The document discusses working capital, which refers to the capital available for conducting day-to-day business operations. It defines working capital as current assets minus current liabilities. There are two types of working capital: gross working capital, which is total current assets, and net working capital, which is current assets minus current liabilities. The objective of working capital management is to maintain an optimal level of working capital to balance liquidity, profitability, and risk. Factors like the business cycle, credit policy, and production cycles determine a firm's working capital needs. Firms require both permanent working capital to fund minimum operational needs and temporary working capital that fluctuates with sales volumes.

2. Working capital issue

3. WORKING CAPITAL
• The capital of a business which is used in its
day-to-day trading operations, calculated as
the current assets minus the current liabilities.
Net Working Capital
Current Assets - Current Liabilities.
There are two concepts of working capital:
Gross and Net.

4. Gross and net working capital
• Gross working capital- means the total
current assets.
• Net working capital- can be defined in two
ways-
o The difference between current assets and
current liabilities.
o The portion of current assets which is
financed with long term funds.

5. Working capital management
• Working capital management is concerned
with the problems that arise in attempting to
manage the current assets, the current
liabilities and the interrelations that exist
between them.

6. Current asset and current liabilities
• Current assets: refer to those assets which in the ordinary
course of business can be, or will be, converted into cash
within one year without undergoing a diminution in value
and without disrupting the operations of the firm.
Examples- cash, marketable securities, accounts receivable
and inventory.
• Current liabilities: are those liabilities which are intended,
at their inception, to be paid in the ordinary course of
business, within a year, out of the current assets or the
earnings of the concern.
Examples- accounts payable, bills payable, bank overdraft
and outstanding expenses.

7. Objective of Working Capital
Management
• The goal of working capital management is to
manage the firm’s current assets and liabilities
in such a way that a satisfactory level of
working capital is maintained.
• The interaction between current assets and
current liabilities is, therefore the main theme
of the theory of the working capital
management.

8. Determinants of Working capital
Requirement
• General nature of business
• Production cycle
• Business cycle fluctuations
• Production policy
• Credit policy
• Growth and expansion
• Profit level
• Level of taxes
• Dividend policy
• Depreciation policy
• Price level changes
• Operating efficiency

9. The Operating-cycle and Working
Capital Needs
• The working capital requirements of a firm depends, to a great
extent upon the operating cycle of the firm. The operating cycle
may be defined as the time duration starting from the
procurement of goods or raw materials and ending with the sales
realization.
• The length and nature of the operating cycle may differ from one
firm to another depending upon the size and nature of the firm.
• The operating cycle of a firm consists of the time required for the
completion of the chronological sequence of some or all of the
following-
o Procurement of raw materials and services.
o Conversion of raw materials into work-in-progress.
o Conversion of work-in-progress into finished goods.
o Sale of finished goods.
o Conversion of receivables into cash.

10. Classifications of Working
Capital
• Time
– Permanent
– Temporary
 Components
 Cash, marketable securities,
receivables, and inventory

11. Types of working capital needs
• The working capital need can be divided into permanent
working capital and temporary working capital.
• Permanent working capital- There is always a minimum level
of working capital which is continuously required by a firm
in order to maintain its activities like cash, stock and other
current assets in order to meet its business requirements
irrespective of the level of operations.
• Temporary working capital- Over and above the permanent
working capital, the firm may also require additional
working capital in order to meet the requirements arising
out of fluctuations in sales volume. This extra working
capital needed to support the increased volume of sales is
known as temporary or fluctuating working capital.

12. Permanent Working
Capital
The amount of current assets required to meet a
firm’s long-term minimum needs.
Permanent current assets
TIME
DOLLARAMOUNT

13. Temporary Working
Capital
The amount of current assets that varies with
seasonal requirements.
Permanent current assets
TIME
DOLLARAMOUNT
Temporary current assets

14. Significance of Working Capital
Management
• In a typical manufacturing firm, current assets
exceed one-half of total assets.
• Excessive levels can result in a substandard Return
on Investment (ROI).
• Current liabilities are the principal source of external
financing for small firms.
• Requires continuous, day-to-day managerial
supervision.
• Working capital management affects the company’s
risk, return, and share price.

