Working capital managememt


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Working capital managememt

  2. 2. OVERVIEW OF WORKING CAPTITAL MANAGEMENT<br /><ul><li>Working capital
  3. 3. Significance of working capital management
  4. 4. Working Capital Concepts
  5. 5. Kinds of working capital
  6. 6. Working Capital Issues
  7. 7. Financing Current Assets:</li></ul> Short-Term and Long-Term Mix<br /><ul><li>Combining Liability Structure and Current Asset </li></ul> Decisions<br />
  8. 8. WORKING CAPITAL<br />working capital management involves the relationship between a firm's short-term assets and its short-term liabilities. <br />The basic goal of working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability to satisfy both maturing short-term debt and upcoming operational expenses. <br />
  9. 9. SINGNIFICANCE OF WORKING CAPITAL MANAGEMENT<br /><ul><li>In a typical manufacturing firm, current assets exceed one-half of total assets.
  10. 10. Excessive levels can result in a substandard Return on Investment (ROI).
  11. 11. Current liabilities are the principal source of external financing for small firms.
  12. 12. Requires continuous, day-to-day managerial supervision.
  13. 13. Working capital management affects the company’s risk, return, and share price.</li></li></ul><li>WORKING CAPITAL CONCEPTS<br /> Net Working Capital:<br />net working capital refers to the difference between current assets and current liabilities. Current liabilities are those claims of outsider, which are expected to mature <br />for payment within an accounting year & include creditors, bills payable & the outstanding expenses. In other words you can say that this is the excess of current assets over current liabilities. <br /> Current Assets – Current Liabilities<br />Gross Working Capital:<br /><ul><li>It refers to the firm’s investment in current assets.
  14. 14. Current assets are the assets, which can be converted into cash within an accounting year or within an operating cycle
  15. 15. cash, short-term securities, debtors (accounts receivable & book debts), bills receivable and stock. </li></ul>Working capital turnover:<br /> Working capital turnover= sales/working capital<br />Working Capital Management:<br /> The administration of the firm’s current assets and the financing needed to support current assets.<br />
  16. 16. CURRENT ASSETS<br />Inventories: Inventories represent raw materials and components, work-in-progress and finished goods. <br /> Trade Debtors: Trade Debtors comprise credit sales to customers. <br />Prepaid Expenses: These are those expenses, which have been paid for goods and services whose benefits have yet to be received. <br /> Loan and Advances: They represent loans and advances given by the firm to other firms for a short period of time. <br /> Investment: These assets comprise short-term surplus funds invested in government securities, shares and short-terms bonds. <br /> Cash and Bank Balance: These assets represent cash in hand and at bank, which are used for meeting operational requirements. One thing you can see here is that this current asset is purely liquid but non-productive. <br />
  17. 17. CURRENT LIABILITY<br />Sundry Creditors: These liabilities stem out of purchase of raw materials on credit terms usually for a period of one to two months. <br />Bank Overdrafts: These include withdrawals in excess of credit balance standing in the firm’s current accounts with banks <br />Short-term Loans: Short-terms borrowings by the firm from banks and others form part of current liabilities as short-term loans. <br />Provisions: These include provisions for taxation, proposed dividends and contingencies. <br />
  18. 18. WORKING CAPITAL FORMAT<br />CURRENT ASSETS <br /> CURRENT LIABILITIES<br />Cash <br />Accounts receivable<br />Notes receivable<br />Marketable securities<br />Inventory<br />Prepaid expenses <br />Total current assets<br />Accounts payable<br />Notes payable<br />Accrued expenses<br />Taxes payable<br />Total current liabilities<br />
  19. 19. POINTS KEPT IN MIND WHILE PLANNING<br />1. Excessive investment (Profitability) <br />It results in unnecessary accumulation of inventories. Thus, chances of inventory mishandling, waste, theft & losses increase. <br />b. It is an indication of defective credit policy & slack collection period. <br />c. Excessive WC makes management complacent, which degenerates into managerial inefficiency. <br />d. Tendencies of accumulating inventories tend to make speculative profits grow. <br />
  20. 20. CONT…<br />2. Inadequate investment (Liquidity) <br />It stagnates growth. <br /> It become difficult to implement operating plans and achieve the firm’s operating profit target. <br /> Operating inefficiencies creep in when it becomes difficult even to meet day-to-day commitments. <br /> Fixed assets are not efficiently utilized for the lack of working capital funds. Thus, the firm’s profitability would deteriorate. <br /> Paucity of WC funds render the firm unable to avail attractive credit opportunities. <br /> The firm loses its reputation when it is not in a position to honour its short-term obligations. <br />
  21. 21. KINDS OF WORKING CAPITAL<br />1.Permanent working capital:<br />Permanent working capital is the minimum amount of current assets, which is needed to conduct a business even during the dullest season of the year. <br />The minimum level of current assets is called permanent or fixed working capital as this part is permanently blocked in current assets. <br />Characteristics of Permanent working capital <br />It is classified on the basis of the time period <br /> It constantly changes from one asset to another and continues to remain in the business process. <br /> Its size increase with the growth of business operations. <br />
  23. 23. CONT…<br />2.Temporary working capital:<br />Temporary working capital represents a certain amount of fluctuations in the total current assets during a short period. <br />Variable working capital is the amount of additional current asset that are required to meet the seasonal needs of a firm, so is also called as the seasonal working capital. <br />Characteristics of Temporary working capital <br />It is not always gainfully employed, though it may change from one asset to another asset, as permanent working capital does. <br />• It is particularly suited to business of a seasonal or cyclical nature. <br />
  25. 25. DETERMINANTS OF WORKING CAPITAL<br /><ul><li>Nature of business
  26. 26. Terms of sales and purchases
  27. 27. Manufacturing cycle
  28. 28. Rapidity of turnover
  29. 29. Business cycle
  30. 30. Changes in technology
  31. 31. Seasonal variation
  32. 32. Market conditions
  33. 33. Seasonality of operation
  34. 34. Dividend policy
  35. 35. Working capital cycle</li></li></ul><li>WORKING CAPITAL ISSUES<br />Assumptions<br /><ul><li>50,000 maximum units of production
  36. 36. Continuous production
  37. 37. Three different policies current asset levels are possible</li></li></ul><li>IMPACT ON LIQUIDITY<br />Liquidity Analysis<br />PolicyLiquidity<br />A High<br />B Average<br />C Low<br /><ul><li>Greater current asset levels generate more liquidity; all other factors held constant.</li></li></ul><li>IMPACT ON EXPECTED PROFITABILITY<br />Return on Investment<br /> =Net profit/Total Assets<br />Let,<br />Current Assets<br />=(Cash+Rec.+Inv.)<br />Return on Investment<br />=(Net Profit/Current +Fixed Assets)<br />
  38. 38. IMPACT ON EXPECTED PROFITABILITY<br />Profitability Analysis<br />PolicyProfitability<br />A Low<br />B Average<br />C High<br /><ul><li>As current asset levels decline, total assets will decline and the ROI will rise.</li></li></ul><li>IMPACT ON RISK<br /><ul><li>Decreasing Cash reduces the firm’s ability to meet its financial obligations. “More risk!”
