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Working capital Presentation Transcript

  • 1. WorkingWorking CapitalCapital ManagementManagement www.StudsPlanet.com
  • 2. Definition of WorkingDefinition of Working CapitalCapital    Working Capital refers to that part of the Working Capital refers to that part of the  firm’s capital, which is required for firm’s capital, which is required for  financing short-term or current assets such a financing short-term or current assets such a  cash marketable securities, debtors and cash marketable securities, debtors and  inventories.  Funds thus, invested in current inventories.  Funds thus, invested in current  assets keep revolving fast and are assets keep revolving fast and are  constantly converted into cash and this cash constantly converted into cash and this cash  flow out again in exchange for other current flow out again in exchange for other current  assets.  Working Capital is also known as assets.  Working Capital is also known as  revolving or circulating capital or short-revolving or circulating capital or short-www.StudsPlanet.com
  • 3. KINDS OF WORKING CAPITALKINDS OF WORKING CAPITAL WORKING CAPITAL BASIS OF CONCEPT BASIS OF TIME Gross Working Capital Net Working Capital Permanent / Fixed WC Temporary / Variable WC Regular WC Reserve WC Special WC Seasonal WC www.StudsPlanet.com
  • 4. Significance of Gross WCSignificance of Gross WC  Optimum investment in CAOptimum investment in CA           Investment in CA must be adequate  CA investment should not Investment in CA must be adequate  CA investment should not  be inadequate or excessive inadequate WC can disturb be inadequate or excessive inadequate WC can disturb  production and can also threaten the solvency of firm , if it fails production and can also threaten the solvency of firm , if it fails  to meet its current obligation  excessive investment in CA to meet its current obligation  excessive investment in CA  should be avoided , since it impairs firms profitability should be avoided , since it impairs firms profitability   Financing of CAFinancing of CA           Need for WC arises due to increasing level of business activity Need for WC arises due to increasing level of business activity  & it is to provided quickly some time surplus fund may arises & it is to provided quickly some time surplus fund may arises  which should be invested in Short term securities , they should which should be invested in Short term securities , they should  not be kept idle not be kept idle  www.StudsPlanet.com
  • 5. Significance of Net Working CapitalSignificance of Net Working Capital  Maintaining Liquidity positionMaintaining Liquidity position   For maintaining liquidity position there is a For maintaining liquidity position there is a  need to maintain CA sufficiently in excess of need to maintain CA sufficiently in excess of  CL CL   Judge Financial Soundness of a firm Judge Financial Soundness of a firm  The Net working capital helps creditors and The Net working capital helps creditors and  investors to judge financial soundness of a investors to judge financial soundness of a  firm firm  www.StudsPlanet.com
  • 6. BALANCE SHEET OF ABC COMPANY AS ON 31-3-2000BALANCE SHEET OF ABC COMPANY AS ON 31-3-2000 LiabilitiesLiabilities R’sR’s AssetsAssets R’sR’s Equity SharesEquity Shares 200000200000 GoodwillGoodwill 2000020000 8% Debentures8% Debentures 100000100000 Land and BuildingLand and Building 150000150000 Reserve & SurplusReserve & Surplus 5000050000 Plant and MachineryPlant and Machinery 100000100000 Sundry CreditorsSundry Creditors 150000150000 InventoriesInventories    Bills PayableBills Payable 3000030000 Finished GoodsFinished Goods 6000060000 Outstanding ExpensesOutstanding Expenses 2000020000 Work in processWork in process 4000040000 Bank OverdraftBank Overdraft 5000050000 Prepaid ExpensesPrepaid Expenses 2000020000 Provision for TaxationProvision for Taxation 2000020000 Marketable SecuritiesMarketable Securities 6000060000 Proposed DividendProposed Dividend 3000030000 Sundry DebtorsSundry Debtors 9000090000       Bills ReceivablesBills Receivables 2000020000       Cash & Bank BalanceCash & Bank Balance 9000090000          TOTALTOTAL 650000650000 TOTALTOTAL 650000650000www.StudsPlanet.com
  • 7. Difference between permanent & temporary workingDifference between permanent & temporary working capitalcapital Amount Variable Working CapitalAmount Variable Working Capital ofof WorkingWorking CapitalCapital Permanent Working CapitalPermanent Working Capital TimeTime Permanent and temporary working capital for Stable firm www.StudsPlanet.com
  • 8.                                   Variable Working Capital Amount of Working Capital Permanent Working Capital Time Permanent and temporary working capital for Growing firm www.StudsPlanet.com
