Css 11 working capital management

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  • Amitabha maheshwari
  • Css 11 working capital management

    1. 1. WORKING CAPITALMANAGEMENT amitabha maheshwari 1
    2. 2.  Concept of working capital Importance of working capital Determents of working capital Source of working capital financing Determination of Operating Cycle amitabha maheshwari 2
    3. 3. Gross working capital (GWC) GWC refers to the firm’s total investment in current assets. Current assets are the assets which can be converted into cash within an accounting year (or operating cycle) and include cash, short-term securities, debtors, (accounts receivable or book debts) bills receivable and stock (inventory). amitabha maheshwari 3
    4. 4.  Net working capital (NWC). NWC  refers to the difference between current assets and current liabilities.  It is the excess of current assets over current liabilities.  It is that portion of a firm’s current assets which is financed by long-term funds. amitabha maheshwari 4
    5. 5.  Net working capital (NWC). Current liabilities (CL) are those claims of outsiders which are expected to mature for payment within an accounting year and include creditors (accounts payable), bills payable, and outstanding expenses. NWC can be positive or negative.  Positive NWC = CA > CL  Negative NWC = CA < CL amitabha maheshwari 5
    6. 6.  GWC focuses on  Optimization of investment in current liabilities  Financing of current assets NWC focuses on  Liquidity position of the firm  Judicious mix of short-term and long-tern financing amitabha maheshwari 6
    7. 7.  Nature of business Manufacturing cycle Production process Business cycle Seasonal variation Scale of Operation Inventory policy Credit policy Depreciation policy amitabha maheshwari 7
    8. 8.  Business Standing Growth of business Market condition Supply Situation Nature of Raw Material Used Process Technology Used Nature of Finished Goods Degree of Competition in the Market Profit level Dividend policy amitabha maheshwari 8
    9. 9.  Liquidity vs. Profitability Choosing the Pattern of Financing amitabha maheshwari 9
    10. 10. amitabha maheshwari 10
    11. 11.  Working capital management refers to the administration of all components of working capital-cash , marketable securities, debtors (receivables), stock (inventories),creditors (payables). The financial manager must determine the levels and composition of current assets. He must see that right sources are tapped to finance current assets, and that current liabilities are paid in time. amitabha maheshwari 11
    12. 12.  There are many aspects of working capital management which make it an important function of the financial manager. ◦ Time: Working capital management requires much of the financial managers time. ◦ Investment: Working capital represents a large portion of the total investment in assets. ◦ Criticality: Working capital management has great significance for all. Firms but it is very critical for small firms. ◦ Growth The need for working capital is directly related to the firms growth. amitabha maheshwari 12
    13. 13.  The financial manager should determine the optimum level of current assets so that the wealth of shareholders is maximized. A firm needs fixed and current assets to support a particular level of output. However, to support the same level of output, the firm can have different levels of current assets. As the firms output and sales increase, the need for current assets increases. amitabha maheshwari 13
    14. 14.  Generally, Current assets do not increase in direct proportion to output. Current assets may increase at a decreasing rate with output. The level of the current assets can be measured by relating current assets to fixed assets. Dividing current assets by fixed assets gives CA/FA ratio. Assuming a constant level of fixed assets, amitabha maheshwari 14
    15. 15.  A higher CA/FA ratio indicates a conservative current assets policy. It implies greater liquidity and lower risk; A lower CA/FA ratio means an aggressive current assets policy, it indicates higher risk and poor liquidity. Moderate Coverage current assets policy falls in the middle of conservative and aggressive policies. The current assets policy of the most firms may fall between these two extreme policies. amitabha maheshwari 15
