A Comprehensive Study on Banks Essay

Every business needs funds for two purposes for its establishment and to carry out its day-to-day operations. Long terms funds are required to create production facilities through purchase of fixed assets such as plant and machinery, land, building, etc. Investments in these assets represent that part of firm’s capital which is blocked on permanent or fixed basis and is called fixed capital. Funds are also needed for short-term purpose for the purchase of raw material, payment of wages and other day-to-day expenses etc. These funds are known as working capital. In simple terms, working capital refers to that part of the firm’s capital which is required for financing short-term of current assets such as cash, marketable securities, debtors & inventories. Funds, thus, invested in current assets keep revolving fast and are being constantly converted into cash and this cash flow out again in exchange for other current assets. Hence, it is also known as revolving or circulat ing capital or short term capital. 1) Jeng-Ren, C. & Cheng, L. (2006) in their article, â€Å"Determinants of working capital† investigate the determinants of working capital management. This study investigates the relation of business indicator and management of short-term capital from the perspective of a firm’s working capital management, which traditionally is rated by current ratio, quick ratio, and net working capital.The authors have used net liquid balance and working capital requirements as measures of a company’s working capital management. Results indicate that the debt ratio and operating cash flow affect the company’s working capital management, and how it influences the business cycle, industry effect, growth of the company, performance of the company and firm size. From the data it can be seen that companies could maintain relatively loose capital management during the prosperous period (1999-2000), when capital was readily available in the market. When the economy slumped dramatically at the end of 2000, financial institutions began to tighten their capital policies, forcing companies to gradually operate a looser policy in workin g capital management. The regression results show the company has to operate a looser working capital management policy in times of recession, as it is not easy to raise capital from outside the firm, so more liquid assets are kept to maintain a relatively higher NLB. The authors conclude that debt ratio and operating cash flow evaluated by both WCR and NLB exert influence on working capital management. 2) Harris, A. (2005) conducted a study â€Å"Working capital management: difficult, but rewarding†. It focuses on the different requirements and the important role that human beings play in the working capital management process. There are various important steps that need to be met in order for them to manage their short term needs primiarily. The author compares Working Capital Management in theory and practice. Internal considerations – such as organizational structure, shared systems, autonomous business units, multinational operations and even information technology can impact working ca pital. The author also stresses on the importance of proper forecasting for efficient Working Capital Management. 3) Filbeck, G. & Krueger, T. (2005) in their article, â€Å"An Analysis of Working Capital Management Results Across Industries,† find that all industries use different modes of working capital managament techniques for their functioning. Even their techniques change over time. 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. Given everything the importance of working capital cannot be ignored and its reticfication to cope with the changing environment should be the main focus of the company. 4) Pimplapure, V. & Kulkarni, P. (2011) conducted a study, â€Å"Working Capital Management: Impact of Profitability†. A firm can be very profitable, but if this is not rendered into cash from operations within the same operating cycle, the firm would need to borrow to support its continued working capital needs. For this study various statistical tools such as correlation and multiple regressions can be used. These tools are used to understand the direct impact of working capital on the profitablity of the firm. 5) Erasmus, P. (2010) in his article, â€Å"Working capital management and profitability: The relationship between the net trade cycle and return on assets,† states that, efficient working capital management should contribute to the creation of shareholder value. This study investigates the relationship between working capital management and firm profitability. Based on the results of the study done in this article, it would appear that management could attempt to improve firm profitability by decreasing the overall investment in net working capital. There is an indirect relationship between the two this is also proved in the article, â€Å"Working Capital Management: Impact of Profitability.† Regarding the normal operations of a firm, working capital management attracts less attention than capital budget and capital structure in financial management. Working capital management relates to the source and application of short-term capital. When working capital is managed improperly, allocating more than enough of it will render management non-efficient and reduce the benefits of short-term investment. On the other hand, if working capital is too low, the company may miss profitable investment opportunities or suffer short-term liquidity crises, leading to degradation of company credit, as it cannot respond effectively to temporary capital requirements. We cannot dimiss the importance of the working capital management in the working of a successful enterprise. 