presentation working capital management

MANAGEMENT OF WORKING CAPITAL

bull 1Working Capital Management -Np Agarwal Bk Mishra( RBSA Publishers ISBN 8176113999 Seller IndusInternational

bull 2Financial Management ndash KeonMartinPetty Scottjr (Prentice Hall of India)

bull 3Financial Management ndashKhanJain(Tata Mcgraw Hill)

bull 4Financial Management ndashVan Horne(PHI)

MANAGEMENT OF WORKING CAPITALbull INTRODUCTIONbull Working Capital Management involves managing the balance between firmrsquos short-term

assets and its short-term liabilities The goal of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses The interaction between current assets and current liabilities is therefore the main theme of the theory of working capital management

bull There are many aspects of working capital management which makes it important function of financial 5555

bull 1048766 Time Working capital management requires much of the finance managerrsquos timebull 1048766 Investment Working capital represents a large portion of the total investment in

assetsbull 1048766 Credibility Working capital management has great significance for all firms but it is

very critical for small firmsbull 1048766 Growth The need for working capital is directly related to the firmrsquos growth



bull a) Valuebull From the value point of view Working Capital can be defined as Gross Working Capital

or Net Working Capitalbull Gross working capital refers to the firmrsquos investment in current assets Current assets

are those assets which can be converted into cash within an accounting year Current Assets

bull include Stocks of raw materials Work-in-progress Finished goods Trade debtorsbull Prepayments Cash balances etcbull Net working capital refers to the difference between current assets and current

liabilitiesbull Current liabilities are those claims of outsiders which are expected to mature for

payment within an accounting year Current Liabilities include Trade creditors Accruals Taxation payable Bills Payables Outstanding expenses Dividends payable short term loans

bull A positive working capital means that the company is able to payoff its short-term liabilities A negative working capital means that the company currently is unable to meet its short-term liabilities

MANAGEMENT OF WORKING CAPITALbull b) Timebull From the point of view of time the term working capital can be divided

into two categories vizPermanent and temporarybull Permanent working capital refers to the hard core working capital It is

that minimum level of investment in the current assets that is carried by the business at all times to carry out minimum level of its activities

bull Temporary working capital refers to that part of total working capital which is required by a business over and above permanent working capital It is also called variable working capital

bull Since the volume of temporary working capital keeps on fluctuating from time to time according to the business activities it may be financed from short-term sources

bull Why Firms Hold Cash The finance profession recognizes the three primary reasons offered by economist John Maynard Keynes to explain why firms hold cash The three reasons are for the purpose of speculation for the purpose of precaution and for the purpose of making transactions All three of these reasons stem from the need for companies to possess liquidity

bull Speculationbull Economist Keynes described this reason for holding cash as creating the ability for a firm

to take advantage of special opportunities that if acted upon quickly will favor the firm An example of this would be purchasing extra inventory at a discount that is greater than the carrying costs of holding the inventory

bull Precautionbull Holding cash as a precaution serves as an emergency fund for a firm If expected cash

inflows are not received as expected cash held on a precautionary basis could be used to satisfy short-term obligations that the cash inflow may have been bench marked for

bull Transactionbull Firms are in existence to create products or provide services The providing of services

and creating of products results in the need for cash inflows and outflows Firms hold cash in order to satisfy the cash inflow and cash outflow needs that they have


MANAGEMENT OF WORKING CAPITALbull Importance of Adequate Working Capital

Management of working capital is an essential task of the finance manager He has to ensure that the amount of working capital available with his concern is neither too large nor too small for its requirements

bull A large amount of working capital would mean that the company has idle funds Since funds have a cost the company has to pay huge amount as interest on such funds

bull If the firm has inadequate working capital such firm runs the risk of insolvency Paucity of working capital may lead to a situation where the firm may not be able to meet its liabilities

bull The various studies conducted by the Bureau of Public Enterprises have shown that one of the reason for the poor performance of public sector undertakings in our country has been the large amount of funds locked up in working capital This results in over capitalization Over capitalization implies that a company has too large funds for its requirements resulting in a low rate of return a situation which implies a less than optimal use of resources A firm has therefore to be very careful in estimating its working capital requirements

