working capital mgt ppt
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8/6/2019 Working Capital Mgt Ppt
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Working Capital
Management
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Topics CoveredTopics Covered
Working Capital conceptsWorking Capital concepts
Credit ManagementCredit Management Inventory ManagementInventory Management
Cash ManagementCash Management
Marketable SecuritiesMarketable Securities
Working capital cycleWorking capital cycle Working Capital FinanceWorking Capital Finance
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Working Capital ConceptsWorking Capital ConceptsGross Working CapitalGross Working CapitalThe firms investment in current assetsThe firms investment in current assets
Net Working CapitalNet Working CapitalCurrent AssetsCurrent Assets -- Current Liabilities.Current Liabilities.
..
Working Capital ManagementWorking Capital ManagementThe administration of the firms current assets and theThe administration of the firms current assets and the
financing needed to support current assetsfinancing needed to support current assets
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Working CapitalWorking CapitalCurrent assets and liabilities for Indian manufacturing firms (31 March,
2008)Rs. Crores
Cash Rs.74651.53 Rs.26285.89 Current portion of long-term debt
Other short-term financial investments 30125.67 155962.85 Accounts payable
Accounts receivable 249097.79 29180.15 Income tax provisions
16957.65 Dividend Provisions
Inventories 173214.88 63028.27 Other current liabilities
Total current assets Rs.527089.87 Rs.291414.81 Total current liabilities
Net working capital (current assets - current liabilities) = 527089.87 - 291414.81 = Rs.235675.06 crores
Current LiabilitiesCurrent Assets
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Significance of WorkingSignificance of Working
Capital ManagementCapital Management In a typical manufacturing firm, current assetsIn a typical manufacturing firm, current assets
exceed oneexceed one--half of total assets.half of total assets.
Excessive levels can result in a substandardExcessive levels can result in a substandardReturn on Investment (ROI).Return on Investment (ROI).
Current liabilities are the principal source ofCurrent liabilities are the principal source ofexternal financing for small firms.external financing for small firms.
Requires continuous, dayRequires continuous, day--toto--day managerialday managerial
supervision.supervision. Working capital management affects theWorking capital management affects the
companys risk, return, and share price.companys risk, return, and share price.
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Working Capital IssuesWorking Capital Issues
AssumptionsAssumptions
50,000 maximum50,000 maximumunits of productionunits of production
ContinuousContinuousproductionproduction
Three differentThree differentpolicies for currentpolicies for currentasset levels areasset levels arepossiblepossible
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
Policy APolicy A
Policy
BPolicy B
Policy CPolicy C
Current Assets
OUTPUT (units)
ASSET
LEVEL
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Impact on LiquidityImpact on Liquidity
Liquidity AnalysisLiquidity Analysis
PolicyPolicy Liquidity Liquidity
AA HighHigh
BB AverageAverage
CC LowLow
Greater current assetGreater current assetlevels generate morelevels generate more
liquidity; all otherliquidity; all otherfactors held constantfactors held constant
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
Policy APolicy A
Policy BPolicy B
Policy CPolicy C
Current Assets
OUTPUT (units)
ASSET LEVEL
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Impact onImpact on
Expected ProfitabilityExpected Profitability
Return on InvestmentReturn on Investment==
Net ProfitNet ProfitTotal AssetsTotal Assets
LetLet Current AssetsCurrent Assets ==(Cash + Rec. + Inv.)(Cash + Rec. + Inv.)
Return on InvestmentReturn on Investment==
Net ProfitNet Profit(Current(Current ++ Fixed Assets)Fixed Assets)
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
Policy APolicy A
Policy BPolicy B
Policy CPolicy C
Current Assets
OUTPUT (units)
ASSET
LEVE
L
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Impact onImpact on
Expected ProfitabilityExpected Profitability
Profitability AnalysisProfitability Analysis
PolicyPolicy Profitability Profitability
AA LowLow
BB AverageAverage
CC HighHigh
As current asset levelsAs current asset levelsdecline, total assetsdecline, total assetswill decline and thewill decline and the
ROI will rise.ROI will rise.
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
Policy APolicy A
Policy BPolicy B
Policy CPolicy C
Current Assets
OUTPUT (units)
ASSET
LEVE
L
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Impact on RiskImpact on Risk
Decreasing cashDecreasing cashreduces the firms abilityreduces the firms abilityto meet its financialto meet its financialobligations.obligations. More risk!More risk!
Stricter credit policiesStricter credit policiesreduce receivablesreduce receivables andandpossibly lose sales andpossibly lose sales andcustomers.customers. More risk!More risk!
Lower inventory levelsLower inventory levelsincrease stock outs andincrease stock outs andlost sales.lost sales. More risk!More risk!
