presentation of preparing Working capital

1. Sabrina Akhter, Assistant Professor,
DIU
1
Principles of Working Capital
Concepts of Working Capital:
Gross Working Capital refers to the firm’s investment in current
assets
Current Assets: Cash, Short Term Securities, Accounts Receivables,
Stock or Inventory
Net Working Capital refers to the difference between current assets
and current liabilities
Current Liabilities: Accounts Payables, bills payables, outstanding
expenses

2. Sabrina Akhter, Assistant Professor,
DIU
2
Principles of Working Capital
Operating Cycle:
The time duration required to convert sales after the conversion of
resources into inventories, into cash.
The operating cycle of a manufacturing firm involves three phases:
Acquisition of Resources such as raw materials, labor,
power and fuel
Manufacturing of Product which includes conversion of
raw material into work in process into finished goods.
Sale of the product either for cash or on credit.
1
2
3

3. Sabrina Akhter, Assistant Professor,
DIU
3
Principles of Working Capital
Calculation of Operating Cycle: Cont..
Basic of Working Capital = Current Asset-Current Liability
= Gross Working Capital- Payables
Net Operating Cycle = Gross Operating Cycle – Payable Deferral Period
Gross Operating Cycle = Inventory Conversion Period + Debtors
Conversion Period
Inventory Conversion Period = Raw Material Conversion Period+ Work in
Process Conversion Period + Finished Goods Conversion Period

4. Sabrina Akhter, Assistant Professor,
DIU
4
Principles of Working Capital
Exercise 01: FROM THE FOLLOWING STATEMENT OF COST OF SALES DETERMINE NET
OPERATING CYCLE OF NATIONAL LAMPS LTD. (AMOUNT IN MILLION TK.)
Particulars Year 0 Year 1
1. Purchase of raw material 7.6 10.8
2. Opening raw material inventory 45.6 56.25
3. Closing raw materials inventory 9.2 12.00
4. Raw material consumed (1+2-3) 44
5. Direct labor 15.3 18
6. Depreciation 5.8 6.2
7. Other manufacturing expenses 2.6 3.6
8. Total cost (4+5+6+7) 67.7
9. Opening work-in-process inventory 3.1 5.2
10. Closing work-in-process inventory 4.6 7.25
11. Cost of production (8+9-10) 66.2
12. Opening finished goods inventory 3.6 6.8
13. Closing finished goods inventory 2.9 4.1
14. Cost of goods sold (11+12-13) 66.9
15. Selling, administrative and general expenses 2.1 5.78
16. Cost of sales (14+15) 69
17. Sales credit 45.9 65.3
18. Opening debtors 8.3 9.3
19. Closing debtors 10.8 12.65
20. Opening creditors 3.7 5.37
21. Closing creditors 1.6 6.52

5. 5
Principles of Working Capital
Calculation of Net Operating Cycle: Cont..
Particulars Year 0 Days
1. Gross Operating Cycle:
a. Inventory Conversion Period
i) Raw Material Conversion Period:
Raw Material Inventory X 360
Raw Material Consumed
=9.2 X 360
44
75 days
ii) Work in Process Conversion Period:
Work in Process Inventory X 360
Cost of Production
= 4.6 X 360
66.2
25 days
iii) Finished Goods Conversion Period
Finished Goods Inventory X 360
Cost of Goods Sold
= 2.9 X 360
66.9
15 days
Inventory Conversion Period (RMCP+WIPCP+FGCP) 115 days
b. Debtor’s Conversion Period:
Debtors X 360
Credit Sales
=10.8 X 360
45.9
84 days
Gross Operating Cycle (ICP+DCP) 199 days
Creditors Deferral Period:
Creditors X 360
Credit Purchase
=1.6 X 360
7.6
75 days
Net Operating Cycle (GOC-CDP) 124 days

6. Sabrina Akhter, Assistant Professor,
DIU
6
Principles of Working Capital
Types of Working Capital:
There is always a minimum level of current
assets which is continuously required by the
firm to carry on its business operations named
as Permanent or Fixed Working Capital.
Depending upon the changes in production and
sales, the need for working over and above
permanent working capital is Fluctuate or
Variable Working Capital.
Permanent
or Fixed
Working
Capital
Fluctuate
or Variable
Working
Capital

7. Sabrina Akhter, Assistant Professor,
DIU
7
Principles of Working Capital
WHAT SHOULD BE THE EXPECTATION
OF A FIRM ?
Balanced Working Capital

