SlideShare a Scribd company logo
1 of 12
Unit 5
Liquidity Decisions
Working Capital
• The working capital management refers to management of the working capital, or to be more
precise, the management of current assets. A firm’s working capital consists of its investment in
current assets which include short term assets such as cash and bank balance, inventories,
receivables (including debtors and bills), and marketable securities.
• Working capital management refers to the management of the level of all these individual current
assets.
• The need for working capital management arises from two considerations.
• First, existence of working capital is imperative in any firm. The fixed assets which usually require
a large chunk of total funds, can be used at an optimum level only if supported by sufficient
working capital, and second, the working capital involves investment of funds of the firm.
• If the working capital level is not properly maintained and managed, then it may result in
unnecessary blocking of scarce resources of the firm. The insufficient working capital, on the
other hand, put different hindrances in smooth working of the firm. Therefore, the working
capital management needs attention of all the financial managers.
Cont..
• The term working capital refers to current assets which may be defined as (i) those which are
convertible into cash or equivalents within a period of one year, and (ii) those which are required to
meet day to day operations.
• The management of current assets is similar to that of fixed assets in the sense that in both cases a
firm analysis their effects on its return and risk. The management of fixed and current assets,
however, differs in three important ways:
• First, in managing fixed assets, time is a very important factor; consequently, discounting and
compounding techniques play a significant role in capital budgeting and a minor one in the
management of current assets.
• Second, the large holding of current assets, especially cash, firm’s liquidity position (and reduces
riskiness), but also reduces the overall profitability. Thus, a risk-return trade-off is involved in holding
current assets.
• Third, levels of fixed as well as current assets depend upon expected sales, but it is only the current
assets which can be adjusted with sales fluctuations in the short run.
• Thus, the firm has a greater degree of flexibility in managing current assets.
CONCEPTS OF WORKING CAPITAL
• Gross working capital refers to the firm’s investment in current assets. Current assets are the
assets which can be converted into cash within an accounting year and include cash, short-term
securities, debtors (accounts receivable or book debts), bills receivable and stock (inventory).
• Net working capital refers to the difference between current assets and current liabilities.
Current liabilities 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.
• Net working capital can be positive or negative. A positive net working capital will arise when
current assets exceed current liabilities. A negative net working capital occurs when current
liabilities are in excess of current assets.
• The two concepts of working capital—gross and net—are not exclusive; rather, they have equal
significance from the management viewpoint.
Cont..
• Too large an investment in current assets means tying up funds that can be productively used elsewhere (or
it means added interest cost if the firm has borrowed funds to finance the investment in current assets).
Excess investment may also expose the firm to undue risk e.g., in case, the inventory cannot be sold or the
receivables cannot be collected.
• On the other hand, too little investment also can be expensive. For example, insufficient inventory may
mean that sales are lost as the goods which a customer wants are not available. The result is that the
financial managers spend a large chunk of their time managing the current assets because level of these
assets changes quickly and a lack of attention paid to them may result in appreciably lower profits for the
firm.
• So, in the working capital management, a financial manager is faced with a decision involving some of the
considerations as follows :
• 1. What should be the total investment in working capital of the firm?
• 2. What should be the level of individual current assets ?
• 3. What should be the relative proportion of different sources to finance the working capital requirements ?
• Thus, the working capital management may be defined as the management of firm’s sources and uses of
working capital in order to maximize the wealth of the shareholders.
The operating Cycle and Working Capital
needs
• The working capital requirement 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.
• Thus, 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 :
• (i) Procurement of raw materials and services.
• (ii) Conversion of raw materials into work-in-progress.
• (iii) Conversion of work-in-progress into finished goods.
• (iv) Sale of finished goods (cash or credit).
• (v) Conversion of receivables into cash.
Cont..
• Operating Cycle Period : The length or time duration of the operating cycle of any firm can be defined
as the sum of its inventory conversion period (ICP) and the receivable conversion period (RCP).
• Inventory Conversion Period (ICP) : It is the time required for the conversion of raw materials into
finished goods sales. In a manufacturing firm the ICP is consisting of Raw Material Conversion Period
(RMCP), Work-in-Progress Conversion Period (WPCP), and the Finished Goods Conversion Period
(FGCP).
• The RMCP refers to the period for which the raw material is generally kept in stores before it is issued
to the production department.
• The WPCP refers to the period for which the raw materials remain in the production process before it is
taken out as a finished unit.
• The FGCP refers to the period for which finished units remain in stores before being sold to the
customers.
• Receivables Conversion Period (RCP) : It is the time required to convert the credit sales into cash
realization. It refers to the period between the occurrence of credit sales and collection of debtors.
• The total of ICP and RCP is also known as Total Operating Cycle Period (TOCP).
• The firm might be getting some credit facilities from the supplier of raw materials, wage earners etc.
The period for which the payments to these parties are deferred or delayed is known as Deferral
Period (DP).
Cont..
Cont..
Cont..
Cont..
Cont..