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
Policy APolicy A
Policy BPolicy B
Policy CPolicy C
Current Assets
OUTPUT (units)
ASSET
LEVE
L
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Impact on RiskImpact on Risk
Risk AnalysisRisk Analysis
PolicyPolicy RiskRisk
AA LowLow
BB AverageAverage
CC HighHigh
Risk increases as the levelRisk increases as the levelof current assets areof current assets are
reduced.reduced.
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
Policy APolicy A
Policy BPolicy B
Policy CPolicy C
Current Assets
OUTPUT (units)
ASSET
LEVE
L
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Summary of the OptimalSummary of the Optimal
Amount of Current AssetsAmount of Current AssetsSSUMMARYUMMARYOOFFOOPTIMALPTIMAL CCURRENTURRENTAASSETSSETAANALYSISNALYSIS
PolicyPolicy Liquidity Liquidity Profitability Profitability RiskRisk
AA HighHigh LowLow LowLow
BB AverageAverage AverageAverage AverageAverageCC LowLow HighHigh HighHigh
1. Profitability varies inversely with liquidity.1. Profitability varies inversely with liquidity.
2. Profitability moves together with risk.2. Profitability moves together with risk.(risk and return go hand in hand!)(risk and return go hand in hand!)
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Classifications of WorkingClassifications of Working
CapitalCapital
ComponentsComponents
Receivables, inventory , cash and
marketable securities
TimeTime
PermanentPermanent
TemporaryTemporary
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Permanent Working Capital
Permanent Working Capital
The amount of current assets required to meet a firms longThe amount of current assets required to meet a firms long--term minimumterm minimum
needsneeds..
TIME
Permanent current assetsPermanent current assets
RUPEE
AMOUNT
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Temporary Working CapitalTemporary Working CapitalThe amount of current assets that varies with seasonal requirementsThe amount of current assets that varies with seasonal requirements..
Temporary current assetsTemporary current assets
Permanent current assets
Permanent current assets
TIME
RUPEE
AMOUNT
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Credit ManagementCredit ManagementTerms ofSaleTerms ofSale -- Credit, discount, and paymentCredit, discount, and payment
terms offered on a sale.terms offered on a sale.
ExampleExample -- 5/10net 305/10net 30
55-- percent discount for early paymentpercent discount for early payment
1010 -- number of days that the discount isnumber of days that the discount isavailableavailable
net 30net 30 -- number of days before payment is duenumber of days before payment is due
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Terms of SaleTerms of Sale A firm that buys on credit is in effect borrowing from itsA firm that buys on credit is in effect borrowing from its
supplier. It saves cash today but will have to pay later.supplier. It saves cash today but will have to pay later.
This, of course, is an implicit loan from the supplier.This, of course, is an implicit loan from the supplier.
We can calculate the implicit cost of this loanWe can calculate the implicit cost of this loan
( )
Effective annual rate
1 + - 1discountdiscounted price365/ extra days credit
=
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Terms of SaleTerms of SaleExampleExample -- On a Rs.100 sale, with terms 5/10 net 60, what is theOn a Rs.100 sale, with terms 5/10 net 60, what is the
implied interest rate on the credit given?implied interest rate on the credit given?
45.4%
or.454,=
1-1
1-1
rateannualective
365/50
95
5
creditdays365/extra
pricediscounteddiscount
!
!
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Credit AgreementsCredit Agreements TerminologyTerminology
open accountopen account
promissory notepromissory note commercial draftcommercial draft
sight draftsight draft
time drafttime draft
trade acceptancetrade acceptance bankers acceptancebankers acceptance
irrevocable letter of creditirrevocable letter of credit
conditional saleconditional sale
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Credit AnalysisCredit AnalysisNumerical Credit Scoring categoriesNumerical Credit Scoring categories
The customers characterThe customers character
The customers capacity to payThe customers capacity to pay
The customers capitalThe customers capital
The collateral provided by the customerThe collateral provided by the customer
The condition of the customers businessThe condition of the customers business
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Credit AnalysisCredit AnalysisCredit AnalysisCredit Analysis -- Procedure to determine theProcedure to determine the
likelihood a customer will pay its bills.likelihood a customer will pay its bills.
Credit agencies provide reports on the creditCredit agencies provide reports on the credit
worthiness of a potential customer.worthiness of a potential customer.
Financial ratios can be calculated to helpFinancial ratios can be calculated to helpdetermine a customers ability to pay its bills.determine a customers ability to pay its bills.
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The Credit DecisionThe Credit DecisionCredit PolicyCredit Policy -- Standards set to determine the amountStandards set to determine the amount
and nature of credit to extend to customers.and nature of credit to extend to customers.
Credit ScoringCredit Scoring What your lender wont tell you.What your lender wont tell you.
Extending credit gives you the probability of making aExtending credit gives you the probability of making aprofit, not the guarantee. There is still a chance ofprofit, not the guarantee. There is still a chance ofdefault.default.
