Detailed presentation on Working Capital

1. Working Capital
Management

2. Operating Cycle
Raw Material
The operating cycle is the time duration starting from the procurement of goods or
raw materials and ending with realization of sales
Accounting
Receivable
Cash Finished Goods
Work in Progress

3. Working Capital
• It is the difference between the inflow and outflow of funds.
• It is defined as the excess of currents assets over current
liabilities and provisions.
Need for Working Capital
• Easy convertible into cash
• To meet day to day operations of business

4. Types of working capital concept
1. Gross working capital:
Example: a business firm has a cash balance of
Rs.100000, debtors Rs.120000 and inventory of
raw material and finished goods has been
assessed at Rs.150000. hence the gross working
capital of business firm is 370000
2. Net working capital:
Example. A business has current assets of Rs.
370000 and current liabilities Rs. 150000 then the
net working capital is Rs. 220000

5. Operating Cycle Period
The length or time duration of the operating cycle of any business firm can be
defined as the sum of its Inventory Conversion Period and the Receivable
Conversion Period.
 Inventory Conversion Period (ICP) – It is the time required for the conversion
of raw material into finished goods and sales.
 Receivable Conversion Period (RCP) – It is the time required converting the
credit sales into cash realization.
 The total of ICP and RCP is also known as Total Operating Period (TOCP).
Symbolically the duration of operating cycle be put as:
RMPC + WPCP + FGCP + RCP = TOCP – DP = NOC
(R) (W) (F) (D) (T) (C) (O)
= O = R + W + F + D – C

6. Average Raw Material Stock
Total Raw Material consumptions
Average Work in Progress
Total Cost of Production
Average Finished Goods
Total Cost of Goods Sold
Average Receivable
Total Credit Sales
Average Creditors
Total Credit Purchases
X 365
X 365
X 365
X 365
R =
C =
D =
F =
W =
X 365
The Formulas :-

7. In the books of A Ltd. Period covered – 365 days
Avg. period of credit allowed by suppliers – 16 days
Avg. debtors outstanding – Rs 4800
Raw materials consumption – Rs 44000
Total production cost – Rs 100000
Total cost of sales – Rs 105000
Sales of the year – Rs 160000
Value of avg stock maintained – Rs 2500
Raw materials – Rs 3200
Work in progress – Rs 3500
Finished goods – Rs 2600
Compute operating cycle days.
Question:

8. I. R = (Avg. raw material stock / total raw material consumption ) X 365
= (3200 / 44000) X 365 = 27 days
II. W = ( Avg. work in progress / total cost of production ) X 365
= (3500 / 100000) X 365 = 13 days
III. F = ( Avg. finished goods / total cost of goods sold ) X 365
= (2500 / 105000) X 365 = 9 days
IV. D = ( Avg. receivable / total credit sales ) X 365
= (4800 / 160000) X 365 = 11 days
V. The credit allowed by creditors = 16 days
O = R+W+F+D-C
O = 27 + 13 + 9 + 11 – 16 = 44 days
Solution:

9. Objectives Of Working Capital Management
i. Optimization of current assets and reducing the level of current liabilities.
ii. The company should always be in position to meet its current obligations,
which should properly be supported by the current assets available with the
firm.
iii. The business firm should manage its current assets in such a way that the
marginal return on investment in these assets is not less than the cost of
capital employed to finance the current assets.

10. Significance Of Adequate Working Capital
i. Easy loans
ii. Regular supply for raw material
iii. Exploitation of favorable market conditions
iv. Good Will
v. Solvency of the business
vi. Cash discounts
vii.Ability to face crisis
viii.High morale
ix. Regular payment of salaries, wages and other day to day
commitments

11. How To Minimize And Reduce Operating Cycle…
a. Strategic production and operations management.
b. Effective marketing management strategy.
c. Sound credit and collection policies.
d. Proper monitoring of external environment.

12. Reasons For Prolonged Operating Cycle
• Surplus /deficit purchase of raw material.
• Buying of inferior and defective raw material.
• Defective inventory policy.
• Lack of production planning.
• Use of out dated machinery, technology.
• Poor maintenance.
• Inability to get credits from suppliers.

13. Types Of Working Capital
1. Permanent Working Capital :
Permanent working capital is that amount of capital which
must be in cash or current assets for continuing the
activities of business.
2. Temporary Working Capital :
Sometime, it may possible that we have to pay fixed
liabilities, at that time we need working capital which is
more than permanent working capital, then this excess
amount will be temporary working capital.

