working capital - Working Capital Working capital...

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Unformatted text preview: Working Capital 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. Concept of working capital • There are two possible interpretations of working capital concept: 1. Balance sheet concept 2. Operating cycle concept Balance sheet concept There are two interpretations of working capital under the balance sheet concept. a. Excess of current assets over current liabilities b. gross or total current assets. TYPES OF WORKING CAPITAL WORKING CAPITAL BASIS OF CONCEPT Gross Working Capital BASIS OF TIME Permanent / Fixed WC Net Working Capital Temporary / Variable WC Seasonal WC Regular WC Reserve WC Special WC • Inventory conversion period Avg. inventory = _________________ Cost of sales/365 • Receivable conversion period Accounts receivable = ___________________ Annual credit sales/365 • Payables deferral period Accounts payable + Salaries, etc = ___________________________ (Cost of sales + selling, general and admn. Expenses)/365 • Cash conversion cycle = operating cycle – payables deferral period. • Importance of working capital – Risk and uncertainty involved in managing the cash flows – Uncertainty in demand and supply of goods, escalation in cost both operating and financing costs. • Strategies to overcome the problem – Manage working financing such as capital investment or – Holding additional cash balances beyond expected needs – Holding a reserve of short term marketable securities – Arrange for availability of additional short-term borrowing capacity – One of the ways to address the problem of fixed set-up cost may be to hold inventory. – One or combination of the above strategies will target the problem • Working capital cycle is the life-blood of the firm Resource flows for a manufacturing firm Used in Production Process Used in Generates Accrued Direct Labour and materials Working Capital cycle Inventory Via Sales Generator Accounts receivable Collection process Accrued Fixed Operating expenses Used to purchase Cash and Marketable Securities External Financing Return on Capital Suppliers Of Capital Used to purchase Fixed Assets Accounts Payable Raw Materials Cash Value Addition WIP THE WORKING CAPITAL CYCLE (OPERATING CYCLE) Accounts Receivable SALES Finished Goods FACTORS DETERMINING WORKING CAPITAL 1. 2. 3. 4. 5. 6. 7. 8. Nature of the Industry Demand of Industry Cash requirements Nature of the Business Manufacturing time Volume of Sales Terms of Purchase and Sales Inventory Turnover Working Capital Determinants (Contd…) 13. 14. 15. 16. 17. 18. 19. 20. Credit control Inflation or Price level changes Profit planning and control Repayment ability Cash reserves Operation efficiency Change in Technology Firm’s finance and dividend policy EXCESS OR INADEQUATE WORKING 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. Disadvantages of Redundant or Excess Working Capital Idle funds, non-profitable for business, poor ROI Unnecessary purchasing & accumulation of inventories over required level Excessive debtors and defective credit policy, higher incidence of B/D. Disadvantages or Dangers of Inadequate or Short Working Capital Can’t pay off its short-term liabilities in time. Economies of scale are not possible. Difficult for the firm to exploit favourable market situations Day-to-day liquidity worsens Improper utilization the fixed assets and MANAGEMENT OF WORKING CAPITAL ( WCM ) To manage the current assets, the current liabilities and the inter-relationship that exists between them. In other words, it refers to all aspects of administration of CA and CL. 3D Nature of Working Capital Management DimensionII Dimension Profitability, Profitability, Risk,& &Liquidity Liquidity Risk, I I I I n on ell i v s o e e i v n ens &LLe e m i DDim sittiioonn& osi CAA p o p m fC om o f o C o C DDiim men C Coom mpo enssiion possiti on IIII itioonn II & ooffCCL& LLeevvel el L FORECASTING / ESTIMATION OF WORKING CAPITAL REQUIREMENTS • • • • • • • • • Factors to be considered Total costs incurred on materials, wages and overheads The length of time for which raw materials remain in stores before they are issued to production. The length of the production cycle or WIP, i.e., the time taken for conversion of RM into FG. The length of the Sales Cycle during which FG are to be kept waiting for sales. The average period of credit allowed to customers. The amount of cash required to pay day-to-day expenses of the business. The amount of cash required for advance payments if any. The average period of credit to be allowed by suppliers. Time – lag in the payment of wages and other overheads PROFORMA - WORKING CAPTIAL ESTIMATES 1. TRADING CONCERN STATEMENTOF OFWORKING WORKINGCAPITAL CAPITALREQUIREMENTS REQUIREMENTS STATEMENT Amount(Rs.) (Rs.) Amount CurrentAssets Assets Current (i)Cash Cash (i) (ii)Receivables Receivables((For…..Month’s For…..Month’sSales)---Sales)---(ii) (iii)Stocks Stocks((For……Month’s For……Month’sSales)----Sales)----(iii) (iv)AdvancePayments Paymentsififany any (iv)Advance Less::Current CurrentLiabilities Liabilities Less (i)Creditors Creditors(For….. (For…..Month’s Month’sPurchases)Purchases)(i) (ii)Lag Lagininpayment paymentof ofexpenses expenses (ii) WORKINGCAPITAL CAPITAL((CA CA––CL CL)) WORKING Add::Provision Provision //Margin Marginfor forContingencies Contingencies Add NETWORKING WORKINGCAPITAL CAPITALREQUIRED REQUIRED NET -----------------------------------_ -----_ xxx xxx --------XXX XXX 1. MANUFACTURING CONCERN STATEMENT OF WORKING CAPITAL REQUIREMENTS Amount (Rs.) Current Assets (i) Stock of R M( for ….month’s consumption) (ii)Work-in-progress (for…months) (a) Raw Materials (b) Direct Labour (c) Overheads (iii) Stock of Finished Goods ( for …month’s sales) (a) Raw Materials (b) Direct Labour (c) Overheads (iv) Sundry Debtors ( for …month’s sales) (a) Raw Materials (b) Direct Labour (c) Overheads (v) Payments in Advance (if any) (iv) Balance of Cash for daily expenses (vii)Any other item Less : Current Liabilities (i) Creditors (For….. Month’s Purchases) (ii) Lag in payment of expenses (iii) Any other WORKING CAPITAL ( CA – CL )xxxx Add : Provision / Margin for Contingencies NET WORKING CAPITAL REQUIRED --------------------------------------------------------------------XXX ...
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