  • 9.  Operating cycle conceptOperating cycle concept  Maximization of share holder’s wealth of a firm is possible onlyMaximization of share holder’s wealth of a firm is possible only when there are sufficient return from the operationswhen there are sufficient return from the operations  Successful sales activity is necessary for earning profit sales do notSuccessful sales activity is necessary for earning profit sales do not convert into cash immediatelyconvert into cash immediately  There is invisible time lap between the sale of good and receipt ofThere is invisible time lap between the sale of good and receipt of cashcash  The time taken to convert raw material into cash is known asThe time taken to convert raw material into cash is known as operating cycleoperating cycle  Conversion of cash into raw materialConversion of cash into raw material  Conversion of raw material into work in progressConversion of raw material into work in progress  Conversion of Work in progress into finished goodsConversion of Work in progress into finished goods  Conversion of finished good into Sales ( Debtors and cash )Conversion of finished good into Sales ( Debtors and cash ) www.StudsPlanet.com
  • 10. Operating Cycle inOperating Cycle in Manufacturing firmManufacturing firm Cash Raw Materials W I P Finished Goods Debtors SALES www.StudsPlanet.com
  • 11. Operating cycle ofOperating cycle of Non ManufacturingNon Manufacturing FirmFirm cash Receivables Stock of finished goods www.StudsPlanet.com
  • 12. Formula for calculatingFormula for calculating Operating cycle forOperating cycle for Manufacturing firmManufacturing firm OC = ICP+ARPOC = ICP+ARP OC = Operating cycleOC = Operating cycle ICP = Inventory Conversion periodICP = Inventory Conversion period ARP = Account Receivable PeriodARP = Account Receivable Period ICP =ICP = Average InventoryAverage Inventory Cost of good sold /365Cost of good sold /365 ARP =ARP = Average Account ReceivableAverage Account Receivable Sales/365Sales/365 www.StudsPlanet.com
  • 13.  ABC Company Provide theABC Company Provide the following information , Computefollowing information , Compute the operating cyclethe operating cycle      Sales 3000 Lakhs Sales 3000 Lakhs   Inventory  Opening R’s 610 Lakhs ; Inventory  Opening R’s 610 Lakhs ;  closing R’s 475 Lakhs closing R’s 475 Lakhs   Receivable opening R’s 915 Lakhs; Receivable opening R’s 915 Lakhs;  Closing R’s 975 LakhsClosing R’s 975 Lakhs  Cost of Goods Sold R’s 2675 LakhsCost of Goods Sold R’s 2675 Lakhs     www.StudsPlanet.com
  • 14.   CASH CONVERSION CYCLECASH CONVERSION CYCLE The amount of time a firm’s resources are tied The amount of time a firm’s resources are tied  up calculated by subtracting  the average up calculated by subtracting  the average  payment period from the operating cycle the payment period from the operating cycle the  time period between the date a firm pays its time period between the date a firm pays its  supplier and the date it receives cash from its supplier and the date it receives cash from its  customer customer  CCC = OC – APPCCC = OC – APP AAI = AAI = Average InventoryAverage Inventory             Cost of good sold /365Cost of good sold /365 ARP = ARP = Average Account ReceivableAverage Account Receivable                 Annual Sales/365 Annual Sales/365  APP = APP = Account Payable PeriodAccount Payable Period           Cost of good sold /365Cost of good sold /365 www.StudsPlanet.com
  • 15. Calculate CCCCalculate CCC (CASH CONVERSION CYCLE)(CASH CONVERSION CYCLE)  Average use of Inventory 80 daysAverage use of Inventory 80 days  Account receivable collection period 50 daysAccount receivable collection period 50 days  Account payable period is 40 daysAccount payable period is 40 days CCC= OC- APPCCC= OC- APP OC = AAI+ARPOC = AAI+ARP 80+50=13080+50=130 CCC =130-40 =90 daysCCC =130-40 =90 days www.StudsPlanet.com
  • 16.         Purchase of                           Sale of Goods                       Purchase of                           Sale of Goods                        Collection of Collection of        Raw Material Raw Material     on Credit   on Credit         Account Receivables         Account Receivables        On creditOn credit        Average age  of Average age  of  Account receivableAccount receivable     Inventory  Inventory  (AII)(AII)    period  period (ARP)(ARP)                                                          Account Payable Account Payable                        Period Period (APP)(APP)                                                                                           Payment to Payment to                                                                                              suppliers suppliers    Receipt of InvoiceReceipt of Invoice Operating Cycle (OC)Operating Cycle (OC) Cash Conversion cycleCash Conversion cycle www.StudsPlanet.com
  • 17. Resource flows for a manufacturing firmResource flows for a manufacturing firm Fixed Assets Production Process Generates Inventory Via Sales Generator Accounts receivable Used in Accrued Direct Labour and materials Accrued Fixed Operating expenses Cash and Marketable Securities Suppliers Of Capital External Financing Return on Capital Collection process Used to purchase Used to purchase Used in Working Capital cycle www.StudsPlanet.com
  • 18. Calculate cash conversionCalculate cash conversion cyclecycle  Sales R’s 1587.95Sales R’s 1587.95  Cost of Good sold R’s 1406.27Cost of Good sold R’s 1406.27  Inventory opening 195.82, closing 202.29Inventory opening 195.82, closing 202.29  Account receivables opening 423.03 closingAccount receivables opening 423.03 closing 449.46449.46  Account payable opening 140.40, closingAccount payable opening 140.40, closing 168.33168.33 CCC = OC –APPCCC = OC –APP OC = AAI + ARPOC = AAI + ARP www.StudsPlanet.com
