Basic learning of Working Capital

1. WORKING CAPITAL
MUHAMMAD ANWAR
INTERNATIONAL ISLAMIC
UNIVERSITY ISLAMABAD
MS MANAGEMENT SCIENCES

2. Will Discuss:
• What is Working Capital
• Types of Working Capital
• Approaches of Working Capital
• Ratios of Working Capital

3. The Firm ability to pay its Current Liabilities
with Current Assets.
Working Capital= Current Assets – Current
Liabilities
Also called Circulating capital, short term
capital

6. Classification
Base on Concepts:
Two main concepts:
1.Net Working Capital = Current Assets - Current
Liabilities
2. Gross Working Capital = Total investment in
Current Assets
Base on Time:
1. Permanent Working
Capital
2. Variable/Temporary
Working Capital

7. WORKING CAPITAL MANAGEMENT
Decision relating to Current assets and Current liabilities
Or
Managing the relationship between short term assets and
short term liabilities
Working Capital Management Concern with two basic
Decision:
1. The Optimal level of investment in Current Assets
2. Appropriate sources of Financing to support this
investment in current assets.
The above decision are influenced by Trade off between
Profitability and Risk

8. 8
DIFFERENT APPROACHES TO
FINANCING
In this section we discuses Approaches, Finance from Short Term
& Long TermFinancing Current Assets: 3 Approaches Conservative, moderate, Aggressive
Temporary Current Assets
Time
Total Assets
Fixed
Assets
Permanent
Current Assets}
}
$5M
$7M
$10M

9. Temporary Current Assets
Time
Fixed
Assets
Permanen
Current
Asset
}
}
$5M
$7M
$10
M
Third Approach is Moderate,
Combined of Both
Average Current Assets,
Liquidity, Risk & Profitability

10. Firm 1 Firm 2
Marketable Securities 0 200
Other Current Assets 200 200
Fixed Assets 800 800
Total Assets 1000 1200
Firm 1 Firm 2
Short Term Debt 100 100
Long Term Debt 400 400
Common Stock 500 700
Total Liabilities&Equity 1000 1200
Firm 1 Firm 2
Operating Earnings 150 150
Interest Earned 0 8
EBT 150 158
Taxes (40%) -60 -63
Net Income 90 95
EXAMPLE: RISK - RETURN TRADE-OFF
COMPARE THE 2 FOLLOWING COMPANIES
Current Ratio = Firm1 200
100
=2 Firm2 = 400 = 4
100
95
1200
=
=.079 = 7.9%
Return on Assets =
N.I
Total Assets
90
1000
=
= .09 = 9%

11. SUMMARY OF THE OPTIMAL
AMOUNT OF CURRENT ASSETS
SUMMARY OF OPTIMAL CURRENT ASSET ANALYSIS
POLICY LIQUIDITY PROFITABILITY
RISK
A HIGH LOW LOW
B AVERAGE AVERAGE AVERAGE
C LOW HIGH
HIGHCurrent Assets increase Liquidity but reduce Profitability and
Risk…?
0 25,000 50,
OUTPUT (units)
CurrentASSET
LEVEL($)
Current Assets
Policy C
Policy A
Policy B

12. FACTORS AFFECTING WORKING
CAPITAL
No. Because it depends on nature of Business
• Manufacturing Companies have high proportion of
Current Assets like Cash, Raw Material, work in
progress and account receivables, account payable for
current liability
• New Product:
• Growth And Expansion:
As co expand or grow, need high working capital
• Competition in Market
If there is competition in market for the company
product than co increase it credit sale/period to its
Is working capital Same for All kinds of
Business?

13. WORKING CAPITAL RATIO ANALYSIS
Current Ratio:
The Best measure of Working Capital.
Current Ratio = Current Assets 50,000 2.08
Current Liabilities 24,000
This means that the company's current assets are 2.08 times greater
than the company's current liabilities. Also called Working Capital
Efficiency.
If the ratio is less than then ‘’1’’ Company have negative working
capital or Working Capital Deficiency.
A high working capital ratio is not always a good thing, it could
indicate that Company have too much inventory or they are not
investing their excess cash.
Most Analyst Believe that the Ratio between 1.2 and 2.00 is sufficient.

14. OTHER RATIOS
These other ratio measure contents of Working Capital
Quick Ratio orAcid Test Ratio=cash+cash equivalent+Short term
investment+Current Receivables
Current Liabilities
Or = Total Current Assets – Inventories – Prepaid Expenses
Current Liabilities
The acid test ratio measures the liquidity of a company or immediate solvency of
company by showing its ability to pay off its current liabilities with quick assets.

15. Activity Ratios:
Also called Efficiency, Turn over ratios, it measures how effectively the
firm is using its assets.
• Receivable Activity: Tells how firm is successful in its Collection
Receivables Turnover = Annual Net Credit Sales 750000 = 5
Receivables 150000
5 times the receivables will be turnover into cash, The Higher the ratio
the shorter will time between sale and cash Collection.
Receivable Turnover in Days= Days in Year 365 73days
Receivable Turnover 5

16. Inventory Turnover: how many times inventory is turnover into
receivables through sales during a year. ‘’Noor Textile Co’’
= Cost of Goods Sold Rs.400,000= 2 times
inventory Rs.200,000
Inventory turnover in Days= 365 = 183 days
2
Note: the ratio will be compared with Textile industry average
Ratio.
For example: Textile industry Average Ratio = 3 times, so 365
= 121 days
3
It means that Noor Co. have less efficient in inventory
management, it has 62 days Slower in inventory sale than Textile
industry.

17. ADVANTAGES OF GOOD WORKING CAPITAL
• Maintain solvency of business
• Helps in increasing and maintaining good will
• Help in managing and borrowing loan from banks and other
sources
• Ensure regular supply of raw material
• Regular payment of salaries and day to day commitment