cf final assignment

8/2/2019 CF Final Assignment

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Corporate Finance Yasir Mehmood1

Working Capital Issue in Corporation

Prepared By

_______________________Yasir Mehmood

Submitted to_______________________

Prof Waqas Rauf

(Buraq IT School)

AAllllaammaa IIqqbbaall OOppeenn UUnniivveerrssiittyy

IIssllaammaabbaadd

TOPIC


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ACKNOWLEDGEMENT

All My Words Dedicated With Respect and

Reverence Love and Affection to

My Loving Parents & Teachers

Whose Love and Prays Always Accompanies Me

Like a Shining Star Whenever I was in Darkness

and Enable Me to Reach This Stage.


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AN ABSTRACTThe management of current assets deals with determination, maintenance, control and

monitoring the level of all the individual current assets. Current assets are referred to as

assets, which can normally be converted into cash within one year therefore investment in

current assets should be just adequate no more no less to the needs of the business.

Excessive investments in current assets should be avoided, because it impairs firms

profitability, as idle investment in current assets and are non-productive and so they can

earn nothing, on the other hand inadequate amount of working capital can threaten

solvency of the firm, if it fails to meet its current obligations.

Working capital is one of the important issue in all the organizations and in case

of the financial institutions it is very important to maintain the main factor of the working

capital and that is the cash so for the management of the cash financial institutions has to

pay more attention and try to implement more strategies so that they may reduce the extra

expenses in case of lack of cash and taking other loans.

Last but not least this organization needs to overcome its weaknesses and avail

the opportunities so that they may able to increase its market and returns.


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IntroductionWorking capital means the part of the total assets of the business that

change from one form to another form in the ordinary course of business

operations.

More business fails for lack of cash than for want of profit . Efficient

management of working capital is one of the pre conditions for the success of

an enterprise. Thus, goal of Working Capital Management is to manage the firms

Current Assets and liabilities in such a way that satisfactory level of Working

Capital minted.

Every Business needs funds for two purposes:-

Long term funds are required to create production facilities throughpurchase of fixed assets such as plants, machineries, lands, & buildings etc.

Short term funds are required for the purchase of raw materials, payment ofwages, and other daytoday expenses.

CONCEPT OF WORKING CAPITAL.

The word working capital is made of two words :

1. Working

2. Capital

The word working means day to day operation of the business, whereas the word

capital means monetary value of all assets of the business.

MEANING OF WORKING CAPITAL.

Working Capital is the amount of capital that a business has available to meet

the day - to - day cash requirements of its operations, or more specially, for

financing the conversion of raw material into finished goods, which the company

sells for payment. Funds are also needed for short term purposes for the purpose

of raw materials, payment of wages and other daytoday expenses, etc. Thesefunds are known as Working Capital. In simple words, Working Capital refers to

that part of the firms capital, which is required for financing short - term or

Current Assets such as cash, marketable securities, debtors and inventories.

Working Capital is a valuation metric that is calculated as Current Assets over

Current Liabilities. Working Capital is also known as Operating Capital.


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TYPES OF WORKING CAPITAL

ON THE BASIS OF CONCEPT.

Gross Working Capital:The Gross Working Capital refers to the firms Investment in all the assets

taken together. The total of investment in all the individual Current

Assets is the Gross Working Capital.

For example: if a firm has a cash balance of Rs. 50,000, debtors of

Rs.70,000 and inventory of raw material and finished goods has been assessed atRs .1,00,000, then the Gross Working Capital of the firm is Rs.2,20,000 (i.e. Rs

50,000 + Rs.70,000 + Rs.1,00,000).

Net Working Capital:The term Net Working Capital may be defined as the excess of Total Current

Assets over Total Current Liabilities. Current Liabilities refer to those liabilitieswhich are payable within a period of 1 year.

The Net Working Capital may either be positive or negative. If the Total Current

Assets are more than Total Current Liabilities, then the difference is known asPositive Net Working Capital, otherwise the difference is known as Negative Net

Working Capital. The Net Working Capital measures the firms liquidity. The

greater the margin, the better will be the liquidity of the firm.


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Net Working Capital = Total Current AssetsTotal Current Liabilities.

A financial manager must consider both (Gross and Net Working Capital)because they provide different interpretation. The Gross Working Capital denotes

the Total Working Capital or the total investment in Current Assets. This willhelp avoiding :

The unnecessary stoppage of work or chance of liquidation due toinsufficient Working Capital.

