Download to read offline
working capital final_041048.ppt Finance
- 1. Working Capital Management Over view of working capital management. Cash and marketable securities management. Accounts receivable and inventory management. Short-term financing
- 2. Over view ofworking capital management.
- 3. Overview of WorkingCapital Management • Working Capital Concepts • Working Capital Issues • Financing Current Assets: Short-Term and Long-Term Mix • Combining Liability Structure and Current Asset Decisions
- 4. Working capital Introduction •Working capital typically means the firm’s holding of current or short-term assets such as cash, receivables, inventory and marketable securities. • These items are also referred to as circulating capital • Corporate executives devote a considerable amount of attention to the management of working capital.
- 5. What is workingcapital? Current assets, which represent the portion of investment that circulates from one form to another in the ordinary conduct of business. Current assets, commonly called working capital
- 6. Working Capital Concepts NetWorking Capital: ( (Current Assets- Current Liabilities) The difference between Current assets and current liabilities is called working capital. If current assets > current liabilites is called surplus or vice a versa. This is one measure of the extent to which the firm is protected from liquidity problems Gross Working Capital The firm’s investment in current assets. like cash and marketable securities, receivables, and inventory).
- 7. Working Capital Management WorkingCapital Management The administration of the firm’s current assets and the financing needed to support current assets is called working capital management or short term financial management. Simply management of current assets and current liabilities.
- 8. Significance of WorkingCapital 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.
- 9. 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) ASSET LEVEL ($) Current Assets Policy C Policy C Policy A Policy A Policy M Policy M
- 10. Impact on Liquidity LiquidityAnalysis Policy Policy Liquidity Liquidity C C High High M M Moderate Moderate A A Low Low Greater current asset levels generate more liquidity; all other factors held constant. Optimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSET LEVEL ($) Current Assets Policy A Policy A Policy C Policy C Policy M Policy M
- 11. Impact on ExpectedProfitability Return on Investment Return on Investment = Net Profit Net Profit Total Assets Total Assets Let Current Assets Current Assets = (Cash + Rec. + Inv.) Return on Investment Return on Investment = Net Profit Net Profit Current Current + Fixed Assets Fixed Assets Optimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSET LEVEL ($) Current Assets Policy C Policy C Policy A Policy A Policy B Policy B
- 12. Impact on ExpectedProfitability Profitability Analysis Policy Policy Profitability Profitability A A Low Low M M Moderate Moderate C C High High As current asset levels decline, total assets will decline and the ROI will rise. Optimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSET LEVEL ($) Current Assets Policy C Policy C Policy A Policy A Policy M Policy M
- 13. Impact on Risk •Decreasing cash reduces the firm’s ability to meet its financial obligations. More risk! More risk! • Stricter credit policies reduce receivables and possibly lose sales and customers. More risk! More risk! • Lower inventory levels increase stock outs and lost sales. More risk! More risk! Optimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSET LEVEL ($) Current Assets Policy C Policy C Policy A Policy A Policy M Policy M
- 14. Impact on Risk RiskAnalysis Policy Policy Risk Risk A A Low Low M M Moderate Moderate C C High High Risk increases as the level of current assets are reduced. Optimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSET LEVEL ($) Current Assets Policy C Policy C Policy A Policy A Policy M Policy M
- 15. Summary of theOptimal Amount of Current Assets S SUMMARY UMMARY O OF F O OPTIMAL PTIMAL C CURRENT URRENT A ASSET SSET A ANALYSIS NALYSIS Policy Policy Liquidity Liquidity Profitability Profitability Risk Risk C C High High Low Low Low Low M M Moderate Moderate Moderate Moderate Moderate Moderate A A Low Low High High High High 1. Profitability varies inversely with liquidity. 2. Profitability moves together with risk. (risk and return go hand in hand!)
- 16. Classifications of Working Capital •Time Time – Permanent Current Assets – Temporary Short Time Investment or Marketable Securities Components Components Cash, marketable securities, receivables, and inventory
- 17. Permanent Working Capital Theamount of current assets required to meet a firm’s long-term minimum needs. You might call this “bare bones” working capital. Permanent working capital is similar to the firm’s fixed assets in two important respects. First, the dollar investment is long term, despite the seeming contradiction that the assets being financed are called “current.” Second, for a growing firm, the level of permanent work ing capital needed will increase over time in the same way that a firm’s fixed assets will need to increase over time. However, permanent working capital is different from fixed assets in one very important respect – it is constantly changing.