More Related Content

Similar to Liquidity Decisions in Financial management

Management of working capital
Management of working capitalManagement of working capital
Management of working capital
Harsimran Kaur
 
PPT-WORKING CAPITAL MGT-MBA-E-III, Aug-30.pptx
PPT-WORKING CAPITAL MGT-MBA-E-III, Aug-30.pptxPPT-WORKING CAPITAL MGT-MBA-E-III, Aug-30.pptx
PPT-WORKING CAPITAL MGT-MBA-E-III, Aug-30.pptx
musharrafk0272
 
Working capital management 2
Working capital management 2Working capital management 2
Working capital management 2
Jamna Bochu
 
Wc management ppt
Wc management pptWc management ppt
Wc management ppt
GS Popli
 
Working capital management 1
Working capital management 1Working capital management 1
Working capital management 1
RS P
 
Cost of Capital and Managing the working capital.pptx
Cost of Capital and Managing the working capital.pptxCost of Capital and Managing the working capital.pptx
Cost of Capital and Managing the working capital.pptx
GinoLacandula1
 

Similar to Liquidity Decisions in Financial management (20)

Working Capital Management
Working Capital ManagementWorking Capital Management
Working Capital Management
 
Meeting 5 - Working capital (Financial Reporting and Analysis)
Meeting 5 - Working capital (Financial Reporting and Analysis)Meeting 5 - Working capital (Financial Reporting and Analysis)
Meeting 5 - Working capital (Financial Reporting and Analysis)
 
WCM.pptx
WCM.pptxWCM.pptx
WCM.pptx
 
Management of working capital
Management of working capitalManagement of working capital
Management of working capital
 
working capital management
working capital managementworking capital management
working capital management
 
9)WCM NEW DOC (1) (PROJECT)
9)WCM NEW DOC (1) (PROJECT)9)WCM NEW DOC (1) (PROJECT)
9)WCM NEW DOC (1) (PROJECT)
 
PPT-WORKING CAPITAL MGT-MBA-E-III, Aug-30.pptx
PPT-WORKING CAPITAL MGT-MBA-E-III, Aug-30.pptxPPT-WORKING CAPITAL MGT-MBA-E-III, Aug-30.pptx
PPT-WORKING CAPITAL MGT-MBA-E-III, Aug-30.pptx
 
L09 working capital management
L09 working capital managementL09 working capital management
L09 working capital management
 
ALL ABOUT Working capital management
ALL ABOUT Working capital management ALL ABOUT Working capital management
ALL ABOUT Working capital management
 
Working capital management
Working capital managementWorking capital management
Working capital management
 
ITFT Working capital management
ITFT Working capital managementITFT Working capital management
ITFT Working capital management
 
NEED FOR AND IMPORTANCE OF FINANCE.pptx
NEED FOR AND IMPORTANCE OF FINANCE.pptxNEED FOR AND IMPORTANCE OF FINANCE.pptx
NEED FOR AND IMPORTANCE OF FINANCE.pptx
 
