Financing of Working Capital in India Industry

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Financing of Working Capital in Indian Industry Author(s): V. S. Kaveri

Source: Economic and Political Weekly, Vol. 20, No. 35 (Aug. 31, 1985), pp. M123-M128 Published by: Economic and Political Weekly

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Financing Qf Working Capital in Indian Industry

V S Kaveri

This review of working capital finance, based on the Reserve Bank of India's studies on Finances of Large Public Limited Companies, concludes that Indian industry has by and large failed to change its pattern of

working capital financing in keeping with the norm suggested by the Chore Committee. While the position of working capital management showed s.ome improvement between 1975-79 and 1979-83, industries have not suc-

ceeded in widening the base of long-term funds to the desired extent.

I

Introduction

WORKING capital generally refers to the in-vestment in current assets which are required to carry on the operations of the business. Sometimes it is also referred to as the dif-ference between current assets and current liabilities. Management of working capital

considers both terms, i e, the investment in

current assets (gross working capital) and the difference between current assets and current

liabilities (net working capital). Gross work-ing capital is used for assessing the quality and quantum of current assets, whereas net

working capital is used for the study of

financing of current assets. A high invest-

ment in the different forms of current assets

helps in maintaining continuous production and sales but at the same time it will prove to be a costly affair to the firm as funds are obtained at a cost. On the other hand, a low

investment in different forms of current

assets may cause shortages and thus bring

obstacles in the smooth flow of production

and sales. So a balance has to be struck between these two extreme levels and in this context the review of the position of working capital at different intervals becomes neces-

sary. To carry out this review, the balance

sheet as a source of information would be

of great help.

The balance sheet is a statement of posi.

tion of assets and liabilities at a point of time. The financial position of the firm is

assessed through the study of assets and liabilities. Current assets and current

liabilities are the two major components of

the balance sheet. Study of the position of gross working capital, i e, current assets, suggests the liquidity position of the firms. These current assets should not only be in liquid form but also be in line with the level of operations. The Tandon Committee sug-

3ested norms for inventory and book debts

for 15 major industries. It is necessary to

examine whether inventory and book debt levels of the firm are as per the suggeted

norms. Similarly, study of the position of net working capital, i e, current assets less current liabilities, indicates short term

solvency of the firm. Current ratio of the

firm is the best indicator of the working

capital position. The ratio should be at least

1.0; this is the manimum requirement. Ef-forts should be made to maintain a higher ratio.

Items in the balance sheet are interdepen-

dent. Hence, if the working capital position is unsound, the total financial position of

the firm gets ad*ersely affected. To elaborate,

if the firm holds current assets more than necessary, it experienceg shortages of long

term assets, provided funds are limited.

Similarly, if the long term funds are short of long term assets, short term funds have to be partially used for the long term assets. In such circumstances, the current ratio is unsatisfactory. Thus in the context of balance sheet analysis, the study of working capital position occupies a significant place.

Each industrial firm aims at maximising return on investment for which it keeps on acquiring assets and using them for produc-tive uses on a regular basis. When this is

done, it can maintain a steady growth in pro-

duction, sales and profits. If profits are con-siderably and regularly ploughed back, it is possible to strengthen the capital base. Con-

sequently, dependence on financial institu-

tions for working capital in particular and term finance in general gets reduced over a period of time. This view was upheld by the

study group to frame guidelines for follow-up of bank credit (Tandon Committee) ap-pointed by the Reserve Bank of India in

1974. This study suggested three methods for computing maximum permissible bank