  • 19. FORECASTING / ESTIMATION OFFORECASTING / ESTIMATION OF WORKING CAPITALWORKING CAPITAL REQUIREMENTSREQUIREMENTS Factors to be consideredFactors to be considered  Total costs incurred on materials, wages and overheadsTotal costs incurred on materials, wages and overheads  The length of time for which raw materials remain in storesThe length of time for which raw materials remain in stores before they are issued to production.before they are issued to production.  The length of the production cycle or WIP, i.e., the time takenThe length of the production cycle or WIP, i.e., the time taken for conversion of RM into FG.for conversion of RM into FG.  The length of the Sales Cycle during which FG are to be keptThe length of the Sales Cycle during which FG are to be kept waiting for sales.waiting for sales.  The average period of credit allowed to customers.The average period of credit allowed to customers.  The amount of cash required to pay day-to-day expenses of theThe amount of cash required to pay day-to-day expenses of the business.business.  The amount of cash required for advance payments if any.The amount of cash required for advance payments if any.  The average period of credit to be allowed by suppliers.The average period of credit to be allowed by suppliers.  Time – lag in the payment of wages and other overheadsTime – lag in the payment of wages and other overheadswww.StudsPlanet.com
  • 20. PROFORMA - WORKING CAPTIAL ESTIMATESPROFORMA - WORKING CAPTIAL ESTIMATES 1.1. TRADING CONCERNTRADING CONCERN STATEMENT OF WORKING CAPITAL REQUIREMENTS Amount (Rs.) Current Assets (i) Cash ---- (ii) Receivables ( For…..Month’s Sales)---- ---- (iii) Stocks ( For……Month’s Sales)----- ---- (iv)Advance Payments if any ---- Less : Current Liabilities (i) Creditors (For….. Month’s Purchases)- ---- (ii) Lag in payment of expenses -----_ WORKING CAPITAL ( CA – CL ) xxx Add : Provision / Margin for Contingencies ----- NET WORKING CAPITAL REQUIRED XXX STATEMENT OF WORKING CAPITAL REQUIREMENTS Amount (Rs.) Current Assets (i) Cash ---- (ii) Receivables ( For…..Month’s Sales)---- ---- (iii) Stocks ( For……Month’s Sales)----- ---- (iv)Advance Payments if any ---- Less : Current Liabilities (i) Creditors (For….. Month’s Purchases)- ---- (ii) Lag in payment of expenses -----_ WORKING CAPITAL ( CA – CL ) xxx Add : Provision / Margin for Contingencies ----- NET WORKING CAPITAL REQUIRED XXX www.StudsPlanet.com
  • 21. 1. MANUFACTURING CONCERN1. MANUFACTURING CONCERN STATEMENT OF WORKING CAPITAL REQUIREMENTS Amount (Rs.) Current Assets (i) Stock of R M( for ….month’s consumption) ----- (ii)Work-in-progress (for…months) (a) Raw Materials ----- (b) Direct Labour ----- (c) Overheads ----- (iii) Stock of Finished Goods ( for …month’s sales) (a) Raw Materials ----- (b) Direct Labour ----- (c) Overheads ----- (iv) Sundry Debtors ( for …month’s sales) (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….. Month’s Purchases) ----- (ii) Lag in payment of expenses ----- (iii) Any other ----- WORKING CAPITAL ( CA – CL )xxxx Add : Provision / Margin for Contingencies ----- NET WORKING CAPITAL REQUIRED XXX www.StudsPlanet.com
  • 22. Prepare an estimate of Working capital requirementPrepare an estimate of Working capital requirement from the following information of a trading concern:from the following information of a trading concern: Projected annual salesProjected annual sales 100000 units100000 units Selling priceSelling price R’s 8 per unitR’s 8 per unit % age of Net profit on sales% age of Net profit on sales 25%25% Average Credit Period allowed toAverage Credit Period allowed to customercustomer 8 weeks8 weeks Average Credit Period allowed byAverage Credit Period allowed by suppliersupplier 4 weeks4 weeks Average stock holding in terma ofAverage stock holding in terma of sales requirementsales requirement 12 weeks12 weeks contingenciescontingencies 10%10%www.StudsPlanet.com
  • 23. Points to be remembered whilePoints to be remembered while estimating WCestimating WC  (1) Profits should be ignored while calculating working capital(1) Profits should be ignored while calculating working capital requirements for the following reasons.requirements for the following reasons.  (a) Profits may or may not be used as working capital(a) Profits may or may not be used as working capital  (b) Even if it is used, it may be reduced by the amount of Income tax,(b) Even if it is used, it may be reduced by the amount of Income tax, Drawings, Dividend paid etc.Drawings, Dividend paid etc.  (2) Calculation of WIP depends on the degree of completion as regards(2) Calculation of WIP depends on the degree of completion as regards to materials, labour and overheads. However, if nothing is mentionedto materials, labour and overheads. However, if nothing is mentioned in the problem, take 100% of the value as WIP. Because in such a case,in the problem, take 100% of the value as WIP. Because in such a case, the average period of WIP must have been calculated as equivalentthe average period of WIP must have been calculated as equivalent period of completed units.period of completed units.  (3) Calculation of Stocks of Finished Goods and Debtors should be(3) Calculation of Stocks of Finished Goods and Debtors should be made at cost unless otherwise asked in the question.made at cost unless otherwise asked in the question. www.StudsPlanet.com
