Working Capital Management
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WORKING CAPITAL MANAGEMENT
Topics To Be Covered
Concept Definitions Types Factors Affecting WK Requirements Operating Cycle Approach Dangers of Excessive and Inadequate WK Practical Exercises
Nature of Working Capital
Managing the current assets, current liabilities and their inter-relationships Current Assets:
Assets that can be converted into cash within 1 year ( marketable securities, cash, inventory, accounts receivables)
Current Liabilities:
Obligations to be paid within a year from current assets or earnings (accounts payable, bills, Bank OD, O/s Expenses)
Contd..
Goal of WK management: to manage the current assets and liabilities so that a satisfactory level of WK is maintained WHY?
To avoid insolvency To avoid bankruptcy Efficient business operations
Right mix of current assets and liabliites
“The interaction between current assets and liabilities is the main theme of WK management”
Concepts and Definitions
Gross Working Capital Net Working Capital
Gross Working Capital
The current assets which represent the proportion of investment that circulates from one form to another in ordinary course of business TOTAL CURRENT ASSETS
Net Working Capital
NWK = CA – CL Tool to measure the liquidity (like CR, Acid Test Ratio)
Non-synchronous cash flows CA > CL More ability to meet obligations
Net Working Capital (contd.)
That portion of current assets which is financed with long term funds
CL represents short term sources of finance If CA > CL then the excess is financed by long term sources
TRADE OFF BETWEEN PROFITABILITY AND RISK
Profits measured by revenues and costs Risk of technical insolvency
Probability that a firm will be unable to meet its obligation as they become due
Effect of level of CA and CL on Profitability-Risk Trade Off
Assumptions:
We are dealing with a manufacturing concern CA are less profitable than fixed assets Short term funds are less expensive than long term funds
PROFITS CA
+
_
RISK of insolvency _
CA
_
+
+
CL
+
+
+
CL
-
_
_
NEED FOR WORKING CAPITAL
Goal of FM : Share-holder Wealth Maximization Profits Sales Time lag involved
need for WK
OPERATING CYCLE/ CASH CYCLE
The continuing flow from cash to suppliers, to inventory, to accounts receivable and back into cash
Operating cycle RECEIVABLES CASH INVENTORY
Cash Cycle
The length of time necessary to complete the cycle of events
TYPES OF WK
Permanent / Fixed WK Temporary / Fluctuating / Variable WK
CHANGES IN WK
Changes in Sales and Operating Expenses Policy Changes Technological Changes
DETERMINANTS OF WK
General Nature of Business Production Cycle Business Cycle Production Policy Credit Policy Growth and Expansion
Vagaries in availability of raw materials Profit Level
Level of taxes Dividend policy Depreciation policy
Price level changes Operating efficiency
DANGERS OF EXCESSIVE WK
Accumulation of inventory – waste, theft, loss Defective credit policy and slack collection period – bad debts Complacency and inefficiency Affects dividend policy – speculative profits in inventory tends to liberal dividend policy- future?
INADEQUATE WK PROBLEMS
Stagnates growth Difficult to achieve target profit levels and operational plans Operating inefficiency Inefficient utilization of fixed assets Inability to avail attractive opportunities
Buy raw materials at low rates Sell on credit to a big buyer
Loss of reputation- inability to meet obligations- tight credit terms
Topics To Be Covered
Concept Definitions Types Factors Affecting WK Requirements Operating Cycle Approach Dangers of Excessive and Inadequate WK Practical Exercises
Nature of Working Capital
Managing the current assets, current liabilities and their inter-relationships Current Assets:
Assets that can be converted into cash within 1 year ( marketable securities, cash, inventory, accounts receivables)
Current Liabilities:
Obligations to be paid within a year from current assets or earnings (accounts payable, bills, Bank OD, O/s Expenses)
Contd..
Goal of WK management: to manage the current assets and liabilities so that a satisfactory level of WK is maintained WHY?
To avoid insolvency To avoid bankruptcy Efficient business operations
Right mix of current assets and liabliites
“The interaction between current assets and liabilities is the main theme of WK management”
Concepts and Definitions
Gross Working Capital Net Working Capital
Gross Working Capital
The current assets which represent the proportion of investment that circulates from one form to another in ordinary course of business TOTAL CURRENT ASSETS
Net Working Capital
NWK = CA – CL Tool to measure the liquidity (like CR, Acid Test Ratio)
Non-synchronous cash flows CA > CL More ability to meet obligations
Net Working Capital (contd.)
That portion of current assets which is financed with long term funds
CL represents short term sources of finance If CA > CL then the excess is financed by long term sources
TRADE OFF BETWEEN PROFITABILITY AND RISK
Profits measured by revenues and costs Risk of technical insolvency
Probability that a firm will be unable to meet its obligation as they become due
Effect of level of CA and CL on Profitability-Risk Trade Off
Assumptions:
We are dealing with a manufacturing concern CA are less profitable than fixed assets Short term funds are less expensive than long term funds
PROFITS CA
+
_
RISK of insolvency _
CA
_
+
+
CL
+
+
+
CL
-
_
_
NEED FOR WORKING CAPITAL
Goal of FM : Share-holder Wealth Maximization Profits Sales Time lag involved
need for WK
OPERATING CYCLE/ CASH CYCLE
The continuing flow from cash to suppliers, to inventory, to accounts receivable and back into cash
Operating cycle RECEIVABLES CASH INVENTORY
Cash Cycle
The length of time necessary to complete the cycle of events
TYPES OF WK
Permanent / Fixed WK Temporary / Fluctuating / Variable WK
CHANGES IN WK
Changes in Sales and Operating Expenses Policy Changes Technological Changes
DETERMINANTS OF WK
General Nature of Business Production Cycle Business Cycle Production Policy Credit Policy Growth and Expansion
Vagaries in availability of raw materials Profit Level
Level of taxes Dividend policy Depreciation policy
Price level changes Operating efficiency
DANGERS OF EXCESSIVE WK
Accumulation of inventory – waste, theft, loss Defective credit policy and slack collection period – bad debts Complacency and inefficiency Affects dividend policy – speculative profits in inventory tends to liberal dividend policy- future?
INADEQUATE WK PROBLEMS
Stagnates growth Difficult to achieve target profit levels and operational plans Operating inefficiency Inefficient utilization of fixed assets Inability to avail attractive opportunities
Buy raw materials at low rates Sell on credit to a big buyer
Loss of reputation- inability to meet obligations- tight credit terms
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