Working Capital Management
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This lecture discusses working capital and its management. It begins by defining working capital as the capital required to meet daily business expenses. It then covers key topics like the components of current assets and liabilities, calculating gross and net working capital, the operating cycle concept, problems of the operating cycle, classifications of working capital, and the importance and management of working capital. The objectives are to understand working capital and its policy, solve operating cycle problems, and manage adequate versus excess working capital levels. Examples and calculations are provided to illustrate various working capital concepts.
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Working Capital Management
- 1. Lecture on the topic Dr. Mohsin Khan Assistant Professor, Department of Commerce B.S. Abdur Rahman Crescent Institute of Science and Technology, Chennai 03-Apr-20Maksons 1
- 2. Objectives of this PPT After completing this Chapter, the students will be able to Understand Working capital and its management Understand the policy of Working capital Solve the problems of Operating Cycle Handle the problems of Working Capital in the organizations Control the excess of Working Capital Manage the adequate working capital 03-Apr-20Maksons 2
- 3. Content….. Introduction of Working Capital Meaning of Working Capital Definitions of Working Capital Concept of Working Capital Components of Current Assets and Liabilities Calculations of Gross Working Capital and Net Working Capital Operating Cycle Calculation of Operating Cycle Problems of Operating Cycle Classifications of Working Capital Importance of Working Capital Working Capital Management Working Capital Policy 03-Apr-20Maksons 3
- 4. Introduction Capital required for a business can be classified under two main categories: 1-Fixed Capital 2-Working Capital Working Capital is the life blood and nerve center of business. It is very essential to maintain the smooth running of a business. Why does this matter? You can find lot of definitions online through google at various platform but they are missing one point i.e. WHY? 03-Apr-20Maksons 4
- 5. What is Working Capital? Example 1 03-Apr-20Maksons 5
- 6. Meaning • Working capital is a part of capital which is used to meet the day to day expenses of the business enterprises. • It is the excess of current assets over current liabilities How ? 03-Apr-20Maksons 6
- 7. Working capital is the amount of funds necessary to cover the cost of operating the enterprises. According to Shubin Definitions of….. Circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another i.e. from Cash to Inventories, Inventories to receivables, Receivables into Cash. According to Genestenberg 03-Apr-20Maksons 7
- 8. Concept of Working Capital Balance Sheet Concept Operating Cycle or Circular Flow Concept Gross Working Capital Net Working Capital Capital invested in total current Assets of the enterprise. (Current Assets – Current Liabilities) GOC = RMCP+WIPCP+FGCP+RCP GOC = RMCP+WIPCP+FGCP+RCP GOC = Gross Operating Cycle RMCP= Raw Material Conversion Period WIPCP= Work-in-progress Conversion Period FGCP= Finished Goods Conversion Period RCP = Receivables Conversion Period 03-Apr-20Maksons 8
- 9. Components of Current Assets and Current Liabilities • Cash in Hand • Cash at Bank • Bills Receivable • Sundry debtors • Short term loans and advances • Stock • Prepaid Expenses • Accrued Income etc. Current Assets • Bills Payable • Sundry Creditors • Outstanding Expenses • Short term loans • Advance and deposits • Dividend Payable • Bank overdraft • Provision for taxations Current Liabilities 03-Apr-20Maksons 9
- 10. How to Calculate Gross Working Capital and Net Working Capital Suppose Maksons Limited has Current Assets Rs. 5,00,000 and Current Liabilities of Rs. 300,000. Fixed Assets are Rs. 1,00,000. Long Term Debt is Rs.1,00,000 and Short Term Debt included in the Current Liability above is Rs. 25,000. Calculate the Working Capital of the Company and analyze the same. 03-Apr-20Maksons 10