bull Optimum Working Capital If a companyrsquos current assets do not exceed its currentbull liabilities then it may run into trouble with creditors that want their money quicklybull Current ratio (current assetscurrent liabilities) (along with acid test ratio to supplement it) hasbull traditionally been considered the best indicator of the working capital situationbull It is understood that a current ratio of 2 (two) for a manufacturing firm implies that the firm

hasbull an optimum amount of working capital This is supplemented by Acid Test Ratio (Quickbull assetsCurrent liabilities) which should be at least 1 (one) Thus it is considered that there is abull comfortable liquidity position if liquid current assets are equal to current liabilitiesbull Bankers financial institutions financial analysts investors and other people interested inbull financial statements have for years considered the current ratio at lsquotworsquo and the acid testbull ratio at lsquoonersquo as indicators of a good working capital situation As a thumb rule this may bebull quite adequatebull However it should be remembered that optimum working capital can be determined only withbull reference to the particular circumstances of a specific situation Thus in a company wherebull the inventories are easily saleable and the sundry debtors are as good as liquid cash thebull current ratio may be lower than 2 and yet firm may be soundbull In nutshell a firm should have adequate working capital to run its business operations Bothbull excessive as well as inadequate working capital positions are dangerous

WORKING CAPITAL MANAGEMENT

bull Operating Cycle Concept

bull W I P

bull bull FINISHED GOODS STOCKS

bull S amp D EXPENSES SALES

bull RAW MATERIAL STOCK WAGES amp OVERHEADS TRADE DEBTORS

bull TRADE CREDITORS

bull BANKCASH

bull BASIC CONCEPTS AND FORMULAS ndash bull 1 Working Capital Managementbull bull Working Capital Management involves managing the balance between firmrsquos shorttermbull assets and its short-term liabilitiesbull bull From the value point of view Working Capital can be defined asbull Gross Working Capital It refers to the firmrsquos investment in current assetsbull Net Working Capital It refers to the difference between current assets and currentbull liabilitiesbull bull From the point of view of time working capital can be divided intobull Permanent Working Capital It is that minimum level of investment in the currentbull assets that is carried by the business at all times to carry out minimum level of itsbull activitiesbull Temporary Working Capital It refers to that part of total working capital which isbull required by a business over and above permanent working capital

bull 2 Factors To Be Considered While Planning For Working Capital Requirementbull bull Nature of businessbull bull Market conditionsbull bull Demand conditionsbull bull Operating efficiencybull bull Credit policybull 3 Finance manager has to pay particular attention to the levels of current assets and

theirfinancing To decide the levels and financing of current assets the risk return trade offmust be taken into account In determining the optimum level of current assets the firm should balance the profitability ndash Solvency tangle by minimizing total costs

bull 4 Working Capital Cycle bull Working Capital Cycle indicates the length of time between a companyrsquos paying forbull materials entering into stock and receiving the cash from sales of finished goods It canbull be determined by adding the number of days required for each stage in the cycle

bull ISSUES IN THE WORKING CAPITAL MANAGEMENTbull Working capital management entails the control and monitoring of all components of workingbull capital ie cash marketable securities debtors (receivables) and stocks (inventories) andbull creditors (payables)bull Finance manager has to pay particular attention to the levels of current assets and theirbull financing To decide the levels and financing of current assets the risk return trade off mustbull be taken into accountbull 141 Current Assets to Fixed Assets Ratio The finance manager is required to determinebull the optimum level of current assets so that the shareholders value is maximizedbull A firm needs fixed and current assets to support a particular level of outputbull As the firmrsquos output and sales increases the need for current assets also increasesbull Generally current assets do not increase in direct proportion to output current assets maybull increase at a decreasing rate with output As the output increases the firm starts using itsbull current asset more efficientlybull The level of the current assets can be measured by creating a relationship between currentbull assets and fixed assets Dividing current assets by fixed assets gives current assetsfixedbull assets ratiobull Assuming a constant level of fixed assets a higher current assetsfixed assets ratio indicatesbull a conservative current assets policy and a lower current assetsfixed assets ratio means anbull aggressive current assets policy assuming all factors to be constantbull A conservative policy implies greater liquidity and lower risk whereas an aggressive policybull indicates higher risk and poor liquidity Moderate current assets policy will fall in the middle ofbull conservative and aggressive policies The current assets policy of most of the firms may fallbull between these two extreme policies