6) Singh, P. (2008) conducted a study titled, â€Å"Inventory and Working Capital Management: An Empirical Analysis†. The importance of working capital management is due to two reasons: (i) a substantial portion of the investment is invested in current assets, and (ii) level of current assets will change quickly, with the variation in sales. Hence, in this study, an attempt has been made to analyze the size and composition of working capital and whether such an investment has increased or declined over a period. We need to first determine the requirement of current assets, one of the important tasks of the financial manager is to select a group of appropriate sources of finance for the current assets. Normally, the excess of current assets over current liabilities should be financed by the long-term sources. It is not possible to find out precisely which long-term sources has been used to finance current assets, but it can be examined as to what proportion of current assets has been financed by long-term funds. Therefore, this article tries to carry out a study in this regard. Inventory is one of the major components of current assets, which requires huge investments. The main purpose of carrying inventory is to uncouple the operation, to make each function of the firm independent of the other functions, so that delay in one area does not affect the production and sales activities. As the shutting down of the production results in increased costs and delay in the delivery can result in loosing the customers, inventory management assumes significance in any firm and it is of great concern to any financial manager. Any firm would like to hold higher inventory. This will enable the firm to be more flexible in supply and find ease in its production schedule. Most of the customers may require immediate help in meeting their demands. However, there is always a cost involved in the inventories. This cost includes the capital cost of the stock and the cost of storing and carrying. Inventories are the assets of the firm and as such, they represent an investment. As such investments require a commitment of funds, managers must ensure that the firm maintains inventories at the correct level. If they become too large, the firm loses the opportunities to employ those funds more effectively. Similarly, if they are too small, the firm may lose sales. Therefore, it is better to maintain an optimum level of inventories that is needed in an organization. While analyzing working capital, it is important to analyze the various components of working capital especially inventory, because inventory is one of the major components and is nearly 50% of the current assets. Hence, it is necessary to analyze the size of inventory and the impact on working capital management. 7) Lifland, S. (2010) in his article, â€Å"The Corporate Soap-Opera, As the Cash Turns: Management of Working Capital and Potential External Financing Needs† finds that firms that efficiently manage their working capital are characterized as having increasing asset turnover ratios and decreasing days of receivables and inventories over the years, are ‘freeing up’ capital. Corporations use these ‘found’ funds to improve their supply chains, corporate logistics, and payment systems. The Days of the Working Capital Cycle represents the average number of days that cash must be committed to the management of a company’s working capital needs. A decline in the ratio translates into the firm’s ability to improve its inflows and management of cash. The existence and maintenance of working capital is the lifeblood of a corporation. It is the cash flow that revitalizes operations or slows it down to inoperable levels. Regardless of the size of th e company, the management of working capital accounts should influence its financial health. Kargar and Blumenthal (1994) found that small businesses were significantly impacted by management’s ability to successfully plan the cash requirements of the firm. Managers need to monitor the ratio of total working capital to total company assets, as a relatively high figure can signal future strains on the operational financial health of the firm. 8) Kelleher, J. & MacCormack, J. (2005) consider the complexity of considering the internal rate of return (IRR) on capital projects. A survey was conducted by the management consulting firm McKinsey & Co. This study asked 30 executives about the risks of this practice, They were surprised to find that only six were aware of IRR’s deficiencies. The article defines the risks IRR poses to capital budget management, considers the use of modified internal rate of return. IRR is a true indication of a project’s annual return on investment only when the project generates no interim cash flows — or when those interim cash flows really can be invested at the actual IRR. 9) Etiennot, H. & Preve, L. (2012) in their study, â€Å"Working Capital Management: An Exploratory Study.† found that Working capital management is an issue in which finance research is scarce. One possible reason behind this fact might relate to the relative ease with which efficient financial markets correct deviations from optimal working capital policies. However, in less efficient financial markets, pervasive among emerging economies, working capital management is critical for both firms ‘ performance and survival. The difference in the market’s ability for providing immediate assistance to firms might explain the differential consequences on firms’ profitability and financial distress. This article explains the fundamentals of working capital management, the importance of its interaction with financial markets, and how this interaction might explain working capital patterns around the world and in the various successful organizations that use it. 10) Singh, J. & Pandey, S. (2008) conducted a study, â€Å"Impact of Working Capital Management in the Profitability of Hindalco Industries Limited.† For any successful working of any business organization, fixed and current assets play a vital role. Management of working capital is essential as it has a direct impact on profitability and liquidity. This is a study of the working capital components and the impact of working capital management on profitability of Hindalco Industries Limited. The study is based on secondary data collected from annual reports of Hindalco for the study period 1990 to 2007. The ratio analysis, percentage method and coefficient of correlation have been used to analyze the data. The current assets of Hindalco witnessed a steady growth over the past years which were 40 times more in 2007 in comparison to that of 1990. Inventory and loans and advances mainly supported this increase. The study also shows that the contribution of long term source in working capital is below 30% in all the study period. This study effectively showed that working capital has a big impact on the profitability of the firm.