  • 24. Prepare statement ofPrepare statement of working capital requirement,working capital requirement, Profit &Loss A/C, BalanceProfit &Loss A/C, Balance Sheet AssumingSheet Assuming  Share CapitalShare Capital 150000150000  8% Debentures8% Debentures 200000200000  Fixed assetFixed asset 130000130000  MaterialMaterial 40%40%  Direct lab ourDirect lab our 20%20%  OverheadsOverheads 20%20% www.StudsPlanet.com
  • 25. The following further particular are availableThe following further particular are available  It is proposed to maintain a level of activityIt is proposed to maintain a level of activity of 2,00,000 unitsof 2,00,000 units  Selling price is R’s 12/- per unitSelling price is R’s 12/- per unit  Raw Material are expected to remain inRaw Material are expected to remain in stores for an average period of one monthstores for an average period of one month  Material will be in process , on averageMaterial will be in process , on average half a monthhalf a month  Finished goods are required to be in stockFinished goods are required to be in stock for an average period of one monthfor an average period of one month  Credit allow to debtors is two monthCredit allow to debtors is two month  Credit allow by supplier is one monthCredit allow by supplier is one month www.StudsPlanet.com
  • 26. Working Capital Financing MixWorking Capital Financing Mix Approaches to Financing Mix The Hedging or Matching Approach The Conservative Approach The Aggressive Approach www.StudsPlanet.com
  • 27. Hedging approach to asset financingHedging approach to asset financing Fixed Assets Permanent Current Assets Total Assets Fluctuating Current Assets Time Short-term Debt Long-term Debt + Equity Capital www.StudsPlanet.com
  • 28. The Hedging approachThe Hedging approach  Hedging approach refers to a process ofHedging approach refers to a process of matching maturities of debt with the maturities ofmatching maturities of debt with the maturities of financial need . In this approach maturity offinancial need . In this approach maturity of source of fund should match the nature of assetsource of fund should match the nature of asset to be financedto be financed  This approach is also known as matchingThis approach is also known as matching approach.approach.  The hedging approach suggests that theThe hedging approach suggests that the permanent working capital requirement should bepermanent working capital requirement should be financed with fund from long term sources whilefinanced with fund from long term sources while the temporary working capital requirementthe temporary working capital requirement should be financed with short term funds.should be financed with short term funds.www.StudsPlanet.com
  • 29. Estimated Total Investment in Current Asset of company X forEstimated Total Investment in Current Asset of company X for the year 2000the year 2000 MonthMonth InvestmentInvestment in Currentin Current AssetAsset (R's )(R's ) Permanent orPermanent or FixedFixed InvestmentsInvestments (R's)(R's) TemporaryTemporary or seasonal Investor seasonal Invest (R's)(R's) JanuaryJanuary 5040050400 4500045000 54005400 FebruaryFebruary 5000050000 4500045000 50005000 MarchMarch 4870048700 4500045000 37003700 AprilApril 4800048000 4500045000 30003000 MayMay 4600046000 4500045000 10001000 JuneJune 4500045000 4500045000 -- JulyJuly 4750047500 4500045000 25002500 AugustAugust 4800048000 4500045000 30003000 SeptemberSeptember 4950049500 4500045000 45004500 OctoberOctober 5070050700 4500045000 57005700 NovemberNovember 5200052000 4500045000 70007000 DecemberDecember 4850048500 4500045000 35003500 TOTALTOTAL 4430044300 www.StudsPlanet.com
  • 30. Conservative ApproachConservative Approach  This approach suggested that the entireThis approach suggested that the entire estimated investments in current asset should beestimated investments in current asset should be finance from long term source and short termfinance from long term source and short term should be use only for emergency requirementshould be use only for emergency requirement  Distinct features of this approachDistinct features of this approach  Liquidity is greaterLiquidity is greater  Risk is minimizedRisk is minimized  The cost of financing is relatively more asThe cost of financing is relatively more as interest has to be paid even on seasonalinterest has to be paid even on seasonal requirement for the entire periodrequirement for the entire period www.StudsPlanet.com
  • 31. Conservative approach to asset financingConservative approach to asset financing Fixed Assets Permanent Current Assets Total Assets Fluctuating Current Assets Time Short-term Debt Long-term Debt + Equity capital www.StudsPlanet.com
  • 32. Trade off between Hedging andTrade off between Hedging and conservative approachesconservative approaches  The hedging approaches implies low cost , highThe hedging approaches implies low cost , high profit and high risk while the conservativeprofit and high risk while the conservative approach leads to high cost , low profit , low riskapproach leads to high cost , low profit , low risk Both the approaches are the two extreme andBoth the approaches are the two extreme and neither of them serve the purpose of efficientneither of them serve the purpose of efficient working capital managementworking capital management  A trade off between the two will then be anA trade off between the two will then be an acceptable approach , One way of determiningacceptable approach , One way of determining the trade off is by finding the AVG of maximumthe trade off is by finding the AVG of maximum and minimum requirement of current asset orand minimum requirement of current asset or working capitalworking capital www.StudsPlanet.com
