Working capital management
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The matter includes concept and types of Working Capital. Further it explains Optimum Level of Current Assets, Various Approaches to Working Capital Financing. Then Operating Cycle, Cash Cycle and ...

The matter includes concept and types of Working Capital. Further it explains Optimum Level of Current Assets, Various Approaches to Working Capital Financing. Then Operating Cycle, Cash Cycle and Working Capital Estimation Techniques are discussed.

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    Working capital management Working capital management Presentation Transcript

    • Working Capital Management By: Navin Chandra
    • A Few Facts… • Every Business requires Funds for financing day to day operations. • Requirement of these Funds varies according to various factors like nature of business, size, technology, production policy, creditability, operating efficiency etc. • These Funds are available from various Long Term and Short Term sources. • Cost of Long Term Sources of Funds is more than that of Short Term Funds. Similarly rate of return from Long Term Asset is more than that of Short Term Asset. • Shortage of these Funds may lead a Business to Technical Insolvency due to default in payment of dues. It may ultimately result in Bankruptcy.
    • A Few Facts… Resource flows for a manufacturing Organisation Used in Used in Production Process Generates Raw Materials, Labour and Variable expenses Working Capital cycle Inventory Sales Generated Accounts receivable Accrued Fixed Operating expenses Used for Cash Collection process Used to purchase External Financing Return on Funds Invested Suppliers of Long Term Funds Fixed Assets
    • Definition of Working Capital • Working Capital refers to that part of the Organisation’s capital which is required for financing short-term or current assets such as cash, debtors and inventories. • Working Capital is also known as revolving or circulating capital or short-term capital.
    • Concept of working capital … • Two interpretations are possible: - Balance sheet concept - Operating cycle concept Balance sheet concept • • Gross Working Capital= Total Current Assets Net Working Capital = Total Current Assets - Total Current Liabilities
    • Concept of working capital … WORKING CAPITAL (WC) ON BASIS OF CONCEPT Gross WC Net WC ON BASIS OF TIME Permanent or Fixed WC Temporary or Variable WC Seasonal WC Special WC
    • Concept of working capital … Operating cycle concept Operating Cycle= Inventory Conversion Period + Receivables Collection Period Cash Cycle = Operating Cycle – Payment Deferral Period -An Organisation’s Cash Cycle consists of following activities: • Purchasing resources and making payment • Producing the product • Selling the product and receiving money
    • Operating cycle of an Organisation Purchase resources Pay for Resources purchased Inventory Conversion Period Payable Deferral Period Operating Cycle Sell Product on credit Receivable Collection Period Cash Cycle Receive Cash
    • MANAGEMENT OF WORKING CAPITAL • Refers to management of current assets and current liabilities consistently in an efficient manner. • Working Capital Management Policies of an Organisation greatly affect its profitability, liquidity and financial health.
    • Dimensions of Working Capital Management Liquidity, Profitability & Risk l eve & L ts n itio t Asse pos ren Com Cur of Com of C positio n& urr ent Lia Level bilit ie s
    • Optimum Level of Current Assets… Assumptions • Maximum production: 50,000 units per year • Production process is evenly spread out during the year • Current Assets Levels: High Level :A Average Level: B Low Level :C ASSETS LEVEL Optimum Amount (Level) of Current Assets A B C Current Assets 0 25,000 OUTPUT (units) 50,000
    • Optimum Level of Current Assets… Impact on Liquidity Higher level of current asset lead to more liquidity. A B C ASSETS LEVEL Liquidity Analysis Approach Liquidity A High B Average C Low Current Assets 0 25,000 OUTPUT (units) 50,000
    • Optimum Level of Current Assets… Impact on Profitability Return on Assets = Return on Assets = Net Profit X100 Current Assets+ Fixed Assets Assets A B C ASSETS LEVEL Net Profit X100 Total Assets Current Assets = (Cash + Receivables + Inventory) Current Assets 0 25,000 OUTPUT (units) 50,000
