

96

“Net change in working capital is the difference in working capital levels from one year

to the next. When more cash is tied up in working capital than the previous year, the increase in

working capital is treated as a cost against free cash flow”

. Table 6-8-Changes in Working Capital

CHANGES IN WORKING CAPITAL CHANGES IN W C

  2008 2009 changes in % INCREASE DECREASE

CURRENT ASSET - A

Bank Balances / Deposits 145,245.00

1,917,381.20

1,403.12

1,772,136.20

-

Trade Debtors (Net of Provisions) 20,461,085.20

13,615,575.65

(38.47)

-

6,845,509.55

Inventory 571,443.05

733,714.95

32.66

162,271.90

-

Work in Progress 1,441,426.10

2,304,751.80

68.88

863,325.70

-

Dues from Related Parties 321,144.40

4,694,014.80

1,565.90

4,372,870.40

-

Other Receivables 341,149.80

100,554.85

(81.10) #VALUE!

240,594.95

TOTAL CURRENT ASSETS-A 23,281,493.55

23,365,993.25

-

-

-

  -

-

-

-

-

CURRENT LIABILITIES - B -

-

-

-

-

Short-term Borrowings 2,042,393.10

561,131.00

(83.40)

1,481,262.10

-

Current Portion of Long Term Debt 1,523,439.50

2,217,367.90

52.38

-

693,928.40

Trade Creditors 10,429,836.45

6,268,618.95

(45.88)

4,161,217.50

-

Dues to Related Parties 1,519,796.30

426,462.55

(82.73)

1,093,333.75

-

Provisions - Tax 407,849.80

934,641.80

148.54

-

526,792.00

Other Payables 7,039,859.55

5,662,426.35

(22.50)

1,377,433.20

-

TOTAL CURRENT LIABILITIES-B 22,963,174.70

16,070,648.55

-

-

-

NET WORKING CAPITAL - (A-B) 318,318.85

7,295,344.70

-

-

-

NET INCREASE IN WC 6,977,025.85

-

-

-

6,977,025.85

TOTAL 7,295,344.70

7,295,344.70

-

15,283,850.75

15,283,850.75

Chart 6.5- Changes in Working Capital

1.5.4 Observations

97

CHANGES IN WORKING CAPITAL

-

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

YEARS

VA

RIA

TIO

N

DECREASE

INCREASE

Working capital has been increased in the year 2008 to 2009 because:

Trade Receivables in the year 2008, for OMR 20,461085/- has been reduced to OMR

13,615,575/-, ie. 33.45% less, compared to 2008. That means there was a good cash collection

effected in 2009, and therefore the bank balance also has been increased from OMR 145,245/-

to OMR 1,917,381/-, an increase of 1220%, where cost of raw material purchased increased by

28.4%.

When the trade receivable has reduced in 2009, simultaneously there was a decrease in trade

creditors also. In 2008 trade creditors was 10,429,836/-, but in 2009 it has been reduced to

OMR 6,268,618/-, a reduction of 39.9%. That means an increase in Working Capital is OMR

4,161,217/-. Same way, Due to related parties; it was OMR 1,519,796/- in the year of 2008, but

it has been reduced to OMR 426,462/. A reduction of 71.9%. That means the there is an

increase in Working Capital for OMR.1, 093,333/-.

In the case of short-term borrowing; in the year 2008 the short-term borrowing was OMR

2,042,393/-. But in 2009 it has been reduced to 561,131/-. There is a decrease of 72.5%. That

means there is an in crease in working capital for 1,481,262/-.

Even though the trade receivables and other receivables are reduced the fund received from

receivables has been utilized to clear the liabilities. This leads to show a good performance and

result in it’s working capital.

1.6 OPERATING CYCLE OR WORKING CAPITAL CYCLE

Working capital is also known as revolving capital and a circular path of conversion/recon version

takes place. This revolution of cycle is called as the Operating Cycle Available cash tends to be tied

up in what is known as the Working Capital Cycle (WCC). Every business, regardless of what they do

operates this cycle. To start any business cash is required; this cash is then used to purchase stock in

order to generate a sale. When the stock is sold it is either by way of a cash sale or is charged to an

account, creating a debtor.

When the debt is collected the WCC continues on. In a service industry the stock is client base or the

service provided. The need of working capital arrived because of time gap between production of

goods and their actual realization after sale. This time gap is called “Operating Cycle” or “Working

Capital Cycle”. The operating cycle of a company consist of time period between procurement of

inventory and the collection of cash from receivables. The operating cycle is the length of time

between the company’s outlay on raw materials, wages and other expanses and inflow of cash from

sales of goods.

98

Thus a revolution or cycle from cash to raw materials to Work-in-Progress, to finished goods, to

debtors, and back to cash takes place. This revolution is called as operating cycle.

While waiting for cash to to return, more stock has to be purchased to keep the business operating and

to do so, many businesses use their overdraft facility which is costing them money. If there is no

overdraft they are using credit funds that could be better utilised elsewhere. The faster you can turn

the WCC the faster the dollar returns and the less overdraft or credit funds you have to use. This is

where efficiency in debt collection and stock turnover is the key.

Managing cash in any business is important. Many profitable businesses end up closing down simply

because they could not get the cash to carry them in the short term. Beyond Survival Workshops

emphasize the difference between cash flow and profits, constructs a cash flow budget for a business

and analyses where does all the cash go. It will demonstrate the importance on the efficient operation

of the working capital cycle, how to improve debtor collection and stock turnover to help increase

cash holdings and reduce the overdraft limit.

OPERATING CYCLE.

Thus, the term operating cycle, otherwise called as cash cycle refers to the length of time necessary to

complete the following cycle of events:

1 Conversion of cash into inventory

2 Conversion of inventory into debtors

3 Conversion of debtors into cash

99

Stage 1: Cash to Inventory – In this stage, cash first gets converted into raw materials, then work-in

progress and then finished goods in a typical manufacturing concern. As regards non-manufacturing

concerns, when the goods are purchased, cash gets converted into inventory

.

Stage 2: Inventory to Debtors – The inventory thus produced or purchased, gets converted into

debtors or receivables upon credit sales.

Stage 3: Debtors to Cash -The debtors or accounts receivables get in turn converted back into cash

when they make payment

.

1.6.1 LENGTH OF OPERATING CYCLE:

When raw materials remain in store pending issue for production for a less duration, when raw

materials gets converted into WIP in a short duration, when finished goods remain in warehouse

pending for sales for a short duration only, and when cash realizations out of sales are made quickly

and finally when payment to creditors is made slowly, the operating cycle would be smaller and

consequently the working capital will also be reasonable. Thus shorter duration of operating cycle

indicates an efficient working capital management.

Operating cycle is an important concept in management of cash and management of cash working

capital. The operating cycle reveals the time that elapses between outlays of cash and inflow of cash.

Quicker the operating cycle less amount of investment in working capital is needed and it improves

profitability. The duration of the operating cycle depends on nature of industries and efficiency in

working capital management.

1.6.2 OPERATING CYCLE APPROACH OR WORKING CAPITAL CYCLE APPROACH

According to this approach, the requirements of working capital depend upon the operating cycle of

the business.

The operating cycle begins with the acquisition of raw materials and ends with the collection of

receivables

It may be broadly classified into the following four stages viz.

1. Raw materials and stores storage stage.

2. Work-in-progress stage.

3. Finished goods inventory stage.

4. Receivables collection stage.

100

1.6.3 CALCULATION OF OPERATING CYCLE OR WORKING CAPITAL CYCLE

To calculate the operating cycle of AI LLC, used last five year data. Operating cycle of the AI LLC

vary year to year as changes in policy of management about credit policy and operating control.

The duration of the operating cycle for the purpose of estimating Working capital requirements is

equivalent to the sum of the durations of each of these stages less the credit period allowed by the

suppliers of the firm.

Symbolically the duration of the working capital cycle can be put as follows: -

O=R+W+F+R-C

The gross operating cycle of a firm is equal to the length of the inventories and receivables conversion

periods.

RMCP = Raw Material Conversion Period

WIPCP = Work–In-Process Conversion Period

FGCP = Finished Goods Conversion Period

RCP = Receivables Conversion Period

CPP = Creditors Payment Period

However, a firm may acquire some resources on credit and thus defer payments for certain period. In

that case, Net Operating Cycle Period can be calculated as below:

101

Net Operating Cycle Period = Gross Operating Cycle Period – Payable Deferral period

Therefore Gross Operating Cycle = RMCP + WIPCP + FGCP + RCP - CPP

Further, following formula can be used to determine the conversion periods. Each of the components

of the Operating Cycle can be calculated as follows:-

Raw Material Conversion Period = Average Stock of Raw Material / Raw Material Consumption per day

Work in process Conversion Period = Average Stock of Work-in-Progress / Total Cost of Production per day

Finished Goods Conversion Period = Average Stock of Finished Goods / Total Cost of Goods sold per day

Receivables Conversion Period = Average Accounts Receivables / Net Credit Sales per day

Payable Deferral Period = Average trade Creditors / Average Credit Purchase per day

After computing the period of one operating cycle, the total number of operating cycles that can be

computed during a year can be computed by dividing 365 days with number of operating days in a

cycle. The total expenditure in the year when year when divided by the number of operating cycles in

a year will give the average amount of the working capital requirement.

OPERATING CYCLE/WORKING CAPITALCYCLE

IF THE FIRM- THEN THE FIRM WILL-

  Collect receivables (debtors) faster Release cash from the cycle

  Collect receivables (debtors) slower Receivables soak up cash

  Get better credit (in terms of duration   or amount)

from suppliers Increase THE cash resources

  Shift inventory (stocks) faster Free up cash

  Move inventory (stocks) slower Consume more cash

1.6.4 CASH CONVERSION CYCLE OR NET OPERATING CYCLE

102

Operating cycle and cash cycle are two important components of working capital management.

Together they determine the efficiency of a firm regarding working capital management. While the

operating cycle is the time period from inventory purchase until the receipt of cash, the cash cycle is

the time period from when cash is paid out, to when cash is received.

Refers to the delay between the buying of raw materials and the receipt of cash from sales proceeds.