WORKING CAPITAL MANAGEMENTbull Liquidity versus Profitability

bull Risk return trade off minus A firm may follow a conservative aggressive or moderate policy as discussed above However these policies involve riskreturn trade off

bull A conservative policy means lower return and risk While an aggressive policy produces higher return and risk

bull The two important aims of the working capital management are profitability and solvency

bull A liquid firm has less risk of insolvency that is it will hardly experience a cash shortage or a stock out situation However there is a cost associated with maintaining a sound liquidity position However to have higher profitability the firm may have to sacrifice solvency and maintain a relatively low level of current assets This will improve firmrsquos profitability as fewer funds will be tied up in idle current assets but its solvency would be threatened and exposed

to greater risk of cash shortage and stock outs bull The following illustration explains the risk-return trade off of various working

capital management policies viz conservative aggressive and moderate etc

WORKING CAPITAL MANAGEMENTbull Illustration 1 A firm has the following data for the year ending 31st March 2006bull RsSales (100000 Rs20-) 2000000 Earning before Interest and Taxes 200000 bull Fixed Assets 500000 bull The three possible current assets holdings of the firm are Rs500000- Rs400000- andbull Rs 300000 It is assumed that fixed assets level is constant and profits do not vary withbull current assets levels The effect of the three alternative current assets policies is as follows

bull Effect of Alternative Working Capital Policiesbull (Amount in Rs)bull Working Capital Policy Conservative Moderate Aggressivebull Sales 2000000 2000000 2000000bull Earnings before Interest and Taxes(EBIT) 200000 200000 200000bull Current Assets 500000 400000 300000bull Fixed Assets 500000 500000 500000bull Total Assets 1000000 900000 800000bull Return on Total Assets (EBITTotal Assets) 20 2222 25bull Current AssetsFixed Assets 100 080 060bull The aforesaid calculations shows that the conservative policy provides greater liquidity(solvency) to the firm but

lower return on total assets On the other hand the aggressive policy gives higher return but low liquidity and thus is very risky The moderate policy generates return higher than Conservative policy but lower than aggressive policy This is less risky than Aggressive policy but more risky than conservative policy

bull In determining the optimum level of current assets the firm should balance the profitability ndashSolvency tangle by minimizing total costs Cost of liquidity and cost of illiquidity

WORKING CAPITAL MANAGEMENTbull Each component of working capital (namely inventory receivables and payables) has twobull dimensions helliphellipTIME helliphelliphellipand MONEY when it comes to managing working capital thenbull time is money If you can get money to move faster around the cycle (eg collect monies duebull from debtors more quickly) or reduce the amount of money tied up (eg reduce inventorybull levels relative to sales) the business will generate more cash or it will need to borrow lessbull money to fund working capital Similarly if you can negotiate improved terms with suppliersbull eg get longer credit or an increased credit limit you are effectively creating free finance tobull help fund future sales bull If youhelliphelliphelliphelliphelliphellip Then helliphelliphelliphelliphelliphelliphellipbull Collect receivables (debtors) faster You release cash from the cyclebull Collect receivables (debtors) slower Your receivables soak up cashbull Get better credit (in terms of duration orbull amount) from suppliers You increase your cash resourcesbull Shift inventory (stocks) faster You free up cashbull Move inventory (stocks) slower You consume more cashbull The determination of operating capital cycle helps in the forecast control and management ofbull working capital The length of operating cycle is the indicator of performance of managementbull The net operating cycle represents the time interval for which the firm has to negotiate forbull Working Capital from its Bankers It enables to determine accurately the amount of workingbull capital needed for the continuous operation of business activitiesbull The duration of working capital cycle may vary depending on the nature of the business

WORKING CAPITAL MANAGEMENTbull In the form of an equation the operating cycle process

can be expressed as followsbull Operating Cycle = R + W + F + D ndash C bull Wherebull R = Raw material storage period