    • Optimum Level of Current Assets… Profitability Analysis Approach Profitability A Low B Average C High As current asset levels decline, total assets will decline and the ROA will increase. ASSETS LEVEL Impact on Profitability 0 A B C Current Assets 25,000 OUTPUT (units) 50,000
    • Optimum Level of Current Assets… Impact on Risk • • Lower cash reduces the Organisation’s ability to meet its financial obligations. Greater risk! Stricter credit policies reduce receivables and possibly lose sales and customers. Greater risk! Lower inventory levels increase stock outs and lead to loss of sales. Greater risk! A B C ASSETS LEVEL • Current Assets 0 25,000 OUTPUT (units) 50,000
    • Optimum Level of Current Assets… Impact on Risk Risk increases as the level of current assets are reduced. A B C ASSETS LEVEL Risk Analysis Approach Risk A Low B Average C High Current Assets 0 25,000 OUTPUT (units) 50,000
    • Optimum Level of Current Assets… SUMMARY OF OPTIMUM CURRENT ASSETS ANALYSIS Approach A B C Liquidity High Average Low Profitability Low Average High Risk Low Average High 1. Profitability varies inversely with Liquidity. 2. Profitability moves together with risk. (remember- higher the risk, higher the returns)
    • Approaches to Current Assets Financing Approaches to Financing Mix The Hedging or Matching Approach The Conservative Approach The Aggressive Approach
    • Hedging approach to assets financing Total Assets Short-term Sources Fluctuating Current Assets Permanent Current Assets Amount Fixed Assets Time Long-term Sources
    • Conservative approach to assets financing Total Assets Short-term Source Fluctuating Current Assets Amount Permanent Current Assets Fixed Assets Time Long-term Source
    • Aggressive approach to assets financing Total Assets Short-term Source Fluctuating Current Assets Permanent Current Assets Amount Fixed Assets Time Long-term Source
    • Concept of Operating cycle •Maximization of share holders’ wealth of an Organisation is possible only when there are sufficient returns from the operations. •Successful sales activity is necessary for earning profit. But sales are not converted into cash immediately. •There is time gap between the sale of goods and receipts of cash. •The time taken to convert cash into cash (Cash-Raw Material-Work in Progress-Finished Goods-ReceivablesCash) is known as operating cycle.
    • Operating cycle of a Trading Organisation Receivables Cash Stock in Trade
    • Operating cycle of a Manufacturing Organisation Raw Materials WIP Cash Finished Goods Receivables Sales
    • Ascertaining Operating Cycle and Cash Cycle for a Trading Organisation Operating Cycle= Inventory Conversion Period(ICP) + Receivables Collection Period(RCP) Cash Cycle = Operating Cycle – Payment Deferral Period (PDP) ICP = Average Inventory X365 Cost of good sold RCP = Average Accounts Receivable X365 Net Credit Sales PDP = Average Accounts Payable X365 Net Credit Purchases
    • Ascertaining Operating Cycle and Cash Cycle for a Trading Organisation • X Limited has provided following information: • Sales Rs.4,000 Lacs • Inventory - Opening Rs. 610 Lacs ; Closing Rs. 475 Lacs • Receivables- Opening Rs. 915 Lacs; Closing Rs. 975 Lacs • Payables- Opening Rs. 355 Lacs; Closing Rs. 410 Lacs • Cost of Goods Sold: Rs. 2,675 Lacs Compute the Operating Cycle and Cash Cycle.
    • Ascertaining Operating Cycle and Cash Cycle for a Manufacturing Organisation Operating Cycle= Raw Material Conversion Period (RMCP) + Work in Progress Conversion Period (WIPCP) + Finished Goods Conversion Period (FGCP)+ Receivables Collection Period(RCP) Cash Cycle = Operating Cycle – Payment Deferral Period (PDP) RMCP = Average Inventory of Raw Material X365 Raw Material Consumed WIPCP = Average Inventory of WIP X365 Cost of Production FGCP = Average Inventory of Finished Goods X365 Cost of Goods Sold
    • Working Capital Estimation… • Factors to be considered: – Total costs incurred on materials, wages and overheads. – The length of time for which raw materials remain in store before they are issued to production. – The length of the production cycle or WIP, i.e., the time taken for conversion of Raw Material into Finished Goods. – The length of the Sales Cycle during which Finished Goods are kept waiting for sales. – The average period of credit allowed to customers. – The amount of cash required to pay day-to-day expenses of the business. – The amount of advance payments if any. – The average period of credit to be allowed by suppliers. – Time – lag in the payment of wages and other overheads.