Financial managment
Financial managmentFinancial managment
Financial managment
 
Working capital management 2
Working capital management 2Working capital management 2
Working capital management 2
 
Wc management ppt
Wc management pptWc management ppt
Wc management ppt
 
Working capital management 1
Working capital management 1Working capital management 1
Working capital management 1
 
Cost of Capital and Managing the working capital.pptx
Cost of Capital and Managing the working capital.pptxCost of Capital and Managing the working capital.pptx
Cost of Capital and Managing the working capital.pptx
 
Woking Capital Management
Woking Capital ManagementWoking Capital Management
Woking Capital Management
 
Meeting 4 - Cash management (Financial Management)
Meeting 4 - Cash management (Financial Management)Meeting 4 - Cash management (Financial Management)
Meeting 4 - Cash management (Financial Management)
 
Working capital
Working capitalWorking capital
Working capital
 

Recently uploaded

State Space Tutorial.pptxjjjjjjjjjjjjjjj
State Space Tutorial.pptxjjjjjjjjjjjjjjjState Space Tutorial.pptxjjjjjjjjjjjjjjj
State Space Tutorial.pptxjjjjjjjjjjjjjjj
joshuaclack73
 
Financial Accounting and Analysis balancesheet.pdf
Financial Accounting and Analysis balancesheet.pdfFinancial Accounting and Analysis balancesheet.pdf
Financial Accounting and Analysis balancesheet.pdf
mukul381940
 
一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书
一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书
一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书
atedyxc
 
ASSESSING HRM EFFECTIVENESS AND PERFORMANCE ENHANCEMENT MEASURES IN THE BANKI...
ASSESSING HRM EFFECTIVENESS AND PERFORMANCE ENHANCEMENT MEASURES IN THE BANKI...ASSESSING HRM EFFECTIVENESS AND PERFORMANCE ENHANCEMENT MEASURES IN THE BANKI...
ASSESSING HRM EFFECTIVENESS AND PERFORMANCE ENHANCEMENT MEASURES IN THE BANKI...
indexPub
 
Bahawalpur Culture.pptx pptx pptx pttx pttx
Bahawalpur Culture.pptx pptx pptx pttx pttxBahawalpur Culture.pptx pptx pptx pttx pttx
Bahawalpur Culture.pptx pptx pptx pttx pttx
AbdulNasirNichari
 
一比一原版(UMich毕业证书)密歇根大学安娜堡分校毕业证成绩单学位证书
一比一原版(UMich毕业证书)密歇根大学安娜堡分校毕业证成绩单学位证书一比一原版(UMich毕业证书)密歇根大学安娜堡分校毕业证成绩单学位证书
一比一原版(UMich毕业证书)密歇根大学安娜堡分校毕业证成绩单学位证书
atedyxc
 
一比一原版(UCSB毕业证书)圣塔芭芭拉社区大学毕业证成绩单学位证书
一比一原版(UCSB毕业证书)圣塔芭芭拉社区大学毕业证成绩单学位证书一比一原版(UCSB毕业证书)圣塔芭芭拉社区大学毕业证成绩单学位证书
一比一原版(UCSB毕业证书)圣塔芭芭拉社区大学毕业证成绩单学位证书
atedyxc
 
SAUDI ARABIYA | +966572737505 |Jeddah Get Cytotec pills for Abortion pills
SAUDI ARABIYA | +966572737505 |Jeddah Get Cytotec pills for Abortion pillsSAUDI ARABIYA | +966572737505 |Jeddah Get Cytotec pills for Abortion pills
SAUDI ARABIYA | +966572737505 |Jeddah Get Cytotec pills for Abortion pills
Abortion pills in Riyadh +966572737505 get cytotec
 