W = Work-in-progress holding periodbull F = Finished goods storage period

D = Debtors collection periodbull C = Credit period availed



Working Capital Based on Operating Cycle One of the method for forecasting working capital requirement is based on the concept of operating cycle The calculation of operating cycle and the formula for estimating working capital on its basis has been demonstrated with the help of following illustration

Illustration 2 From the following information of XYZ Ltd you are required to calculate (a) Net operating cycle period(b) Number of operating cycles in a year Rs(i) Raw material inventory consumed during the year 600000(ii) Average stock of raw material 50000(iii) Work-in-progress inventory 500000(iv) Average work-in-progress inventory 30000 (v) Finished goods inventory 800000(vi) Average finished goods stock held 40000(vii) Average collection period from debtors 45 days(viii) Average credit period availed 30 days(ix) No of days in a year 360 days

Calculation of Net Operating Cycle period of XYZ Ltd

Calculation of Net Operating Cycle period of XYZ Ltdbull (a) + (b) + (c) in last slide (Pre-page) 70bull Debtors collection period (d) 45

bull Total operating cycle period 115bull [(a) + (b) + (c) + (d)]

bull Less Average credit period availed 30 bull (i) Net operating cycle period 85bull (ii) Number of operating cycles in a year 42bull (360 days 85 days)

Working Capital Management bull Problem ndash bull X Company plans to attain sales of Rs 5 crores It has the following information for production amp

selling activity It is assumed that the activities are evenly spread throughout the year bull A) Average time raw materials are kept in store prior to issue to production 2 months bull B) Production cycle time or work in progress cycle time 2 months bull C) Average time finished stock are kept in state in unsold condition frac12 month bull D) Average credit available from suppliers 1 frac12 months bull E) Average credit allowed to customers 1 frac12 months bull F) Analysis of cost plus profit for above sales - bull Rs In Crores bull Raw Materials 50 250 bull Direct Labour 20 100 bull Overheads 10 050 bull Profit 20 100 bull Total 100 500

Working Capital Management bull Solution ndash bull 1 Total Months to be financed to Raw Materials Months bull Time in Raw Material Stores 2 bull Working Capital Cycle 2 bull Finished Goods in Stores frac12 bull Credit given to Customers 1 frac12 bull 6 bull Less credit available from suppliers 1 frac12 bull Total months to be financed to raw materials 4 frac12 bull 2 Total months to be financed to Labour bull Production Cycle 2 bull Finished stock store frac12 bull Credit to Customers 1 frac12 bull Total months to be financed 4 bull 3 Total months to be financed to Overhead bull Production Cycle 2 bull In finished goods store frac12 bull Credit to customers 1 frac12 bull 4 bull Less credit from suppliers 1 frac12 bull Total months to be financed 2 frac12

Working Capital Management 4 Maximum Working Capital Required - Raw materials 4 frac12 ------ 250 094 12 Diraect Labour 4 ---- 100 033 12 Overheads 2 frac12 ----- 050 010 12 Maximum working capital 137

Working Capital Management




Working Capital Management bull Illustration On 1st January the Managing Director of Naureen Ltd wishes to

know the amount of working capital that will be required during the year From the following information prepare the working capital requirements forecast Production during the previous year was 60000 units It is planned that this level of activity would be maintained during the presentyear The expected ratios of the cost to selling prices are Raw materials 60 Direct wages10 and Overheads 20 Raw materials are expected to remain in store for an average of 2 months before issue to production Each unit is expected to be in process for one month the raw materials being fed into the pipeline immediately and the labour and overhead costs accruing evenly during the month Finished goods will stay in the warehouse awaiting dispatch to customers for approximately 3 months Credit allowed by creditors is 2 months from the date of delivery of raw material Credit allowed to debtors is 3 months from the date of dispatch Selling price is Rs5 per unit There is a regular production and sales cycle

bull Wages and overheads are paid on the 1st of each month for the previous month The company normally keeps cash in hand to the extent of Rs20000

