Working capital management


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Working capital management

  1. 1. Prepared By : Shalu Maria Paul
  2. 2.  Working capital refers to be a part of firm’s capital which is required for financing short term or current assets such as cash, marketable securities, debtors and inventories etc.  It is also known as resolving or circulating capital or short-term capital.  It refers to the funds, which company must posses to meet its day to day expenses.
  3. 3.  From the accountants’ perspective- It refers to current assets-current liabilities differentials.  From the financial managers’ angle it implies the total investment made in current assets.  From the production managers’ view it refers to the total funds that a firm needs to carry out its day-to-day operations.
  4. 4.  In the words of Shubin, “Working capital is the amount of funds necessary to cost of operating the expenses”.  According to Genestenberg, “Circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another. For example, from cash to inventories, inventories to receivables, receivables into cash”.
  5. 5. There are two concepts of working capital: (A) Balance Sheet Concept (B) Operating cycle or Circular Flow Concept
  6. 6. (A) Balance Sheet Concept There are two interpretation of working capital under the balance sheet concept: (i) Gross Working Capital  is the amount invested in total current assets of the enterprise. is the firm’s investment in short term assets such as cash, short term securities, account receivables and inventories. The concept helps in making optimum investment in current assets and their financing.  
  7. 7. (ii)Net working capital     is the excess of current assets over current liabilities. Net working capital = current assets – current liabilities. Net working capital refers to the portion of firm’s current assets, which financed with long term funds. It indicates or measures the liquidity and also suggest an extent to which working capital need may be financed by the permantant source of funds.
  8. 8. refers to the period that a business enterprise takes in converting cash back to cash. In case of a manufacturing concern the duration of time required to complete the following sequence of events is called the operating cycle.
  9. 9. 1. Conversion of cash into raw materials 2. Conversion of raw materials into work-in-progress 3. Conversion of work-in progress into finished goods 4. Conversion of finished goods into debtors and B/R through sales 5. Conversion of debtors and B/R into cash
  10. 10. Accounts Payable Raw Materials Cash Value Addition WIP THE WORKING CAPITAL CYCLE (OPERATING CYCLE) Accounts Receivable SALES Finished Goods
  11. 11. WORKING CAPITAL BASIS OF CONCEPT Gross Working Capital BASIS OF TIME Permanent / Fixed WC Net Working Capital Temporary / Variable WC Seasonal WC Regular WC Reserve WC Special WC
  12. 12. Permanent or fixed working capital is the minimum investment kept in the form of inventory or raw materials, work in progress etc to facilitate uninterrupted operation in the firm. It also grow with the size of the firm. It could be financed out of ling term funds.
  13. 13. Temporary or Variable working capital is the amount of working capital which is required to meet the seasonal demands and some special exigencies. Variable working capital can be further classified into Seasonal and Special working capital. The capital required to meet the seasonal needs of the enterprise is called seasonal working capital. Special working capital is that part of working capital which is required to meet special exigencies such as launching of extensive marketing, campaign for conducting research etc.
  14. 14. Amount of Working Capital Variable Working Capital Permanent Working Capital Time
  15. 15. Variable Working Capital Amount of Working Capital Permanent Working Capital Time
  16. 16. 1. 2. 3. 4. 5. 6. 7. 8. Solvency of the firm. Goodwill. Easy Loan. Cash discount. Regular supply of raw materials. Regular payment of salaries, wages and other day-to-day commitments. Ability to faces crisis High morale.
  17. 17.      Excess of working capital represents idle funds which earn no profits for the business and hence the business cannot earn a proper rate of return on its investments. Low rate of return Unnecessary purchase inventories: Defective Credit Policy Speculative transaction: His working capitals in excess give rise to speculative
  18. 18.      Loss reputation Lowers credit worthless Cash Discount Irregularity payment of day-to- day Low Rate of Return
  19. 19. 1. 2. 3. 4. 5. 6. 7. Nature of the business. Sixe of the business. Production policy. Production cycle process. Seasonal variation Working capital cycle Rate of stock turnover
  20. 20. 8. Credit Policy 9. Business Cycle 10. Rate of growth of business 11. Earning capacity and dividend policy. 12.Price level changes 13. Other factors.
  21. 21. Management of working capital is concerned with the problems that arises in attempting to manage the current assets, the current liabilities and the inter-relationship that exists between them. In other words it refers to all aspects of administration of both current assets and current liabilities.  Working Capital Management Policies of a firm have a great effect on its profitability, liquidity and structural health of the organizations. 