In other words, operating cycle refers to the number of days taken for the conversion of cash to

inventory through the conversion of accounts receivable to cash. It indicates towards the time period

for which cash is engaged in inventory and accounts receivable. If an operating cycle is long, then

there is lower accessibility to cash for satisfying liabilities for the short term.

Operating cycle takes into consideration the following elements: accounts payable, cash, accounts

receivable, and inventory replacement. The following formula is used for calculating operating cycle:

(1) Disregarding the capacity to defer payables, the cash conversion cycle is the length of time

between the payment of cash for inventory and receipt of cash from accounts receivable.

(a) If a firm holds its inventory 50 days and collects its accounts receivable in 30 days, then it would

take 80 days for the original investment to be converted back into cash.

(b) However, if the firm has the option of creating an accounts payable for 20 days, the cash

conversion cycle can be reduced from 80 days to 60 days.

(2) The cash conversion cycle is equal to the inventory conversion period, plus the receivables

collection period, minus the payables deferral period.

(a) The inventory conversion period is the average time between buying inventory and selling the

goods. We have: inventory conversion period = inventory/(cost of sales/365) = 365/(inventory

turnover).

(b) The receivables collection period, or days' sales outstanding (DSO), is the average number of days

that it takes to collect on accounts receivable. We have: receivables collection period =

receivables/(sales/365) = 365/receivables turnover.

(c) The payables deferral period is (the accounts payable + wages, benefits, and payroll taxes payable)

/ ([the cost of sales + selling, general, and administrative expenses]/365).

Table 6.9- Operating cycle (No. of Days)103

YEARS 2006 2007 2008 2009

Days Debtors 83 78 136 96

Days Inventory 80 45 18 17

Days Payable 75 66 84 55

Chart 6.6- Net Operating Cycle

83

80

75

78

45

66

136

18

84

96

17

55

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

DAYS

2006 2007 2008 2009

YEARS

NET OPERATING CYCLE

Days Payable

Days Inventory

Days Debtors

THE FIRMS GROSS OPERATING PROFIT (GOC) CAN BE DETERMINED AS:-

INVENTORY CONVERSIONPERIOD (ICP) + DEBTORS CONVERSION PERIOD (DCP).

GOC=ICP+DCP

Observations

Operating cycle of AI LLC shows the numbers of day are decreasing in recent year it is reflect the

efficiency of management. Days of operating cycle shows period of lack of funds in current assets, if

no of day are more than it increases the cost of funds as taken from outside of the business. In 2008/09

shows the high no. of days because of reduced of creditors holding period.

1.7 WORKING CAPITAL LEVERAGE OR GEARING OF WORKING CAPITAL

104

ICP+RMCP+WIPCP

In finance, leverage (also known as gearing or levering) refers to the use of debt capital to supplement

equity capital. Companies usually leverage to attempt to increase returns on equity capital, as it can

increase the scope for gains or losses. The temporary increases in stock prices due to leverage at some

banks have been blamed for the unusually high overall remuneration for top executives during the

financial crisis of 2007–2010, since gains in stock prices were often rewarded regardless of how they

were achieved. Deleveraging is the action of reducing borrowings. In macroeconomics, a key measure

of leverage is the debt to GDP ratio.

One of the important objectives of working capital management is by maintaining the optimum level

of investment in current assets and by reducing the level of investment in current assets and by

reducing the level of current liabilities the company can minimize the investment in the working

capital thereby improvement in return on capital employed is achieved. The term working capital

leverage refers to the impact of level of working capital on company’s profitability. The working

capital management should improve the productivity of investment in current assets and ultimately it

will increase the return on capital employed. Higher level of investment in current assets than is

actually required means increase in the cost of Interest charges on short term loans and working

capital finance raised from banks etc. and will result in lower return on capital employed and vice

versa. Working capital leverage measures the responsiveness of ROCE (Return on Capital Employed)

for changes in current assets. It is measures by applying the following formula,

The working capital leverage reflects the sensitivity of return on capital employed to changes in level

of current assets. Working capital leverage would be less in the case of capital intensive capital

105

employed is same working capital leverage expresses the relation of efficiency of working capital

management with the profitability of the company.

Table 6.10- Calculation of working capital leverages.

YEARS 2006 2007 2008 2009

ROCE 630% 1650% 1960% 2460%

WC LEVERAGE 3.37 3.23 3.14 1.8

Chart 6.7- Working Capital Leverage

Working capital leverage of the company has decreased in the year 2009 as compare to the year 2006,

and increase in working capital shows the efficient current assets management. In the year 2006 and

2007 the current assets has increased by high rate of 261% and 347% respectively. It tends to increase

ROCE, which increased at the rate of 6.3% and 16.5% respectively, that resulted in push down the

working capital leverage to 3.37% and 2.32% respectively. When investment in current assets and

fixed asset will help the firm to run with sufficient fund without any overdraft or interrupt in it’s fund

flow.

106

WORKING CAPITAL LEVERAGE = % CHANGES IN ROCE / % CHANGES IN CURRENT ASSETS

RETURN ON CAPITAL EMPLOYED – (ROCE) = EBIT / TOTAL ASSETS

6.30%

3.37%

16.50%

3.23%

19.60%

3.14%

24.60%

1.80%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

% CHANGES

2006 2007 2008 2009

YEARS

WORKING CAPITAL LEVERAGE

ROCE

WC LEVERAGE

CHAPTER V1I

7.1 INTRODUCTION TO FINANCIAL RATIO ANALYSIS – ARABIAN INDUSTRIES LLC

107

1) Introduction2) Role of ratio analysis3) Limitations of ratio analysis4) Classifications of ratios5) Efficiency ratio6) Liquidity ratio

Financial ratios are one of the most common tools of managerial decision making. Financial ratios

involve the comparison of various figures from the financial statements in order to gain information

about a company's performance. It is the interpretation, rather than the calculation, that makes

financial ratios a useful tool for business managers. Ratios may serve as indicators, clues, or red flags

regarding noteworthy relationships between variables used to measure the firm's performance in terms

of profitability, asset utilization, liquidity, leverage, or market valuation.

Financial statement analysis is a judgmental process. One of the primary objectives is identification of

major changes in trends, and relationships and the investigation of the reasons underlying those

changes. The judgment process can be improved by experience and the use of analytical tools.

Probably the most widely used financial analysis technique is ratio analysis, the analysis of

relationships between two or more line items on the financial statement. Financial ratios are usually

expressed in percentage or times. Generally, financial ratios are calculated for the purpose of

evaluating aspects of a company's operations and fall into the following categories:

Ratio analysis is the powerful tool of financial statements analysis. A ratio is define as “the indicated

quotient of two mathematical expressions” and as “the relationship between two or more things”. The

absolute figures reported in the financial statement do not provide meaningful understanding of the

performance and financial position of the firm. Ratio helps to summaries large quantities of financial

data and to make qualitative judgment of the firm’s financial performance

7.2 ROLE OF RATIO ANALYSIS

Ratio analysis helps to appraise the firms in the term of there profitability and efficiency of

performance, either individually or in relation to other firms in same industry. Ratio analysis is one of

the best possible techniques available to management to impart the basic functions like planning and

control. As future is closely related to the immediately past, ratio calculated on the basis historical

financial data may be of good assistance to predict the future, the ratio analysis may be able to locate

the point out the various arias which need the management attention in order to improve the situation.

E.g. Current ratio which shows a constant decline trend may be indicate the need for further

introduction of long term finance in order to increase the liquidity position. As the ratio analysis is

concerned with all the aspect of the firm’s financial analysis liquidity, solvency, activity, profitability

and overall performance, it enables the interested persons to know the financial and operational

characteristics of an organization and take suitable decisions.

7.3 LIMITATIONS OF RATIO ANALYSIS

108

1 The basic limitation of ratio analysis is that it may be difficult to find a basis for making the

comparison

2 Normally, the ratios are calculated on the basis of historical financial statements. An organization

for the purpose of decision making may need the hint regarding the future happiness rather than

those in the past. The external analyst has to depend upon the past which may not necessary to

reflect financial position and performance in future.

3 The technique of ratio analysis may prove inadequate in some situations if there is differs in

opinion regarding the interpretation of certain ratio.

4 As the ratio calculates on the basis of financial statements, the basic limitation which is applicable

to the financial statement is equally applicable In case of technique of ratio analysis also i.e. only

facts which can be expressed in financial terms are considered by the ratio analysis.

5 The technique of ratio analysis has certain limitations of use in the sense that it only highlights the

strong or problem arias, it dose not provide any solution to rectify the problem arias.

Ratio analysis is very important for the franchisor to establish norms and seek patterns of financial

operations over a period of time. Unfortunately, few franchisors (or any kind of business) use ratio

analysis -- it is estimated that just two percent compute financial ratios and use them in managing

their businesses. The franchisor can use ratio analysis also to obtain a bank loan.

There are different financial ratios which may

1 liquidity ratios,

2 leverage ratios, 

3 operating ratios, and 

4 profitability ratios

7.4 CLASSIFICATION OF WORKING CAPITAL RATIO

Working capital ratio means ratios which are related with the working capital management e.g.

current assets, current liabilities, liquidity, profitability and risk turnoff etc. these ratio are classified as

follows

7.4.1 EFFICIENCY RATIO

109

The ratios compounded under this group indicate the efficiency of the organization to use the various

kinds of assets by converting them the form of sale. This ratio also called as activity ratio or assets

management ratio. As the assets basically categorized as fixed assets and current assets and the

current assets further classified according to individual components of current assets viz. investment

and receivables or debtors or as net current assets, the important of efficiency ratio as follow

1) Working capital turnover ratio

2) Inventory turnover ratio

3) Receivable turnover ratio

4) Current assets turnover ratio

7.4.2 LIQUIDITY RATIO

The ratios compounded under this group indicate the short term position of the organization and also

indicate the efficiency with which the working capital is being used. The most important ratio under

this group is follows

1. Current ratio

2. Quick ratio

3. Absolute liquid ratio

7.5 EFFICIENCY RATIO

7.5.1 WORKING CAPITAL TURNOVER RATIO

It signifies that for an amount of sales, a relative amount of working capital is needed. If any increase

in sales contemplated working capital should be adequate and thus this ratio helps management to

maintain the adequate level of working capital. The ratio measures the efficiency with which the

working capital is being used by a firm. It may thus compute net working capital turnover by dividing

sales by working capital.