Zepto Case study(On Track to Profitability).pptx
Zepto Case study(On Track to Profitability).pptxZepto Case study(On Track to Profitability).pptx
Zepto Case study(On Track to Profitability).pptx
aryan963438
 
一比一原版(SFU毕业证书)西蒙菲莎大学毕业证成绩单学位证书
一比一原版(SFU毕业证书)西蒙菲莎大学毕业证成绩单学位证书一比一原版(SFU毕业证书)西蒙菲莎大学毕业证成绩单学位证书
一比一原版(SFU毕业证书)西蒙菲莎大学毕业证成绩单学位证书
atedyxc
 
一比一原版(Concordia毕业证书)康卡迪亚大学毕业证成绩单学位证书
一比一原版(Concordia毕业证书)康卡迪亚大学毕业证成绩单学位证书一比一原版(Concordia毕业证书)康卡迪亚大学毕业证成绩单学位证书
一比一原版(Concordia毕业证书)康卡迪亚大学毕业证成绩单学位证书
atedyxc
 

Recently uploaded (20)

Economics - Development 01 _ Handwritten Notes.pdf
Economics - Development 01 _ Handwritten Notes.pdfEconomics - Development 01 _ Handwritten Notes.pdf
Economics - Development 01 _ Handwritten Notes.pdf
 
State Space Tutorial.pptxjjjjjjjjjjjjjjj
State Space Tutorial.pptxjjjjjjjjjjjjjjjState Space Tutorial.pptxjjjjjjjjjjjjjjj
State Space Tutorial.pptxjjjjjjjjjjjjjjj
 
Financial Accounting and Analysis balancesheet.pdf
Financial Accounting and Analysis balancesheet.pdfFinancial Accounting and Analysis balancesheet.pdf
Financial Accounting and Analysis balancesheet.pdf
 
Retail sector trends for 2024 | European Business Review
Retail sector trends for 2024  | European Business ReviewRetail sector trends for 2024  | European Business Review
Retail sector trends for 2024 | European Business Review
 
一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书
一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书
一比一原版(BU毕业证书)波士顿大学毕业证成绩单学位证书
 
ASSESSING HRM EFFECTIVENESS AND PERFORMANCE ENHANCEMENT MEASURES IN THE BANKI...
ASSESSING HRM EFFECTIVENESS AND PERFORMANCE ENHANCEMENT MEASURES IN THE BANKI...ASSESSING HRM EFFECTIVENESS AND PERFORMANCE ENHANCEMENT MEASURES IN THE BANKI...
ASSESSING HRM EFFECTIVENESS AND PERFORMANCE ENHANCEMENT MEASURES IN THE BANKI...
 
Bahawalpur Culture.pptx pptx pptx pttx pttx
Bahawalpur Culture.pptx pptx pptx pttx pttxBahawalpur Culture.pptx pptx pptx pttx pttx
Bahawalpur Culture.pptx pptx pptx pttx pttx
 
L1 2024 Prequisite QM persion milad1371.pdf
L1 2024 Prequisite QM persion milad1371.pdfL1 2024 Prequisite QM persion milad1371.pdf
L1 2024 Prequisite QM persion milad1371.pdf
 
一比一原版(UMich毕业证书)密歇根大学安娜堡分校毕业证成绩单学位证书
一比一原版(UMich毕业证书)密歇根大学安娜堡分校毕业证成绩单学位证书一比一原版(UMich毕业证书)密歇根大学安娜堡分校毕业证成绩单学位证书
一比一原版(UMich毕业证书)密歇根大学安娜堡分校毕业证成绩单学位证书
 
Production and Cost of the firm with curves
Production and Cost of the firm with curvesProduction and Cost of the firm with curves
Production and Cost of the firm with curves
 
20240514-Calibre-Q1-2024-Conference-Call-Presentation.pdf
20240514-Calibre-Q1-2024-Conference-Call-Presentation.pdf20240514-Calibre-Q1-2024-Conference-Call-Presentation.pdf
20240514-Calibre-Q1-2024-Conference-Call-Presentation.pdf
 
NO1 Top Vashikaran Specialist in Uk Black Magic Specialist in Uk Black Magic ...
NO1 Top Vashikaran Specialist in Uk Black Magic Specialist in Uk Black Magic ...NO1 Top Vashikaran Specialist in Uk Black Magic Specialist in Uk Black Magic ...
NO1 Top Vashikaran Specialist in Uk Black Magic Specialist in Uk Black Magic ...
 