Working Capital Management bull Solution bull Working Notesbull 1 Raw material inventory The cost of materials for the whole year is 60 of the Salesbull value 60bull Hence it is 60000 units Rs5 ---- = Rs180000bull 100bull The monthly consumption of raw material would be Rs15000 Raw material requirements

would be for two months hence raw materials in stock would be Rs30000bull 2 Debtors The average sales would be Rs25000 pm Therefore a sum of Rs75000-bull would be the amount of sundry debtorsbull 3 Work in process (Give special attention to this point) It is stated thatbull each unit of production is expected to be in process for one monthbull Rsbull (a) Raw materials in work-in-process (being onebull monthrsquos raw material requirements) 15000bull (b) Labour costs in work-in-processbull (It is stated that it accrues evenly during the monthbull Thus on the first day of each month it would be zerobull and on the last day of month the work-in-processbull would include one monthrsquos labour costs On anbull average therefore it would be equivalent to frac12 of the 1250 bull monthrsquos labour costs)


bull (c) Overheads 2500 (For frac12 month as explained above) ----------

Total work-inprocess 18750

bull 4 Finished goods inventory (3 monthrsquos costs of production)bull Raw materials 45000 Labour 7500 Overheads 15000 ---------- 67500bull 5 Creditors Suppliers allow a two monthsrsquo credit period Hence the average amount of

creditors would be Rs30000 being two monthsrsquo purchase of raw materialsbull 6 Direct Wages payable The direct wages for the whole year is 60000 units times Rs5 x 10 = Rs30000 The monthly direct wages would be Rs2500 (Rs 30000 divide12) Hence wages payable would be Rs2500bull 7 Overheads Payable The overheads for the whole year is 60000 units times Rs5 x 20 = Rs60000 The monthly overheads will be Rs5000 (Rs60000 divide 12) Hence overheads payable would be Rs5000 pm


bull Statement of Working Capital requiredbull Current Assetsbull Rs Rsbull Raw materials inventory (Refer to working note 1) 30000bull Debtors (Refer to working note 2) 75000bull Workingndashin-process (Refer to working note 3) 18750bull Finished goods inventory (Refer to working note 4) 67500bull Cash 20000 211250 bull ----------- Current Liabilitiesbull Creditors (Refer to working note 5) 30000bull Direct wages payable (Refer to working note 6) 2500bull Overheads payable (Refer to working note 7) 5000 37500 bull ---------- bull Estimated working capital requirements 173750

Working Capital Management bull Working capital requirement estimation based on cash cost

We have already seen that working capital is the difference between current assets and current liabilities

bull To estimate requirements of working capital we have to forecast the amount required for each item of current assets and current liabilities

bull In practice another approach may also be useful in estimating working capital requirementsbull This approach is based on the fact that in the case of current assets like sundry debtors andbull finished goods etc the exact amount of funds blocked is less than the amount of suchbull current assets For eg If we have sundry debtors worth Rs1 lakh and our cost of production is

Rs75000 the actual amount of funds blocked in sundry debtors is Rs75000 the cost of sundry debtors the rest (Rs25000) is profit

bull 1048766 Again some of the cost items also are non-cash costs depreciation is a non-cash costbull item Suppose out of Rs75000 Rs5000 is depreciation then it is obvious that thebull actual funds blocked in terms of sundry debtors totaling Rs1 lakh is only Rs70000 Inbull other words Rs70000 is the amount of funds required to finance sundry debtors worthbull Rs1 lakhbull 1048766 Similarly in the case of finished goods which are valued at cost non-cash costs may bebull excluded to work out the amount of funds blockedbull Many experts therefore calculate the working capital requirements by working out the cashbull costs of finished goods and sundry debtors Under this approach the debtors are calculatedbull not as a percentage of sales value but as a percentage of cash costs Similarly finishedbull goods are valued according to cash costs

Working Capital Management bull Illustration The following annual figures relate to XYZ Co bull Rsbull Sales (at two monthsrsquo credit) 3600000bull Materials consumed (suppliers extend two monthsrsquo credit) 900000bull Wages paid (monthly in arrear) 720000bull Manufacturing expenses outstanding at the end of the yearbull (Cash expenses are paid one month in arrear) 80000bull Total administrative expenses paid as above 240000bull Sales promotion expenses paid quarterly in advance 120000 bull The company sells its products on gross profit of 25 counting depreciation as part of

the cost of production It keeps one monthsrsquo stock each of raw materials and finished goods and a cash balance of Rs100000

bull Assuming a 20 safety margin work out the working capital requirements of the company on cash cost basis Ignore work-in-process

