Working capital means current assets such as cash, accounts receivables and inventory etc. Working capital or circulating capital indicates circular flow of funds is the day-to-day or routine activities of business The management of working capital is more important than the management of fixed assets The fate of most of the businesses very largely depends upon the manner in which their working capital is managed.
Gerstenberg – “Circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another ,as for example , from cash to inventories , inventories to receivable, receivables into cash.”
According to one school of thought, working capital represents all current assets of the Company. They believe that working capital represents those assets, which change their form during the process of production. Working Capital = Total Current Assets According to the other school of thought, working capital is the excess of current assets over current liabilities. Working Capital = Current Assets – Current Liabilities
CONSTITUENTS OF WORKINGCAPITAL CURRENT ASSETS Inventory Sundry Debtors Cash and Bank Balances Loans and advances CURRENT LIABILITIES Sundry creditors Short term loans Outstanding expenses
Type of Working Capital On basis of Requirement concept Measurement Temporary PermanentGross Net Wc Wc Positive Negative
Operating Cycle is the time duration required to convert sales, after the conversion of resources into inventories, into cash
A company’s operating cycle typically consists of three primary activities: Purchasing resources Producing the product and Distributing (selling) the product These activities results in inflow and out flow of funds that are both unsynchronized and uncertain. Unsynchronized because cash disbursements (for example, payments for resource purchases) usually take place before cash receipts (for example collection of receivables). They are uncertain because future sales and costs, which generate the respective receipts and disbursements, cannot be forecasted with complete accuracy.
Accounts Payable Value Addition Raw WIP Materials THE WORKING CAPITALCash CYCLE Finished (OPERATING CYCLE) Goods Accounts SALES Receivable
Ratios associated with WCMStock Turnover Ratio COGS(Times) AVERAGE STOCKStock Turnover Ratio (Days) Average Stock x 365 COGSReceivables Turnover Ratio Net Credit Sales(Times) Average Accounts Receivable
Average Receivables Period Avg A/C Receivable x 365(Days) Net Credit SalesPayables Turnover Ratio Net Credit Purchases(Times) Average Accounts ReceivableAverage Payables Period Avg A/C Receivable x 365(Days) Net Credit Sales
Current Ratio Current Assets Current LiabilitiesQuick Ratio CA – Stock Current LiabilitiesWorking Capital Turnover Net SalesRatio Net Working Capital
Particulars AmountMaterial 48000Labour 36000Factory Over Head 24000Total Cost 108000Add: Profit 12000Sales 120000Raw Material is stock for two months before it is issued to factory.Production cycle takes one month.FG are in stock for 1 ½ monthsDebtors are allowed 3 months credit, creditors give 2 months creditExpenses are outstanding for 1 monthCompany maintains a cash balance of 20000
Particulars AmountCurrent AssetsStock:Raw Material: 48000 x 2/12 8000WIP: Material: 48000 x 1/12 = 4000 Labour : 36000 x 1/12*50% = 1500 OH : 24000 x 1/12*50% = 1000 6500Finished Goods : 108000 x 1.5/12 13500Debtors : 120000 x 3/12 30000Cash / Bank 20000Total A 78000
Particulars AmountCurrent LiabilitiesCreditors : 48000 x 2/12 8000O/S Expenses (36000+24000)* 1/12 5000Total B 13000Total A – Total B: Estimated WC 65000
Each component of working capital(namely inventory, receivables andpayables) has two dimensions ........TIME......... and MONEY, when it comes tomanaging working capital
You can get money to move faster around thecycle or reduce the amount of money tied up.Then, business will generate more cash or it willneed to borrow less money to fund workingcapital. As a consequence, you could reduce the costof bank interest or youll have additional freemoney available to support additional salesgrowth or investment. Similarly, if you can negotiate improvedterms with suppliers e.g. get longer credit or anincreased credit limit, you effectively create freefinance to help fund future sales.
If you Then ......Collect receivables (debtors) You release cash from thefaster cycleCollect receivables (debtors) Your receivables soak upslower cashGet better credit (in terms You increase your cashof duration or amount) from resourcessuppliersShift inventory (stocks) You free up cashfasterMove inventory (stocks) You consume more cashslower
The size and nature of investment in current assets is a function of different factors such as type of products manufactured, the length of operating cycle, the sales level, inventory policies, unexpected demand and unanticipated delays in obtaining new inventories, credit policies and current assets.
Nature of the Industry & Business Demand of Industry Volume of Sales Terms of Purchase and Sales Inventory Turnover Current Assets requirements Production Cycle Inflation or Price level changes Profit planning and control Operation efficiency Attitude towards Risk
Amount Variable Working CapitalofWorkingCapital Permanent Working Capital Time
Variable Working CapitalAmountofWorkingCapital Permanent Working Capital Time
Working Capital Management Cash Receivables InventoryManagement Management Management
Cash Management• Identify the cash balance which allows for the business to meet day to day expenses• reduces cash holding costsReceivables Management• Money which is owed to a company by a customer for products and services provided on credit• Identify the appropriate credit policyInventory Management• Identify the level of inventory which allows for uninterrupted production• Reduces the investment in raw materials, minimizes reordering costs and hence increases cash flow