8. Sabrina Akhter, Assistant Professor,
DIU
8
Principles of Working Capital
DANGERS OF EXCESS AND INADEQUATE
WORKING CAPITAL

9. Sabrina Akhter, Assistant Professor,
DIU
9
Principles of Working Capital
Determinants of Working Capital:
02
05
01
04
03
06
07
Nature of Business
Sales and Demand Condition
Technology & Manufacturing Policy
Credit Policy
Availability of Credit
Operating Efficiency
Price Level Changes

10. Sabrina Akhter, Assistant Professor,
DIU
10
Principles of Working Capital
Estimating Working Capital Needs of A Firm:
For the estimation of Net Working Capital there are 3
(Three) approaches:
Current Assets Holding Period
Ratio of Sales
Ratio of Fixed Investment
1
2
3

11. Sabrina Akhter, Assistant Professor,
DIU
11
Principles of Working Capital
CURRENT ASSETS HOLDING PERIOD
(THE CALCULATIONS ARE BASED ON THE
FOLLOWING ASSUMPTIONS)
Inventory: 1 month’s supply of each of raw material, semi
finished goods and finished material
Debtors: 1 month’s sales
Operating Cash: 1 month’s total cost

12. Sabrina Akhter, Assistant Professor,
DIU
12
Principles of Working Capital
Calculation of Net Working Capital:
Net Working Capital = Current Asset - Current Liabilities
Current Asset also know as Gross Working Capital
Gross Working Capital = Investment in Inventory + Investment in Debtors
(Accounts Receivables) + Cash Balance
Current Liabilities = Creditors (Accounts Payables)+All Outstanding Expenses

13. Sabrina Akhter, Assistant Professor,
DIU
13
Principles of Working Capital
Example of Net Working Capital:
From the following information of ABV Company Ltd, prepare a statement showing the net
working capital requirement of the company. Additional Information:
i) Average raw material in stock: 1 month, average raw material in process: 14 days,
average finished good: 1 month, credit allowed by the suppliers: 2 months, credit allowed to
the buyer: half a month.
ii) Time lag in payment of wages: daily basis, overhead: 1 month.
iii) Cash balance is expected to be Tk. 2,00,000
iv) Credit sales is 50% of total sales
v) Total sales 80,000 units.
Particulars( Per unit) Amount in Tk.
Total cost 120
Cost of Raw Materials 65
Cost of Direct Labor 28.75
Cost of overhead 26.25
Selling Price 140
Profit 20

14. Sabrina Akhter, Assistant Professor,
DIU
14
Principles of Working Capital
Calculation of Net Working Capital Cont..
Particulars Tk.
1. Current Assets:
i. Inventory:
a. Raw Materials Inventory:
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 (𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) 𝐗 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
360 𝑑𝑎𝑦𝑠
X Average raw materials holding period.
b. Work-in-Process Inventory:
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 (𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) 𝐗 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑤𝑜𝑟𝑘−𝑖𝑛−𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
360 𝑑𝑎𝑦𝑠
X Average holding period of WIP.
c. Finished Goods Inventory:
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 (𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) 𝐗 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 (𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑒𝑥𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑑𝑒𝑠)
360 𝑑𝑎𝑦𝑠
X Average holding period of finished
goods inventory.
Total Investment in Inventory
ii) Debtor or Accounts Receivables:
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 (𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) 𝐗 𝐶𝑜𝑠𝑡 𝑜𝑓𝑠𝑎𝑙𝑒𝑠 (𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑒𝑥𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑑𝑒𝑠)
360 𝑑𝑎𝑦𝑠
X Average debtors’ collection period.
iii) Cash (Cash in hand and Balance with Bank)
Total Current Assets or Gross Working Capital

15. Sabrina Akhter, Assistant Professor,
DIU
15
Principles of Working Capital
Calculation of Net Working Capital Cont..
2. Current Liabilities Tk.
i) Trade Creditors:
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑌𝑒𝑎𝑟𝑙𝑦 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 (𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) ∗ 𝑅𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 𝑟𝑒𝑞𝑢𝑖𝑟𝑚𝑒𝑛𝑡𝑠 (𝑝𝑒𝑟 𝑢𝑛𝑖𝑡)
360 𝑑𝑎𝑦𝑠
*
Credit period granted by supplies.
ii) Direct Wages:
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 (𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) ∗ 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡 (𝑝𝑒𝑟 𝑢𝑛𝑖𝑡)
360 𝑑𝑎𝑦𝑠
* Average time lag
in payment of overheads.
iii) Overheads:
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑌𝑒𝑎𝑟𝑙𝑦 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 (𝑖𝑛 𝑢𝑛𝑖𝑡𝑠) ∗ 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝐶𝑜𝑠𝑡 (𝑝𝑒𝑟 𝑢𝑛𝑖𝑡)
360 𝑑𝑎𝑦𝑠
* Average time
lag in payment of overheads.
Total Current Liabilities
Net Working Capital (Current Asset- Current Liabilities)