    • Working Capital Estimation… Statement of Working Capital Required-Trading Concern Particulars Amount (Rs.) Particulars Amount (Rs.) Current Assets Current Assets (i) Cash (i) Cash (ii) Receivables For…..Months’ Operating Cost) (ii) Receivables ((For…..Months’ Operating Cost) (iii) Stocks For……Months’ COGS) (iii) Stocks ((For……Months’ COGS) (iv)Advance Payments if any (iv)Advance Payments if any Less Current Liabilities Less ::Current Liabilities (i) Creditors (For….. Months’ Purchases) (i) Creditors (For….. Months’ Purchases) (ii) Lag in payment of expenses (ii) Lag in payment of expenses WORKING CAPITAL CA CL WORKING CAPITAL ((CA ––CL )) Add Provision Margin for Contingencies Add ::Provision //Margin for Contingencies NET WORKING CAPITAL REQUIRED NET WORKING CAPITAL REQUIRED XXX XXX -----------------------------------_ -----_ xxx xxx ---------
    • MANUFACTURING CONCERN STATEMENT OF WORKING CAPITAL REQUIRED Amount (Rs.) Current Assets (i) Stock of R M( for ….months’ consumption) (ii)Work-in-progress (for…months’ production) (a) Raw Materials (b) Direct Labour (c) Overheads (iii) Stock of Finished Goods ( for …months’ COGS) (a) Raw Materials (b) Direct Labour (c) Overheads (iv) Sundry Debtors ( for …months’ operating Cost) (a) Raw Materials (b) Direct Labour (c) Overheads (v) Payments in Advance (if any) (iv) Balance of Cash for daily expenses (vii)Any other item Less : Current Liabilities (i) Creditors (For….. Months’ Purchases) (ii) Lag in payment of expenses (iii) Any other WORKING CAPITAL ( CA – CL ) Add : Provision / Margin for Contingencies NET WORKING CAPITAL REQUIRED ----------------------------------------------------________________ -------------___ xxx ----_________________ XXX
    • Working Capital Estimation… Prepare an estimate of Working capital requirement from the following information of a trading concern: Projected annual sales 100000 units Selling price Rs 8 per unit % age of Gross profit on sales 25% Average Credit Period allowed to customer 8 weeks Average Credit Period allowed by supplier 4 weeks Average stock holding in terms of sales requirement 12 weeks Provide for Contingencies 10%
    • Working Capital Estimation… Special Points: •Profits should be ignored while calculating working capital requirements for the following reasons: (a) Profits may or may not be used as working capital (b) Even if these are used, these may have to be reduced by the amount of Income tax, Drawings, Dividends etc. •Calculation of WIP depends on the degree of completion as regards to materials, labour and overheads. •Calculation of Stocks of Finished Goods at cost of Goods Sold and that of Receivables at COGS+ Operating Expenses. •Depreciation should be ignored in Working Capital Estimation as it is non-cash expense.
    • Working Capital Estimation… Prepare a statement of working capital required, Profit & Loss Account and Balance Sheet from following Figures: • Share Capital Rs.1,50,000 • 8% Debentures Rs.2,00,000 • Fixed asset Rs.1,30,000 The Cost Component is made up as follows: • Material 40% • Direct Labour 20% • Overheads 20%
    • Working Capital Estimation… • It is proposed to maintain a level of activity of 2,00,000 units per annum • Selling price is Rs. 12/- per unit • Raw Material are expected to remain in store for an average period of one month. • Material will be in process on average for half a month. • Finished goods are required to be in stock for an average period of one month. • Credit allowed to debtors is two months. • Credit allowed by supplier is one month.
    • THANK YOU