14. Financing Of Working Capital
The business firm has to decide about source of funds, which can be availed
to make investment in current assets.
• LONG TERM SOURCES:
It provides funds for relatively longer period. The main sources
are share capital retained earning , debentures , long term borrowings.
• SHORT TERM SOURCES:
It provides funds for relatively short period of one year or so.
This category includes sources of funds as bank credit , public deposits ,
commercial papers etc.
• TRANSACTION SOURCES:
Provides funds to a business through a normal business operation. Ex:
credit allowed by supplier, outstanding wages. This is also called as
spontaneous source of finance.

15. TIME
DOLLARAMOUNT
Long-term financing
Fixed assets
Current assets*
Short-term financing**
Hedging approach
The hedging approach involves matching the cash flows generating
characteristics of an assets with the maturing of the sources of
financing used to finance it. The life of the current asset and the
maturity period of the source of funds are matched.

16. TIME
DOLLARAMOUNT
Long-term financing
Fixed assets
Current assets
Short-term financing
Conservative approach
Under this approach the finance manager does not undertake risk, as
a result all working capital needs are primarily financed by long tern
sources and use of short term may be restricted to and emergency
situation only.

17. TIME
DOLLARAMOUNT
Long-term financing
Fixed assets
Current assets
Short-term financing
Aggressive approach
This approach seeks to minimize the excessive liquidity while
meeting the short term requirements.

18. Determinants Of Working Capital
The following are the factor, which generally influence the working
capital requirement of business firms
• Nature of Business
• Business Cycle Impact and Fluctuation
• Seasonal Operations
• Credit Policy
• Market Competitiveness
• Supply Position and Condition

19. Working capital analysis
1) Monitoring the operating cycle : It is to be noted that total
working capital need depends upon the length of the operating cycle.
The long the operating cycle, the greater would be the working capital
need.
2) Working capital ratios: Another analytical tool that can be
used to monitor the working capital is the accounting ratios particularly
the working capital ratios. for the following purpose the working capital
ratios may be worth noted : current ratio, liquid ratio, current assets to
total assets ratio.
3) Monitoring the liquidity : Even though, profitability and
selection of good investment are keys to the prosperity of business firm
in long run , yet it is a liquidity which insures the short term survival of
the business organization.

20. Steps To Reduce The Liquidity Problem
• Reduce the safety stock that may result in order size
• Delaying the payment to the creditors but without
impairing the goodwill of the business
• Concentrate more on collection of receivables.

21. Working Capital Leverage measures the responsiveness of return on capital
employed for changes in current assets.
It is measured by applying the following formula:-
Working Capital Leverage = CA
TA - CA
Where,
CA = Current Assets
TA = Total Assets (Net fixed assets + Current assets)
CA = Change in Current Assets
Working Capital Leverage

22. Illustration
Calculate the responsiveness of Return on Capital employed for changed in current assets.
Particulars A Ltd. B Ltd.
Fixed Assets 3000 2000
Current Assets 2000 3000
Total Assets 5000 5000
EBT 90 90
ROCE 18% 18%
The current assets decline by 20% over the existing level.
(Rs. In lakhs)

23. Working Capital Leverage = CA
TA - CA
A Ltd. = Rs.2000 lakhs
Rs.5000 lakhs - Rs.400 lakhs
= 0.435
B Ltd. = Rs.3000 lakhs
Rs.5000 lakhs - Rs.600 lakhs
= 0.682
From the analysis of the above. Working Capital Leverage is higher for B
Ltd and therefore it is more responsible as compared to A Ltd.
Solution:

24. 1.Working Capital as a percentage of Net Sales
This approach of estimation of Working Capital of a business
organization's requirement is based on the fact that the Working
Capital for any business is directly related and linked to sale volume
of the business.
Steps involved:
• To estimate total current assets as % of estimated net sales.
• TO estimate current liabilities as % of estimated net sales.
• The difference between the two above, is the net Working Capital as
a % of net sales.

25. 2.Working Capital as a percentage of Total assets
(or) Fixed Assets
 This approach is based on the fact that the total assets of the firm are
consisting of fixed assets and current assets.
 On the basis of past experience a relationship between:
Total current assets i.e. gross working capital or net working capital
and total fixed assets or total assets of the firm is established
 The business firm plans the future level of fixed assets in terms of
capital budgeting. In order to use the fixed assets(FA) in an optimal
way the business firm must have sufficient working capital.
Therefore the WCR depends on planned level of FA.

