3. What is mean by working capital? And
explain its components.
Working capital is the capital which is needed to meet the day-to-day
transaction of the business concern. It may cross working capital and net
working capital. Normally working capital consists of various compositions of
current assets such as inventories, bills, receivable, debtors, cash, and bank
balance and prepaid expenses. Working capital is needed to meet the
following purpose:
Purchase of raw material
Payment of wages to workers
Payment of day-to-day expenses
4. Definition
According to the definition of Weston and Brigham, "Working Capital refers
to a firm's investment in short-term assets, cash, short-term securities,
accounts receivables and inventories".
5. What do you mean by working capital
management?
Working capital management refers to the management of both current
assets and current liabilities. It is a study of relationship between current
assets and current liabilities. The main aim of financial management is to
supply continuous flow of funds to administer the day-to-day activities. The
size of this capital must not be in excess nor inadequate. It should be
adequately supplied to increase the wealth of the organization.
6. Working capital management involves two
main processes:
Determining the size of the amount of working capital
Arranging the sources of working capital
7. CONCEPTS OF WORKING CAPITAL
1. Gross working capital
2. Net working capital
8. What is the circular flow concept of
working capital?
9. What are the different types of
Working Capital?
1. Permanent working capital
2. Temporary working capital
3. Gross working capital
4. Net working capital
5. Negative Working capital
6. Reserve Working capital
10. NEEDS FOR WORKING CAPITAL
Replenishment of inventory
Provision for operating expenses
Support for credit sales
Provision of a safety margin
11. Principles of working capital
Principles of Risk Valuation
Principle of Equity Position
Principle of cost capital
Principles of Maturity Payment
12. DETERMINANTS OF WORKING CAPITAL
REQUIREMENTS
1. Nature of business
2. Size of business
3. Manufacturing cycle
4. Production policy
5. Volume of sales
6. Term of purchases and sales
13. CONT…
7. Business cycle
8. Growth and Expansion
9. Fluctuations in the Supply of Raw Materials
10. Price Level Changes
11. Operating efficiency
12. Profit Margin
13. Profit appropriation
14. Credit policies of Reserve Bank of India
15. Capital structure of the company
14. What are the different sources of working
capital?
Sources of working capital:
Long term financing
Short term financing
Spontaneous financing
15. CONT…
Long term financing:
Loans from financial institutions
Floating of debentures
Accepting public deposits
Issue of shares
Raising funds by Internal financing
16. ISSSUES IN WORKING CAPITAL
Components
Time
Investment
Criticality
Growth
17. ACCOUNTS RECEIVABLES MANAGEMENT
What is Receivables?
Receivables represent amounts owed to the firm as a result of sale of
goods or services in the ordinary course of business. These are claims of the
firm against its customers and form part of its current assets.
18. What do you mean by receivables
management?
It is the process of making decisions relating to the investment of funds in
accounting receivables which will result in maximizing the overall return on the
investment of the firm. Thus, the objective of receivables management
19. What are the purposes of receivables?
Achieving growth in sales
Increasing profits
Meeting competition
20. Explain the factors influencing the size of
the receivables?
Level of sales
Credit policies
Terms of trade
21. FACTORING
The word ‘factor’ has been derived from the Latin word ‘factor’ which
means ‘to make or to do’. In other words, it means ‘to get things done’.
Factoring is a method of financing where by a company sells its trade debts
at a discount to a financial institution, (namely the factor) and a company
(namely the client) which sells good and services to trade customers on
credit.
23. What are the functions of factoring?
i) Maintenance of Sales Ledger
ii) Collection of Accounts Receivables
iii) Credit Control and Credit Protection
iv) Financing of Receivable
v) Advisory Services
24. What are the advantages of factoring?
1. Prompt Payment and Reduction in Debt
2. Improves Current Ratio
3. Increase in the Turnover of Stocks
4. Improved Credit Standing
5. Lesser Risk
6. Specialized Service
7. No need for Collection Department
25. What are the disadvantages of factoring?
1. High Risk
2. Existence of Teething Problems
3. Unsuitability
26. Meaning of Inventory Management:
The dictionary meaning of inventory is ‘stock of goods’. The word ‘inventory’
is understood differently by various authors. In accounting language it may
mean stock of finished goods only. In a manufacturing concern, it may
include raw materials, work in process and stores, etc.
27. What are the kinds of inventories?
Raw materials
Work-in-progress
Finished goods
28. What are benefits of holding inventories?
Avoiding losses of sales
Reducing ordering cost
Achieving efficient production runs
29. Explain the Costs and Risks associated with
Inventories?
Cost and risk Associated with Holding Inventory
Financial cost
Cost of storage
Price Fluctuation
Risk of obsolescence
Deterioration in Quality
30. Cont….
Theft, Damage and Accident
Order placing cost
Inventory carrying cost
Cost of shortage of stock
31. What is Inventory Management?
The investment inventory is very high in most of the undertakings engaged
manufacturing, wholesale and retail trade. The amount of investment is
sometimes more in inventory than in other assets. About 90% part of
working capital invested in inventories. It is necessary for every
management to give proper attention to inventory management. A proper
planning of purchase, handling, storing, and accounting should form a part
of inventory management. An efficient system of inventory management
will determine
What to purchase
How much to purchase
From where to purchase
Where to store etc.
