Ch 8

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Ch 8

  1. 1. Working Capital Policy
  2. 2. In this chapter… <ul><li>Importance of working capital management… </li></ul><ul><li>Components of working capital… </li></ul><ul><li>Factors influencing the working capital requirement… </li></ul><ul><li>Profitability/Liquidity Trade off… </li></ul><ul><li>Estimating working capital requirement… </li></ul><ul><li>Operating cycle method… </li></ul><ul><li>Percent of sales method… </li></ul><ul><li>Finance Manager’s role in working capital management… </li></ul>
  3. 3. Estimation of Required Working Capital… <ul><li>For estimation of working capital, following four step procedure is applicable: </li></ul><ul><ul><li>Estimation of cash cost of the various current assets required by the firm. </li></ul></ul><ul><ul><li>Estimation of current liabilities of the firm. </li></ul></ul><ul><ul><li>Calculation of net working capital. </li></ul></ul><ul><ul><li>Add percentage of contingency. </li></ul></ul>
  4. 4. Estimation of Current Assets… <ul><li>A. Estimation of Current Assets: </li></ul><ul><ul><li>i) Raw materials </li></ul></ul><ul><ul><li>ii) Work-in-process </li></ul></ul><ul><ul><li>Raw materials (full cost) </li></ul></ul><ul><ul><li>Direct labor (to the extent of completed stage) </li></ul></ul><ul><ul><li>Overheads (to the extent of completed stage) </li></ul></ul><ul><ul><li>iii) Finished goods inventory </li></ul></ul><ul><ul><li>iv) Debtors </li></ul></ul><ul><ul><li>v). Cash balance required </li></ul></ul>
  5. 5. Where… <ul><li>Raw Material = Budgeted Production in Units * Raw Material Cost per unit * Average Raw material Holding Period / 12 months or 365 days. </li></ul><ul><li>WIP = Budgeted Production in Units * Estimated WIP Cost per unit * Average WIP Holding Period / 12 months or 365 days. </li></ul>
  6. 6. <ul><li>Finished Goods Inventory = Budgeted Production in Units * Cost of Goods produced * finished Goods Holding period /12 months or 365 days. </li></ul><ul><li>Investment in Debtors = Budgeted Credit Sales in Unit * Cost of Sales per Unit * Average Debt Collection Period / 12 months or 365 days. </li></ul>
  7. 7. Estimation of Current Liabilities… <ul><li>B. Estimation of Current Liabilities: </li></ul><ul><ul><li>i) Creditors </li></ul></ul><ul><ul><li>ii) Expenses : </li></ul></ul><ul><ul><li>Overheads </li></ul></ul><ul><ul><li>Labor </li></ul></ul>
  8. 8. Where… <ul><li>Creditors = Budgeted Production in Units * Raw Material Cost per unit * Credit period Allowed by Suppliers / 12 months or 365 days. </li></ul><ul><li>Direct Wages = Budgeted Production in Units * Direct Wages Cost per unit * Lag in Payment of Wages / 12 months or 365 days. </li></ul><ul><li>Overheads = Budgeted Production in Units * Overhead Cost per unit * Lag in Payment of Overheads / 12 months or 365 days. </li></ul>
  9. 9. Operating cycle… <ul><li>Operating cycle is the time that elapses to convert raw materials into cash. </li></ul><ul><ul><li>Operating cycle of Manufacturing firm. </li></ul></ul><ul><ul><li>Operating cycle of a Non manufacturing firm. </li></ul></ul>
  10. 10. Operating cycle of Manufacturing firm… Cash Raw Materials Debtor Work-in- Process Sales Finished goods
  11. 11. Operating Cycle of a Non Manufacturing Firm… <ul><li>Stock of </li></ul><ul><li>Finished </li></ul><ul><li>Goods </li></ul>CASH Receivables
  12. 12. Formula… <ul><li>OC = ICP + ARP </li></ul><ul><li>Where; </li></ul><ul><ul><li>OC = Operating Cycle. </li></ul></ul><ul><ul><li>ICP = Inventory Conversion Period. </li></ul></ul><ul><ul><li>ARP = Accounts Receivable Period. </li></ul></ul><ul><ul><li>ICP = Average Inventory / COGS/ 365 </li></ul></ul><ul><ul><li>ARP = Ave. Accounts Receivable/ Sales / 365 </li></ul></ul>
  13. 13. Cash Conversion Cycle… <ul><li>CCC means the time period between the date of a firm pays its suppliers and the date it receives cash from customers. </li></ul><ul><li>CCC = OC – APP </li></ul><ul><li>Where; </li></ul><ul><ul><li>OC = Operating Cycle. </li></ul></ul><ul><ul><li>APP = Accounts Payable Period </li></ul></ul><ul><ul><li>APP = Ave. Accounts Payables / COGS / 365 </li></ul></ul>

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