Working Capital Turnover Ratio = Sales / Net Working Capital

This ratio maker a comparison between net sales and net working capital in order to find the working

capital turnover ratio the working capital turnover ratio for the year 2004-2009. We can see an

increase in working capital turnover ratio for the next 5 year has increased in a gradual way in the last

year the net sales has been increased and the working capital in being similarly that of previous year

hence the working that of previous year hence the working that capital turnover ratio is 27.63 in 200

but 1.59 in 2009 after clearing all bills payables.

Table 7-1 Working Capital Turnover Ratio

110

YEAR 2004 2005 2006 2007 2008 2009

GROSS SALES 6,927,072 11,279,759 24,739,046 39,165,363 43,850,144 63,664,311

Cost of Goods sold -5,939,978 -9,866,566 -21,708,552 -33,554,054 -35,055,556 -52,042,769

NET SALES 987,094 1,413,192 3,030,494 5,611,309 8,794,588 11,621,541

NET WORKING CAPITAL 1,142,515 112,409 250,012 326,831 318,319 7,295,345

WC TURN OVER RATIO 0.86 12.57 12.12 17.17 27.63 1.59

Chart 7-1 Working Capital Turnover

WORKING CAPITAL TURNOVER

0

2000000

4000000

6000000

8000000

10000000

12000000

14000000

16000000

18000000

2004 2005 2006 2007 2008 2009

YEARS

WC

TU

RN

OV

ER

WC TURN OVERRATIO

NET WORKINGCAPITAL

NET SALES

YEAR

Observations

High working capital ratio indicates the capability of the organization to achieve maximum sales with

the minimum investment in working capital. Company’s working capital ratio shows mostly more

than two, except for the year 2005-06 because of excess of cash balance in current assets which

occurred due to encashment of deposits. In the year 2004 and 2008 The ratio was above 3, it indicates

that the capability of the company to achieve maximum sales with the minimum investment in

working capital. But in the year 2009 the WC graph has gone down to 1.59% from 27.63 % in 2008.

In 2009 wecan see that the payables are also gone down. That means after clearing all bills payables,

still AI LLC is having a good working capital reserve.

7.5.2 INVENTORY TURNOVER RATIO:

111

Inventory turnover ratio, defined as how many times the entire inventory of a company has been sold

during an accounting period, is a major factor to success in any business that holds inventory. It

shows how well a company manages its inventory levels and how frequently a company replenishes

its inventory. In general, a higher inventory turnover is better because inventories are the least liquid

form of asset. Inventory turnover ratio explanations occur very simply through an illustration of high

and low turnover ratios. Despite this, many businesses do not survive due to issues with inventory.

Average inventory and cost of goods sold are the two elements of this ratio. Average inventory is

calculated by adding the stock in the beginning and at the and of the period and dividing it by two. In

case of monthly balances of stock, all the monthly balances are added and the total is divided by the

number of months for which the average is calculated.

A low inventory turnover ratio shows that a company may be overstocking or deficiencies in the

product line or marketing effort. It is a sign of ineffective inventory management because inventory

usually has a zero rate of return and high storage cost.

Higher inventory turnover ratios are considered a positive indicator of effective inventory

management. However, a higher inventory turnover ratio does not always mean better performance. It

sometimes may indicate inadequate inventory level, which may result in decrease in sales.

Although the first calculation is more frequently used, COGS (cost of goods sold) may be substituted

because sales are recorded at market value, while inventories are usually recorded at cost. Also,

average inventory may be used instead of the ending inventory level to minimize seasonal factors.

This ratio should be compared against industry averages. A low turnover implies poor sales and,

therefore, excess inventory. A high ratio implies either strong sales or ineffective buying.

High inventory levels are unhealthy because they represent an investment with a rate of return of zero.

It also opens the company up to trouble should prices begin to fall.

(a) [Inventory Turnover Ratio = Cost of goods sold / Average inventory at cost]

(b) [Inventory Turnover Ratio = Net Sales / Average Inventory at Cost]

(c) [Inventory Turnover Ratio = Net Sales / Average inventory at Selling Price]

(d) [Inventory Turnover Ratio  = Net Sales / Inventory]

Table 7-2- Inventory Turnover

112

YEAR 2004 2005 2006 2007 2008 2009

COST OF GOODS SOLD 5

,939,978 9

,866,566 21

,708,552 33

,554,054 35

,055,556 52,0

42,769

AVERAGE INVENTORY 1

,896,089 2

,636,564 2

,972,822 1

,670,429 2

,012,869 3,0

38,467

INVENTORY TURNOVER 3.1 3.7 7.3 20.1 17.4 17.1

Chart 7-2 Inventory Turnover Ratio

INVENTORY TURNOVER RATIO

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

45,000,000

50,000,000

2004 2005 2006 2007 2008 2009

YEARS

INV

EN

TO

RY

COST OFGOODSSOLD

AVERAGEINVENTORY

INVENTORYTURNOVER

Observations

It was observed that Inventory turnover ratio indicates maximum sales achieved with the minimum

investment in the inventory. As such, the general rule high inventory turnover is desirable but high

inventory turnover ratio may not necessary indicates the profitable situation. An organization, in order

to achieve a large sales volume may sometime sacrifice on profit, inventory ratio may not result into

high amount of profit.

The result represents the turnover or inventory or how many times inventory was used and then again

replaced. This number is representative for a one year time period. If the value of the inventory-

turnover ratio is low, then it indicates that the management team doesn't do its job properly in

managing inventories.

Importance of   Inventory   Turnover:

If the company can quickly sell its inventory, then the Inventory Turnover will be higher.  Conversely,

if the company cannot sell its inventory very well, then the Inventory Turnover will be low.   We have

to watch this figure closely - if the Inventory Ratio climbs too high, then the company may be keeping

too little inventory.  This could cause lost profits due to customer orders that had to wait until

inventory arrived.

7.5.3 RECEIVABLE TURNOVER RATIO

113

Debtors turnover ratio or accounts receivable turnover ratio  indicates the velocity of debt collection

of a firm. In simple words it indicates the number of times average debtors (receivable) are turned

over during a year.

Formula of Debtors Turnover Ratio:

[Debtors Turnover Ratio = Net Credit Sales / Average Trade Debtors]

The two basic components of accounts receivable turnover ratio are net credit annual sales and

average trade debtors. The trade debtors for the purpose of this ratio include the amount of Trade

Debtors & Bills Receivables. The average receivables are found by adding the opening receivables

and closing balance of receivables and dividing the total by two. It should be noted that provision for

bad and doubtful debts should not be deducted since this may give an impression that some amount of

receivables has been collected. But when the information about opening and closing balances of trade

debtors and credit sales is not available, then the debtors turnover ratio can be calculated by dividing

the total sales by the balance of debtors (inclusive of bills receivables) given. and formula can be

written as follows.

[Debtors Turnover Ratio = Total Sales / Debtors]

The derivation of this ratio is made in following way

Receivable turnover ratio = Gross sales/Average account receivables

Average receivable calculate by opening plus closing balance divide by 2. Increasing volume of

receivables without a matching increase in sales is reflected by a low receivable turnover ratio. It is

indication of slowing down of the collection system or an extend line of credit being allowed by the

customer organization. The latter may be due to the fact that the firm is loosing out to competition. A

credit manager engage in the task of granting credit or monitoring receivable should take the hint

from a falling receivable turnover ratio use his market intelligence to find out the reason behind such

failing trend.

Debtor turnover indicates the number of times debtors turnover each year. Generally the higher the

value of debtor’s turnover, the more is the management of credit.

Debtor’s turnover ratio = 365 days/Receivable turnover ratio

Table 7-3- Debtor’s Turnover Ratio

114

YEAR 2004 2005 2006 2007 2008 2009

GROSS SALES 6,927,072

11,279,759

24,739,046

39,165,363

43,850,144

63,664,311

AVERAGE ACCOUNT RECEIVABLE

2,217,269

3,697,475

6,862,676

14,158,999

22,939,489

27,268,874

RECEIVABLE TURNOVER RATIO

3.12 3.05 3.60 2.77 1.91 2.33

Table 7-3- Receivable Turnover Ratio

RECEIVABLE TURNOVER RATIO

-

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

70,000,000

80,000,000

90,000,000

2004 2005 2006 2007 2008 2009

YEARS

TU

RN

OV

ER

RECEIVABLETURNOVERRATIO

AVERAGEACCOUNTRECEIVABLE

GROSS SALES

Observations

It was observed from receivable turnover ratio that receivables turned around the sales were less than

4 times. The actual collection period was more than normal collection period allowed to customer. It

concludes that over investment in the debtors which adversely affect on requirement of the working

capital finance and cost of such finance.

Significance of the Ratio:

Accounts receivable turnover ratio or debtors turnover ratio indicates the number of times the debtors

are turned over a year. The higher the value of debtors turnover the more efficient is the management

of debtors or more liquid the debtors are. Similarly, low debtors turnover ratio implies inefficient

management of debtors or less liquid debtors. It is the reliable measure of the time of cash flow from

credit sales. There is no rule of thumb which may be used as a norm to interpret the ratio as it may be

different from firm to firm.

7.5.4 CURRENT ASSETS TURNOVER RATIO

115

Current assets are a major component of the balance sheet and represent assets that are expected to be

sold or used, typically within the next 12 months.  They are also an important measure of a companies

liquidity position.  Current assets have become a very important factor in evaluating the financial

strength of a company, in the event of a weak economic environment or one of lower demand.  Many

of the popular financial ratios will utilize the current assets when performing analysis to gauge

financial performance and stability.

Current Assets Turnover ratio, shows the productivity of the company's current assets. The formula is

the following:

= turnover / average (current assets, other + stocks + debtors + cash & equivalents)

Current assets turnover ratio is calculate to know the firms efficiency of utilizing the current assets.

