Basic theme is same (i.e. Working Capital = Current Assets -Current Liabilities) but working and its Impact is totally different in both type of Industry i.e. Heavy Goods Industry & MSME Industry.
Working Capital is necessary to run the Business smoothly over the period after its initial start-up. Maximum time the Entrepreneur fails to control Working Capital Requirement of the organisation & pour the money unnecessarily. Working Capital refers to the funds invested in Current Assets to run the business & churn the cycle. Current Assets are essential for using Fixed Assets Profitably. For Example, a Machine cannot be used without Raw Material. Above headlines may confuse you but it is really very Interesting to see how it works in Economy. A working capital of Heavy Goods Industry (or Large Scale Industry) runs the Working Capital of MSME Industry. Why I say so have a strong reason as MSME are heavily depend upon the Large Scale Industries Supply & Erection of the Machine. Here I am chalked down few important things to differentiate between these two concepts. Factors which has to be taken into consideration while determining Working Capital in both type of industry(i.e. MSME Industry & in Capital Goods Industry) are a) Production Policies, b) Nature of the Business, c)Credit Policy, d) Inventory Policy, e) Abnormal Factors, f)Market Conditions, g) Condition of Supply ,h) Business Cycle, i)Growth and Expansion, j)Level of Taxes, k) Dividend Policy, l) Price Level changes, m)Operating Efficiency etc….
First we deal with Working capital of MSME Industry and then deal with Heavy Capital Goods Industry (Large Scale Industry or Material Handling Equipment). Let’s chalked down this difference in following manner.
We commonly know that Working Capital segregate in two parts i.e. Current Assets & Current Liability. Current Assets categories in following parts i.e. a) Trade Receivables, b) Inventory, c) Cash & Cash Equivalents, d) Advances & Deposit, e) Other Current Assets. Whereas Current Liabilities categories in following parts i.e. a) Trade Payable, b) Provisions and Liabilities, c) Unsecured Creditors, d) Advances & Deposits, e) Other Current Liabilities.
Working Capital for MSME Industry: –
In MSME Industry the focus is at Micro Level i.e. on Ageing Analysis. Trade Receivable contain the Ageing Analysis which is bifurcated in following buckets i.e. Not Due (Generally of 30 Days), 30- 60 days, 60-90 days,90-180 days, 180- 365 days & last but not the least more than 365 days. This bifurcation not only helpful in focusing the area of collection & but also for making provision against Bad & Doubtful Debts. All these buckets are again linked with the Credit Policy of the organisation with respect to each customer. It may differ to customer to customer or universal acceptable i.e. apply to Entire Customer Portfolio. Credit Policy again divided according to class of the product and Geographical area of the market. In other industry, the credit policy is based on volume and margin of the goods. Where as in Capital Goods Industry it is totally based on number of days required to “Finish” the particular project. Here “Finish means Erection & Installation works” also. In Capital Goods Industry each order is taken as a “Project” whether it is small or large by volume or size it is irrelevant. Hence the Outstanding Amount is not only based on Supply of Goods but it is also depending on its Erection & Installation (assuming Order of Supply & Erection are with same supplier). Due to which the Ageing bucket is continuously shown in not due portion as it is already due. This will discuss in later part of this article. Second part of the current assets is Inventory which is generally FMI (i.e. Fast Moving Item in MSME) either it is saleable or consumable. So, Inventory is not pile up so long and Investment in Inventory not huge subject to market condition & demand supply position of the goods. The carrying cost of the inventory is also reduces as the goods are either consumed in making Finish Goods or frequently sold out. So, Inventory is also not a big issue in MSME. Another important area is Advances & Deposits which are generally to the small stake holders which can be converted in cash as & when time requires. Last but not the least is Cash & Cash Equivalents which is also affects the position of current assets & in turn to Working of Working Capital. In MSME Industry the cash & cash Equivalent portion is more as compare to Capital Goods Industry as the position of Trade receivable is in very much controlled and easily liquidated.
Now we come to Current Liabilities of this sector which is almost similar to what we have discuss above. There were few changes which differentiate from Current Assets accounting. As per trade receivable, ageing analysis is also prepared for Trade Payable which is also bifurcated in different age buckets. Here the most important aspect is actual liabilities against all GRN (i.e. Good Received Note) which is booked in system. GRN which is pending at the cut of date are either reversed or booked it appropriately. Provisions are taken of all future certain liabilities and account for.
Working Capital of Capital Goods Industry:-
The working of Working Capital of “Capital Goods Industry” is entirely different as compare to Consumer Durable Goods. As it involves two measure activity i.e. Supply of Goods and Services of the same. Supply portion also bifurcated in many Portions (commonly known as Milestones) which involved from getting purchase order to its supply and later part is its erection, installation & claim of last retention portion. Ageing analysis buckets are commonly prepared in three parts i.e. a) Against Advance, b) Actual Due against Supply & c) Against Last Milestone i.e. Retention Amount which can be claimed at the end of the project. The whole Trade Receivables are divided in 6 Milestones i.e. a) Advance with Order (Confirm Purchase Order or some time it is against Purchase Intent which include Advance Bank Guaranty), b) Against Approval of Drawings (this Milestone against Approved Drawings), c) Against Readiness of Material/Inspections, d) Against Dispatch of Material, e) After Erection & Commissioning and last but not least e) Against Guaranty & Final Acceptance Test (which is Commonly known as Retention Money). All these Milestones are affecting the Ageing Bucket of Trade Receivables.
All the Milestones have their own Ageing buckets which makes the things critical hence to view as a whole you need to summaries the position in 3 portion as started above. If you check the First Parts i.e. Advance, you come to notice that though it is part & parcel of Trade Receivables but it is actually a Liability & not the Current Asset. Unless & until work is started and finished & it is ready for inspection it is not received. The organisation can not considered it as Revenue until the “Final Test” is approved by the Customer. As per Revenue Recognition Accounting Standard the Ownership still lies with supplier and hence it is a liability and not an asset. In other words, the status of above advance is still remain a liability unless goods are prepared and ready for dispatch. Once it is ready then its status change to “received” against the debtors and actual o/s reduce to that extent. This result into changes of Bucket of ageing.
1. Formula of Working Capital
2. Type of Ageing (Domestic & Export).
3. Bucket of Ageing.
4. Customer base.
5. Payment Terms.
6. Inco Terms (Commercial Terminology).
7. Market Ratio.
8. Dependency Factor.
In nutshell we can say that MSME industry are controlled (Indirectly) by the Large Scale Industry. I dare to write this article on the basis of my experience in both industry, if someone have other angel which is missed out here are requested to most welcome and add the same to this article or express your comments.