- 18. Temporary Working Capital Theamount of current assets that varies with seasonal requirements. Like permanent working capital, temporary working capital also consists of current assets in a constantly changing form. However, because the need for this portion of the firm’s total current assets is seasonal, we may want to consider financing this level of current assets from a source which can itself be seasonal or temporary in nature.
- 19. Financing Current Assets:Short-Term and Long-Term Mix Spontaneous Financing 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.
- 20. Hedging (or MaturityMatching) Approach A method of financing where each asset would be offset with a financing instrument of the same approximate maturity.
- 21. Financing Needs and theHedging 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).
- 22. Self-Liquidating Nature of Short-TermLoans • 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.
- 23. TYPES OF WORKINGCAPITAL WORKING CAPITAL BASIS OF CONCEPT BASIS OF TIME Gross Working Capital Net Working Capital Permanent / Fixed WC Temporary / Variable WC Regular WC Reserve WC Special WC Seasonal WC
- 24. FACTORS DETERMINING WORKINGCAPITAL FACTORS DETERMINING WORKING CAPITAL 1. Nature of the Industry 1. Nature of the Industry 2. Demand of Industry 2. Demand of Industry 3. Cash requirements 3. Cash requirements 4. Nature of the Business 4. Nature of the Business 5. Manufacturing time 5. Manufacturing time 6. Volume of Sales 6. Volume of Sales 7. Terms of Purchase and Sales 7. Terms of Purchase and Sales 8. Inventory Turnover 8. Inventory Turnover 9. Business Turnover 9. Business Turnover 10. Business Cycle 10. Business Cycle 11. Current Assets requirements 11. Current Assets requirements 12. Production Cycle 12. Production Cycle contd… contd…
- 25. Working Capital Determinants(Contd…) Working Capital Determinants (Contd…) 13. Credit control 13. Credit control 14. Inflation or Price level changes 14. Inflation or Price level changes 15. Profit planning and control 15. Profit planning and control 16. Repayment ability 16. Repayment ability 17. Cash reserves 17. Cash reserves 18. Operation efficiency 18. Operation efficiency 19. Change in Technology 19. Change in Technology 20. Firm’s finance and dividend policy 20. Firm’s finance and dividend policy 21. Attitude towards Risk 21. Attitude towards Risk
- 26. EXCESS OR INADEQUATEWORKING CAPITAL Every business concern should have adequate working capital to run its business operations. It should have neither redundant or excess working capital nor inadequate or shortage of working capital. Both excess as well as shortage of working capital situations are bad for any business. However, out of the two, inadequacy or shortage of working capital is more dangerous from the point of view of the firm.
- 27. Disadvantages of Redundantor Excess Working Capital Idle funds, non-profitable for business, poor ROI Idle funds, non-profitable for business, poor ROI Unnecessary purchasing & accumulation of Unnecessary purchasing & accumulation of inventories over required level inventories over required level Excessive debtors and defective credit policy, Excessive debtors and defective credit policy, higher incidence of B/D. higher incidence of B/D. Overall inefficiency in the organization. Overall inefficiency in the organization. When there is excessive working capital, Credit When there is excessive working capital, Credit worthiness suffers worthiness suffers Due to low rate of return on investments, the Due to low rate of return on investments, the market value of shares may fall market value of shares may fall
- 28. Disadvantages or Dangersof Inadequate or Short Disadvantages or Dangers of Inadequate or Short Working Capital Working Capital Can’t pay off its short-term liabilities in time. Can’t pay off its short-term liabilities in time. Economies of scale are not possible. Economies of scale are not possible. Difficult for the firm to exploit favorable market Difficult for the firm to exploit favorable market situations situations Day-to-day liquidity worsens Day-to-day liquidity worsens Improper utilization the fixed assets and Improper utilization the fixed assets and ROA/ROI falls sharply ROA/ROI falls sharply
- 29. MANAGEMENT OF WORKINGCAPITAL ( WCM ) MANAGEMENT OF WORKING CAPITAL ( WCM ) Management of working capital is concerned with Management of working capital is concerned with the problems that arise in attempting to manage the the problems that arise in attempting to manage the current assets, the current liabilities and the inter- current assets, the current liabilities and the inter- relationship that exists between them. relationship that exists between them. In other In other words, it refers to all aspects of administration of CA words, it refers to all aspects of administration of CA and CL. and CL. Working Capital Management Policies of a firm have Working Capital Management Policies of a firm have a great effect on its a great effect on its profitability, liquidity and profitability, liquidity and structural health of the organization. structural health of the organization.