Working Capital Management bull Solutionbull Statement of Working Capital requirements (cash cost basis) bull A Current Asset Rs Rs bull Materials (Rs 900000 divide12) 75000bull Finished Goods (Rs 2580000 divide12) 215000bull Debtors (Rs2940000divide6) 490000bull Cash 100000bull Prepaid expenses (Sales promotion) (Rs 120000divide4) 30000 910000bull B Current Liabilitiesbull Creditors for materials (Rs900000divide6) 150000bull Wages outstanding (Rs720000divide 12) 60000bull Manufacturing expenses 80000bull Administrative expenses (Rs240000divide12) 20000 310000bull Net working capital (A-B) 600000bull Add safety margin 20 120000bull Total working capital requirements 720000bull Working Notesbull (i) Computation of Annual Cash cost of Production Rsbull Material consumed 900000bull Wages 720000bull Manufacturing expenses (Rs80000 x 12) 960000bull Total cash cost of production 2580000bull (ii) Computation of Annual Cash cost of sales Rsbull Cash cost of production as in (i) above 2580000bull Administrative Expenses 240000bull Sales promotion expenses 120000bull Total cash cost of sales 2940000

Working Capital Managementbull Problem bull While preparing a project report on behalf of a client you have collected the following facts Estimate the net

working capital required for that project Add 10 per cent to your computed figure to allow contingenciesbull Particulars Amount per unit Estimated cost per unit of productionbull Raw material Rs 80bull Direct labour 30bull Overheads (exclusive of depreciation Rs 10 per unit) 60bull Total cash cost 170 bull Additional informationbull Selling price Rs 200 per unitbull Level of activity 104000 units of production per annum bull Raw materials in stock average 4 weeksbull Work in progress (assume 50 per cent completion stage in respect of conversion costs and 100 per cent

completion in respect of materials) average 2 weeksbull Finished goods in stock average 4 weeksbull Credit allowed by suppliers average 4 weeksbull Credit allowed to debtors average 8 weeksbull Lag in payment of wages average 15 weeksbull Cash at bank is expected to be Rs 25000bull You may assume that production is carried on evenly throughout the year (52 weeks) and wages and

overheads accrue similarly All sales are on credit basis only

bull bull bull bull

Working Capital Management bull Solution Net working capital estimate of a projectbull (A) Current assets (i) Raw materials in stock (104000 times Rs 80 times 452) Rs 640000 (ii) Work-in-progress (a) Raw material (104000 times Rs 80 times 252) 320000 (b) Direct Labour (104000 times Rs 15 times 252) 60000 (c) Overheads (104000 times Rs 30 times 252) 120000 (iii) Finished goods stock (104000 times Rs 170 times 452) 1360000 (iv) Debtors (104000 times Rs 170 times 852) 2720000 (v) Cash at bank 25000 bull Total investment in current assets 5245000bull (B) Current liabilities (i) Creditors average 4 weeks (104000 times Rs 80 times 452) 640000 (ii) Lag in payment of wages (104000 times Rs 30 times 1552) 90000bull Total current liabilities 730000bull (C) Net working capital Current assets ndash Current liabilities 4515000bull Add 10 per cent contingencies 451500 Net working capital required 4966500

Working Capital Managementbull Factors Affecting Working Capital ndash bull Controllability of Working Capital bull Elements Influence bull ------------------------------------------------------------------------------------------------------------------------------------ bull Debtor Volume of Credit Sales bull Length of credit given bull Effective Credit Control amp Cash Collection

bull Stocks Lead time amp safety level bull Variability of Demand bull Production cycle bull No of product lines bull Volume of -- Planned output bull -- Actual output bull -- Sales bull -------------------------------------------------------------------------------------------------------------------------------------- bull Payables Volume of purchases bull Length of credit allowed bull Length of credit taken ndash Discounts bull Short-term finance All the above bull Other paymentsreceipts bull Availability of credit bull Interest rates

