working capital details

8/7/2019 Working capital details

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WorkingWorking

CapitalCapital

ManagemeManagementnt


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Definition of Workingefinition of WorkingCapitalapital

Working Capital refers to that part of theWorking Capital refers to that part of the

firms capital, which is required forfirms capital, which is required for

financing short-term or current assets such afinancing short-term or current assets such a

cash marketable securities, debtors andcash marketable securities, debtors and

inventories. Funds thus, invested in currentinventories. Funds thus, invested in current

assets keep revolving fast and areassets keep revolving fast and are

constantly converted into cash and this cashconstantly converted into cash and this cash

flow out again in exchange for other currentflow out again in exchange for other current

assets. Working Capital is also known asassets. Working Capital is also known as

revolving or circulating capital or short-revolving

or circulating capital or short-


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KINDS OF WORKING CAPITALKINDS OF WORKING CAPITAL

WORKINGCAPITAL

BASIS OF

CONCEPT

BASIS OF

TIME

Gross

Working

Capital

Net

Working

Capital

Permanent

/ Fixed

WC

Temporary

/ Variable

WC

Regular

WC

Reserve

WC

Special

WC

Seasonal

WC


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Significance of Gross WCignificance of Gross WC Optimum investment in CAOp

timum investment in CA

Investment in CA must be adequate CA investment should not beInvestment in CA must be adequate CA investment should not beinadequate or excessive inadequate WC can disturb production andinadequate or excessive inadequate WC can disturb production andcan also threaten the solvency of firm , if it fails to meet its currentcan also threaten the solvency of firm , if it fails to meet its current

obligation excessive investment in CA should be avoided , since itobligation excessive investment in CA should be avoided , since itimpairs firms profitabilityimpairs firms profitability

Financing of CAFinancing

of CA

Need for WC arises due to increasing level of business activity & it isNeed for WC arises due to increasing level of business activity & it isto provided quickly some time surplus fund may arises which shouldto provided quickly some time surplus fund may arises which should

be invested in Short term securities , they should not be kept idlebe invested in Short term securities , they should not be kept idle


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Significance of Net Working CapitalSignificance of Net Working Capital

Maintaining Liquidity positionMaintaining

Liquidity position

For maintaining liquidity position there is a need toFor maintaining liquidity position there is a need to

maintain CA sufficiently in excess of CLmaintain CA sufficiently in excess of CL

Judge Financial Soundness of a firmJudg

e Financial Soundness of a firm

The Net working capital helps creditors andThe Net working capital helps creditors and

investors to judge financial soundness of a firminvestors to judge financial soundness of a firm


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BALANCE SHEET OF ABC COMPANY AS ON 31-3-2000BALANCE SHEET OF ABC COMPANY AS ON 31-3-2000

LiabilitiesLiabilities RsRs AssetsAssets RsRs

Equity SharesEquity Shares 200000200000 GoodwillGoodwill 2000020000

8% Debentures8% Debentures 100000100000 Land and BuildingLand and Building 150000150000

Reserve & SurplusReserve & Surplus 5000050000 Plant andPlant andMachineryMachinery

100000100000

Sundry CreditorsSundry Creditors 150000150000 InventoriesInventories

Bills PayableBills Payable 3000030000 Finished GoodsFinished Goods 6000060000

OutstandingOutstandingExpensesExpenses

2000020000 Work in processWork in process 4000040000

Bank OverdraftBank Overdraft 5000050000 Prepaid ExpensesPrepaid Expenses 2000020000

Provision forProvision forTaxationTaxation

2000020000 MarketableMarketableSecuritiesSecurities

6000060000

Proposed DividendProposed Dividend 3000030000 Sundry DebtorsSundry Debtors 9000090000