Current assets includes the assets like inventories, sundry debtors, bills receivable, cash in hand or

bank, marketable securities, prepaid expenses and short term loans and advances. This ratio includes

the efficiency with which current assets turn into sales. A higher ratio implies a more efficient use of

funds thus high turnover ratio indicate to reduced the lock up of funds in current assets. An analysis of

this ratio over a period of time reflects working capital management of a firm.

Current assets TOR= Sales / Current assets

Table 7.-4-Calculation of Current Assets Turnover Ratio

YEAR 2004 2005 2006 2007 2008 2009

SALES 6

,927,072 11

,279,759 24,7

39,046 39

,165,363 43

,850,144 63,6

64,311

TOTAL CURRENT ASSETS 8

,673,117 11

,645,737 22,6

44,900 30

,612,473 45

,900,693 41,9

37,417

CURRENT ASSET TOR 0.80 0.97 1.09 1.28 0.96 1.52

Chart No.7-4-Current assets Turnover Ratio

-

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

TU

RN

OV

ER

2004 2005 2006 2007 2008 2009

YEARS

CURRENT ASSET TURNOVER RATIO

SALES

TOTALCURRENTASSETS

CURRENTASSET TOR

Observations

116

It was observed that current assets turnover ratio does not indicate any trend over the period of time.

Turnover ratio was 0.80 in the year 2004 and increase to 1.09 and 1.28 in the year 2006 and 2007

respectively, but it decreased in the year 2008, because of high cash balance. Cash did not help to

increase in sales volume, as cash is non earning asset. In the year 2006-07 company increased its sales

with increased investment in current assets, thus current assets turnover ratio increased to 1.28 from

1.09 in the year 2006.

7.6 LIQUIDITY RATIO

7.6.1 CURRENT RATIO

Current ratio may be defined as the relationship between current assets and current liabilities. This

ratio is also known as "working capital ratio". It is a measure of general liquidity and is most widely

used to make the analysis for short term financial position or liquidity of a firm. It is calculated by

dividing the total of the current assets by total of the current liabilities.

The ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities

(debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current

ratio, the more capable the company is of paying its obligations. A ratio under  1 suggests that the

company would be unable to pay off its obligations if they came due at that point. While this shows

the company is not in good financial health, it does not necessarily mean that it will go bankrupt - as

there are many ways to access financing - but it is definitely not a good sign.

The current ratio can give a sense of the efficiency of a company's operating cycle or its ability to

turn its Product into cash. Companies that have trouble getting paid on their receivables or have long

inventory turnover can run into liquidity problems because they are unable to alleviate their

obligations. Because business operations differ in each industry, it is always more useful to compare

companies within the same industry.

This ratio is similar to the acid-test ratio except that the acid-test ratio does not include inventory and

pre paid as assets that can be liquidated. The components of current ratio (current assets and current

liabilities) can be used to derive working capital (difference between current assets and current

liabilities). Working capital is frequently used to derive the working capital ratio, which is working

capital as a ratio of sales.

[Current Ratio = Current Assets / Current Liabilities]

Or

[Current Assets: Current Liabilities]

Components :

117

The two basic components of this ratio are current assets and current liabilities. Current assets include

cash and those assets which can be easily converted into cash within a short period of time, generally,

one year, such as marketable securities or readily realizable investments, bills receivables, sundry

debtors, (excluding bad debts or provisions), inventories, work in progress, etc. Prepaid expenses

should also be included in current assets because they represent payments made in advance which will

not have to be paid in near future.

Current liabilities are those obligations which are payable within a short period of tie generally one

year and include outstanding expenses, bills payable, sundry creditors, bank overdraft, accrued

expenses, short term advances, income tax payable, dividend payable, etc. However, some times a

controversy arises that whether overdraft should be regarded as current liability or not. Often an

arrangement with a bank may be regarded as permanent and therefore, it may be treated as long term

liability. At the same time the fact remains that the overdraft facility may be cancelled at any time.

Accordingly, because of this reason and the need for conversion in interpreting a situation, it seems

advisable to include overdrafts in current liabilities.

Limitations of Current Ratio :

This ratio is measure of liquidity and should be used very carefully because it suffers from many

limitations. It is, therefore, suggested that it should not be used as the sole index of short term

solvency.

1 It is crude ratio because it measures only the quantity and not the quality of the current assets.

2 Even if the ratio is favorable, the firm may be in financial trouble, because of more stock and

work in process which is not easily convertible into cash, and, therefore firm may have less cash

to pay off current liabilities.

3 Valuation of current assets and window dressing is another problem. This ratio can be very easily

manipulated by overvaluing the current assets. An equal increase in both current assets and

current liabilities would decrease the ratio and similarly equal decrease in current assets and

current liabilities would increase current ratio.

Table 7-5-Current Ratio

118

YEAR 2004 2005 2006 2007 2008 2009

TOTAL CURRENT ASSETS 4,513,561

5,849,374

11,798,754

15,662,831

23,281,494

23,365,993

TOTAL CURRENT LIABILITIES

3,903,540

6,264,607

13,384,679

15,336,000

22,963,175

16,070,649

CURRENT RATIO 1.16 0.93 0.88 1.02 1.01 1.45

Chart No. 7.5 Current Ratio

CURRENT ASSET RATIO

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

2004 2005 2006 2007 2008 2009

YEARS

RA

TIO

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

TOTALCURRENTASSETS

TOTALCURRENTLIABILITIES

CURRENTRATIO

Observations

The current ratio indicates the availability of funds to payment of current liabilities in the form of

current assets. A higher ratio indicates that there were sufficient assets available with the organization

which can be converted in cash, without any reduction in the value.: Generally, the higher the ratio,

the more liquid the company is. This means the company would have a better short-term financial

standing to meet its debt obligations.

A low current ratio is can often be supported by a strong operating cash flow. On the other hand, if a

company is able to operate with a low current ratio, it means that the company is more efficient about

using its capital. Therefore, a low current ratio can lead to higher return of assets. Generally speaking,

the more liquid the current assets, the smaller the current ratio can be without cause for concern. For

most industrial companies, 1.5 is an acceptable current ratio

7.6.2 QUICK RATIO

119

The quick ratio, defined also as the acid test ratio, reveals a company's ability to meet short-term

operating needs by using its liquid assets. It is similar to the current ratio, but is considered a more

reliable indicator of a company’s short-term financial strength. The difference between these two is

that the quick ratio subtracts inventory from current assets and compares the quick asset to the current

liabilities. Similar to the current ratio, value for the quick ratio analysis varies widely by company and

industry. In theory, the higher the ratio is, the better the position of the company is. However, a better

benchmark is to compare the ratio with the industry average.

Quick ratios are often explained as measures of a company’s ability to pay their current debt liabilities

without relying on the sale of inventory. Compared with the current ratio, the quick ratio is more

conservative because it does not include inventories which can sometimes be difficult to liquidate. For

lenders, the quick ratio is very helpful because it reveals a company’s ability to pay off under the

worst possible condition.

Although the quick ratio gives investors a better picture of a company’s ability to meet current

obligations the current ratio, investors should be aware that the quick ratio does not apply to the

handful of companies where inventory is almost immediately convertible into cash.

Quick Ratio Formula

Quick Ratio = (Current assets – Inventories) / Current liabilities

Or

Quick assets / Current liabilities

Or

(Cash + Accounts Receivable + Cash equivalents) / Current liabilities

Quick Ratio Calculation

Quick ratio calculation is a useful skill for any business that may face cash flow issues. Quick assets

include those current assets that presumably can be quickly converted to cash at close to their book

values. It normally includes cash, marketable securities, and some accounts receivables. The quick

ratio, sometimes called the acid-test, is a more stringent test of liquidity than the current ratio. This is

because it removes inventory from the equation. Inventory is the least liquid of all the current assets.

A business has to find a buyer if it wants to liquidate inventory, or turn it into cash. Finding a buyer is

not always easy.

120

Quick ratios establish the relationship between quick or liquid assets and liabilities. An asset is liquid

if it can be converting in to cash immediately or reasonably soon without a loss of value. Cash is the

most liquid asset .other assets which are consider to be relatively liquid and include in quick assets are

debtors and bills receivable and marketable securities. Inventories are considered as less liquid.

Inventory normally required some time for realizing into cash. Their value also be tendency to

fluctuate. The quick ratio is found out by dividing quick assets by current liabilities

Table 7-.6- Quick Ratio

YEAR 2004 2005 2006 2007 2008 2009

TOTAL CURRENT ASSETS 4,513

,561 5,849,374

11,798,754

15,662,831

23,281,494

23,365,993

INVENTORY 114

,127 465,475

162,532

378,049

571,443

733,715

LIQUID CURRENT ASSET 4,399

,434 5,383,899

11,636,222

15,284,782

22,710,051

22,632,278

TOTAL CURRENT LIABILITIES 3,903

,540 6,264,607

13,384,679

15,336,000

22,963,175

16,070,649

QUICK RATIO 1.13 0.86 0.87 1.00 0.99 1.41

Chart No.7-.6 Quick ratio

QUICK RATIO

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

45,000,000

2004 2005 2006 2007 2008 2009

YEARS

VA

LU

ES

QUICK RATIO

TOTALCURRENTLIABILITIES

LIQUIDCURRENTASSET

Observations

Quick ratio indicates that the company has sufficient liquid balance for the payment of current

liabilities. In some ways, the quick ratio is a more conservative standard.  If the quick ratio is greater

than one, there would seem to be no danger that the firm would not be able to meet its current

obligations.  If the quick ratio is less than one, but the current ratio is considerably above one, the

status of the firm is more complex. 

121

In this case, the valuation of inventories and the inventory turnover are obviously in a better stage.

The liquid ratio of 1:1 is suppose to be standard or ideal. In the year 2007 and 2009 company had

Rs.1.40 cash for every 1 rupee of expenses; such a policy is called conservative policy of finance for

working capital, Rs.0.90 is the ideal investment which affects on the cost of the fund and returns on

the funds.

7.6.3 ABSOLUTE LIQUID RATIO

Absolute liquid ratio is the ratio, which expresses the relationship between Absolute Liquid Assets

and Quick Liabilities.