Effect on profitability (over flowing Working Capital implies cost). TheGross Working Capital also gives an idea of total funds required for

maintaining Current Assets.

On the other hand, Net Working Capital refers to the amount of funds that

must be invested by firm, more or less, regularly in Current Assets. The NetWorking Capital also denotes the net liquidity being maintained by the firm.

ON THE BASIS OF TIME.

Permanent / Fixed Working Capital:Permanent Working Capital may be defined as the minimum level of Current

Assets, which is required by a firm to carry on its business operations. Every

firm has to maintain a minimum level of raw materials, work in progress,finished goods and cash balances.

For exampleextra inventory of finished goods will have to be maintained tosupport the peak periods of sale. Permanent Working Capital is permanentlyneeded for the business and therefore, it should be financed out of long term

funds.

Fluctuating / Variable Working Capital: It is the extra Working Capitalneeded to support the changing production and sales activities of the firm. The

amount of Temporary Working Capital keeps on fluctuating on time to time onthe basis of business activity.

Both kind of Working CapitalPermanent and Fluctuating (Temporary) are

necessary to facilitate production and sales through the Operating Cycle. Theamount over and above Permanent Working Capital is temporarily variable or

fluctuating.


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PERMANENT AND VARIABLE WORKING CAPITAL OF A STABLE

FIRM.

Amount

Of Temporary Working Capital.

Working

Capital.

Permanent Working Capital.

Time.

In the above figure, it is shown that Permanent Working Capital is stable

over the time, while Temporary Working Capital is fluctuatingsome times

increasing and sometimes decreasing.

PERAMANENT AND TEMPORARY WORKING CAPITAL OF A RISING

FIRM.

However when the business is Growing, the level of Permanent Working

Capital also grows. The Working Capital graph will be rising one as given in

figure below:

Temporary Working Capital.

Amount

Of

WorkingCapital.

Permanent Working Capital.

Time.


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(The Working Capital Cycle (Operating cycle)

The Working Capital requirement of a firm depends, to a great extent upon

the Operating Cycle of the firm. The operating cycle may be defined as the time

duration starting from the procurement of goods or raw material and ending withthe sales of realization. The length and nature of the Operating Cycle may differ

from one firm to another depending upon the size and nature of the firm. In a

trading concern, there is a series of activities starting from procurement of goods

(saleable goods) and ending with the realization of sales revenue (at the time ofsale itself in the case of cash sales and at the time of debtors realization in case

of credit sales). Similarly in case of manufacturing concern, this series starts from

the procurement of raw materials and ending with the sales realization of finished

goods. In both the cases, however, there isa time gap between the happening of the first event and the happening of the last

event. This time gap is called the Operating Cycle.

Thus, the Operating Cycle of a firm consists of the time requiredfor the completion of the chronological sequences of some or all of the

following:-

Procurement of raw material and services. Conversion of raw material into workinprogress. Conversion of workinprogress into finished goods. sale of finished good(cash or credit) Conversion of receivable into cash.

Symbolically: -

O = R + W + F + D - C.

Where, O= Length of Operating Cycle.R= Raw Material storage period.

W= work in progress period.

F= Finished stock storage period.

D= Debtors collection period.C= Creditors payment period

Work inProgress.

FinishedGoods

Debtors/AccountRecievabls &

Sales

Profit.

RawMaterial.


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DETERMINANTS OF WORKING CAPITAL:

Working Capital requirements of a concern depends on a number of

factors, each of which should be considered carefully for determining the properamount of Working Capital. It may be however be added that these factors affect

differently to the different units and these keeps varying from time to time. Ingeneral, the determinants of Working Capital which re common to all

Organizations can be summarized as under:

(a)- Nature of Business:

Need for Working Capital is highly depends on what type of business, the firm

in. there are trading firms, which needs to invest a lot in stocks, ills receivables,

liquid cash etc. public utilities like railways, electricity, ete., need much less

inventories and cash. Manufacturing concerns stands in between these two extends.Working Capital requirement for manufacturing concerns depends on various

factors like the products, technologies, marketing policies.

(b)- Production Policies:

Production policies of the organization effects Working Capital requirements

very highly. Seasonal industries, which produces only in specific season requiresmore Working Capital. Some industries which produces round the year but sale

mainly done in some special seasons are also need to keep more Working

Capital.

(c)- Size Of Business:

Size of business is another factor to determines the need for Working Capital.(d)- Length Of Operating Cycle:Operating Cycle of the firm also influence the Working Capital. Longer the

Operating Cycle, the higher will be the Working Capital requirement of the

organization.