Working Capital Management bull Example - How excess cash can be found out amp its utilisation bull April May June July Aug Sept bull Total Receipts 75 79 91 99 94 96 bull Total Payments 80 94 82 78 83 106 bull Net Cash (5) (15) 9 21 11 (10) bull Opening Cash Balance 40 35 20 29 50 61 bull Closing Cash Balance 35 20 29 50 61 51 bull Minimum Cash Balance 20 20 20 20 20 20 bull ------------------------------------------------------------------------------------------------------------------------- bull Excess Cash 15 0 9 30 41 31 bull -------------------------------------------------------------------------------------------------------------------------- bull For short term investment of such surplusexcess cash the company can put them in short term

Fixed Deposit with Bank for a period upto 46 days to the minimum The other alternative is to invest in inter company Deposit for short term However if the money can be held at least for period of one year that can be put in Portfolio Management Scheme with renowned company

bull bull

Working Capital Management bull MARKETABLE SECURITIES -

bull Bajaj Auto 2006 cash investments

Investment Amount

Investment in mutual funds Rs 48362 Crores

Investment in govt securities 29575

Investment in debenturesPSU bonds 1307Total Rs 474812 Crores


bull Credit Analysis Numerical Credit Scoring categories

ndash The customerrsquos characterndash The customerrsquos capacity to payndash The customerrsquos capitalndash The collateral provided by the customerndash The condition of the customerrsquos business


Credit Analysis

Credit Analysis - Procedure to determine the likelihood a customer will pay its bills

Credit agencies such as CRISILCAREDun amp Bradstreet provide reports on the credit worthiness of a potential customer

bull Financial ratios can be calculated to help determine a customerrsquos ability to pay its bills


bull The Credit DecisionCredit Policy - Standards set to determine the amount and nature of credit to

extend to customersCredit Scoring ndash What your lender wonrsquot tell tell you

bull Extending credit gives you the probability of making a profit not the guarantee There is still a chance of default

bull Denying credit guarantees neither profit or loss bull Collection Policy ndash Example next slide


Customers Less than More than1-2 months 2-3 months Total Owed

Name 1 month 3 months

A 10000 0 0 0 10000

B 8000 3000 0 0 11000

Z 5000 4000 6000 15000 30000

Total Rs200000 Rs40000 Rs15000 Rs43000 Rs298000

Sample aging schedule for accounts receivable

Working Capital Management Inventory Managementbull Components of Inventory

ndash Raw materialsndash Work in processndash Finished goods

bull Goal = Minimize amount of cash tied up in inventory

bull Tools used to minimize inventoryndash Just-in-time ndash Lean manufacturing

Overtrading (undercapitalisation)bull Overtrading as the name implies is trading in excess of what existing working capital can

sustain In case a company tries to attain a upper limit of turnover without being backed by sufficient working capital the company will be said to be doing overtrading

bull With existing current assets being low if the company wants to procure materials on credit terms beyond the existing limit susequently it will fail to clear dues of creditors for goods in timeThis will lead to interruption of flow of production ultimately Unless additional capital is pumped into business the overtrading will lead to disaster

bull Large volume of trade supported by too small a working capital basebull Often operating at a profitbull Rapid increase in turnoverbull Pay suppliers before receive cash from customersbull Leads to liquidity crisis

Working Capital Management bull Tandon Committeersquos Recommendation of 3 methods of Lending ndash bull Method 1 - 25 net working capital should be funded by the borrower from owned fund and

Long Term Liabilities bull Method 2 ndash 25 of all current assets should be funded by the borrower from owned fund and Long

Term Liabilities bull Method 3 ndash The borrower should fund current assets which are permanently required along with bull 25 contribution of balance current assets bull In all three cases balance working capital will be financed by the bank bull Example to explain the 3 methods ndash bull Current Liabilities Current Assets bull Sundry Creditors 400 Raw Materials 400 bull Other Current Liabilities 100 Work- in- progress 250 bull Bank Borrowing 500 Finished Goods 180 bull Sundry Debtors 250 bull Other Current Assets 50 bull ----- ---- bull 1000 1130 bull ------ ------ bull Thus Current Assets = 1130 Current Liabilities other than Bank Borrowing =500