  • 33. Aggressive approach to asset financingAggressive approach to asset financing Fixed Assets Permanent Current Assets Total Assets Fluctuating Current Assets Time Short-term Debt Long-term Debt + Equity capital www.StudsPlanet.com
  • 34. Aggressive approachAggressive approach  The aggressive approach suggests that the entireThe aggressive approach suggests that the entire estimated requirement of current asset should beestimated requirement of current asset should be financed from short-term sources and even afinanced from short-term sources and even a part of fixed asset investment be financed frompart of fixed asset investment be financed from short - term sourcesshort - term sources This approach make the finance mix :This approach make the finance mix :  More RiskyMore Risky  Less costlyLess costly  More ProfitableMore Profitable www.StudsPlanet.com
  • 35. Prepare a projected balancePrepare a projected balance sheet , profit and loss a/csheet , profit and loss a/c and then an estimation ofand then an estimation of working capital .working capital .  Issued Share CapitalIssued Share Capital 300000300000  6% Debentures6% Debentures 200000200000  Fixed assetFixed asset 200000200000  Raw MaterialRaw Material 50%50%  Lab ourLab our 20%20%  OverheadsOverheads 20%20%  ProfitProfit 10%10%  There is a regular production andThere is a regular production and sales cyclesales cycle www.StudsPlanet.com
  • 36.  Raw Material are kept in stores for anRaw Material are kept in stores for an average period of two monthaverage period of two month  Finished goods remain in stock for anFinished goods remain in stock for an average period of three monthaverage period of three month  Production during the previous year wasProduction during the previous year was 180000 units and it is planned to maintain180000 units and it is planned to maintain the same in the current year alsothe same in the current year also  Each unit of production is expected to beEach unit of production is expected to be in process for half a monthin process for half a month  Credit allow to customer is three monthCredit allow to customer is three month and given by supplier is two monthand given by supplier is two month  Selling price is Rs 4 per unitSelling price is Rs 4 per unit  Calculation of debtors may be made atCalculation of debtors may be made at selling priceselling price www.StudsPlanet.com
  • 37. Management of Working CapitalManagement of Working Capital  Working capital in general practice refer to theWorking capital in general practice refer to the excess of CA over CL.excess of CA over CL.  Management of working capital therefore isManagement of working capital therefore is concerned with the problems that arise inconcerned with the problems that arise in attempting to manage the CA, the CL and theattempting to manage the CA, the CL and the inter-relationship that exists between them.inter-relationship that exists between them.  The basic goal of WCM is to manage the CA & CLThe basic goal of WCM is to manage the CA & CL of a firm in such a way that a satisfactory level ofof a firm in such a way that a satisfactory level of WC is maintained.WC is maintained.  Working Capital Management Policies of a firmWorking Capital Management Policies of a firm have a great effect on its profitability, liquidity andhave a great effect on its profitability, liquidity and structural health of the organizationstructural health of the organization www.StudsPlanet.com
  • 38. Working capital management is 3 dimensional inWorking capital management is 3 dimensional in NatureNature Dimension I Profitability, Risk, & Liquidity Dimension I Profitability, Risk, & Liquidity Dimension II Composition & Level of CA Dimension II Composition & Level of CA Dimension III Composition & Level of CL Dimension III Composition & Level of CL www.StudsPlanet.com
  • 39. Working Capital IssuesWorking Capital Issues AssumptionsAssumptions  50,000 maximum units50,000 maximum units of productionof production  Continuous productionContinuous production  Three different policiesThree different policies for current asset levelsfor current asset levels are possibleare possible Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSETLEVEL Current Assets Policy CPolicy C Policy APolicy A Policy BPolicy B www.StudsPlanet.com
  • 40. Impact on LiquidityImpact on Liquidity Liquidity AnalysisLiquidity Analysis PolicyPolicy LiquidityLiquidity AA HighHigh BB AverageAverage CC LowLow Greater current asset levelsGreater current asset levels generate more liquidity; allgenerate more liquidity; all other factors held constant.other factors held constant. Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSETLEVEL Current Assets Policy CPolicy C Policy APolicy A Policy BPolicy B www.StudsPlanet.com
  • 41. Impact onImpact on Expected ProfitabilityExpected Profitability Return on InvestmentReturn on Investment == Net ProfitNet Profit Total AssetsTotal Assets LetLet Current AssetsCurrent Assets = (Cash += (Cash + Rec. + Inv.)Rec. + Inv.) Return on InvestmentReturn on Investment == Net ProfitNet Profit CurrentCurrent ++ Fixed AssetsFixed Assets Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSETLEVEL Current Assets Policy CPolicy C Policy APolicy A Policy BPolicy B www.StudsPlanet.com