Components of Absolute Liquid Assets

Absolute Liquid assets

1. Cash in Hand and at Bank

2. Readily Marketable Securities

Quick Liabilities

1. Outstanding Expenses

2. Bills Payable

3. Sundry Creditors

4. Short- term Advances

5. Income Tax payable

6. Dividends Payable

Expression of Absolute liquid ratio

Absolute Liquid Ratio = Absolute Liquid assets / Quick Liabilities

Significance of Absolute liquid ratio

The ratio shows very clearly whether a concern is liquid or not. In other words, it is the real measure

of the liquidity or short-term solvency of a concern Even though debtors and bills receivables are

considered as more liquid then inventories; it can not be converted in to cash immediately or in time.

Therefore the while calculation of absolute liquid ratio only the absolute liquid assets as like cash in

hand cash at bank, short term marketable securities are taken in to consideration to measure the ability

of the company in meeting short term financial obligation. It calculates by absolute assets dividing by

current liabilities.

122

Table 7.7- Absolute Liquid Ratio

YEAR 2004 2005 2006 2007 2008 2009

Current Assets            

BANK/CASH 46,1

98 199,

387 68

,798 570,2

67 145,2

45 1,917,381

OTHER RECEIVABLES 354,0

06 53,

010 735

,450 518,9

97 341,1

50 100,555

TOTAL LIQUID ASSET 400,2

03 252,

397 804

,248 1,089,2

64 486,3

95 2,017,936

CURRENT LIABILITIES 3,371,0

47 5,736,

965 11,548

,742 15,336,0

00 22,963,1

75 16,070,649

ABSOLUTE LIQUID RATIO 0.119 0.044 0.070 0.071 0.021 0.126

Chart No.7.7- Cash and bank to current liabilities

ABSOLUTE LIQUID RATIO

2004 2005 2006 2007 20082009

2004

2005

2006

2007

2008

2009

2004

2005

2006

2007

2008

2009

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

2004 2005 2006 2007 2008 2009

YEARS

VA

LU

ES

ABSOLUTELIQUIDRATIO

CURRENTLIABILITIES

TOTALLIQUIDASSET

Observations

Absolute liquid ratio indicates the availability of cash with company is sufficient because company

also has other current assets to support current liabilities of the company. In the year 2007 and

2008,absolute liquid ratio increased because of company carry more cash balance, as a cash balance is

ideal assets company has to take control on such availability of funds which is affect on cost of the

funds. The absolute liquid ratio is the best for three years like 2007/2008/2009, and the cash balances

as to the current liability has improved for the firm. Firm has large resources in cash and bank

balances. While large resources in cash and bank balances may seem to affect the revenue the firm

could have earned by investing it elsewhere as maintenance of current assets as cash and in near cash

assets may increase the liquidity position but not the revenue or profit earning capacity of the firm.

123

CHAPTER VIII

124

1) Introduction

2) Receivables Management

3) Inventory Management

4) Cash Management

5) Working Capital Finance and Estimation

6) Source of Working Capital

7) Estimation of working capital

8.1 INTRODUCTION TO WORKING CAPITAL MANAGEMENT

Decisions relating to working capital and short term financing are referred to as working capital

management. These involve managing the relationship between a firm's short-term assets and its

short-term liabilities. The goal of working capital management is to ensure that the firm is able to

continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and

upcoming operational expenses.

Guided by the above criteria, management will use a combination of policies and techniques for the

management of working capital. These policies aim at managing the current assets (generally cash and

cash equivalents, inventories and debtors) and the short term financing, such that cash flows and

returns are acceptable.

Debtors management . Identify the appropriate credit policy, i.e. credit terms which will attract

customers, such that any impact on cash flows and the cash conversion cycle will be offset by

increased revenue and hence Return on Capital (or vice versa); see Discounts and allowances.

Cash management . Identify the cash balance which allows for the business to meet day to day

expenses, but reduces cash holding costs.

Inventory management . Identify the level of inventory which allows for uninterrupted

production but reduces the investment in raw materials - and minimizes reordering costs - and

hence increases cash flow; see Supply chain management; Just In Time (JIT); Economic order

quantity (EOQ); Economic production quantity

Short term financing . Identify the appropriate source of financing, given the cash conversion

cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be

necessary to utilize a bank loan (or overdraft), or to "convert debtors to cash" through "factoring".

8.2 RECEIVABLES MANAGEMENT

Receivables or debtors are the one of the most important parts of the current assets which is created if

the company sells the finished goods to the customer but not receive the cash for the same

immediately. Trade credit arises when firm sells its products and services on credit and dose not

receive cash immediately. It is essential marketing tool, acting as bridge for the movement of goods

through production and distribution stages to customers. Trade credit creates receivables or book

debts which the firm is expected to collect in the near future. The receivables include three

characteristics

125

1) It involve element of risk which should be carefully analysis.

2) It is based on economic value. To the buyer, the economic value in goods or services

passes immediately at the time of sale, while seller expects an equivalent value to be received

later on.

3) It implies futurity. The cash payment for goods or serves received by the buyer will be

made by him in a future period.

1. OBJECTIVE OF RECEIVABLE MANAGEMENT

The sales of goods on credit basis are an essential part of the modern competitive economic system.

The credit sales are generally made up on account in the sense that there are formal

acknowledgements of debt obligation through a financial instrument. As a marketing tool, they are

intended to promote sales and there by profit. However extension of credit involves risk and cost,

management should weigh the benefit as well as cost to determine the goal of receivable management.

Thus the objective of receivable management is to promote sales and profit until that point is reached

where the return on investment in further funding of receivables is less .than the cost of funds raised

to finance that additional credit

Table 8.1-Size of receivables

YEAR 2004 2005 2006 2007 2008 2009TRADE RECEIVABLES

2,217,269

2,960,413

7,804,526

12,708,947

20,461,085

13,615,576

RECEIVABLE INDEX 100 134 352 573 923 614

Chart 8.1-Receivable Index

SIZE OF RECEIVABLES

20042005

2006

2007

2008

2009

12

3

4

5

6

-

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

18,000,000

20,000,000

2004 2005 2006 2007 2008 2009

YEARS

VA

LU

ES

0

100

200

300

400

500

600

700

800

900

1000

TradeDebtors

INDEX

126

2. AVERAGE COLLECTION PERIOD

The average collection period measures the quality of debtors since it indicate the speed of there

collection. The shorter the average collection period, the better the quality of the debtors since a short

collection period implies the prompt payment by debtors. The average collection period should be

compared against the firm’s credit terms and policy judges its credit and collection efficiency. The

collection period ratio thus helps an analyst in two respects.

In determining the collect ability of debtors and thus, the efficiency of collection efforts.

In ascertaining the firm’s comparative strength and advantages related to its credit policy and

performance. The debtor’s turnover ratio can be transformed in to the number of days of

holding of debtors.

Table 8.2- Average Collection Period

YEAR 2004 2005 2006 2007 2008 2009

GROSS SALES 6,927,072 11,279,759 24,739,046 39,165,363 43,850,144 63,664,311

TRADE RECEIVABLES 2,217,269 2,960,413 7,804,526 12,708,947 20,461,085 13,615,576

RECEIVABLE

TURNOVER 3.12 3.81 3.17 3.08 2.14 4.68

AVERAGE

COLLECTION PERIOD 116.83 95.80 115.15 118.44 170.31 78.06

Chart No.8.2 Average Collection Period

3.12

116.83

3.81

95.80

3.17

115.15

3.08

118.44

2.14

170.31

4.68

78.06

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

160.00

180.00

VA

LU

ES

2004 2005 2006 2007 2008 2009

YEARS

AVERAGE COLLECTION PERIOD

RECEIVABLETURNOVER

AVERAGECOLLECTIONPERIOD

127

3. Observations

The size of receivables are staidly increasing it indicates that the company was allowing more credit

year to year, but it was not bad signal because as receivables were supporting to the increase in the

sales. Average collection period are reducing to present situation, but as compare with the normal

collection period allowed to customer by JISL of 90 day’s, it was clear that the company required to

increase our efficiency of collection of receivables. All the above factors directly or indirectly affects

in the debtors turnover ratio, current ratio and working capital ratio. For effective management of

credit, the firm should lay down clear cut guidelines and procedure for granting credit to individual

customers and collecting individual accounts should involve following steps: (1) Credit information

(2) Credit investigation (3) Credit limits (4) Collection procedure.

8.3 INVENTORY MANAGEMENT

Inventory management is primarily about specifying the size and placement of stocked goods.

Inventory management is required at different locations within a facility or within multiple locations

of a supply network to protect the regular and planned course of production against the random

disturbance of running out of materials or goods. The scope of inventory management also concerns

the fine lines between replenishment lead time, carrying costs of inventory, asset management,

inventory forecasting, inventory valuation, inventory visibility, future inventory price forecasting,

physical inventory, available physical space for inventory, quality management, replenishment,

returns and defective goods and demand forecasting. Balancing these competing requirements leads to

optimal inventory levels, which is an on-going process as the business needs shift and react to the

wider environment.

Inventory management involves a retailer seeking to acquire and maintain a proper merchandise

assortment while ordering, shipping, handling, and related costs are kept in check.

Systems and processes that identify inventory requirements, set targets, provide replenishment

techniques and report actual and projected inventory status.

Handles all functions related to the tracking and management of material. This would include the

monitoring of material moved into and out of stockroom locations and the reconciling of the

inventory balances. Also may include ABC analysis, lot tracking, cycle counting support etc.

Management of the inventories, with the primary objective of determining/controlling stock levels

within the physical distribution function to balance the need for product availability against the

need for minimizing stock holding and handling costs

128

The term ‘inventory’ is used to designate the aggregate of those items of tangible assets which are:-

1) Finished goods (‘saleable’)

2) Work-in-progress (‘convertible’)

3) Material and supplies (‘consumable’)

In financial view, inventory defined as the sum of the value of raw material and supplies, including

spares, semi-processed material or work in progress and finished goods. The nature of inventory is

largely depending upon the type of operation carried on. For instance, in the case of a manufacturing

concern, the

inventory will generally comprise all three groups mentioned above while in the case of a trading

concern, it will simply be by stock- in- trade or finished goods.