16. Sabrina Akhter, Assistant Professor,
DIU
16
Principles of Working Capital
CURRENT ASSET TO FIXED ASSET RATIO
(THE LEVEL OF CURRENT ASSETS CAN BE MEASURED BY
RELATING CURRENT ASSETS TO FIXED ASSETS)
A higher CA/FA ratio indicates a Conservative Current Assets Policy
A lower CA/FA ratio indicates an Aggressive Current Assets Policy
An alternative of CA/FA Ratio lies between these two is an Average Policy

17. Sabrina Akhter, Assistant Professor,
DIU
17
Principles of Working Capital
EFFECTS OF LONG TERM AND SHORT TERM FINANCING:
A RISK RETURN TRADE OFF
A company wants to analyze the effect of its working capital investment for the next year.
Estimated fixed assets and Current liabilities for the next year are respectively Tk. 2.60 crore and
Tk. 2.34 crore. The company has a policy of maintaining a debt to total assets ratio of 60%, where
debt consists of both short term debt and long term debt from bank. The following data relate to
three alternative policies:
Assume that bank borrowing will cost 16% per annum. You are required to calculate the following
for each policy (a) rate of return on total assets, (b) net working capital position, (c) current asset to
fixed asset ratio. Also discuss the return risk tradeoffs of the three policies.
Working Capital
Policy
Investment in Current
Assets (Tk. crore)
Estimated Sales
(Tk. crore)
Bank Borrowings
(Tk. crore)
EBIT
(Tk. crore)
Conservative 34.50 22.30 6.10 15.2
Moderate 23.90 38.50 6.70 27.36
Aggressive 12.60 56.00 8.00 39.10

18. Sabrina Akhter, Assistant Professor,
DIU
18
Principles of Working Capital
Cont..
EFFECTS OF LONG TERM AND SHORT TERM FINANCING:
A RISK RETURN TRADE OFF
Particulars Working Capital Policy
Conservative Moderate Aggressive
Current Asset 34.5 23.9 12.6
Fixed Asset 22.60 22.60 22.60
Total Asset 57.10 26.5 35.2
Current Liabilities 2.34 2.34 2.34
Total Debt 34.26 27.9 21.12
Short Term Debt 28.16 21.2 13.12
Long Term Debt 6.1 6.7 8
Equity Capital 20.5 16.26 11.74
Total Liability and Equity 57.1 46.5 35.2
EBIT 15.2 27.36 39.1
Less, Interest
STD 4.5056 3.392 2.0992
LTD 0.976 1.072 1.28
EBT 9.7184 22.896 35.7208
Less, Tax 2.91552 6.8688 10.71624
EAT 6.80288 16.0272 25.00456
ROA 12% 34% 71%
Net Working Capital 4 0.36 -2.86
Current Asset/Fixed Asset 1.526548673 1.057522124 0.557522124

19. Sabrina Akhter, Assistant Professor,
DIU
19
Principles of Working Capital
Risk Return Trade Off:
Rate of Return on total assets is the measure of return
while CA/CL ratio or net working capital position can be
taken as the measure of risk. Expected return and risk
are minimum under conservative policy and highest
under the aggressive policy. This implies that if the firm
wants to increase its profitability by reducing investment
in working capital, it has to be ready to bear more risk
being unable to meet its financial obligations.

20. Sabrina Akhter, Assistant Professor,
DIU
20
Principles of Working Capital
DEPENDING ON THE MIX OF SHORT TERM AND
LONG TERM FINANCING, A FIRM CAN FOLLOW
THE FOLLOWING APPROACHES:
Matching Approach
Conservative Approach
Aggressive Approach
1
2
3

21. Sabrina Akhter, Assistant Professor,
DIU
21
Principles of Working Capital
Financing Current Asset: Cont..
Long term Financing
Short Term Financing
Spontaneous Financing
1
2
3

22. Thank
You