32. Determination of Economic Ordering
Quantity
Determination of the quantity for which the order should be placed is
one of the important problems concerned with efficient inventory
management. EOQ refers to the size of the order which gives maximum
economy in purchasing any item of raw material or finished product. It is
fixed mainly after taking into account the ordering cost and inventory
carrying cost. It can be determined by applying the following formula:
2AB
EOQ = ----------
S
33. Cont…
Where,
EQ = Economic Ordering Quantity
A = Quantity (units) purchased in a year
B = cost of placing an order
S = Annual cost of storage of one unit.
34. Determination of optimum production
quantity
The EOQ model can be extended to production runs to determine the optimum
production quantity. The two costs involved in this process are: set up cost and
inventory carrying cost. The formula for EOQ can also be used for determining
the optimum production quantity as given below:
2U x P
E = ----------
S
35. Cont…
Where,
E = optimum production quantity
U = Annual output
P = set up cost for each production run
S = cost of carrying inventory per unit per annum
36. Determination of re-order level
Re order level is the level of inventory at which the firm should place an
order to replace the inventory. In case, the order is placed at this level, the
new goods will arrive before the firm runs out of goods to sell. It can be
determined by applying the following formula.
Re-order level = Maximum usage x Maximum lead time
37. Inventory turnover ratio
This is calculated minimize the investment in inventories. It is calculated for
each item of inventory by applying the following formula.
Cost of goods consumed / sold during the period
Inventory turnover ratio= -------------------------------------------------------------
--
Average inventory held during the perio
38. Aging schedule of inventory
Classification of the inventories according to age also helps in identifying inventories
which are moving slowly into production or sales. This requires identifying the date of
purchase/manufacture of each item of the inventory and classifying them.
39. ABC analysis
ABC analysis is a form of inventory control wherein different degrees of control are exercised over
different items of stores on the basis of the investment involved.
For example, in the making of aircraft, cryogenic engines involving high costs will be monitored closely
while cost of tyres, nuts and bolts etc. will be given lesser attention.
Categorisation: Under this system, the items are divided into three categories according to their
importance (value) and frequency of replenishment during a period.
These categories are:
A category – Highly important – 70%
B category – Relatively less important – 20%
C category – Least important – 10%
ABC analysis is also called as 70-20-10 analysis or selective stock control.
40. VED analysis
V - Some spares would be so important that their non availability would render
extreme damage to plant equipment or human life. If these items go out of stock
or not readily available, results in loss of production for the whole period.
E – Essential items which reduce the equipments performance but do not render it
inoperative or unsafe: non availability of these items may result in temporary loss
of production or dislocation of production work replacement can be delayed
without affecting the equipments performance seriously temporary repairs are
sometimes possible.
D – Desirable items which are mostly non functional and do not affect the
performance of the equipment.
41. Just-in-Time inventory (JIT)
Business concerns are giving maximum attention to reduce stock
levels by establishing cordial relationship with suppliers to
arrange for frequent delivery of quantities. This is called Just-in-
time purchasing. The objective of Just-in-time purchasing is to
obtain delivery of material immediately before their use. This is
possible with the co-operation of supplier.
42. What do you mean by cash management?
Cash management: Cash management has assumed importance because it
is the most significant of all the current assets. It is required to meet business
obligations and it is unproductive when not used.
Cash management deals with the following:
Cash inflows and outflows
Cash inflows with the firm
Cash balances held by the firm at a point of time
43. What are the motives for holding cash?
Transaction motive
Precautionary motive
Speculative motive
Compensatory motive
44. Explain the cash management models.
(a) Baumol model: This model was suggested by William J.Baumol.
According to this model, optimum cash level is that level of cash where the
carrying costs and transactions costs are the minimum.
Carrying costs: This refers to the cost of holding cash namely, the interest
foregone on marketable securities. They may also be termed as opportunity
costs of keeping cash balance.
Transaction costs: This refers to the cost involved in getting the marketable
securities converted into cash. This happens when the firm falls short of cash
and has to sell the securities resulting in clerical, brokerage, registration and
other costs
45. Miller Orr – Model
This model helps in determining the optimum level of cash in
such circumstances. It deals with cash management problem
under the assumption of random cash flows by laying down
control limits for cash balances. These limits consist of an upper
limit (U), lower limit (O) and return point (R). When cash
balance reaches the upper limit, a transfer of cash equal to “U-R”
is affected to marketable securities. When it touches the lower
limit, a transfer equal to “R-O” from marketable securities to
cash is made.
46. Working capital finance
Trade credit
Commercial paper
Public deposits
Letter of credit
Bank finance
Accruals
Bills discounting
Installment of credit