Bills ReceivablesBills Receivables 2000020000Cash & BankCash & Bank 9000090000


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Difference between permanent &Difference between permanent &

temporary working capitaltemporary working capital

Amount Variable Working CapitalAmount Variable Working Capitalofof

WorkingWorking

CapitalCapital

Permanent Working CapitalPermanent Working Capital

TimeTimePermanent and temporary working capital for Stable firm


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Variable Working Capital

Amount

ofWorking

Capital

Permanent Working Capital

Time

Permanent and temporary working capital for Growing firm


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Operating cycle conceptperating cycle concept Maximization of share holders wealth of a firm is possibleMaximization of share holders wealth of a firm is possible

only when there are sufficient return from the operationsonly when there are sufficient return from the operations Successful sales activity is necessary for earning profitSuccessful sales activity is necessary for earning profit

sales do not convert into cash immediatelysales do not convert into cash immediately There is invisible time lap between the sale of good and There is invisible time lap between the sale of good and

receipt of cashreceipt of cash The time taken to convert raw material into cash is knownThe time taken to convert raw material into cash is known

as operating cycleas operating cycle Conversion of cash into raw materialConversion of cash into raw material Conversion of raw material into work in progressConversion of raw material into work in progress

Conversion of Work in progress into finished goodsConversion of Work in progress into finished goods Conversion of finished good into Sales ( Debtors and cash )Conversion of finished good into Sales ( Debtors and cash )


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Operating Cycle inOperating Cycle in

Manufacturing firmManufacturing firmCash

Raw

MaterialsW I P

Finished

Goods

DebtorsSALES


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Operating cycle oferating cycle oNon Manufacturingon ManufacturingFirmirm

cash

Receivables

Stock of finished goods


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Formula for calculatingormula for calculatingOperating cycle forperating cycle forManufacturing firmanufacturing firm OC = ICP+ARPOC = ICP+ARP

OC = Operating cycleOC = Operating cycle

ICP = Inventory Conversion periodICP = Inventory Conversion period

ARP = Account Receivable PeriodARP = Account Receivable Period

ICP =ICP = Average InventoryAverage Inventory

Cost of good sold /365Cost of good sold /365ARP =ARP = Average Account ReceivableAverage Account Receivable

Sales/365Sales/365


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ABC Company Provide theABC Company Provide the

following information , Computefollowing information , Compute

the operating cyclethe operating cycle Sales 3000 LakhsSales 3000 Lakhs

Inventory Opening Rs 610 Lakhs ;Inventory Opening Rs 610 Lakhs ;

closing Rs 475 Lakhsclosing Rs 475 Lakhs

Receivable opening Rs 915 Lakhs;Receivable opening Rs 915 Lakhs;

Closing Rs 975 LakhsClosing Rs 975 Lakhs

Cost of Goods Sold Rs 2675 LakhsCost of Goods Sold Rs 2675 Lakhs


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CASH CONVERSION CYCLECASH CONVERSION CYCLE

The amount of time a firms resources are tied upThe amount of time a firms resources are tied upcalculated by subtracting the average payment periodcalculated by subtracting the average payment periodfrom the operating cycle the time period between thefrom the operating cycle the time period between thedate a firm pays its supplier and the date it receives cashdate a firm pays its supplier and the date it receives cashfrom its customerfrom its customer

CCC = OC APPCCC = OC APP

AAI =AAI = Average InventoryAverage Inventory

Cost of good sold /365Cost of good sold /365ARP =ARP = Average Account ReceivableAverage Account Receivable

Annual Sales/365Annual Sales/365

APP =APP = Account Payable PeriodAccount Payable Period

Cost of good sold /365Cost of good sold /365


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Calculate CCCalculate CCC(CASH CONVERSION CYCLE)CASH CONVERSION CYCLE) Average use of Inventory 80 daysAverage use of Inventory 80 days

Account receivable collection period 50 daysAccount receivable collection period 50 days

Account payable period is 40 daysAccount payable period is 40 days

CCC= OC- APPCCC= OC- APP

OC = AAI+ARPOC = AAI+ARP

80+50=13080+50=130

CCC =130-40 =90 daysCCC =130-40 =90 days


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Purchase of Sale of GoodsPurchase of Sale of Goods Collection ofCollection of

Raw MaterialRaw Material on Crediton Credit Account ReceivablesAccount Receivables

