Advanced Working Capital Management

1. WORKING CAPITAL
MANAGEMENT
Dr. MANGESH M. BHOPLE
Asst. Prof.,
MIT Arts, commerce and science college,
Alandi (D) Pune

2.  Working Capital are the funds necessary
to carry out the day-to-day operations of
an organization.
 It is similar to the blood circulation system
in our body.
 Generally, ‘working capital’ means the difference between current assets
and current liabilities.
Introduction

3.  Current Assets may be defined as assets
convertible into cash within a period of
one year, e.g. Inventory, Receivables,
Prepaid exp., Short term investments etc.
 Current Liabilities refer to those liabilities
which are payable within a period of one
year, for e.g. Creditors, B/P, outstanding
exp. etc.
Introduction

4.  Working Capital Management can be defined as the management of a
firm’s sources and uses of working capital, for maximization of
shareholders’ wealth.
 Working capital management is a short term concept, and hence time
value of money not considered.
 Working capital affects the short term liquidity.
 Excess working capital implies blocking up funds that can be productively
used elsewhere.
 Insufficient working capital affects profitability, prod interruptions,
inefficiencies and results in loss of opportunity, e.g. stock-outs, delayed
payments etc.
Working Capital
Management

5. Effects of excessive working capital –
Unnecessary accumulation of inventories, resulting in possibility of theft,
wastage etc.
Indication of defective credit policy, resulting in delays in collection of
debtors, bad debts etc.
Excess working capital makes management complacent, leading to
inefficiencies
Higher liquidity may result in incorrect decision making, unproductive use of
resources
Idle cash – loss of investment opportunity, risk of theft and misappropriation.
Symptoms of poor
management

6. Effects of inadequate working capital –
It stagnates growth, it becomes tough for the firm to undertake profitable
projects due to non-availability of working capital resources/ funds.
Difficult to implement operating plans and achieve firm’s profit targets.
Operating inefficiencies due to daily crunch situation.
Fixed assets are not efficiently utilized, leading to decreased profitability
Interruptions in production, stock-outs, delivery schedules not met, poor
quality (i.e. loss of reputation)
Symptoms of poor
management

7. Ω Gross Working Capital – refers to firm’s investment in all the current assets
taken together.
Ω Net Working Capital – refers to the excess of total current assets over total
current liabilities. The net working capital measures the firm’s liquidity.
Ω Permanent Working Capital – minimum level of WC always required by a
firm to maintain its activities. Also known as ‘Fixed’ or ‘Core’ working
capital.
Ω Temporary Working Capital – WC required to meet seasonal changes,
fluctuations, contingencies etc.
Types of Working
Capital

8. 1) Nature of Business
 WC needs of trading firms, retail shops is very less since their business is on
cash basis, small scale
 Large manufacturing concerns require huge WC, due to various production,
processing, packing, inventory, selling, receivables etc.
2) Business Cycle Fluctuations
 Periods of boom, recession, recovery etc.
 In case of boom phase, there are inflationary pressures and WC needs
increase.
 In case of recession, there is dullness in business and WC requirements
decrease.
Factors determining WC
needs –

9. 3) Seasonal Operations
 WC needs fluctuate as per seasonal activities.
 For e.g. ice-creams, AC, coolers – demand is highest in summers and WC
requirement shoots up due to higher stock of inventories and receivables. In
winters, the same WC level may not be required.
4) Market Competitiveness
 To cope up with the competition, firm may give liberal terms to customers,
increasing its receivables
 Larger inventories may be maintained to fulfill market demands and quick
supply.
Factors determining WC
needs –

10. 5) Credit Policy
 Credit policy means the total terms and conditions on which goods are sold
and purchased.
 Every firm deals with two credit policies – supplier policies and customer
policies. Hence, WC needs depends on the favourable balancing of credit
policies.
6) Supply Conditions
 Availability of raw material, lead times for delivery determine the WC needs
 Import policies, logistics management affect the WC requirements.
Factors determining WC
needs –

11. # Overtrading means to maintain or expand the scale of operations, with
insufficient cash resources.
# Normally, firms with a tendency of overtrading have a high turnover ratio
and low current ratio.
# There are immense pressures on liquidity, position is very critical – low
stocks (RM & FG), no credit to customers, delayed payment to creditors etc.
# Such a situation is very dangerous to the business, since disproportionate
increase in operations without adequate resources, might cause a sudden
collapse.
Overtrading

12. ø Working Capital depletion
ø Faulty financial policy like using WC for FA purchases
ø Over-expansion without adequate resources
ø Inflation and rising prices, material, labour costlier
ø Excessive taxation resulting in cash outflows
ø Liberal dividend policies
Causes of Overtrading

13. ♠ Difficulty in paying salaries & taxes, (uncertainty,
brand)
♠ Purchase cost will go up due to no bargain power,
no bulks
♠ Pressure in sales, coz strict credit policies, stock outs
etc.
♠ Reduction in profits- high discounts, low selling
prices
♠ Wear-tear of fixed assets due to non-maintenance
Consequences of
Overtrading