(e)- Credit Policy:Companies; follows liberal credit policy needs to keep more Working Capital with

them. Efficiency of debt collecting machinery is also relevant in this matter. Credit

availability form suppliers also effects the companys Working Capitalrequirements. A company doesnt enjoy a liberal credit from its suppliers will have

to keep more Working Capital.

(f)- Business Fluctuation:Changes in the Economy also influencing the Working Capital. During boom

period, the tendency of Management is to increase the up inventories of raw

materials and finished goods to avail the advantage of rising prove. This creates

demand for more Capital. Similarly during depression when the prices anddemand for manufactured goods. Constantly reduce the industrial and trading

activities show a downward termed. Hence the demand for Working Capital is

low.


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(g)- Current Asset Policies:

The quantum of Working Capital of a company is significantly determined

by its Current Assets policies. A company with conservative assets policy mayoperate with relatively high level of Working Capital than its sales volume. A

company pursuing an aggressive amount assets policy operates with a relativelylower level of Working Capital.

(i)- Other Factors:Effective coordination between production and distribution can reduce the

need for Working Capital. Transportation and communication means. If developed

helps to reduce the Working Capital requirement.

SOURCES OF WORKING CAPITAL.

The company can choose to finance its Current Assets by:

Long term sources. Short term sources. A combination of them.

ISSUES IN WORKING CAPITAL MANAGEMENT

Working capital management refers to the administration of all components of workingcapital cash, marketable securities, debtors (receivables), and stock (inventories) and

creditors (payables). The financial manager must determine levels and composition of

current assets. He must see that right sources are tapped to finance current assets, and that

current liabilities are paid in time.There are many aspects of working capital management which make it an important

function of the financial manager.

Time. Working capital management requires much of the financial managerstime.

Investment. Working capital represents a large portion of the total investment inassets. Actions should be taken to curtail unnecessary investment in current

assets.

Criticality. Working capital management has great significance for all firms but itis very critical for small firms. Small firms face a severe problem of collecting

their dues debtors. Further, the role of current liabilities is more significant in caseof small firms, as, unlike large firms, they face difficulties in raising long-term

finances.

Growth. The need for working capital is directly related to the firms growth. Assales grow, the firm needs to invest more in inventories and debtors. Continuous

growth in sales may also require additional investment in fixed assets.


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Practical Study of Organization

About MCB

MCB is one of the leading banks of Pakistan with a deposit base of Rs. 368

Billion and total assets over Rs.500 Billion. Incorporated in 1947, MCB soon earned the

reputation of a solid and conservative financial institution managed by expatriate

executives. In 1974, MCB was nationalized along with all other private sector banks.

The Bank has a customer base of approximately 4 million, a nationwide

distribution network of over 1,000 branches and over 450 ATMs in the market.

Vision Statement

To be the leading financial services provider, partnering with our customers for a

more prosperous and secure future.

Mission Statement

We are a team of committed professionals, providing innovative and efficient financial

solutions to create and nurture long-term relationships with our customers. In doing so,

we ensure that our shareholders can invest with confidence in us.

Corporate Banking

Cash Management ServicesMCBs network of over 900 branches in Pakistan enables it to collect and disburse

payments efficiently with its cash management services. This also enables it to offer you

a choice of paper based or electronic fund transfer solutions including collection

amounts, cross branch on- line transactions etc.

Working Capital LoansBased on the customers specific needs, the Corporate Bank offers a number of different

working capital financing facilities including Running Finance, Cash Finance, Export

Refinance, Pre-shipment and Post- shipment etc. Tailor- made solutions are developed

keeping in view the unique requirements of your business.


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Term LoansMCB offers Short to Medium Term Finance to meet capital expenditure and short

term working capital requirements of our customers. The loans are structured on the basis

of underlying project characteristics and cash flows of the business. Trade Finance Services

Under Corporate Banking MCB offers trade finance services that include an

entire range of import and export activities including issuing Letters of Credit (L/Cs),

purchasing export documents, providing guarantees and other support services.

Working Capital Management in MCB:

As MCB is a financial institution so there working capital main factor is the cash

so they have to manage the cash at first and then there comes payables and the

receivables there is no concept of inventory in the financial institution as they are not

manufacturing anything on the other hand their cash cycle become narrow in the cash,

receivable and the payables. And accounts receivable are mostly related with the

accounts payable because the bank is using proportion of the payable to generate the

loans and other short term financing to the customers. Now I am going to tell you the

working capital management of the MCB.