The Pfandbrief Roundtable 2024 - Covered Bonds
The Pfandbrief Roundtable 2024 - Covered BondsThe Pfandbrief Roundtable 2024 - Covered Bonds
The Pfandbrief Roundtable 2024 - Covered Bonds
 
一比一原版(UCSB毕业证书)圣塔芭芭拉社区大学毕业证成绩单学位证书
一比一原版(UCSB毕业证书)圣塔芭芭拉社区大学毕业证成绩单学位证书一比一原版(UCSB毕业证书)圣塔芭芭拉社区大学毕业证成绩单学位证书
一比一原版(UCSB毕业证书)圣塔芭芭拉社区大学毕业证成绩单学位证书
 
SAUDI ARABIYA | +966572737505 |Jeddah Get Cytotec pills for Abortion pills
SAUDI ARABIYA | +966572737505 |Jeddah Get Cytotec pills for Abortion pillsSAUDI ARABIYA | +966572737505 |Jeddah Get Cytotec pills for Abortion pills
SAUDI ARABIYA | +966572737505 |Jeddah Get Cytotec pills for Abortion pills
 
Slideshare - ONS Economic Forum Slidepack - 13 May 2024.pptx
Slideshare - ONS Economic Forum Slidepack - 13 May 2024.pptxSlideshare - ONS Economic Forum Slidepack - 13 May 2024.pptx
Slideshare - ONS Economic Forum Slidepack - 13 May 2024.pptx
 
Managing personal finances wisely for financial stability and
Managing personal finances wisely for financial stability  andManaging personal finances wisely for financial stability  and
Managing personal finances wisely for financial stability and
 
Zepto Case study(On Track to Profitability).pptx
Zepto Case study(On Track to Profitability).pptxZepto Case study(On Track to Profitability).pptx
Zepto Case study(On Track to Profitability).pptx
 
一比一原版(SFU毕业证书)西蒙菲莎大学毕业证成绩单学位证书
一比一原版(SFU毕业证书)西蒙菲莎大学毕业证成绩单学位证书一比一原版(SFU毕业证书)西蒙菲莎大学毕业证成绩单学位证书
一比一原版(SFU毕业证书)西蒙菲莎大学毕业证成绩单学位证书
 
一比一原版(Concordia毕业证书)康卡迪亚大学毕业证成绩单学位证书
一比一原版(Concordia毕业证书)康卡迪亚大学毕业证成绩单学位证书一比一原版(Concordia毕业证书)康卡迪亚大学毕业证成绩单学位证书
一比一原版(Concordia毕业证书)康卡迪亚大学毕业证成绩单学位证书
 

