Assignment No.

Financial Management

Introduction
In this assignment we have to particularly talk about a new trend that many large companies are following.
This new concept is maintaining negative working capital. Many companies which are having rapid
transactions in the market are maintaining negative working capital as they are collecting cash money for
sales but are paying to their suppliers of raw material after a handsome credit period. We have to analyze
the working capital of Godrej Ltd. by using ratio analysis. We need to understand some theoretical
concepts before doing this assignment which are as follows:

Liquidity Ratios

Common liquidity ratios include the current ratio, the quick ratio and the operating cash flow ratio.
Different analysts consider different assets to be relevant in calculating liquidity. Some analysts will
calculate only the sum of cash and equivalents divided by current liabilities because they feel that they
are the most liquid assets, and would be the most likely to be used to cover short-term debts in an
emergency.

A company's ability to turn short-term assets into cash to cover debts is of the utmost importance when
creditors are seeking payment. Bankruptcy analysts and mortgage originators frequently use the liquidity
ratios to determine whether a company will be able to continue as a going concern.

Current Ratio

The current ratio is the ratio of current assets to current liabilities:

Current Assets
Current Ratio   =  
Current Liabilities

Short-term creditors prefer a high current ratio since it reduces their risk. Shareholders may prefer a lower
current ratio so that more of the firm's assets are working to grow the business. Typical values for the
current ratio vary by firm and industry. For example, firms in cyclical industries may maintain a higher
current ratio in order to remain solvent during downturns.

Quick Ratio

One drawback of the current ratio is that inventory may include many items that are difficult to liquidate
quickly and that have uncertain liquidation values. The quick ratio is an alternative measure of liquidity
that does not include inventory in the current assets. The quick ratio is defined as follows:

Current Assets - Inventory

Quick Ratio   =  
Current Liabilities

The current assets used in the quick ratio are cash, accounts receivable, and notes receivable. These assets
essentially are current assets less inventory. The quick ratio often is referred to as the acid test.

Activity/Turnover Ratios

Companies will typically try to turn their production into cash or sales as fast as possible because this will
generally lead to higher revenues.

Such ratios are frequently used when performing fundamental analysis on different companies. The raw
material turnover ratio and work in progress turnover ratio are good examples of activity ratios.

Raw Material Turnover Ratio

This is the ratio which determines that how many times the raw materials are converted into finished goods
which will ultimately earn revenues for the company as a whole. The raw material turnover ratio can be
explained by following formula easily:

COMC
Raw Material (RM) Turnover Ratio =
Average Stock of RM
Work In Progress Turnover Ratio

FactoryCost
Work in Progress (WIP) Turnover Ratio =
Average WIP

Finished Goods Turnover Ratio

This ratio indicates that how many times the stock of finished goods got converted into liquid cash during
the year. The more this ratio is, it is better for the firm as it will indicate that sales of the company is
increased.

COGS
Finished Goods Turnover Ratio =
Average Stock
 Working Capital Analysis Of Godrej Industries

Liquid Ratios

Current Year Previous Year

Current Assets

Inventories 13476.87 9355.62

Debtors 11086.55 16099.68
Cash and Bank 1508.61 2851.17

Total CA 26072.03 28306.47

Liquid Assets 12595.16 18950.85
Total Liabilities 21035.53 14045.42
Working Capital 5036.5 14045.42
Current Ratio 1.24 2.02
Quick Ratio 0.60 1.35

If we see the above table we can see that the current ratio and quick ration both have decreased in the
current year as compared to last year i.e. 2009. If we talk about the standard norm of current ratio we can
comment that current ratio as well as quick ratios are not good enough and are showing that the company is
not able to pay its debts in short term. But we can also say that the company is running on principles of
negative working capital. There are so many companies that are managing their negative working capital
very effectively. Some companies can generate cash so quickly they actually have a negative working
capital. If we see here Godrej has less working capital and also these ratios which indicates that company is
having fast turnover of its products while it is getting a good amount of credit period from raw material
suppliers which increase its short term liabilities which are not at all suggesting that the company is not
able to pay its short term debts but is having cash which it is going to pay after the credit period. So by
looking at the above figures we can say that the company is running good and having a good financial
position and is sustaining well in the market.
Turnover Ratios

COMC
Raw Material (RM) Turnover Ratio:- Average Stock of RM

228698.21
=
11958.205

= 19.1248 times a year.

FactoryCost
Work in Progress (WIP) Turnover Ratio:-
Average WIP

333474.13
=
3460.52

= 96.36×a year.

COGS
Finished Goods Turnover Ratio:-
Average Stock

356824.69
=
5637.735

= 63.29×a year

If we see the above ratios we can see a very high amount of turnover of raw material, Work in Progress
goods and Finished Goods as well. It shows that the sales of the company have increased which is
indicating more business and which finally means more revenues & more profits. Thus we can say that the
company is increasing its business day by day. Even though the company is having less working capital it
does not mean that it is not having money to pay debts. We can see here that sales of the company are very
high indicating high amount of cash available and thus there is no doubt that company is not aable to pay
its debts when demanded.

Conclusively we can say that the company enjoys a good financial position and having a large amount of
market share.
 Current Trend Of Negative Working Capital
What is negative working capital??

Any organisation is said to be working with negative working capital when its current assets are less than
its current liabilities and is still effectively managing its cash flows.

Is it good or bad?

For the FMCG companies raising funds is not a tough task as the customer pays upfront for the product
before the company even pays to the supplier. Working with negative working capital means operating
your business with low inventory and low receivables. It holds good for FMCG companies because;

 As any particular product is sold, company receives the money which is charged for it, but on the
other hand it need not to pay to its suppliers instantly.

Case of Big Bazaar:

 In case of Big Bazaar, it purchases material of worth Rs. 1 lakh from various vendors on the terms
that they will get the payment in due coarse of 21 days. Then it sales those same goods through its
various outlets. Suppose the goods purchased by Big Bazaar to sell gets sold within a week, that
means company has sold the goods of Rs. 1lakh without investing a single rupee. This money it can
use for next 2 weeks and thus the working capital required for those weeks gets reduced.
 The biggest advantage of this negative working capital is that you almost work on cash basis and
you don’t need to worry for current liabilities all the time

Operating cycles of companies with negative working capital are such that they collect funds prior to
disbursing payments to their suppliers. There are two basic scenarios:-

1. Supplier credit is much more than inventory turnover

2. Customers pays in advance.

A low working capital is advantages to the organisation which is looking to expand its operations without
resources to external capital.

Conclusion:-

In today’s world with the use of negative working capital it has become easier for the organisations
to operate there cash flows without much efforts. Also it can go for the operations expansions in cases
when it don’t have access to external capital.