Cash Management:

For any financial institution the main source of cash are their deposits so the main

source from where they get the cash is the deposits of the customers maintained by the

bank and by the use of this cash they are able to fulfill there operating expenses and to

maintain the profit of their organization.

There are lesser chances of the cash out but if they face any such condition they

go for the non depository ways to fulfill there needs like taking out some money out of

the reserve fund maintained by the SBP or at security office or by taking loans from the

other banks.

There are following strategies they are using for the cash management.

Deposits Segregation:The deposits which they are accepting from the customers they are going to distribute the

percentages of these deposits and this segregation is they are going to use the 60-70

percent cash for the lending and remaining 30 percent is used for the fulfillment the needs


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of the customers for example if customer has to withdraw the amount they use this 30

percent for the same. And through this way they are able to circulate their cash.

Cash fulfillment by non depository way:To manage the liquidity of the bank if they have lack of cash they may take it

from the main office or head office otherwise head office arrange the cash for the

specific branch from the state bank or they are going to get a loan from state bank

out of the reserve they have with the state bank on the other hand they are taking

loans from other banks so that they will be able to fulfill the need of cash at the

branch.

Investment Strategies:To get the maximum benefit of the cash they are going to invest the cash into the

short as well as long term investments so that they will get the returns and

because of these returns they are able to get the excessive cash through this cash

they are able to easily maintain the operating cycle of the bank.

Accounts payable management:

Here the bank first is distributing the deposits in to the following two categories.

Certain Accounts:These are such kind of accounts by which bank is certain that the depositor may not

withdraw the deposited money frequently means that they are clear that the deposit is for

long time these are mostly the saving accounts depositors fixed account depositors or the

small accounts deposits here the bank is able to fund out the money for the purpose of

lending from these deposits.

Uncertain Accounts:These are such accounts about which banks are uncertain means that the bank is not

certain about the time up to which they may hold these deposits. Bank is not certain about

the withdrawal of the amount. These kinds of accounts may increase the bank costs as

banks are not able to utilize such amount further due to uncertainty. Mostly these kinds of

accounts are maintained by the corporate and they have many transactions in a day to do

the business so they are uncertain deposits.


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Amount payable by the bank are the amounts which depositors has deposit and

interests which bank has to disbursed to the depositors on the other hand the bank has to

utilize these deposits for the lending purpose so main disbursements of the banks are

depositors withdrawals and the loans to the customers.

In case of lending the bank has a specific policies which are maintained and dully

checked by the audit staff of the bank according to the lending policy of the MCB

regional head has authority to allow a person or a customer to get 5 million as a running

finance loan and 20 million as instance financing.

So the banks has to maintain the balance for these things as well as the payment

of the dividends or for payment of the interest to depositors these all payments are

regulated through the deposit management and by the returns they get from the

investments they have made in short term and long term securities on the other hand the

returns banks get from the loans. But if they have less money for the payment they have

options which I have discussed in the cash management.

Accounts receivable management:

In case of the MCB the receivables are the loans which they have provided to the

customers and there new policy is to not provide any loan to the individuals so they are

only providing the loans to the corporate.

MCB has proper setup in shape of the credit policy they have all rules and

regulations about the loans and they have ability to get proper investigation of the

customers in all aspects before they are going to give them the loan.

For the recovery of the interest they deduct it directly from the customer account

after a quarter as in the loan agreement they mostly pick the authority to directly deduct

the interest out of the amount in the bank account of the customer. So after a quarter they

are going to directly deduct it from the customers account and they send a letter to the

customer about the deduction with the interest schedule. For the interest if they do not get

the authority then they give 25 days after the quarter to the customer to give the interest

otherwise the rate may increase on the daily bases.

In case of loan default if a loan is of rupees 2 million then it is the responsibility

of the advances department to take the loan back from the customer.


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In case of the loan more than the 2 million the defaulter case is not the

responsibility of the advances department they forward this defaulter responsibility to the

department managed at the main branch of the Islamabad that is SAMG (Special Asset

Management Group) this department can do so.

This department approve certain time limit for the repayment of the loan and give

time to the defaulter and also sending him the notices after the dead line is over if the

loan is secure then they go and sale out the collateral which customer has mortgage with

them on the other hand if the loan is insecure then the special lawyers of this department

take the party to the court and then recover loan as well as damages.

