DEFINING WORKING CAPITAL Holding of the firm in current assets. Part of firm’s capital that is required for financing short term current assets. It is never exhausted. Revolves in the operating cycle.
CURRENT ASSETS That can be converted into cash within one accounting year. Includes : cash receivables Inventory Marketable securities
TYPES OF WORKING CAPITAL CONCEPT TIME Gross working temporary capital Net working permanent capital
NET WORKING CAPITAL GROSS WORKING CAPITAL FOCUSSES ON :- FOCUSSES ON : Liquidity position of the Financing of current firm assets Judicious mix of short term and long term Optimization of financing. investments in current assets.
TYPES OF WORKING CAPITALON THE BASIS OF CONCEPT NET WORKING GROSS WORKING CAPITAL CAPITAL CA-CL Investment in CA +ive CA>CL -ive CA < CL
RAW MATERIAL CONVERSION PERIOD(RMCP) Average time taken to convert material into work in process. It depends upon – ( i ) raw material consumption per day ( ii ) raw material inventoryRMCP = RM inventory*360 RM consumed
WORK IN PROCESS CONVERSIONPERIOD (WIPCP ) Average time taken to complete the semi finished workWIPCP=(WIPinventory*360) COP
FINISHED GOODS CONVERSIONPERIOD (FGCP ) Average time taken to sell the finished goods.FGCP= FGI*360 COGS
DEBTORS CONVERSION PERIOD (DCP) Average time taken to convert debtors into cash.DCP = debtors*360 credit sales
CREDITORS DEFERRAL PERIOD (CDP) Average time taken by the firm in paying its debts.CDP= creditors*360 credit purchases
PERMANENT AND TEMPORARYWORKING CAPITAL PERMANENT WC – minimum level of required current assets. TEMPORARY WC – extra WC needed to support the changing production and sales activities of the firm.
GRAPHICAL INTERPRETATION OFWORKING CAPITAL Permanent and temporary working capital
DETERMINANTS OF WORKING CAPITAL Nature of business Market and demand conditions Technology and manufacturing policy Credit policy Availability of credit from suppliers Operating efficiency Price level changes
ISSUES IN WORKING CAPITALMANAGEMENT Current assets to fixed assets ratio Liquidity Vs profitability – RISK RETURN TRADE OFF THE COST TRADE--OFF
(1.) CURRENT ASSETS TO FIXEDASSETS RATIO Alternative current asset policies
CURRENT ASSETS TO FIXED ASSETSRATIO Optimum level of current assets so that the wealth of the shareholders is maximized. APPROACHES TO DETERMINE OPTIMUM LEVEL OF CA/FA RATIO - conservative - aggressive - moderate
THE COST TRADE OFF cost of liquidity : If a firm’s level of CA is very high it has excessive liquidity. Its return on assets is very low because funds are tied up in idle stocks which earns nothing. Cost of illiquidity: Cost of holding insufficient current assets.
OPTIMUM LEVEL OF CURRENT ASSETS With the level of CA the cost of liquidity increases while the cost of illiquidity decreases. The firm should maintain current assets at that level where the sum of these two cost is minimized.
ESTIMATING WORKING CAPITALNEEDS BEST METHOD – OPERATING CYCLE THREE APPROACHES ARE :-i. Current assets holding periodii. Ratio of salesiii. Ratio of fixed investments.ROR = PBIT / NET FIXED INVEST. + WC
POLICIES FOR FINANCING CURRENTASSETS ( TYPES ) LONG TERM FINANCING – sources are ordinary share capital , preference share capital , debentures , long term borrowings. SHORT TERM FINANCING : banks, public deposit, factoring of receivables etc. SPONTANEOUS FINANCING – automatic sources of short term funds arising from normal course of a business.
THREE APPROACHES FOR MIX OFSHORT TERM AND LONG FINANCNG Matching approach Conservative approach Aggressive approach
MATCHING PLAN ( HEDGINGAPPROACH ) Financing under matching plan
MATCHING APPROACH Firm can adopt a financial plan that matches the expected life of assets. Long term financing – fixed assets Short term financing – variable current assets.