26. 3.Working Capital Based on Operating Cycle
 The concept of operating cycle is also a tool to determine the time
scale over which the current assets are maintained.
 The operating cycle for different components of Working Capital
gives the time for which an asset is maintained, once it is acquired.
 The operating cycle concept can be used as a tool to estimate the
WCR for any business organisation.

27. The estimation of Working Capital requirement
component and its methodology
 Need for Cash and Bank Balance : Every business firm must
maintain minimum cash and bank balance as immediate liquidity to meet
the day to day requirements towards petty expenses. general expenses and
for cash purchases.
 Need for Procurement of Raw Materials : Every manufacturing
organization has to maintain stock of raw materials in stores in order to
meet the requirements of the production process.
 Need for Finished goods : In case of trading concern as well as
manufacturing business units the goods are not immediately sold after
purchases Procurement and finally completion of production process.

28.  Need for Receivables : The term receivables comprises of
debtors and bills. When a firm on cash basis sells the goods, the
sales revenue is, realized immediately and no Working Capital is
required after sale period.
 Creditors for Purchase : Business organization sells goods and
services on credit. It may procure/purchase raw materials and
finished goods on credit basis, The payment may be postponed for
the purchases for a period of credit allowed by suppliers.
 Creditors for Expenses and Wages: Normally the expenses
and wages are paid at the end of the month.
 Need for Work in Process of Production : in any
manufacturing concern the production process is continuous and
generally consuming of several stages.

29. ESTIMATION OF WORKING CAPITAL REQUIREMENTS
Amount(Rs.)
Current Assets:
Minimum Cash Balance xxxx
(i) Inventories:
Raw Materials -------
Work-in-progress -------
Finished goods -------
xxxx
(ii) Receivables :
Debtors -------
Bills Receivable -------
xxxx
Gross Working Capital
(Total Current Assets) xxxx
Current Liabilities:
(i) Creditors for Purchases -------
(ii) Creditors for Wages -------
(iii) Creditors for Overheads -------
Total Current Liabilities xxxx
NET WORKING CAPITAL ( Total Current Assets – Total Current Liabilities ) xxxx

30. Determining the amount of current assets and current liabilities
Illustration
Mr. Rajesh wants to buy a business and seeks your help to calculate working capital
requirements in the first year of trading. The following information are given and you
are asked to add 10% for contingencies:
1. Average amount locked up on stock :
Stock of finished product and work-in-progress 2500
Stock of stores, materials 4000
2. Average Credit given to customers :
Local sales (2 weeks credit) 39000
Outside sales (6 weeks credit) 156000
3. Time allowed by supplier for payment (4 weeks) 48000
4. Time available for payment of wages (2 weeks) 130000
Prepare a statement showing the working capital requirement.
Particulars Rs.

31. Solution
Statement showing the amount of Working Capital
Current assets:
1. Inventories
Stock of finished product and WIP 2500
Stock of stores, Materials 4000 6500
2. Accounts receivables:
Local sales (39000*2/52) 1500
Outside sales (156000*6/ 18000 19500
Total current assets 26000
(-) Current liabilities:
Accounts payable (48000*4/52) 3692
Outstanding Wages (130000*2/52) 5000 8692
17308
(+) 10% for Contingencies 1731
19039Working capital requirements
Particulars Rs. Rs.

32. High Inflation Rate Has Direct Impact On
Requirement Of WC
Reasons:
i. Higher the sales mean higher the level of
balance in receivables
ii. Increases the expenses
iii. Increase in taxes, dividends and bonus.

33. Zero Working Capital Concept
• Working capital is the current assets minus current liabilities.
• Creditors prefer high working capital levels as they signify a
stronger ability to meet short term obligations.
• The financial managers prefer minimal working capital. This
means a company's assets are not being tied up in daily operations
and can be utilized elsewhere.
• When attempting to minimize working capital a company wants
to convert receivables as quickly to cash as possible, they want to
fill orders on demand instead of keeping heavy inventory, and
they want to hold out on paying payables as long as possible
without injuring cred

34. Over Trading
• Attempt to finance a certain volume of
production with inadequate working capital.
• Examples:
i. Credit from suppliers
ii. Extension of overdraft
iii. Dependence on outside finance