15. Working Capital Issues
Assumptions
• 50,000 maximum units
of production
• Continuous
production
• Three different
policies for current
asset levels are
possible
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL($)
Current Assets
Policy C
Policy A
Policy B

16. Impact on Liquidity
Liquidity Analysis
Policy Liquidity
A High
B Average
C Low
Greater current asset
levels generate more
liquidity; all other factors
held constant.
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL($)
Current Assets
Policy C
Policy A
Policy B

17. Impact on
Expected Profitability
Return on Investment =
Net Profit
Total Assets
Let Current Assets = (Cash +
Rec. + Inv.)
Return on Investment =
Net Profit
Current + Fixed Assets
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL($)
Current Assets
Policy C
Policy A
Policy B

18. Impact on
Expected Profitability
Profitability Analysis
Policy Profitability
A Low
B Average
C High
As current asset levels
decline, total assets will
decline and the ROI will rise.
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL($)
Current Assets
Policy C
Policy A
Policy B

19. Impact on Risk
• Decreasing cash reduces the
firm’s ability to meet its
financial obligations. More
risk!
• Stricter credit policies reduce
receivables and possibly lose
sales and customers. More
risk!
• Lower inventory levels
increase stockouts and lost
sales. More risk!
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL($)
Current Assets
Policy C
Policy A
Policy B

20. Impact on Risk
Risk Analysis
Policy Risk
A Low
B Average
C High
Risk increases as the level of
current assets are reduced.
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL($)
Current Assets
Policy C
Policy A
Policy B

21. Summary of the Optimal
Amount of Current Assets
SUMMARY OF OPTIMAL CURRENT ASSET ANALYSIS
Policy Liquidity Profitability Risk
A High Low Low
B Average Average Average
C Low High High
1. Profitability varies inversely with liquidity.
2. Profitability moves together with risk.
(risk and return go hand in hand!)

22. Current asset working capital
• For instance, if the owner makes an additional
investment of $20,000 in her company, the
company's total current assets will increase by
$20,000 but there is no increase in its current
liabilities. As a result, the company's working
capital increases by $20,000. (The other
change is an increase in the owner's capital
account.)
Current asset working capital

23. Current asset working capital
• If a company borrows $50,000 and agrees to
repay the loan in 90 days, the company's
working capital has not increased. The reason
is that the current asset Cash increased by
$50,000 and the current liability Loans
Payable also increased by $50,000.

24. Current asset working capital
• The use of $30,000 to buy merchandise
for inventory will not change the amount of
working capital. The reason is that the total
amount of current assets will not change. The
current asset Cash decreases by $30,000 and
the current asset Inventory increases by
$30,000.

25. Current asset working capital
• If a company sells a product for $3,400 which
is in its inventory at a cost of $2,500 the
company's working capital will increase by
$900. Working capital increased because 1)
the current asset accounts Cash or Accounts
Receivable will increase by $3,400 and
Inventory will decrease by $2,500; 2) current
liabilities will not change. Owner's equity will
increase by $900.

26. Current liability working capital
• Payment made to creditors causes decrease in
current assets and also decrease in current
liability but not affect working capital.
• Bank overdraft paid by issue of preference
shares cause decrease in current liability but
increase in non current liability.

27. Current liability working capital
• Bank over draft to redeem debenture causes an
increase in current liability but also decrease non
current liability.
• If a company borrows $50,000 and agrees to
repay the loan in 90 days, the company's working
capital has not increased. The reason is that the
current asset Cash increased by $50,000 and the
current liability Loans Payable also increased by
$50,000.

28. Financing current assets and
short term and long term mix

29. What is financing?
• Financing is defined as a means of obtaining
the resources to purchase an item, then
paying back the loan in a set time period for
a set monthly, weekly, yearly.

30. What is short term financing
• Arranging of available External funds to meet
the needs of a firm for a year or less time.

31. Why Do Firms Need Short-term
Financing
 Cash flow from operations may not be
sufficient to keep up with growth-related
financing needs.
Firms may prefer to borrow now for their
inventory or other short term asset needs
rather than wait until they have saved
enough.
Firms may prefer short-term financing
instead of long-term sources of financing.

32. Sources for short term financing
 Trade credit
 Accrued expenses
 Bank financing
 Factoring
 Commercial paper

33. 1.Trade credit
 It is a credit that a customer gets from
supplier of goods.
 It is the spontaneous source of financing.
 In this the buying firm don’t pay immediately.
 Deferral of payments is a short- term
financing called “Trade Credit.”