  22. 22. Dimension I Profitability, Risk, & Liquidity
  23. 23. PRINCIPLES OF WORKING CAPIAL MANAGEMENT Principle of Risk Variation Principle of Cost of Variation Principle of Equity Position Principle of Maturity Payement
  24. 24.  The firm’s policies for managing its working capital should be designed to achieve three goals : 1. Adequate liquidity 2. Minimization of risk 3. Contribute to maximizing firm’s value
  25. 25. 1.Adequate liquidity- maintain sufficient cash to pay its bills when due. 2. Minimization of risk - matching of assets and liabilities among current assets. 3. Contribute to maximizing firm’s value – The investment of excess cash, minimizing of inventories, speedy collection of receivables and elimination of unnecessary and costly short term financing contribute to maximizing the value of the firm
  26. 26. is the risk-return trade off associated with the appropriate mix between: 1. Current assets and fixed assets 1. Short - term and long –term funds.
  27. 27. Conservative Approach:  High level of current assets  Lower risk  Higher liquidity  Lower profitability  Lower chance of technical insolvency  Higher current ratio
  28. 28. Minimum investment in current assets  Lower liquidity  Higher risk  Higher return  Greater chance of technical insolvency  Lower current ratio 
  29. 29. A compromise between the extreme approaches  Satisfactory return  Sustainable risk  Average liquidity 
  30. 30. Policy C Policy B Current Assets Rs.) Policy A Sales (Rs.)
  31. 31.  Policy C represents conservative approach Policy A represents aggressive approach Policy B represents a moderate approach  Optimal level of working capital investment  Risk of long-term versus short-term debt  
  32. 32. Working capital financing
  33. 33. Working capital is the fund invested in current assets and is needed for meeting day to day expenses . It is an operating liquidity available to a business. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital.
  34. 34. a) b) Permanent or long term or fixed working capital requirement Temporary or variable or short term working capital requirement
  35. 35.  Fixed working capital is that portion of the total capital that is required to be maintained in the business on the permanent basis or uninterrupted basis. This working capital is required to invest in fixed assets. The requirement of this type of working capital is unaffected due to the changes in the level of activity.
  36. 36.  Variable working capital is that portion of the total capital that is required over and above the fixed working capital. This working capital is required to meet the seasonal needs and some contingencies. The requirement of this type of working capital changes with the changes in the level of activity.
  37. 37. Permanent or fixed 1.Shares 2. Debentures 3.Public deposits 4.retained profits 5.Loans from financial institutions Temporary or variable 1.Indigenous bankers 2.Deferred Incomes 3.Trade credit 4.Instalment credit 5.Advances 6.Accrued expenses 7. commercial paper
  38. 38.  Shares A company can issue various kinds of shares as equity shares, preference shares and deferred shares. According to the Companies Act, 1956 a company cannot issue deferred shares. Preference shares carry preferential rights in respect of dividend at a fixed rate and in regards to the repayment of capital at the time of the winding up the company.
  39. 39.  Debentures A debenture is an instrument issued by the company acknowledging its debt to its holders. The debentureholder are the creditors of the company. A fixed rate of interest is paid on debentures. The interest of the debentures is a charge against profit and loss account. The debentures are giving floating charge on the assets of the company.
  40. 40.  Public Deposits Public deposits are the fixed deposits accepted by a business enterprise directly from the public. This source of raising short term and medium term finance was very popular in the absence of banking facilities. Ploughing Back of Profits It means the reinvestments by concern of its surplus earnings in its business. It is an internal source of finance and is most suitable for an established firm for its expansion, modernization and replacement etc. This method of finance has number of advantages as it is the cheapest rather than cost free source of finance. 
  41. 41.  Loans from Financial Institutions Financial Institutions such as Commercial Banks, Life Insurance Corporation, Industrial Finance Corporation Of India, State Financial Corporations, State Industrial Development Corporations, Industrial Development Bank Of India etc also provides short term, medium term and long term loans. This source of finance is more suitable to meet the medium term demands of working capital. Interest is charged on such loans at a fixed rate and the amount of loan is to be repaid by way of installments in a number of years.
  42. 42.  Indigenous Banks Private money lenders and other country bankers used to be the only source of finance prior to the establishment of commercial banks. They used to charge very high rates of interest and exploited customers to the largest extent possible. Advances Some business house get advances from their customers and agents and this source is a short term source of finance for them. It is a cheap source of finance in order to minimize their investment in working capital 
  43. 43.  Trade Credit Trade Credit refers to the credit extended by the suppliers of goods in the normal course of business. At present day, commerce is built upon credit, the trade credit arrangement of a firm with its suppliers is an important source of short term finance. The credit worthiness of a firm and the confidence of its suppliers are the main basis of securing trade credit.
  44. 44.  Installment Credit This is another method by which the assets are purchased and the possession of goods is taken immediately but the payment is made in installment over a pre-determined period of time.  Deferred Incomes Deferred incomes are incomes received in advances before supplying goods or services in future. These funds increase the liquidity of a firm and constitute an important source of short term finance.
  45. 45.  Accrued Expenses Accrued Expenses are the expenses which have been incurred but not yet due and hence not yet paid also. These simply increases the liquidity that a firm has to pay for the services already received by it.  Commercial Paper It represents unsecured promissory notes issued by the firm to raise short term funds. It is an important money market instrument in advanced countries like U.S.A.