  39. 39. Stricter credit policies reduce receivables and possibly lose sales and customers. “More risk!”
  40. 40. Lower inventory levels increase stock outs and lost sales.</li></li></ul><li>IMPACT ON RISK<br />Risk Analysis<br />PolicyRisk<br />A Low<br />B Average<br />C High<br /><ul><li>Risk increases as the level of current assets are reduced.</li></li></ul><li>SUMMARY OF THE OPTIMAL AMOUNT OF CURRENT ASSETS<br />SUMMARY OF OPTIMAL CURRENT ASSET ANALYSIS<br />Policy Liquidity Profitability Risk <br /> A High Low Low<br /> B Average Average Average<br /> C Low High High<br />Profitability varies inversely with liquidity.<br />Profitability moves together with risk. (risk and return go hand in hand!)<br />
  41. 41. FINANCING CURRENT ASSETS:SHORT-TERM AND LONG-TERM MIX<br />Spontaneous Financing:<br />Trade credit, and other payables and accruals, that arise spontaneously in the firm’s day-to-day operations.<br /><ul><li>Based on policies regarding payment for purchases, labor, taxes, and other expenses.
  42. 42. We are concerned with managing non-spontaneous financing of assets.</li></li></ul><li>HEDGING(or MATURITY MATCHING) APPROACH<br />A method of financing where each asset would be offset with a financing instrument of the same approximate maturity..<br />
  43. 43. HEDGING(or MATURITY MATCHING) APPROACH<br />Less amount financed spontaneously by payables and accruals.<br />In addition to spontaneous financing (payables and accruals).<br />
  44. 44. FINANCING NEEDS AND THE HEDGING APPROACH<br /><ul><li>Fixed assets and the non-seasonal portion of current assets are financed with long-term debt and equity(long-term profitability of assets to cover the long-term financing costs of the firm).
  45. 45. Seasonal needs are financed with short-term loans (under normal operations sufficient cash flow is expected to cover the short-term financing cost).</li></li></ul><li>SELF-LIQUIDATING NATURE OF SHORT-TERM LOANS<br /><ul><li>Seasonal orders require the purchase of inventory beyond current levels.
  46. 46. Increased inventory is used to meet the increased demand for the final product.
  47. 47. Sales become receivables.
  48. 48. Receivables are collected and become cash.
  49. 49. The resulting cash funds can be used to pay off the seasonal short-term loan and cover associated long-term financing costs.</li></li></ul><li>RISKS VS. COSTS TRADE-OFF (CONSERVATIVE APPROACH)<br />Long-term Financing Benefits:<br /><ul><li>Less worry in refinancing short-term obligations
  50. 50. Less uncertainty regarding future interest costs</li></ul>Short-term Financing Risks:<br /><ul><li>Borrowing more than what is necessary
  51. 51. Borrowing at a higher overall cost(usually)</li></ul>Result:<br /><ul><li>Manager accepts less expected profits in exchange for taking less risk.</li></li></ul><li>RISKS VS. COSTS TRADE-OFF (CONSERVATIVE APPROACH)<br />Firm can reduce risks associated with short-term borrowing by using a larger proportion of long-term financing.<br />
  52. 52. COMPARISON WITH AN AGGRESSIVE APPROACH<br />Short-Term Financing Benefits:<br /><ul><li>Financing long-term needs with a lower interest cost than short-term debt
  53. 53. Borrowing only what is necessary</li></ul>Short-Term Financing Risks:<br /><ul><li>Refinancing short-term obligations in the future
  54. 54. Uncertain future interest costs</li></ul>Result:<br /><ul><li>Manager accepts greater expected profits in exchange for taking greater risk.</li></li></ul><li>RISKS VS. COSTS TRADE-OFF (AGGRESSIVE APPROACH)<br />Firm increases risks associated with short-term borrowing by using a larger proportion of short-term financing.<br />
  56. 56. COMBINING LIABILITY STRUCTURE AND CURRENT ASSET DECISIONS<br /><ul><li>The level of current assets and the method of financing those assets are interdependent.
  57. 57. A conservative policy of “high” levels of current assets allows a more aggressive method of financing current assets.
  58. 58. A conservative method of financing (all-equity) allows an aggressive policy of “low” levels of current assets.</li>