14. ¢ Under-trading is the exact opposite of overtrading, where there is
improper and under-utilization of funds. Cash lying idle in the business.
¢ There are increased levels of inventory, debtors and high cash balances.
Under-trading is nothing but over-capitalization vis-à-vis current operation
levels.
¢ Reasons may be conservative policies, recession, lack of opportunities etc.
¢ Consequences are reduction in profits, low rate of returns, falling share
price, loss of reputation etc.
Under-trading

15. Financing Working
Capital
1) Trade Credit
2) Commercial Banks
a) WC term loans
b) Cash credit facility
c) Bank overdraft
d) Bill discounting
3) Outstanding expenses
4) Inter-corporate deposits
5) Commercial Paper
6) Factoring of Receivables
Short Term
Sources

16. Financing Strategy
 Matching Approach – matches the expected life of assets
with the expected life of the source of funds raised to finance
assets. Also known as Hedging Approach, long term funds
for fixed assets and short term funds for working capital
(short term).
 Conservative Approach – depends on long-term financing
for both, fixed assets and current assets. In periods of
recession, idle funds are invested in tradable securities.
 Aggressive Approach – use of higher short-term financing
for current assets as well as some part of fixed assets. Higher
risk involved in this approach.

17. Govt.
Recommendations
• Banks play a vital role in working capital financing.
• Over a period of time, Reserve Bank of India has formed
various committees to decide the norms for working
capital financing by commercial banks.
• Based on the recommendations of these committees, RBI
sets the norms for granting working capital finance to
companies.
Dahejia Committee
Tandon Committee
Chore Committee

18. Dahejia Committee (1968)
Findings –
• Companies were using short
term credit in excess of its
requirements.
• Short-term funds were used
for purchase of long-term
assets, i.e. fixed assets.
• Financing of commercial
banks was security-oriented.
• Financial position of the
borrower was not assessed
• Repayment was long-term
Recommendations –
• Thorough credit appraisal be
done, cash flow statements
• Present & projected financial
position must be analysed
• Total funds be divided into 2
heads – permanent needs
and temporary requirements
• Companies should avoid
multiple borrowings, deal
with single bank only.

19. Tandon Committee (1975)
Recommendations –
• Borrower must provide in
advance an operating plan.
• Bank to appraise such plans.
• Bank should finance genuine
production needs of a firm
• Borrower must maintain
reasonable levels of stocks
and accounts receivables
• Bank to finance only a part
of borrower’s requirements,
balance by borrower himself.
Findings –
• Borrower decides amount
of borrowing, rather than
the banker.
• Bank credit is treated as the
first source of finance
• Short-term funds are used
for long-term purposes
• Bank finance was based on
security, and not operations
• Sufficient credit analysis
was not done by banks.

20. Recommendations (contd.) –
• Banks should finance only a reasonable level of current
assets, as per normal industry norms. Suggested 15 industries
to be covered such as paper, pharma, engg., cement, oil etc.
• Maximum Permissible Bank Finance (MPBF) –
– Bank to finance 75% of working capital gap (CA – CL).
Borrower to maintain min current ratio of 1:1
– Bank to finance 75% of current assets, current ratio 1.3:1
– Borrower to contribute 100% of permanent current assets
and 25% of balance current assets. Still higher current ratio.
• Cash credit facility should be divided into fixed demand loan
and a fluctuating cash credit facility based on requirements.
Tandon Committee (1975)

21. Chore Committee (1980)
Recommendations –
• Borrowers to reduce their dependence on bank credit.
• 2nd slab of Tandon be used
• Introduction of ‘WCTL’ repayable in five years
• Credit limits bifurcated into peak level & non-peak level
• Ad-hoc credits discouraged
• Borrowers with working cap limits > 50 lakhs to submit
quarterly statements of funds.

22. Commercial Paper (CP)
σ An unsecured promissory note issued as a debt
σ Purpose is raising short term funds (30 – 180 days)
σ Issued by highly-rated corporate borrowers
σ CP can be issued to any person, bank, company
σ CP are negotiable, by endorsement and delivery
σ Issued at discount and redeemed at face value
σ Denomination of Rs. 5 lakhs, max investment per individual
investor Rs. 25 lakhs.
σ Issuing company must have minimum tangible net worth of
Rs. 5 crores
σ Issuing company’s shares must be listed on exchange
σ Issuing company must obtain credit ratings
σ Current ratio should be 1.33

23. Factoring
 Factoring is a mechanism of managing, financing &
collecting of receivables. It is a formal agreement
between a ‘Factor’ (i.e. specialist) and client (i.e. seller)
 Factoring is a method of selling receivables to a
company that specializes in their collection and
administration.
 A factor is a financial institution (e.g. bank) that offers
the following services for management of receivables –
* Finance the customer (loans and advances etc.)
* Maintenance of accounts (relating to receivables)
* Collection of receivables
* Protection against default in payment by debtors

24. Factoring
 Purchase of receivables is the prime function of
factoring. It also provides the following basic services –
 Credit administration – a factor helps in deciding credit
extension to customers. It maintains proper accounts of all
customers as per due dates, provides info for credit analysis
and determining credit- worthiness, monitoring debtors etc.
 Credit collection & protection – a factor undertakes all the
collection activities. It provides full/ partial support against
bad debts.
 Financial assistance – providing loans and advances against
book debts. Advances of 70-80 % are provided to the clients.
 A factor charges commission for its various services,
interest on loans & advances and reserve for bad-debts.

25. Thank You!!!!!