  • 42. Impact onImpact on Expected ProfitabilityExpected Profitability Profitability AnalysisProfitability Analysis PolicyPolicy ProfitabilityProfitability AA LowLow BB AverageAverage CC HighHigh As current asset levels decline,As current asset levels decline, total assets will decline andtotal assets will decline and the ROI will rise.the ROI will rise. Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSETLEVEL Current Assets Policy CPolicy C Policy APolicy A Policy BPolicy B www.StudsPlanet.com
  • 43. Impact on RiskImpact on Risk  Decreasing cashDecreasing cash reduces thereduces the firm’s ability to meet itsfirm’s ability to meet its financial obligations.financial obligations. MoreMore risk!risk!  Stricter credit policiesStricter credit policies reducereduce receivablesreceivables and possibly loseand possibly lose sales and customers.sales and customers. MoreMore risk!risk!  Lower inventory levelsLower inventory levels increase stockouts and lostincrease stockouts and lost sales.sales. More risk!More risk! Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSETLEVEL Current Assets Policy CPolicy C Policy APolicy A Policy BPolicy B www.StudsPlanet.com
  • 44. Impact on RiskImpact on Risk Risk AnalysisRisk Analysis PolicyPolicy RiskRisk AA LowLow BB AverageAverage CC HighHigh Risk increases as the level ofRisk increases as the level of current assets are reduced.current assets are reduced. Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSETLEVEL Current Assets Policy CPolicy C Policy APolicy A Policy BPolicy B www.StudsPlanet.com
  • 45. Summary of the OptimalSummary of the Optimal Amount of Current AssetsAmount of Current Assets SSUMMARYUMMARY OOFF OOPTIMALPTIMAL CCURRENTURRENT AASSETSSET AANALYSISNALYSIS PolicyPolicy LiquidityLiquidity ProfitabilityProfitability RiskRisk AA HighHigh LowLow LowLow BB AverageAverage AverageAverage AverageAverage CC LowLow HighHigh HighHigh 1. Profitability varies inversely with liquidity.1. Profitability varies inversely with liquidity. 2. Profitability moves together with risk.2. Profitability moves together with risk. (risk and return go hand in hand!)(risk and return go hand in hand!) www.StudsPlanet.com
  • 46. Techniques of analysis of workingTechniques of analysis of working capitalcapital The analysis of working capital can be conductedThe analysis of working capital can be conducted through a number of devices such asthrough a number of devices such as  Ratio analysisRatio analysis  Fund flow analysisFund flow analysis  Working capital BudgetingWorking capital Budgeting  Ratio analysis : A ratio is a simple arithmeticalRatio analysis : A ratio is a simple arithmetical expression of the relationship of one number toexpression of the relationship of one number to another , this technique can be employed foranother , this technique can be employed for measuring short term liquidity or working capitalmeasuring short term liquidity or working capital position of a firm.position of a firm. www.StudsPlanet.com
  • 47. The following ratios may beThe following ratios may be calculated for this purposecalculated for this purpose  Liquidity RatioLiquidity Ratio a)a) Current RatioCurrent Ratio b)b) Acid test ratio/quick ratio/liquid ratioAcid test ratio/quick ratio/liquid ratio c)c) Cash Position ratio/absolute liquid ratioCash Position ratio/absolute liquid ratio  Inventory turnover ratioInventory turnover ratio  Receivable turnover ratioReceivable turnover ratio  Payable turnover ratioPayable turnover ratio  Working capital turnover ratioWorking capital turnover ratio www.StudsPlanet.com
  • 48.  Current ratio may be define as theCurrent ratio may be define as the relationship between CA and CLrelationship between CA and CL  This ratio is also known as WCR.This ratio is also known as WCR. (Working capital ration).(Working capital ration).  It is helpful to measure short – termIt is helpful to measure short – term financial position or liquidity of a firmfinancial position or liquidity of a firm Current ratio:Current ratio: Current assetCurrent asset Current liabilitiesCurrent liabilities www.StudsPlanet.com
  • 49. CURRENT ASSETS CURRENT LIABILITIES Cash in hand Bills Payable Cash at bank Sundry Creditors Sundry Debtors Accrued or Outstanding Expenses Marketable securities (Short term) Short term loan and advances Bills Receivable Dividend payable Inventories of Stock Bank Overdraft Work in progress   Finished goods   Prepaid Expenses  www.StudsPlanet.com
  • 50. Quick or Acid test or LiquidQuick or Acid test or Liquid RatioRatio  An asset is said to be liquid if it can be convertAn asset is said to be liquid if it can be convert into cash with in a short period with out loss ofinto cash with in a short period with out loss of valuevalue  Inventory cannot be termed to be liquid assetInventory cannot be termed to be liquid asset because they cannot be convert into cashbecause they cannot be convert into cash immediatelyimmediately  The quick ratio can be calculatedThe quick ratio can be calculated Quick ratio:Quick ratio: liquid assetliquid asset Current liabilitiesCurrent liabilities www.StudsPlanet.com