- 11. Calculations of Gross Working Capital and Net Working Capital Gross Working Capital = Total Current Assets Total Current Assets given in the question is Rs. 5 lac. Hence Gross working capital = Rs. 5 Lac Note= if total Current Assets are not given then you have to add all the given components of current assets i.e. cash in hand, Debtors, stock etc. Net Working Capital = Current Assets – Current Liabilities Current Assets given in the question is Rs. 5 lac. Current Liabilities given Rs. 3 lac Therefore, Net working capital = Current Assets – Current Liabilities = 5,00,000- 3,00,000 = 2,00,000 Hense, Net working capital = 2,00,000 Note= if total Current Liabilities are not given then you have to add all the given components of current Liabilities i.e. Bills Payable, Creditors, Bank overdrafts etc. 03-Apr-20Maksons 11
- 12. Operating Cycle or Circular Flow Concept Working capital refers to that part of firm’s capital which is required for financing short- term or current assets such as cash, marketable securities, debtors and inventories. Hence, invested funds in current assets keep revolving fast and are being constantly converted into cash and this cash flows out again for exchange other current Assets. It is also called Revolving capital or Circulating Capital. 03-Apr-20Maksons 12
- 13. Cash received from debtors and paid to suppliers of raw material Finished Goods Produced RawMaterialintroducedintoprocess SalesofFinishedGoods Operating Cycle RawMaterial Conversion Period Work–in-Process Conversionperiod FinishedGoods Conversion Period Receivables Conversion Period 03-Apr-20Maksons 13
- 14. GOC = RMCP + WIPCP + FGCP + RCP Calculation of Operating Cycle GOC = Gross Operating Cycle RMCP = Raw Material Conversion Period WIPCP = Work-in-progress Conversion Period FGCP = Finished Goods Conversion Period RCP = Receivables Conversion Period PDP = Payables Deferral Period Step -1 Formula Net Operating Cycle Period = Gross Operating Cycle – Payable Deferral Period Step -2 Now RMCP = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑃𝑒𝑟 𝐷𝑎𝑦 WIPCP = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝑊𝑜𝑟𝑘− 𝑖𝑛−𝑃𝑟𝑜𝑔𝑟𝑒𝑠𝑠 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟 𝐷𝑎𝑦 FGCP = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝐹𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝐺𝑜𝑜𝑑𝑠 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑 𝑃𝑒𝑟 𝐷𝑎𝑦 RCP = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 𝑃𝑒𝑟 𝐷𝑎𝑦 PDP = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠 𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 𝑃𝑒𝑟 𝐷𝑎𝑦 03-Apr-20Maksons 14
- 17. Classification or Kinds of Working Capital 03-Apr-20Maksons 17
- 18. Importance of….. Solvency of the Business Goodwill Easy Loans Regular Payment of salaries, wages & other expenses Cash Discounts Exploitation of Favorable market Conditions Ability to Face Crisis Quick and Regular Return on Investment Regular Supply of Raw Material High Morale 03-Apr-20Maksons 18
- 19. Working Capital Management Working Capital generally, refers to the excess of current assets over current liabilities. Working Capital Management, is concerned with the problems that arises in attempting to manage the current Assets, the current Liabilities and the inter relationship between them. The basic goal of Working Capital Management is to manage the current and current liabilities of a firm in such a way that a satisfactory level of working capital is maintained. It should neither inadequate nor excessive. The consequences of being inadequate or excess of working capital may put your business in danger. Inadequate working capital may lead the firm to insolvency Where as excess working capital implies idle funds which earn no profits for the business. 03-Apr-20Maksons 19
- 21. Working Capital Management Policies of a firm have a great effect on its Profitability, liquidity and structural health of the organization. Hence, Working Capital Management is in three dimensional in nature. Dimension II Dimension I DimensionIII First Dimension • is Concerned with the formulation of policies with regards to profitability, risk and liquidity Second Dimension • is concerned with the decisions about the composition and level of current Assets Third Dimension • is concerned with the decisions about the composition and level of current Liabilities Working Capital Management Policies 03-Apr-20Maksons 21