There were some working capital management issues related with the MCB now I

am going to give my recommendations conclusion and the SWOT analysis about the

MCB working capital management.


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SWOT Analysis

Strengths:

First bank to privatize, which has, now become the leader in market with largeston line ATM network in the country.

Easy access to the customers at their residential localities through a large numberof branches.

MCB has now started Mobile banking, which is definitely a truly innovativeproduct and according to the needs of the customers.

The current customers list of MCB is very large and having a large number ofdeposit.

MCB instant financing products for customer wanting instant loan facility atMCB branches.

Best and optional policies and attractive compensation packages, for employees,which has really improved their commitment, dedication and hard work, towards

the accomplishment of banks objectives.

Banks emphasis on consumer banking by providing them with innovative savingschemes, products and services suiting best to their life style.

Extension and improvement in services to domestic as well as foreign customer.Weaknesses:

Customers having account, with small amounts are not given some services anddealing to those with high accounts.

Financial weaknesses i.e. excess operating cost Human Resources i.e. low morale due under compensation, no accountability,

political interference

No marketing of advances Not many advances to agriculture sector and small and medium enterprises. No policy to provide loans to individuals Experienced but old staff, which are not aware of using modern technologies/

equipments?


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Opportunities:

Due to largest ATM network, MCB can expand its 24 hours cash facilities to thefar off cities of the growing market demand.

Increasing focus/target on different types of customers, MCB can open womenbranches, especially in those areas where women class want to get involved but

couldnt due to environmental restriction.

Benefits from incoming expertise and competition. To open overseas branches throughout the world like National Bank of Pakistan

and Habib Bank Limited or merger with other foreign banks outside Pakistan.

The formation of new and energetic marketing teams can increase thedisbursement of loans and new customers can be searched out.

They can capture a large portion of the market, if they expand its ATM andbranch network to other countries of the as well.

Threats:

New competitors especially foreign banks. Highly specialized and attractive services provided by foreign banks to their

customers.

Growing global technological advancement. Return on deposits is very low. Inconsistency in government policies regarding to business and economic sector. Strict regulations by the government over credit facilities to the customers as to

meet the prudential regulations.


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ConclusionWorking Capital in business is just live blood in human body.

Optimum and appropriate movement of blood through the body is extremely

necessary to continue life. Like human blood, the proper circulation of funds

(Working / Circulating Capital) is utmost necessary to continue business. If the

circulation of Working Capital becomes weak, the businesses can hardly prosper

and service. An enterprise should maintain optimum amount of Working Capital

so as to carry on the productive and distributive activities smoothly. While, the

determination of optimum level of Working Capital involves fundamental decisions

to an organizations liquidity, which in turn are influenced by a trade off between

profitability and liquidity According to my point of view MCB is managing the working

capital in appropriate way but they have to increase the ways or techniques through

which they may able to increase the cash as well as the returns so that they will be able to

get the appropriate profits. On the other hand they have to give little bit relaxation to the

individuals so that they will be able to get loan and try to attract more certain accounts.

Recommendations

For better Working capital management I would like to recommend the following things

to the MCB so that they will be able to get the benefit of the working capital as well as

easily able to manage the cash requirements.

Try to reduce the operating cost (cost of processing the loans like valuation staffsalary, stationary etc.) and time so that the expense may reduce.

Give loans to the individuals through this they are able to get more returns on thelesser lendings.

Try to attract the small accounts so that the certainty may increase and they mayable to invest and lend out more money for profit creation.

Must advertise the advances so that the customer get easy now how about theavailability of the loans.


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References and Sources used

[1] Forcans A., Hindelang J. T, (1974) Working capital management for the

multinational firm: A simulation model Winter Simulation Conference, Proceedings

of the 7th conference on Winter simulation - Volume 1, Washington, DC, pp.141

149

[2] James C. Van Horne & John M. Wachowicz, Jr., Fundamentals of Financial

Management, 13th

Edition, pp. 206-215

[3] Shapiro, Alan C., (1982), Multinational Financial Management

[4] Professor Kanwal, Lecture on the Working Capital Management, (2009) available at

http://www.youtube.com/watch?v=zJCiEIqAxbs, (last assessed on 25 September

2010)

[5] Dilipchanda, presentation on working capital management and cash inventory

management, (2008) available at

http://www.authorstream.com/Presentation/dilipchanda-211308-working-capital-

management-cash-inventory-ch08-entertainment-ppt-powerpoint/, (last accessed

on 23 September 2010)

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