Liquidity Decisions in Financial management

  • 2. Working Capital • The working capital management refers to management of the working capital, or to be more precise, the management of current assets. A firm’s working capital consists of its investment in current assets which include short term assets such as cash and bank balance, inventories, receivables (including debtors and bills), and marketable securities. • Working capital management refers to the management of the level of all these individual current assets. • The need for working capital management arises from two considerations. • First, existence of working capital is imperative in any firm. The fixed assets which usually require a large chunk of total funds, can be used at an optimum level only if supported by sufficient working capital, and second, the working capital involves investment of funds of the firm. • If the working capital level is not properly maintained and managed, then it may result in unnecessary blocking of scarce resources of the firm. The insufficient working capital, on the other hand, put different hindrances in smooth working of the firm. Therefore, the working capital management needs attention of all the financial managers.
  • 3. Cont.. • The term working capital refers to current assets which may be defined as (i) those which are convertible into cash or equivalents within a period of one year, and (ii) those which are required to meet day to day operations. • The management of current assets is similar to that of fixed assets in the sense that in both cases a firm analysis their effects on its return and risk. The management of fixed and current assets, however, differs in three important ways: • First, in managing fixed assets, time is a very important factor; consequently, discounting and compounding techniques play a significant role in capital budgeting and a minor one in the management of current assets. • Second, the large holding of current assets, especially cash, firm’s liquidity position (and reduces riskiness), but also reduces the overall profitability. Thus, a risk-return trade-off is involved in holding current assets. • Third, levels of fixed as well as current assets depend upon expected sales, but it is only the current assets which can be adjusted with sales fluctuations in the short run. • Thus, the firm has a greater degree of flexibility in managing current assets.
  • 4. CONCEPTS OF WORKING CAPITAL • Gross working capital refers to the firm’s investment in current assets. Current assets are the assets which can be converted into cash within an accounting year and include cash, short-term securities, debtors (accounts receivable or book debts), bills receivable and stock (inventory). • Net working capital refers to the difference between current assets and current liabilities. Current liabilities 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. • Net working capital can be positive or negative. A positive net working capital will arise when current assets exceed current liabilities. A negative net working capital occurs when current liabilities are in excess of current assets. • The two concepts of working capital—gross and net—are not exclusive; rather, they have equal significance from the management viewpoint.
  • 5. Cont.. • Too large an investment in current assets means tying up funds that can be productively used elsewhere (or it means added interest cost if the firm has borrowed funds to finance the investment in current assets). Excess investment may also expose the firm to undue risk e.g., in case, the inventory cannot be sold or the receivables cannot be collected. • On the other hand, too little investment also can be expensive. For example, insufficient inventory may mean that sales are lost as the goods which a customer wants are not available. The result is that the financial managers spend a large chunk of their time managing the current assets because level of these assets changes quickly and a lack of attention paid to them may result in appreciably lower profits for the firm. • So, in the working capital management, a financial manager is faced with a decision involving some of the considerations as follows : • 1. What should be the total investment in working capital of the firm? • 2. What should be the level of individual current assets ? • 3. What should be the relative proportion of different sources to finance the working capital requirements ? • Thus, the working capital management may be defined as the management of firm’s sources and uses of working capital in order to maximize the wealth of the shareholders.
  • 6. The operating Cycle and Working Capital needs • The working capital requirement 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. • Thus, 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 : • (i) Procurement of raw materials and services. • (ii) Conversion of raw materials into work-in-progress. • (iii) Conversion of work-in-progress into finished goods. • (iv) Sale of finished goods (cash or credit). • (v) Conversion of receivables into cash.
  • 7. Cont.. • Operating Cycle Period : The length or time duration of the operating cycle of any firm can be defined as the sum of its inventory conversion period (ICP) and the receivable conversion period (RCP). • Inventory Conversion Period (ICP) : It is the time required for the conversion of raw materials into finished goods sales. In a manufacturing firm the ICP is consisting of Raw Material Conversion Period (RMCP), Work-in-Progress Conversion Period (WPCP), and the Finished Goods Conversion Period (FGCP). • The RMCP refers to the period for which the raw material is generally kept in stores before it is issued to the production department. • The WPCP refers to the period for which the raw materials remain in the production process before it is taken out as a finished unit. • The FGCP refers to the period for which finished units remain in stores before being sold to the customers. • Receivables Conversion Period (RCP) : It is the time required to convert the credit sales into cash realization. It refers to the period between the occurrence of credit sales and collection of debtors. • The total of ICP and RCP is also known as Total Operating Cycle Period (TOCP). • The firm might be getting some credit facilities from the supplier of raw materials, wage earners etc. The period for which the payments to these parties are deferred or delayed is known as Deferral Period (DP).