1. OBJECTIVE OF INVENTORY MANAGEMENT

In company there should be an optimum level of investment for any asset, whether it is plant, cash or

inventories. Again inadequate disrupts production and causes losses in sales. Efficient management of

inventory should ultimately result in wealth maximization of owner’s wealth. It implies that while the

management should try to pursue financial objective of turning inventory as quickly as possible, it

should at the same time ensure sufficient inventories to satisfy production and sales demand. The

objectives of inventory management consist of two counterbalancing parts:

To minimize the firms investment in inventory

To meet a demand for the product by efficiently organizing the firms production and sales

operation.

This two conflicting objective of inventory management can also be expressed in term of cost and

benefits associated with inventory. That the firm should minimize the investment in inventory implies

that maintaining an inventory cost, such that smaller the inventory, the better the view

point .obviously, the financial manager should aim at a level of inventory which will reconcile these

conflicting elements. Some objectives are as follows:-

To have stock available as and when they are required.

To utilize available storage space but prevents stock levels from exceeding space available.

To maintain adequate accountability of inventories assets.

To provide, on item – by- item basis, for re-order point and order such quantity as would ensure

that the aggregate result confirm with the constraint and objective of inventory control.

129

Table 8.3-Size of inventory

YEAR 2004 2005 2006 2007 2008 2009

INVENTORY 114,1

27 465,4

75 162,5

32 378,0

49 571

,443 733

,715 WORK IN PROGRESS

1,781,962

2,171,088

2,810,291

1,292,380

1,441,426

2,304,752

TOTAL INVENTORY 1,896,0

89 2,636,5

64 2,972,8

22 1,670,4

29 2,012

,869 3,038

,467

INVENTORY INDEX 100 139 157 88 106 160

Chart No. 8.3 - Inventories index

100

139157

88106

160

-

20

40

60

80

100

120

140

160

180

VALUES

2004 2005 2006 2007 2008 2009

YEARS

INVENTORY INDEX

INVENTORY INDEX

2. INVENTORY COMPONENTS

The manufacturing firm’s inventory consists following components:-

I) Inventory

II) Work- in-progress

To analyze the level of raw material inventory and work in progress inventory held by the firm on an

average it is necessary to examine the efficiency with which the firm converts raw material inventory

and work in progress into finished goods.

Table No. 8.4-Components of inventories

YEAR 2004 2005 2006 2007 2008 2009

INVENTORY 114,127

465

,475

162

,532

378

,049

571,4

43

733,7

15

WORK IN

PROGRESS 1,781,962

2,171

,088

2,810

,291

1,292

,380

1,441,4

26

2,304,7

52

130

Chart No. 8.4-Components of inventories

INVENTORY COMPONENTS

-

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

2004 2005 2006 2007 2008 2009

YEAR

VA

LU

E

INVENTORY

WORK IN PROGRESS

3. INVENTORY HOLDING PERIOD

The reciprocal of inventory turnover gives average inventory holding in percentage term. When the

numbers of days in year are divided by inventory turnover, we obtain Days of Inventory Holding

(DIH).

Inventory management involves a retailer seeking to acquire and maintain a proper merchandise

assortment while ordering, shipping, handling, and related costs are kept in check. Systems and

processes that identify inventory requirements, set targets, provide replenishment techniques and

report actual and projected inventory status.

Formula to calculate number of days inventory: 

Number of Days Inventory = 365 days / inventory turnover ratio. Number of day’s inventory ratio definition and explanation:

 The number of day’s inventory is also known as average inventory period and inventory holding

period. A high number of days inventory indicates that, their is a lack of demand for the product being

sold. A low days inventory ratio (inventory holding period) may indicate that the company is not

keeping enough stock on hand to meet demands.    The number of days inventory and inventory

turnover ratios are included in the financial statement ratio analysis spreadsheets highlighted in the

left column, which provide formulas, definitions, calculation, charts and explanations of each ratio. 

Table - 8. 5- Inventory Turnover Ratio

131

YEAR 2004 2005 2006 2007 2008 2009 INVENTORY TURNOVER RATIO 3.1 3.7 7.3 20.1 17.4 17.1 DAYS OF INVENTORY HOLDING 117.74 98.65 50.00 18.16 20.98 21.35

Cost of Goods sold 5,939

,978 9,866,

566 21,708,

552 33,554,

054 35,055,

556 52,042,

769

Inventory 114

,127 465,

475 162,

532 378,

049 571,

443 733,

715

RAW MAT. TURN OVER 52.05 21.20 133.56 88.76 61.35 70.93

RAW MAT. HOLDING PERIOD 7.01 17.22 2.73 4.11 5.95 5.15

Chart No. 8.5 – Inventory Turnover Ratio

INVENTORY TURNOVER RATIO

3.13.7

7.3

20.117.4 17.1

1

10

100

2004 2005 2006 2007 2008 2009

YEARS

VA

LU

ES

INVENTORY TURNOVER RATIO

Table - 8.6-Inventory holding Period

YEAR 2004 2005 2006 2007 2008 2009 INVENTORY TURNOVER RATIO 3.1 3.7 7.3 20.1 17.4 17.1 DAYS OF INVENTORY HOLDING 117.74 98.65 50.00 18.16 20.98 21.35

COST OF GOODS SOLD 5,939

,978 9,86

6,566 21,70

8,552 33,55

4,054 35,055

,556 52,042,76

9

INVENTORY 114

,127 46

5,475 16

2,532 37

8,049 571

,443 733,71

5

WORK IN PROGRESS 1,781

,962 2,17

1,088 2,81

0,291 1,29

2,380 1,441

,426 2,304,75

2

TOTAL INVENTORY 1,896

,089 2,63

6,564 2,97

2,822 1,67

0,429 2,012

,869 3,038,46

7

RAW MAT. TURN OVER 3.13 3.74 7.30 20.09 17.42 17.13 RAW MAT. HOLDING PERIOD 116.51 97.54 49.98 18.17 20.96 21.31

Chart- 8.6-Inventory holding Period

132

116.51

97.54

49.98

18.17 20.96 21.31

0.00

20.00

40.00

60.00

80.00

100.00

120.00

VALUES

2004 2005 2006 2007 2008 2009

YEARS

RAW MAT. HOLDING PERIOD

RAW MAT.HOLDINGPERIOD

4. Observations

Size of inventory of AI LLC, was increasing gradually with the increase the sales. The inventory size

was increasing because of increment in the finished goods stock; it indicates that the company

reduced the liquidity of finished goods. High inventory turnover ratio is showing that the maximum

sales turnover is achieved with the minimum investment in the inventories. Raw material turnover has

increased in the year 2007 it indicates that company are investing more in raw material purchasing;

thus raw material holding period has reduced in the same year to 18 days from 49 days in the previous

year 2006. Overall inventory holding period has reduced because of increases in the inventory

turnover and sales volume.

8.4 MANAGEMENT OF CASH

Cash is money that is easily accessible either in the bank or in the business. It is not inventory, it is

not accounts receivable, and it is not property. These might be converted to cash at some point in

time, but it takes cash on hand or in the bank to pay suppliers, to pay the rent, and to meet the payroll.

Profit growth does not always mean more cash.

Profit is the amount of money you expect to make if all customers paid on time and if your expenses

were spread out evenly over the time period being measured. However, it is not your day-to-day

133

reality. Cash is what you must have to keep the doors of your business open. Over time, a company's

profits are of little value if they are not accompanied by positive net cash flow. You can't spend profit;

you can only spend cash.

Cash Flow refers to the flow of cash into and out of a business over a period of time. The outflow of

cash is measured by the money you pay every month to salaries, suppliers, and creditors. The inflows

are the cash you receive from customers, lenders, and investors.

1. POSITIVE CASH FLOW

If the cash coming into the business is more than the cash going out of the business, the company has

a positive cash flow. A positive cash flow is very good and the only concern here is managing the

excess cash prudently.

2. NEGATIVE CASH FLOW

If the cash going out of the business is more than the cash coming into the business, the company has

a negative cash flow. A negative cash flow can be caused by a number of problems that result in a

shortage of cash, such as too much or obsolete inventory, or poor collections on accounts receivable.

If the company doesn't have money in the bank or can't borrow additional cash at this point, it may be

in serious trouble.

A Cash Flow Statement is typically divided into three components so that you can see and understand

both the internal and external sources and uses of cash.

3. OPERATING CASH FLOW (INTERNAL)

Operating cash flow, often referred to as working capital, is the cash flow generated from internal

operations. It is the cash generated from sales of the product or service of your business. Because it is

generated internally, it is under your control.

4. INVESTING CASH FLOW (INTERNAL)

Investing cash flow is generated internally from non-operating activities. This component would

include investments in plant and equipment or other fixed assets, nonrecurring gains or losses, or

other sources and uses of cash outside of normal operations.

5. FINANCING CASH FLOW (EXTERNAL)

134

Financing cash flow is the cash to and from external sources, such as lenders, investors and

shareholders. A new loan, the repayment of a loan, the issuance of stock and the payment of dividend

are some of the activities that would be included in this section of the cash flow statement.

6. GOOD CASH MANAGEMENT MEANS:

Knowing when, where, and how your cash needs will occur, Knowing what the best sources are for

meeting additional cash needs; and, Being prepared to meet these needs when they occur, by keeping

good relationships with bankers and other creditors. Daily cash, and Long-term (annual, 3-5 year)

cash flow projections to help firms to develop the necessary capital strategy to meet their business

needs. They also prepare and use historical cash flow statements to gain an understanding about

where all the money went.

7. PRECAUTIONARY MOTIVE

Cash flows are somewhat unpredictable, with the degree of predictability varying among firms and

industries. Unexpected cash needs at short notice may also be the result of following:

1) Uncontrollable circumstances such as strike and natural calamities.

2) Unexpected delay in collection of trade dues.

3) Cancellation of some order for goods due unsatisfactory quality.

4) Increase in cost of raw material, rise in wages, etc.

The higher the predictability of firm’s cash flows, the lower will be the necessity of holding this

balance and vice versa. The need for holding the precautionary cash balance is also influenced by the

firm’s capacity to have short term borrowed funds and also to convert short term marketable securities

into cash.

8. SPECULATIVE MOTIVE

Speculative cash balances may be defined as cash balances that are held to enable the firm to take

advantages of any bargain purchases that might arise. While the precautionary motive is defensive in

nature, the speculative motive is aggressive in approach.