34. 2. Accrued expenses
• It represents the liability that a firm has to
pay for those services which have been
received earlier.
 Accrued wages and salaries
 Accrued taxes and interest

35. 3.Bank financing
 Bank overdraft
 Cash credit
 Purchase and discounting of bills
 Short term loan
 Letter of credit

36. 4. Commercial paper
• It is unsecured money market instruments issued
in the form of a promissory note.
 It was introduced in India in 1990.
 RBI regulates the Commercial paper.
 Corporates, primary dealers, Indian financial
institution are eligible to issue it.
 A corporate firm can be eligible to offer a
Commercial paper if it has the value of 10 crore.
 Maturity of Cp in india is 91 to 180 days.

37. 5.Factoring
 It is financial transaction where a firm sells
its account receivable to any third party.
It emphasizes on the receivable financial
assets
It involves the purchase of financial assets
It involves three parties
Period for factoring is 90 to 150 days.

38. Sources for long term financing
The main sources of long term finance are as follows:
1. Shares: These are issued to the general public. These may be
of two types: (i)Equity & (ii)Preference. The holders of shares
are the owners of the business.
2. Debentures: These are also issued to the general public. The
holders of debentures are the creditors of the company.
3. Public Deposits :General public also like to deposit their
savings with popular and well established company which can
pay interest periodically and pay-back the deposit when due.
.

39. 4. Retained earnings:
The company may not distribute the whole of its
profits among its shareholders. It may retain a part of
the profits and utilize it as capital
5. Term loans from banks:
Many industrial development banks, cooperative
banks and commercial banks grant medium term
loans for a period of three to five years.
6. Loan from financial institutions:
There are many specialized financial institutions
established by the Central and State governments
which give long term loans at reasonable rate of
interest.

40. Financing Current Assets: Short-Term
and Long-Term Mix
Spontaneous Financing: Trade credit, and other
payables and accruals, that arise spontaneously in
the firm’s day-to-day operations.
– Based on policies regarding payment for purchases,
labor, taxes, and other expenses.
– We are concerned with managing non-spontaneous
financing of assets.

41. Hedging (or Maturity
Matching) Approach
A method of financing where each asset would be offset with a financing
instrument of the same approximate maturity.
TIME
DOLLARAMOUNT
Long-term financing
Fixed assets
Current assets*
Short-term financing**

42. Hedging (or Maturity
Matching) Approach
* Less amount financed spontaneously by payables and accruals.
** In addition to spontaneous financing (payables and accruals).
TIME
DOLLARAMOUNT
Long-term financing
Fixed assets
Current assets*
Short-term financing**

43. Financing Needs and
the Hedging Approach
• Fixed assets and the non-seasonal portion of
current assets are financed with long-term debt and
equity (long-term profitability of assets to cover the
long-term financing costs of the firm).
• Seasonal needs are financed with short-term loans
(under normal operations sufficient cash flow is
expected to cover the short-term financing cost).

44. Self-Liquidating Nature of
Short-Term Loans
• Seasonal orders require the purchase of inventory
beyond current levels.
• Increased inventory is used to meet the increased
demand for the final product.
• Sales become receivables.
• Receivables are collected and become cash.
• The resulting cash funds can be used to pay off the
seasonal short-term loan and cover associated long-
term financing costs.

45. Risks vs. Costs Trade-Off
(Conservative Approach)
• Long-Term Financing Benefits
– Less worry in refinancing short-term obligations
– Less uncertainty regarding future interest costs
• Long-Term Financing Risks
– Borrowing more than what is necessary
– Borrowing at a higher overall cost (usually)
• Result
– Manager accepts less expected profits in exchange for
taking less risk.

46. Risks vs. Costs Trade-Off
(Conservative Approach)
Firm can reduce risks associated with short-term borrowing by using a
larger proportion of long-term financing.
TIME
DOLLARAMOUNT
Long-term financing
Fixed assets
Current assets
Short-term financing

47. Comparison with an
Aggressive Approach
• Short-Term Financing Benefits
– Financing long-term needs with a lower interest cost than
short-term debt
– Borrowing only what is necessary
• Short-Term Financing Risks
– Refinancing short-term obligations in the future
– Uncertain future interest costs
• Result
– Manager accepts greater expected profits in exchange for
taking greater risk.