Denying credit guarantees neither profit or lossDenying credit guarantees neither profit or loss
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The Credit DecisionThe Credit DecisionThe credit decision and its probable payoffsThe credit decision and its probable payoffs
Customer pays = p
Customer de aults = 1-p
Payo = 0
Payo = Rev - Cost
Payo = - Cost
Offer credit
Refuse credit
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The Credit DecisionThe Credit Decision Based on the probability of payoffs, the expected profit can beBased on the probability of payoffs, the expected profit can be
expressed as:expressed as:
p x PV(Rev - Cost) - (1 - p) x (PV(cost)
The break even probability of collection is:
p = PV(Cost)PV(Rev)
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Collection PolicyCollection PolicyCollection PolicyCollection Policy -- Procedures to collectProcedures to collect
and monitor receivables.and monitor receivables.
Ageing ScheduleAgeing Schedule -- Classification ofClassification of
accounts receivable by timeaccounts receivable by time
outstanding.outstanding.
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Collection PolicyCollection Policy Sample ageing schedule for accounts receivableSample ageing schedule for accounts receivable
Customer's Less than More than1-2 months 2-3 months Total Owed
Name 1 month 3 months
A 10,000 0 0 0 10,000
B 8,000 3,000 0 0 11,000
* * * * * *
* * * * * *
* * * * * *Z 5,000 4,000 6,000 15,000 30,000
Total s.200,000 s.40,000 s.15,000 s.43,000 s.298,000
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Inventory ManagementInventory Management Components of InventoryComponents of Inventory
Raw materialsRaw materials
Work in processWork in process
Finished goodsFinished goods
Goal = Minimize amount of cash tied up in inventoryGoal = Minimize amount of cash tied up in inventory
Tools used to minimize inventoryTools used to minimize inventory JustJust--inin--timetime
Lean manufacturingLean manufacturing
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Cash ManagementCash ManagementCash does not pay interestCash does not pay interest
Move money from cash accounts intoMove money from cash accounts intoshort term securitiesshort term securities
Sweep programsSweep programs
MMDAsMMDAs
Concentration bankingConcentration banking
LockLock--box systembox system
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Money Market InvestmentsMoney Market Investments
(India)(India)Investment
Borrower
Maturities
When Issued Marketability
Basis for
Calculating Interest Comments
Treasury Bills Government of India
14-days, 91-
days, 182-days,
or 364 days
Good
Secondary
Market
Discount
14-day and 91-day T-Bills are auctioned
weekly. The 182-days and 364-days T-Bills
are auctioned fortnightly.
Certificates of
DepositBanks
14 days to 1
year
Fair
secondary
market
Discount The CDs are negotiable instruments
Commercial Papers
Industrial firms,
financial institutions
apart from primary
dealers and satellite
dealers
15 days to 1
year
Fair
secondary
market
Discount
Only companies with a CRISIL rating of P2
and above or equivalent rating can issue
CPs
Repurchase
agreements (repos)
Banks and primarydealers, and all entities
having SGL and current
account with RBI
1 day (2 to 3days if issued
on Fridays or
holidays)
ExcellentSecondary
market
Repurchase price
set higher than
selling price;difference quoted
as repo interest
rate (adjusted for
coupon)
Since June 2000, RBI is conducting Repotransactions every day under the Liquidity
Adjustment Scheme
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WORKING
CAPITAL CYCLEWORKING
CAPITAL CYCLEReceivable AR
converted to Cash
Goods orServices
converted to
Accounts
Receivable AR
Collect ARCollect AR CashCash
Produce goodsProduce goodsor Servicesor Services
Cash converted toCash converted to
prepaid expensesprepaid expenses
DeliverGoodsDeliverGoods
or servicesor servicesSalesSales
OrderOrder
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WORKING CAPITAL FINANCINGWORKING CAPITAL FINANCING
Working Capital is financed by following sources:
OWNED FUNDS
A portion of long term funds, equity share capital and reserves& surplus is utilized to fund working capital BANK BORROWINGS
Various bank products like cash credit, packing credit, billsdiscounting etc.
CREDITORS
Raw Materials W-I-P Finished Goods Debtors
Trade Payables Long Term Funds + Bank Borrowings
Funding the Cash Operating Cycle
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WORKING CAPITAL FINANCINGWORKING CAPITAL FINANCING
WorkingWorkingCapitalCapital
ProductsProducts
FundFund
BasedBased
NonNonFundFund
BasedBased
StructuredStructured
ProductsProducts
DomesticDomestic ExportExport
Letter ofLetter of
CreditCredit
BankBank
GauranteeGaurantee
Buyer &Buyer &
SuppliersSupplierscreditcredit
CommercialCommercial
PaperPaper
CorporateCorporate
LoansLoansS
ecuritizationS
ecuritization FactoringFactoring ForfeitingForfeiting
PrePre--shipmentshipment
PostPostshipmentshipment
CashCashCreditCredit
OverdraftOverdraft
BillBillFinanceFinance
DocumentaryDocumentary
CleanClean
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