  • 51. Quick or liquid Current Liabilities Cash in hand Bills Payable Cash at bank Sundry Creditors Sundry Debtors Accrued or Outstanding Expenses Marketable securities Short term advances Temporary Investments Dividend payable Bank Overdraft  Income tax payable Convection quick ratio of 1:1 is consider satisfactory www.StudsPlanet.com
  • 52. Cash Position ratio/absolute liquid ratioCash Position ratio/absolute liquid ratio  Absolute Liquid assets include cash in hand andAbsolute Liquid assets include cash in hand and cash at bank and marketable securities orcash at bank and marketable securities or temporary investmentstemporary investments  The acceptable norms for this ratio is 50% or .The acceptable norms for this ratio is 50% or . 05%05% Cash ratio:Cash ratio: Cash & bank + Short –term securitiesCash & bank + Short –term securities Current liabilitiesCurrent liabilities www.StudsPlanet.com
  • 53. Calculate all the three ratioCalculate all the three ratio Liabilities Rs Assets Rs 9% preference share 500000 Goodwill 100000 Equity share capital 1000000 Land and building 650000 8% debentures 200000 Plant 800000 Long term loan 100000 Furniture and fixtures 150000 Bills payable 60000 Bills receivable 70000 Sundry creditors 70000 Sundry debtors 90000 Bank over draft 30000 Bank balance 45000 Outstanding expenses 5000 short term investments 25000 Prepaid expenses 5000 Stock 30000 1965000 1965000www.StudsPlanet.com
  • 54. CONCLUSION:CONCLUSION:  Current ratio of the company is notCurrent ratio of the company is not satisfactory because the ratio 1:6 is muchsatisfactory because the ratio 1:6 is much below then the expected Standards .below then the expected Standards .  Acid test ratio on the other hand is moreAcid test ratio on the other hand is more than the normal standard of 1:1than the normal standard of 1:1  Absolute ratio is slightly low because it isAbsolute ratio is slightly low because it is 0.42 where as the accepted standard is 0.50.42 where as the accepted standard is 0.5  In this company need to improve its shortIn this company need to improve its short term financial positionterm financial position www.StudsPlanet.com
  • 55. Inventory turnover ratioInventory turnover ratio Inventory turn over ratio =Inventory turn over ratio = Cost of good soldCost of good sold Average Inventory at costAverage Inventory at cost Generally , the cost of good sold may not be knownGenerally , the cost of good sold may not be known from the published financials , in suchfrom the published financials , in such circumstancescircumstances Inventory turn over ratio =Inventory turn over ratio = Net SalesNet Sales Average Inventory at costAverage Inventory at cost Inventory turn over ratio =Inventory turn over ratio = Cost of good soldCost of good sold Average Inventory at selling priceAverage Inventory at selling price www.StudsPlanet.com
  • 56. Inventory conversion periodInventory conversion period Inventory conversion period =Inventory conversion period = Days in a yearDays in a year Inventory Turnover RatioInventory Turnover Ratio M/s Rakesh & Co supplies you the followingM/s Rakesh & Co supplies you the following information for the year ending 31information for the year ending 31stst Dec 1999Dec 1999 Credit Sales Rs 150000Credit Sales Rs 150000 Cash SalesCash Sales Rs 250000Rs 250000 Return Inward Rs 25000Return Inward Rs 25000 Opening Stock Rs 25000Opening Stock Rs 25000 Closing Stock Rs 35000Closing Stock Rs 35000www.StudsPlanet.com
  • 57. Debtor/Receivable turnover ratioDebtor/Receivable turnover ratio /Debtor velocity/Debtor velocity Debtor(Receivable) =Debtor(Receivable) = Net credit Annual salesNet credit Annual sales Average Trade debtorsAverage Trade debtors Trade debtors = Sundry debtor + Bill Receivable andTrade debtors = Sundry debtor + Bill Receivable and account receivable saccount receivable s Average Trade Debtors = Opening Trade debtor +Average Trade Debtors = Opening Trade debtor + Closing Trade Debtor /2Closing Trade Debtor /2 Note : Debtor should always be taken at gross value , NoNote : Debtor should always be taken at gross value , No provision for doubtful debt be deducted from them but whenprovision for doubtful debt be deducted from them but when the information about opening and closing balance of tradethe information about opening and closing balance of trade debtor and credit sales is not available , then the debtorsdebtor and credit sales is not available , then the debtors turnover ratio calculated by dividing the total sales by theturnover ratio calculated by dividing the total sales by the balance of debtors(inclusive of Bills receivables) givenbalance of debtors(inclusive of Bills receivables) given Debtors turn over Ratio =Debtors turn over Ratio = Total salesTotal sales DebtorsDebtorswww.StudsPlanet.com
  • 58. Average Collection PeriodAverage Collection Period The average collection period represent theThe average collection period represent the average number of days for which a firm has toaverage number of days for which a firm has to wait before its receivable are converted into cashwait before its receivable are converted into cash Average Collection period =Average Collection period = Average Trade Debtors (Drs + B/R)Average Trade Debtors (Drs + B/R) Sales per daySales per day Sales Per daySales Per day == Net SalesNet Sales No of working daysNo of working days www.StudsPlanet.com