48. Firm increases risks associated with short-term borrowing by using a
larger proportion of short-term financing.
TIME
DOLLARAMOUNT
Long-term financing
Fixed assets
Current assets
Short-term financing
Risks vs. Costs Trade-Off
(Aggressive Approach)

49. Summary of Short- vs. Long-
Term Financing
Financing
Maturity
Asset
Maturity
SHORT-TERM LONG-TERM
Low
Risk-Profitability
Moderate
Risk-Profitability
Moderate
Risk-Profitability
High
Risk-Profitability
SHORT-TERM
(Temporary)
LONG-TERM
(Permanent)

50. Motives for holding cash

51. WHAT IS CASH?
• In narrow sense: currency and generally accepted
equivalents of cash like cheques, drafts etc.
• In broad sense: includes near-cash assets, such as
marketable securities and time deposits in banks.
– They can be readily sold and converted into cash.
– Can serve as a reserve pool of liquidity.
– Also provide short term investment outlet for excess cash.

52. Motives for holding cash
• Transaction motive
• Precautionary motive
• Speculative motive
• compensating motive

53. Transaction motive
• Holding of cash to meet routine cash requirements
to finance the transactions which a firm carries on in
the ordinary course of business.

54. Precautionary motive
• The cash balances held in reserve for random and
unforeseen fluctuations in cash flows.
• A cushion to meet unexpected contingencies.
– Floods, strikes and failure of imp customers
– Unexpected slowdown in collection of accounts
receivable
– Sharp increase in cost of raw materials
– Cancellation of some order of goods
• Defensive in nature

55. Speculative motive
• Is a motive for holding cash/near-cash to quickly take
advantage of opportunities typically outside the
normal course of business.
• Positive and aggressive approach
• Helps to take advantage of:
– An opportunity to purchase raw materials at reduced price
– Make purchase at favorable prices
– Delay purchase on anticipation of decline in prices
– Buying securities when interest rate is expected to decline

56. Compensating motive
• Is a motive for holding cash/near-cash to
compensate banks for providing certain services or
loans.
• Clients are supposed to maintain a minimum balance
of cash at the bank which they cannot use
themselves.

57. Speeding up cash receipts and
slowing down cash payments

58. Speeding Up
Cash Receipts
• Expedite preparing and mailing the invoice
• Accelerate the mailing of payments from
customers
• Reduce the time during which payments received
by the firm remain uncollected
Collections

59. Collection Float
Collection Float: total time between the mailing
of the check by the customer and the availability
of cash to the receiving firm.
Processing
Float
Availability
Float
Mail
Float
Deposit Float

60. Mail Float
Mail Float: time the check is in the mail.
Customer
mails check
Firm
receives check

61. Processing Float
Processing Float: time it takes a company
to process the check internally.
Firm
deposits check
Firm
receives check

62. Availability Float
Availability Float: time consumed in clearing
the check through the banking system.
Firm
deposits check
Firm’s bank
account credited

63. Deposit Float
Deposit Float: time during which the check
received by the firm remains uncollected funds.
Processing Float Availability Float

64. Earlier Billing
Accelerate preparation and mailing of
invoices
– computerized billing
– invoices included with shipment
– invoices are faxed
– advance payment requests
– preauthorized debits

65. Preauthorized Payments
Preauthorized debit
The transfer of funds from a payor’s bank
account on a specified date to the payee’s bank
account; the transfer is initiated by the payee
with the payor’s advance authorization.

66. Lockbox Systems
Traditional Lockbox
A post office box maintained by a firm’s bank that is
used as a receiving point for customer remittances.
Electronic Lockbox
A collection service provided by a firm’s bank that
receives electronic payments and accompanying
remittance data and communicates this information to
the company in a specified format.

67. Lockbox Process*
• Customers are instructed to mail their remittances to
the lockbox location.
• Bank picks up remittances several times daily from
the lockbox.
• Bank deposits remittances in the customers account
and provides a deposit slip with a list of payments.
• Company receives the list and any additional mailed
items.
* Based on the traditional lockbox system

68. Lockbox System
Disadvantage
Cost of creating and maintaining a lockbox
system. Generally, not advantageous for small
remittances.
Advantage
Receive remittances sooner which reduces
processing float.