    16. 16.  Gross working capital and Net working capital. Gross working capital is equal to the total of all current assets (including ‘loans and advances’) of a company. Net working capital is defined as the difference between gross working capital and current liabilities (including ‘provisions’). Sometimes net working capital is also referred to as ‘net current assets.’ amitabha maheshwari 16
    17. 17.  Working capital can be viewed as the amount of capital required for the smooth and uninterrupted functioning of the normal business operations of a company ranging from the procurement of raw materials, converting the same into finished products for sale and realizing cash along with profit from the accounts receivables that arise from the sale of finished goods on credit. amitabha maheshwari 17
    18. 18.  Operating cycle is the time duration required to convert sales, after the conversion of resources into inventories, into cash. The operating cycle of a manufacturing company involves three phases:  Acquisition of resources such as raw material, labour, power and fuel etc.  Manufacture of the product which includes conversion of raw material into work-in-progress into finished goods.  Sale of the product either for cash or on credit. Credit sales create account receivable for collection. amitabha maheshwari 18
    19. 19.  The length of the operating cycle of a manufacturing firm is the sum of: inventory conversion period (ICP). Debtors (receivable) conversion period (DCP). Creditors or payables deferral period (CDP) amitabha maheshwari 19
    20. 20.  Inventory conversion period is the total time needed for producing and selling the product. Typically, it includes: raw material conversion period (RMCP) work-in-process conversion period (WIPCP) finished goods conversion period (FGCP) amitabha maheshwari 20
    21. 21.  Inventory conversion period is the total time needed for producing and selling the product. Typically, it includes:raw material conversion period (RMCP) Average Raw Materials=------------------- x 365 Raw material consumed work-in-process conversion period (WIPCP) finished goods conversion period (FGCP) amitabha maheshwari 21
    22. 22.  Inventory conversion period is the total time needed for producing and selling the product. Typically, it includes: raw material conversion period (RMCP)work-in-process conversion period (WIPCP) Average work in process=------------------- x 365 Total cost of production finished goods conversion period (FGCP) amitabha maheshwari 22
    23. 23.  Inventory conversion period is the total time needed for producing and selling the product. Typically, it includes: raw material conversion period (RMCP) work-in-process conversion period (WIPCP)finished goods conversion period (FGCP) Average stock (FG)=------------------- x 365 Total cost of goods sold amitabha maheshwari 23
    24. 24. The debtors conversion period is the time required to collect the outstanding amount from the customers. Average debtors=------------------- x 365 Total credit sales amitabha maheshwari 24
    25. 25. Creditors or payables deferral period (CDP) is the length of time the firm is able to defer payments on various resource purchases. Average Creditors=------------------- x 365 Total credit Purchases amitabha maheshwari 25
    26. 26.  Gross operating cycle (GOC) The total of inventory conversion period and debtors conversion period is referred to as gross operating cycle (GOC). Gross Operating Cycle = Raw Material Storage Period + Conversion period + Finished Goods Storage Period + Average Collection Period amitabha maheshwari 26
    27. 27.  Net operating cycle (NOC) NOC is the difference between GOC and CDP. Net Operating Cycle = Gross Operating Cycle – Average Payment period amitabha maheshwari 27
    28. 28.  RMCP ----- +WPCP ----- +FGCP ----- +RCP(DCP) ----- TOCP(Gross operating cycle) ----- - CDP ----- NOC ----- amitabha maheshwari 28
    29. 29.  What has been considered in figure above as working capital cycle is more popularly known as the operating cycle. This title is more expressive in the sense that the normal business operations of a manufacturing and trading company start with cash, go through the successive segments of the operating cycle, viz, raw material storage period, conversion period, finished goods storage period and average collection period before getting back cash along with profit. The total duration of all the segments mentioned above is known as ‘gross operating cycle period’. amitabha maheshwari 29
