CP: 303 A PRESENTATION ON THE DIFFERENT APPROACHES TO WORKING CAPITAL Presented to: Presented by:- ASST. Amit kr .gupta(07) PROFESSOR Rameshwar Baidya(60) Prasenjit Dhar()DR. RANJIT SINGH Jabed H. Laskar(31)
WORKING CAPITALWorking Capital refers to that part of the firm’scapital, which is required for financing short-term or current assets such a cash marketablesecurities, debtors and inventories. Funds thus,invested in current assets keep revolving fastand are constantly converted into cash and thiscash flow out again in exchange for othercurrent assets. Working Capital is also known asrevolving or circulating capital or short-termcapital.
APPROACHES TO WORKING CAPITAL MATCHING APPROACH CONSERVATIVE APPROACH AGGRESSIVE APPROACH ZERO CAPITAL APPROACH
MATCHING APPROACHThe matching or balancing approach makesdistinction between fluctuating current assetsand permanent current assets with thesuggestion that to finance working capital;short-term source of finance should be used tofinance fluctuating current assets, whiles long-term source of finance should be used tofinance permanent current assets. Thismatches the source of finance with thecharacter of the assets.
Balance between cost and risk, leading to abalance between profitability and liquidity.This approach refers to a process ofmatching the maturities of debt with thematurities of financial need i.e, the maturityof source of fund should match the nature ofasset to be financed
Total Assets Short-term DebtFluctuating Current Assets Long-term Permanent Current Assets Debt + Equity Capital Fixed Assets
CONSERVATIVE APPROACHThis approach favours maximum reliance on long-term sourcesof financing. A firm following this approach would finance notonly its fixed assets and its permanent working capital fromlong sources but also partly finance its temporary (seasonal)working capital requirement from long term sources as can beseen in figure given below:-
Conservative ApproachTotal Assets Short-term Sources $10M Temporary Current Assets $7M } Permanent Long-term Sources Current Assets $5M } Time Fixed Assets 8
*The conservative approach is termed as low profitability and high liquidity approach to working capital financing because more reliance on the long term funds would have an impact on returns, although its strengthen the liquidity position of the business. *This utilization of funds under this approach may be restricted due to the capacity of the firm to bear its day to day obligation and to hold the firm in order to meet the future contingencies, replacement of any fixed assets, to prevent the insolvency and to provide the sufficient funds to meet the pressure of seasonal requirement or to meet the peak level working capital need.
Advantages of the conservative approach:*High liquidity.*Solvency.*Less risk.*Opportunity to earn income by investing theidle fund in short term marketable securities,which explained by the diagram below:-
Conservative approach to working capital financing Short term source of financingLevel of assets b a Y X Long term source of financing Fixed assets Time
Disadvantage:-*Less profitability.*Inefficient utilization of funds.*More interest paid.
AGGRESSIVE APPROACHUnder this approach C.A are maintained just to make the C.Lwithout keeping any cushion for the variation in workingcapital need. This core W.C. is financed by long termsources of capital and seasonal variation are meet throughshort term borrowing. Adaptation of this strategy willminimize the investment in the net working capital and itlowers the cost of financing W.C.
A working capital policy is called an aggressive policy if the firmdecides to finance a part of the permanent working capital byshort term sources. So, the short term financing underaggressive policy is more than the short term financing under thehedging approach. The aggressive policy seeks to minimize excessliquidity while meeting the short term requirements. The firm mayaccept even greater risk of insolvency in order to save cost oflong term financing and thus in order to earn greater return.
“Financing strategy” in Aggressive approach:• Long-term funds = fixed asset + part of permanent current assets.• Short- term funds = part of permanent current assets + total temporary current asset
ZERO WORKING CAPITAL:Zero Working capital of a company is the situation where it has neither positive working capital nor negative working capital but the total of current asset may just be equal to the total of current liabilities. Such a situation is called as Zero Working capital situation. When, Total of Current Assets= Total of Current Liabilities Total of Current Assets-Total of Current Liabilities = 0
Explanation of the ConceptIn financial terms, zero working capital is the state where the total accounts receivable, accounts payable, and inventory is zero. Inventory + Account Receivables – Accounts Payables = 0. A company uses its working capital to purchase inventory, sell goods on credit, collects accounts receivable, and then again purchase inventory. The amount of working capital deployed in a cash conversion cycle bases itself as an optimal trade-off between reducing working capital deployed to purchase inventory, and the potential loss of sales owing to reduced inventory levels or higher costs owing to longer periods of deferred payments. Zero working capital tries to minimize the working capital deployed in the cash conversion cycle to the extent possible, and if possible, continuing the process without any working capital at all.
One way to implement Zero Working Capital :is to have a demand-based organization. Demand-based organizationsdo everything only as they are demanded: Fill customer orders, receivesupplies, manufacture products, and other functions are done only asneeded. The production facilities run 24 hours a day non-stopaccording to the demands within the marketplace. There are noinventories; everything is supplied immediately as needed.When is the methodology of a zero working capital process used?Companies such as Dell, General Electric, and Campbell Soup have implemented zero workingcapital to improve their financials.The shift of zero working capital becomes easy when the companys products are in highdemand, there are few competing products, and when the company commands a demandingposition in the supply chain, with suppliers valuing the companys order.
Advantages: ZWC helps the company attain financial and production economies by------------------------------- freeing up blocked cash permanently and thereby raising the company’s earnings speeding up the production and sales process to reduce lag in cash inflows As competitive pressure forces companies to make maximum advantage of its resources, more and more companies look into what is zero working capitalDisadvantage It is not possible for most firm to achieve zero working capital and infinitely efficient production. Liquidity less. More risky in nature