69. Concentration Banking
Compensating Balance
Demand deposits maintained by a firm to
compensate a bank for services provided, credit
lines, or loans.
Cash Concentration
The movement of cash from lockbox or field
banks into the firm’s central cash pool residing
in a concentration bank.

70. Concentration Banking
• Improves control over inflows and outflows
of corporate cash.
• Reduces idle cash balances to a minimum.
• Allows for more effective investments by
pooling excess cash balances.
Moving cash balances to
a central location:

71. Concentration Services for
Transferring Funds
Definition: A non-negotiable check payable to a
single company account at a
concentration bank.
Funds are not immediately available upon
receipt of the DTC.
(1) Depository Transfer Check (DTC)

72. Concentration Services for
Transferring Funds
Definition: An electronic version of the depository
transfer check (DTC).
(1) Electronic check image version of the DTC.
(2) Cost is not significant and is replacing DTC.
(2) Automated Clearinghouse
(ACH) Electronic Transfer

73. Concentration Services for
Transferring Funds
Definition: A generic term for electronic funds
transfer using a two-way
communications system, like
Fedwire.
Funds are available upon receipt of the wire
transfer. Much more expensive.
(3) Wire Transfer

74. S-l-o-w-i-n-g D-o-w-n
Cash Payouts
• “Playing the Float”
• Control of Disbursements
– Payable through Draft (PTD)
– Payroll and Dividend
Disbursements
– Zero Balance Account (ZBA)
• Remote and Controlled Disbursing

75. “Playing the Float”
You write a check today, which is subtracted from your
calculation of the account balance. The check has not
cleared, which creates float. You can potentially earn
interest on money that you have “spent.”
Net Float -- The dollar difference between the
balance shown in a firm’s (or individual’s)
checkbook balance and the balance on the bank’s
books.

76. Control of Disbursements
Solution:
Centralize payables into a single (smaller number
of) account(s). This provides better control of the
disbursement process.
Firms should be able to:
1. shift funds quickly to banks from which
disbursements are made.
2. generate daily detailed information on
balances, receipts, and disbursements.

77. Methods of Managing
Disbursements
• Delays the time to have funds on deposit to cover
the draft.
• Some suppliers prefer checks.
• Banks will impose a higher service charge due to
the additional handling involved.
Payable Through Draft (PTD):
A check-like instrument that is drawn against the payor
and not against a bank as is a check. After a PTD is
presented to a bank, the payor gets to decide whether to
honor or refuse payment.

78. Methods of Managing
Disbursements
• Many times a separate account is set up to handle each
of these types of disbursements.
• A distribution scheduled is projected based on past
experiences.
• Funds are deposited based on expected needs.
• Minimizes excessive cash balances.
Payroll and Dividend Disbursements
The firm attempts to determine when payroll and
dividend checks will be presented for collection.

79. Methods of Managing
Disbursements
• Eliminates the need to accurately
estimate each disbursement account.
• Only need to forecast overall cash needs.
Zero Balance Account (ZBA):
A corporate checking account in which a zero balance is
maintained. The account requires a master (parent)
account from which funds are drawn to cover negative
balances or to which excess balances are sent.

80. Remote and Controlled
Disbursing
Example: A Vermont business pays a Maine supplier with a
check drawn on a bank in Montana.
This may stress supplier relations, and raises ethical issues.
Remote Disbursement -- A system in which the firm
directs checks to be drawn on a bank that is
geographically remote from its customer so as to
maximize check-clearing time.
This maximizes disbursement float.

81. Remote and Controlled
Disbursing
Late check presentments are minimal, which allows more
accurate predicting of disbursements on a day-to-day
basis.
Controlled Disbursement -- A system in which the
firm directs checks to be drawn on a bank (or
branch bank) that is able to give early or mid-
morning notification of the total dollar amount of
checks that will be presented against its account
that day.

82. Combining liability structure and
current assets decision

83. Combining Liability Structure and
Current Asset Decisions
• The level of current assets and the method of
financing those assets are interdependent.
• A conservative policy of “high” levels of current
assets allows a more aggressive method of
financing current assets.
• A conservative method of financing
(all-equity) allows an aggressive policy of “low”
levels of current assets.