9. ADVANTAGES OF CASH MANAGEMENT

135

Cash does not enter in to the profit and loss account of an enterprise, hence cash is neither profit nor

losses but without cash, profit remains meaningless for an enterprise owner.

A sufficient of cash can keep an unsuccessful firm going despite losses

An efficient cash management through a relevant and timely cash budget may enable a firm to

obtain optimum working capital and ease the strains of cash shortage, fascinating temporary

investment of cash and providing funds normal growth.

Cash management involves balance sheet changes and other cash flow that do not appear in the

profit and loss account such as capital expenditure.

Table 8.7-Size and index of cash

YEAR 2004 2005 2006 2007 2008 2009

BANK/CASH 46,198 199,387 68,798 570,267 145,245 1,917,381

CASHINDEX 100 432 149 1234 314 4150

Chart No. 8.7-Cash Index

1

10

100

1,000

10,000

100,000

1,000,000

10,000,000

INDEX

2004 2005 2006 2007 2008 2009

YEARS

CASH INDEX

BANK/CASH

CASHINDEX

10. CASH CONVERSION CYCLE:-

The cash conversion cycle is simply the duration of time it takes a firm to convert its activities

requiring cash back into cash returns. The cycle is composed of the three main working capital

components: Accounts Receivable outstanding in days (ARO), Accounts Payable outstanding in days

(APO) and Inventory in days (IOD). The Cash Conversion Cycle (CCC) is equal to the time is takes

to sell inventory and collect receivables less the time it takes to pay your payables,

OR

CCC = IOD + ARO – APO

Cash Cycle is very important, because it represents the number of days a firm's cash remains tied up

within the operations of the business. It is also a powerful tool for assessing how well a company is

136

managing its working capital. The lower the cash conversion cycle, the more healthy a company

generally is. If you compare the results of the cycle over time and see a rising trend it is often a

warning sign that the business may be facing a cash flow crunch.

CASH CONVERSION CYCLE

Understanding the components of the cycle

When evaluating cash flow, those factors directly affecting profit, revenue and expenses, are easy to

understand and their affect on cash is straight forward; decreases in costs or increases in profit margin

results in less cash going out or more cash coming in, and increased profits. However, the working

capital components of the CCC are a little more complex. In simple terms, an increase in the amount

of time accounts receivables are outstanding uses up cash, a decrease provides cash; an increase in the

amount of inventory uses cash, a decrease provides cash; an increase in the amount of time it takes

you to pay your payables provides cash, a decrease uses cash.

The Operating Cycle consists of 3 phases:-

Phase 1

In Phase 1, Cash gets converted into Inventory. This includes purchase of Raw Material, Conversion

of Raw Material into Work-in-Progress, Finished Goods and finally the transfer of goods to stock at

the end of the manufacturing process. In the case of Trading Companies, this phase is shorter as there

would be no manufacturing activity and cash is directly converted into Inventory. This Phase is of

course totally absent in the case of Service Organizations.

Phase 2

137

In Phase 2 of the cycle, the Inventory is converted into Receivables as Credit Sales are made to

customers. Firms which do not sell on Credit obviously don't have the Phase 2 of the operating Cycle.

 

Phase 3

The Last Phase i.e. Phase 3 of the Operating Cycle, represents the stage when Receivables are

collected. This phase completes the operating cycle. Thus, the firm has moved from cash to inventory,

to receivables and to cash again.

Table 8.8-Operating Cycle

YEAR 2004 2005 2006 2007 2008 2009

DAYS OF INVENTORY

HOLDING 117 98 50 18 21 21

AVERAGE COLLECTION

PERIOD 117 96 115 118 170 78

CREDITORS PAYMENT

PERIOD 70 75 65 70 85 55

CASH CONVERTION CYCLE 163 118 100 67 106 44

Chart No. 8.8-Cash Conversion Cycle

CASH CONVERSION CYCLE

11798

50

18 21 21

117

96

115

118

170

78

7075

6570

85

55

163

118

100

67

106

44

0

50

100

150

200

250

2004 2005 2006 2007 2008 2009

YEARS

DA

YS

AVERAGECOLLECTION PERIOD

DAYS OFINVENTORYHOLDING

CASH CONVERTIONCYCLE

CREDITORSPAYMENT PERIOD

Observations

138

The size of the cash in the current assets of the company indicates the good cash management of the

company. After 2004, the cash balance in the year 2006 and 2008 was extremely increased; because

of the good collection from Debtors. Company failed to proper investment of available cash. After the

study of cash management it mentioned above it can be conclude that management of cash involve

three things: a) Managing cash flow into and out of the firm. b) Managing cash inflow within the firm,

c) Financial deficit or investing surpluses cash and thus controlling cash balance at a point of a time.

The firm should hold an optimum balance of cash and invest any temporary excess amount in short

term bank deposits and inter corporate deposit. The high portion of cash balance in the current assets

it adversely affected on profitability of the company as cash is ideal asset; it reduced the working

capital leverage.

8.5 WORKING CAPITAL FINANCE AND ESTIMATION

Introduction

Corporate finance is an area of finance dealing with financial decisions business enterprises make and

the tools and analysis used to make these decisions. The primary goal of corporate finance is to

maximize corporate value while managing the firm's financial risks. Although it is in principle

different from managerial finance which studies the financial decisions of all firms, rather than

corporations alone, the main concepts in the study of corporate finance are applicable to the financial

problems of all kinds of firms.

The discipline can be divided into long-term and short-term decisions and techniques. Capital

investment decisions are long-term choices about which projects receive investment, whether to

finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On

the other hand, the short term decisions can be grouped under the heading "Working capital

management". This subject deals with the short-term balance of current assets and current liabilities;

the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the

terms on credit extended to customers).

The terms corporate finance and corporate financier are also associated with investment banking. The

typical role of an investment bank is to evaluate the company's financial needs and raise the

appropriate type of capital that best fits those needs.

After determine the level of working capital, a firm has to consider how it will finance. Following are

sources of working capital finance.

8.6 SOURCES OF WORKING CAPITAL FINANCE

139

1) Trade credit

2) Bank Finance

3) Letter of credit

1. Trade credit

Trade credit is an arrangement between businesses to buy goods or services on account, that is,

without making immediate cash payment. The supplier typically provides the customer with an

agreement to bill them later, stipulating a fixed number of days or other date by which the customer

should pay. It can be viewed as an essential element of capitalization in an operating business because

it can reduce the required capital investment required to operate the business if it is managed properly.

Trade credit is the largest use of capital for a majority of business to business (B2B) sellers in most of

the countries, and is a critical source of capital for a majority of all businesses.

2. BANK FINANCE FOR WORKING CAPITAL

Banks are main institutional source of working capital finance in India. After trade credit, bank credit

is the most important source of financing working capital in India. A banks considers a firms sales

and production plane and desirable levels of current assets in determining its working capital

requirements. The amount approved by bank for the firm’s working capital is called credit limit.

Credit limit is the maximum funds which a firm can obtain from the banking system. In practice

banks do not lend 100% credit limit; they deduct margin money.

Forms of bank finance:-

1) Over Draft

2) Term Loan

3) Cash credit

4) Purchase or discounting of bills

1) Overdraft

An overdraft occurs when withdrawals from a bank account exceed the available balance. In this

situation a person is said to be "overdrawn". If there is a prior agreement with the account provider for

an overdraft protection plan, and the amount overdrawn is within this authorized overdraft limit, then

interest is normally charged at the agreed rate. If the balance exceeds the agreed terms, then fees may

be charged and higher interest rate might apply.

2) Term Loan

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While the four prior debt instruments address cyclical working capital needs, term loans can finance

medium-term no cyclical working capital. A term loan is a form of medium-term debt in which

principal is repaid over several years, typically in 3 to 7 years. Since lenders prefer not to bear interest

rate risk, term loans usually have a floating interest rate set between the prime rate and prime plus 300

basis points, depending on the borrower’s credit risk. Sometimes, a bank will agree to an interest rate

cap or fixed rate loan, but it usually charges a fee or higher interest rate for these features. Term loans

have a fixed repayment schedule that can take several forms. Level principal payments over the loan

term are most common. In this case, the company pays the same principal amount each month plus

interest on the outstanding loan balance.

3) Cash credit

In practice, the operations in cash credit facility are similar to those of those of overdraft facility

except the fact that the company need not have a formal current account. Here also a fixed limit is

stipulated beyond which the company is not able to withdraw the amount.

4) Bills purchased / discounted

This form of assistance is comparatively of recent origin. This facility enables the company to get the

immediate payment against the credit bills / invoice raised by the company. The banks hold the bills

as a security till the payment is made by the customer. The entire amount of bill is not paid to the

company. The company gets only the present worth of amount of bill from of discount charges. On

maturity, bank collects the full amount of bill from the customer.

3. LETTER OF CREDIT

A standard, commercial letter of credit is a document issued mostly by a financial institution, used

primarily in trade finance, which usually provides an irrevocable payment undertaking. The letter of

credit can also be source of payment for a transaction, meaning that redeeming the letter of credit will

pay an exporter. Letters of credit are used primarily in international trade transactions of significant

value, for deals between a supplier in one country and a customer in another. They are also used in the

land development process to ensure that approved public facilities (streets, sidewalks, storm water

ponds, etc.) will be built. The parties to a letter of credit are usually a beneficiary who is to receive the

money, the issuing bank of whom the applicant is a client, and the advising bank of whom the

beneficiary is a client.

Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without prior

agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing a

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transaction, letters of credit incorporate functions common to General Inter bank Recurring Order and

Traveler's cheques. Typically, the documents a beneficiary has to present in order to receive payment

include a commercial invoice, bill of lading, and documents proving the shipment were insured

against loss or damage in transit. However, the list and form of documents is open to imagination and

negotiation and might contain requirements to present documents issued by a neutral third party

evidencing the quality of the goods shipped, or their place of origin.