    30. 30. Calculate operational cycle No.of days requirement Inventory 60 Work-in-process 30 Finished products 30 Credit allowed to customers 30 Cash balance (approximate) 7 Creditors 30 amitabha maheshwari 30
    31. 31.  From the following information, extracted from the books of a manufacturing company, compute the operational cycle in days. Period covered : 365 days. Average Period of credit allowed by Suppliers - 16 days. Rs.’000Average total of debtors outstanding 480Raw-material consumption 4,400Total Production Cost 10,000Total Cost of Sales 10,500Sales for the yearValue of Average Stock maintained -- 16,000Raw-material 320Work - in -Progress 350Finished Goods 260 amitabha maheshwari 31
    32. 32. From the following details, prepare an estimate of the requirement of working Capital Production 60,000Units Selling price per unit Rs. 5 Raw Materials 60% of selling Price Direct wages 10% of selling Price Overheads 20% of selling Price Materials in hand 2 month’s requirements Production Time 1 month Finished Goods in Stores 3 months Credit for Material 2 months Credit allowed to Customers 3 months Average Cash Balance Rs. 20,000 Wages and overheads are paid at the beginning of the month following. in production all the required materials are charged in the initial stage and wages and overheads accrue evenly. amitabha maheshwari 32
    33. 33. Cash conversion cycle (CCC) CCC is the difference between NOP and non-cash items like depreciation.#NOP: net operating profit amitabha maheshwari
    34. 34.  Gross Operating Cycle = Raw Material Storage Period + Conversion period + Finished Goods Storage Period + Average Collection Period Net Operating Cycle = Gross Operating Cycle – Average Payment period amitabha maheshwari 34
    35. 35. Current Assets:L Cash ----L Debtors or Receivables(for ..month’s sales ) ----v Stock (for…month’s sales) ----’ Advance payment, if any ---- Others ----Total Current Assets ----Less: Current Liabilitiesa Creditors (for..month’s Purchases) ----m Lag in payment of expenses(o/s expenses, if any) ----Total Current Liabilities ----Working capital(C.A. – C.L. ) ----Add: Provision / Margin For Contingencies ----Net Working Capital Required ---- amitabha maheshwari 35
    36. 36. Current Assets(i)Stock of Raw Material(for…month’s consumption) ----(ii) Work – in- Process (For..month’s) (a) Raw Materials ---- (b) Direct Labour ---- (c) Overheads ---- ----(iii) Stock of finished Goods (For.. Month’s sales) (a) Raw Materials ---- (b) Direct Labour ---- (c) Overheads ---- ----(iv) Sundry Debtors(For..month’s sales) (a) Raw Materials ---- (b) Direct Labour ---- (c) Overheads ---- ----(V) Payment in advance ----(vi) Balance of cash (Required to meet day-to-day exp.) ----Total current AssetsLess: Current Liabilities:a Creditors (for..month’s Purchases) ----m Lag in payment of expenses(o/s expenses, if any) ---- ----Total Current Liabilities ----Working capital(C.A. – C.L. ) ----Add: Provision / Margin For Contingencies ----Net Working Capital Required ----- amitabha maheshwari 36
    37. 37. Prepare an estimate of working capital requirement from the following information of a trading concern(b)Project annual sales 100000 units(c) Selling price Rs. 8 per unit(d)Net profit on sales 25%(e)Average credit period allowed to customers 8 weeks(f) Average credit period allowed by suppliers 4 weeks(g)Average stock holding in terms of sales requirement 12 weeks(g) Allow 10% for contingencies amitabha maheshwari 37
    38. 38. Current AssetsDebtors(8 weeks) 92,308Stock (12 weeks) 1,38,462 2,30,770Less: Current LiabilitiesCreditors(4 weeks) 46,154Net Working Capital 1,84,616Add 10% for Contingencies 18,462Working Capital Required 2,03,078 amitabha maheshwari 38
    39. 39.  Liquidity Availability of Cash Inventory Turnover Credit Extended to Customers Credit Obtained from Suppliers amitabha maheshwari 39
    40. 40.  Current Ratio Quick Ratio Cash to Current Assets Sales to Cash Average Collection Period Inventory Turnover Ratio Working Capital to Sales amitabha maheshwari 40
    41. 41.  Objective of Working Capital Management Static view of Working Capital Dynamic view of Working Capital Determination of Operating Cycle Evaluating Working Capital Management amitabha maheshwari 41
    42. 42. amitabha maheshwari 42

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