  • 59. OrOr Average collection period =Average collection period =Average trade debtorsAverage trade debtors Net SalesNet Sales No of working daysNo of working days If the period is in months:If the period is in months: Average collection period =Average collection period =No of working daysNo of working days Debtors turnover ratioDebtors turnover ratio The two basis component of the ratio are debtorsThe two basis component of the ratio are debtors and sales per dayand sales per day www.StudsPlanet.com
  • 60. Creditor/Payable turnover ratioCreditor/Payable turnover ratio The analysis for credit turnover is basically the sameThe analysis for credit turnover is basically the same as of debtors turnover ratio except that in place ofas of debtors turnover ratio except that in place of trade debtor, the trade creditor are taken and intrade debtor, the trade creditor are taken and in place of sales , average daily purchase are taken asplace of sales , average daily purchase are taken as the other component of the ratio.the other component of the ratio. Creditors turnover ratioCreditors turnover ratio == Net credit annual purchaseNet credit annual purchase Average Trade creditorsAverage Trade creditors www.StudsPlanet.com
  • 61. Average Payment period RatioAverage Payment period Ratio = Average Trade Creditors( Creditors+ Bills= Average Trade Creditors( Creditors+ Bills payable)/Average Daily purchases.payable)/Average Daily purchases. Average daily purchase = Annual Purchase /No ofAverage daily purchase = Annual Purchase /No of working days in a year.working days in a year. Average Payment Period = Trade creditor * No ofAverage Payment Period = Trade creditor * No of working days / Net annual purchase.working days / Net annual purchase. Average Payment Period = No of working days /Average Payment Period = No of working days / Credit turnover Ratio.Credit turnover Ratio. www.StudsPlanet.com
  • 62. Working capital turnover ratioWorking capital turnover ratio Working capital of a concern is directly related toWorking capital of a concern is directly related to sales and current asset like debtors , billssales and current asset like debtors , bills receivable , cash , stock etc .receivable , cash , stock etc . Working capital turnover ratio = Cost of Sales /Working capital turnover ratio = Cost of Sales / Average working capitalAverage working capital Average working capital = Opening workingAverage working capital = Opening working capital + Closing Working capital/2capital + Closing Working capital/2 ** If cost of sales is not given , then the figure of** If cost of sales is not given , then the figure of sale can be used . O n the other hand if openingsale can be used . O n the other hand if opening working capital is not disclosed then workingworking capital is not disclosed then working capital at the end of the year will be used.capital at the end of the year will be used.www.StudsPlanet.com
  • 63. The following information is given about M/s S.PThe following information is given about M/s S.P Ltd for the year ending Dec 31 2000Ltd for the year ending Dec 31 2000  Stock turnover ratio = 6timesStock turnover ratio = 6times  Gross Profit ratio = 20% on salesGross Profit ratio = 20% on sales  Sales for 2000 = Rs 300000Sales for 2000 = Rs 300000  Closing stock is Rs 10000 more than theClosing stock is Rs 10000 more than the opening stockopening stock  Opening Creditors = Rs 20000Opening Creditors = Rs 20000  Closing Creditors = Rs 30000Closing Creditors = Rs 30000  Trade debtor at the end = Rs 60000Trade debtor at the end = Rs 60000  Net Working Capital = Rs 50000Net Working Capital = Rs 50000 www.StudsPlanet.com
  • 64.  FIND OUTFIND OUT  Average StockAverage Stock  PurchasesPurchases  Credit turnover ratioCredit turnover ratio  Average Payment PeriodAverage Payment Period  Average Collection PeriodAverage Collection Period  Working Capital turnover ratioWorking Capital turnover ratio www.StudsPlanet.com
  • 65. Fund flow analysisFund flow analysis : Fund flow analysis is a: Fund flow analysis is a technical device designated to study the sourcestechnical device designated to study the sources from which additional fund were derived andfrom which additional fund were derived and the use to which these sources were put . It is anthe use to which these sources were put . It is an effective management tool to study change ineffective management tool to study change in the financial position of businessthe financial position of business The fund flow analysis consists ofThe fund flow analysis consists of  Preparing schedule of change in working capitalPreparing schedule of change in working capital  Statement of sources and application of fundsStatement of sources and application of funds www.StudsPlanet.com
  • 66.  Working capital Budgeting : WorkingWorking capital Budgeting : Working capital budget as a part of totalcapital budget as a part of total budgeting process of a business , isbudgeting process of a business , is prepared estimating future long termprepared estimating future long term and short term working capital needand short term working capital need and the sources of finance them .and the sources of finance them .  The objective of a working capitalThe objective of a working capital budget is to ensure availability of fundbudget is to ensure availability of fund as and when needed and to ensureas and when needed and to ensure effective utilization of these resources .effective utilization of these resources . www.StudsPlanet.com