Chart No. 8.-9-Cash Conversion Cycle

YEAR 2004 2005 2006 2007 2008 2009

SHORTTERM BORROWINGS

345,371

912,579

2,076,834

2,042,393

561,131

INTEREST @8.5%

25,903

68,443 15

5,763 -

153,180

42,085

Chart No. 8.9-Cash Conversion Cycle

WORKING CAPITAL LOAN AND INTEREST

-

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

2,000,000

2004 2005 2006 2007 2008 2009

YEARS

BO

RR

OW

ING

S

SHORTTERMBORROWINGS

INTEREST@8.5%

Observations

Arabian Industries LLC, takes only very low working capital loan to fulfill the requirement of

working capital, thus company saved a lot from paying interest, on working capital loan. Company

raised the funds for working capital through term loan from bank.. We can see that in 2007 firm

doesn’t have any kind of loan. The supplier extending trade credit incurs cost in the form of

opportunity cost of funds invested in accounts receivable. The annual opportunity cost of forgoing

cash discount can be very high. Therefore AI LLC, should compare the opportunity cost of trade

credit with the cost of other sources of credit while making its financial decisions.

8.7 Estimation of working capital

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After considering the various factors affecting the working capital needs, it is necessary to forecast the

working capital requirements. For this purpose, first of all estimate of all current assets should be

made, these should be followed by the estimation of all current liabilities. Difference between the

estimated current assets and estimated current liabilities will represent the working capital

requirements. The estimation of working capital requirement of Arabian Industries LLC is based on

few assumptions such as follows.

· Gross sales will increase by 40%

· Receivables collection period will be 90 day as per standards fixed by company.

· Unnecessary balance of Cash may reduce by finance management.

· For working capital finance company can use maximum trade credit.

· Inventory holding period can be 60 days instead of present 95

ESTIMATED BALANCE SHEET OF ARABIAN INDUSTRIES LLC FOR THE YEAR 2010

  2005 2006 2007 2008 2009 20% 2010

CURRENT ASSET - A              

BANK BALANCE 199

,387 68,

798 570,

267 145,

245 1,917,3

81 383

,476 2,300,857

TRADE DEBTORS 2,960,

413 7,804,5

26 12,708,9

47 20,461,0

85 13,615,5

76 2,723,

115 16,338,691

INVENTORY 465

,475 162,

532 378,

049 571,

443 733,

715 146

,743 880,458

WORK IN PROGRESS 2,171,

088 2,810,2

91 1,292,3

80 1,441,4

26 2,304,7

52 460

,950 2,765,702

DUE FROM RELATED PARTIES

-

217,158

194,191

321,144

4,694,015

938,803 5,632,818

OTHER RECEIVABLE 53

,010 735,

450 518,

997 341,

150 100,

555 20

,111 120,666

TOTAL CURRENT ASSETS

5,849,374

11,798,754

15,662,831

23,281,494

23,365,993

- 28,039,192

  -

-

-

-

-

- -

CURRENT LIABILITIES - B

-

-

-

-

-

- -

SHORT TERM LOAN 912

,579 2,076,8

34 -

2,042,393

561,131

112,226 673,357

CURRENT PORTION OF TERM LOAN

187,158

505,393

1,455,553

1,523,440

2,217,368

443,474 2,660,841

TRADE CREDITORS 3,053,

555 5,222,1

37 6,931,0

94 10,429,8

36 6,268,6

19 1,253,

724 7,522,343

DUE TO RELATED PARTIES

2,070

23,814

31,484

1,519,796

426,463

85,293 511,755

PROVISION FOR TAX 27

,784 184,

470 177,

498 407,

850 934,

642 186

,928 1,121,570

OTHER PAYABLES 1,553,

819 3,536,0

92 6,740,3

72 7,039,8

60 5,662,4

26 1,132,

485 6,794,912

TOTAL CURRENT LIABILITIES

5,736,965

11,548,742

15,336,000

22,963,175

16,070,649

- 19,284,778

NET WORKING CAPITAL - (A-B)

112,409

250,012

326,831

318,319

7,295,345

- 8,754,414

Table 8-10-Estimation of the Working Capital For the year 2010 For AI LLC.

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Chart 8-10-Estimation of the Working Capital For the year 2010 For AI LLC.

ESTIMATION OF WORKING CAPITAL FOR 2010

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

2005 2006 2007 2008 2009 2010 2010

YEARS

VA

LU

ES

TOTALCURRENTASSETS

TOTALCURRENTLIABILITIES

NET WORKINGCAPITAL - (A-B)

Observations

Arabian Industries LLC has good credit in the market because it is No. 1 Engineering and

Manufacturing Contracting Company in Sultanate of Oman, and 3 rd position in entire GCC countries.

Company took benefit of such position to raise the funds for working capital finance. In the year 2006

and 2008, term loan from bank was the major source of finance, but it reduced by 250% in the

subsequent year, which shows the paying capacity due to the efficient financial management and also

it ndicate that company changed the finance policy to get benefit sources like term credit (export

package credit) which is not directly affect on cost of finance. In the year 2006 and 08 company used

latter of credit but after that company not used such facility from third person.. Company mainly used

term loan and letter of credit for the working capital requirement and clearing the debt for import

within the year itself. For working capital finance company use cash credit facility provided by

scheduled banks and national banks. Company required such huge amount for working capital finance

because liquidity of the company locked in debtors. Company had around 50 % receivables account

of total current assets. Company fixed normal collection period of 90 days, but collection system of

the company was not able to collection from debtors within credit term. Company has receivable but

not liquidity to payment of creditors thus company took cash credit and credit term, which increased

the interest on working capital finance by around 126% from year 2006 compared to 2005, but in

2007 it become 126% and it reduced to 38.5 % in the year 2009. Cash management of the company is

more efficient and conservative thus company carry huge amount in terms of liquid assets.

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CHAPTER IX

9.1 FINDINGS

145

1-Findings

3-Conclusions

4-Recommendations

Working capital management is important aspect of financial management. The study of working

capital management of Arabian Industries LLC, has revealed that the current ratio was as per the

standard industrial practice but the liquidity position of the company showed an increasing trend. The

study has been conducted on working capital ratio analysis, working capital leverage, working capital

components which helped the company to manage its working capital efficiency and affectively.

1. Working capital of the company was increasing and showing positive working capital each

year. It shows good liquidity position.

2. Positive working capital indicates that company has the ability of payments of short terms

liabilities.

3. Working capital increased because of increment in the current assets is more than increase in

the current liabilities.

4. Company’s current assets were always more than requirement and it affected on profitability

of the company.

5. Current assets are more than current liabilities indicate that company used long term funds for

short term requirement, where long term funds are most costly then short term funds.

6. Current assets components shows sundry debtors were the major part in current assets it

shows that the efficient receivables collection management.

7. In the year 2009 working capital decreased because of increased the expenses as

manufacturing expenses and increase the price of raw material as increased in the inflation

rate.

8. Inventory was supporting to sales, thus inventory turnover ratio was increasing, but company

increased the raw material holding period.

9. Study of the cash management of the company shows that company have a good control on

cash management in the year 2009, where cash came from receivables and short term funds.

10. When comparing Working capital is compared with net sales it is in increasing trend

indicating the effective utilization of the net working capital.

11. The decrease in figures of sources and applications from the year 20004- to the year 20009

makes at clear that the company is doing activity increasing or standardizing of its operations.

9.2 CONCLUSION

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Working Capital is the lifeline of every industry, irrespective of whether it’s a manufacturing

industry, services industry. Working Capital is the prime and most important requirement for carrying

out the day to day operations of the business. Working Capital gives the much-needed liquidity to the

business. Working Capital Finance reduces the overall fund requirement, required to build up the

Current Assets, which in turn help you improve your Turn Over Ratio.

The company is performing exceptionally well due to the up wising in the global market followed by

the domestic market. It is an up coming one with good and innovative ideas and believed in

improving all the areas of its operations. The company has a good liquidity position and does not

delay its commitment in case of both its creditors and debtors. The company being mostly dependent

on the working capital facilities, it is maintaining very good relationship with their banks and their

working capital management is well balanced.

1. The working capital position of the company is sound and the various sources through which it is

funded are optimal.

2. The company has used its dividend policy, purchasing, financing and investment decisions to

good effect can be seen from the inferences made earlier in the project.

3. The returns have been affected by a marked growth in working capital and 2009 return on

investment is good, but it got reduced as compared to 2008.

4. The various ratios calculated are an indicator as to the fact that the profitability of the firm and

sales are on a rise and also the deletion of the inefficiencies in the working capital management.

5. The firm has not compromised on profitability despite the high liquidity is commendable.

6. Arabian Industries has reached a position where the default costs are as low as negligible and

where they can readily factor their accounts receivables for availing finance is noteworthy.

9.3 SUGGESTIONS

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Suggestions can be use by the firm for the betterment increased of the firm after study and

analysis of project report on study and analysis of working capital. The suggestions are:-

1. Company should raise funds through short term sources for short term requirement of funds,

which comparatively economical as compare to long term funds.

2. Company should take control on debtor’s collection period which is major part of current

assets.

3. Company has to take control on cash balance because cash is non earning assets and

increasing cost of funds.

4. Company should reduce the inventory holding period with use of zero inventory concepts.

5. The current assets should be managed more effectively so as to avoid unnecessary blocking of

capital that could be used for other purposes.

6. There are various global challenges that are faced by every company n the present

competitive environment and AI LLC is not any exemption. To face the present global

challenges the human resources department should be develop to improve various skills

among the employees specially the motivational skills and having the regular training for the

employees about various developments in the market.

Over all company has good liquidity position and sufficient funds to repayment of liabilities.

Company has accepted conservative financial policy and thus maintaining more current assets

balance. Company is increasing sales volume per year which supported to company for sustain 2 nd

position in Sultanate of Oman and 3rd position in GCC Countries.

Summarizing the overall project work done during these 2 months, it can be said that the

project was a good learning experience. The entire staff of finance department was very cooperative

and they helped in all the phases of this project. It was an opportunity to learn about inventory

management at the same time problems faced by the Company. These two months has given an

opportunity to conceptualize and implement a new initiative. There we could learn how to interpret

working capital and ratio analysis with the help of guidance given by the Finance Manager. There

were lot of difficulties in the beginning of the project but slowly it got the grip on the road towards

future.

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