Working Capital Managementbull Method 1 ndash bull A) Total Current Assets 1130 bull B) Less other current liabilities 500 bull ------- bull C) Working Capital Gap 630 bull D) Less 25 margin on working capital gap 157 bull (to be funded from long term sources) bull E) Maximum Permissible Bank Finance ( c- d) 473 bull F) Excess Borrowing 27 bull ( Bank Borrowing (-) c ie 500 - 473 )

Working Capital Managementbull Method 2 ndash bull A) Total Current Assets 1130 bull B) Less 25 margin on (a) to be funded from bull long term sources 283 bull 847

C) Less other current liabilities 500 ----- D) Maximum Permissible Bank Finance 347 E) Excess Borrowing 153 ( Bank Borrowing (-) d ie 500 ndash 347)

Working Capital ManagementMethod 3 ndash A) Total Current Assets 1130 B) Less Permissible Current Assets or Core Current Assets (say)

To be funded from Long Term Sources 250 C) Effective Current Asset for this purpose 880 D) Less 25 of (c) 220 660 E) Less other current liabilities 500 F) Maximum Permissible Bank Finance 160 G) Excess Borrowing (Bank Borrowing ndash f ie 500 -160 340

It may be noted that demand from borrower for long term fund is increasing as we go from Method 1 to Method 2 and to Method 3 It is 157 283 and 470 (250 +220)

respectively in Method 1Method 2 and Method 3 At present all sanctions of Working Capital by banks are based on Method 2

Working Capital Managementbull Collection of Financial Data ndash bull In the present system of working capital assessmentthe required financial

data are obtained from the borrower in the following forms bull FORM I Particulars of the existingproposed limits from the banking

system bull FORM II Operating Statement bull FORM III Analysis of Balance Sheet bull FORM IV Comparative Statement of CACL bull FORM V Computation of MPBF for Working Capital bull FORM VI Fund Flow Statement


Slide 2

MANAGEMENT OF WORKING CAPITAL (2)




Slide 7


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WORKING CAPITAL MANAGEMENT (2)








Calculation of Net Operating Cycle period of XYZ Ltd (2)



Working Capital Management (2)






















Overtrading (undercapitalisation)






bull 1Working Capital Management -Np Agarwal Bk Mishra( RBSA Publishers ISBN 8176113999 Seller IndusInternational

bull 2Financial Management ndash KeonMartinPetty Scottjr (Prentice Hall of India)

bull 3Financial Management ndashKhanJain(Tata Mcgraw Hill)

bull 4Financial Management ndashVan Horne(PHI)






































bull W I P





bull BANKCASH

































































bull bull bull bull






bull bull



Investment Amount








Credit Analysis












A 10000 0 0 0 10000

B 8000 3000 0 0 11000

Z 5000 4000 6000 15000 30000

























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bull W I P





bull BANKCASH

































































bull bull bull bull






bull bull



Investment Amount








Credit Analysis












A 10000 0 0 0 10000

B 8000 3000 0 0 11000

Z 5000 4000 6000 15000 30000

























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bull bull bull bull






bull bull



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Credit Analysis












A 10000 0 0 0 10000

B 8000 3000 0 0 11000

Z 5000 4000 6000 15000 30000

























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bull bull



Investment Amount








Credit Analysis












A 10000 0 0 0 10000

B 8000 3000 0 0 11000

Z 5000 4000 6000 15000 30000

























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Investment Amount








Credit Analysis












A 10000 0 0 0 10000

B 8000 3000 0 0 11000

Z 5000 4000 6000 15000 30000

























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Credit Analysis












A 10000 0 0 0 10000

B 8000 3000 0 0 11000

Z 5000 4000 6000 15000 30000

























Slide 2





Slide 7


Slide 9

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Slide 15

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A 10000 0 0 0 10000

B 8000 3000 0 0 11000

Z 5000 4000 6000 15000 30000

























Slide 2





Slide 7


Slide 9

Slide 10

Slide 11


Slide 13


Slide 15

Slide 16

Slide 17






























































Slide 2





Slide 7


Slide 9

Slide 10

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Slide 17








































presentation working capital management

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