On creditOn credit

Average age ofAverage age of Account receivableAccount receivable

InventoryInventory (AII)(AII) periodperiod (ARP)(ARP)

Account PayableAccount PayablePeriodPeriod (APP)(APP)

Payment toPayment to

supplierssuppliers

Receipt of InvoiceReceipt of Invoice Operating Cycle (OC)Operating Cycle (OC)

Cash Conversion cycleCash Conversion cycle


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Resource flows for aResource flows for a

manufacturing firmmanufacturing firm

FixedAssets

Production

Process

Generates

Inventory

Via Sales Generator

Accounts

receivable

Used in

Accrued Direct

Labour and

materials

Accrued Fixed

Operating

expenses

Cash and

Marketable

Securities

Suppliers

Of Capital

External Financing

Return on Capital

Collection

process

Used to

purchase

Used to

purchase

Used in

Working

Capital

cycle


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Calculate cash conversion cyclealculate cash conversion cycle Sales Rs 1587.95Sales Rs 1587.95

Cost of Good sold Rs 1406.27Cost of Good sold Rs 1406.27 Inventory opening 195.82, closing 202.29Inventory opening 195.82, closing 202.29

Account receivables opening 423.03Account receivables opening 423.03

closing 449.46closing 449.46 Account payable opening 140.40, closingAccount payable opening 140.40, closing

168.33168.33

CCC = OC APPCCC = OC APP

OC = AAI + ARPOC = AAI + ARP


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WORKING CAPITALORKING CAPITALREQUIREMENTSEQUIREMENTSFactors to be consideredFactors to be considered

Total costs incurred on materials, wages and overheadsTotal costs incurred on materials, wages and overheads

The length of time for which raw materials remain in stores before they are issued toThe length of time for which raw materials remain in stores before they are issued to

production.production.

The length of the production cycle or WIP, i.e., the time taken for conversion of RM intoThe length of the production cycle or WIP, i.e., the time taken for conversion of RM into

FG.FG.

The length of the Sales Cycle during which FG are to be kept waiting for sales.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 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 to pay day-to-day expenses of the business.

The amount of cash required for advance payments if any.The amount of cash required for advance payments if any.

The average period of credit to be allowed by suppliers.The average period of credit to be allowed by suppliers.

Time lag in the payment of wages and other overheadsTime lag in the payment of wages and other overheads


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PROFORMA - WORKING CAPTIALPROFORMA - WORKING CAPTIAL

ESTIMATESESTIMATES

1.1. TRADING CONCERNTRADING CONCERN

STATEMENT OF WORKING CAPITAL REQUIREMENTS

Amount (Rs.)

Current Assets

(i) Cash ----

(ii) Receivables ( For..Months Sales)---- ----

(iii) Stocks ( ForMonths Sales)----- ----(iv)Advance Payments if any ----

Less : Current Liabilities

(i) Creditors (For.. Months Purchases)- ----

(ii) Lag in payment of expenses -----_

WORKING CAPITAL ( CA CL ) xxxAdd : Provision / Margin for Contingencies -----

NET WORKING CAPITAL REQUIRED XXX


Amount (Rs.)

Current Assets

(i) Cash ----

(ii) Receivables ( For..Months Sales)---- ----

(iii) Stocks ( ForMonths Sales)----- ----(iv)Advance Payments if any ----


(i) Creditors (For.. Months Purchases)- ----

(ii) Lag in payment of expenses -----_

WORKING CAPITAL ( CA CL ) xxxAdd : Provision / Margin for Contingencies -----


1 MANUFACTURING CONCERN1 MANUFACTURING CONCERN


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1. MANUFACTURING CONCERN1. MANUFACTURING CONCERN


Amount (Rs.)

Current Assets

(i) Stock of R M( for .months consumption) -----

(ii)Work-in-progress (formonths)(a) Raw Materials -----

(b) Direct Labour -----

(c) Overheads -----

(iii) Stock of Finished Goods ( for months sales)

(a) Raw Materials -----


(c) Overheads -----

(iv) Sundry Debtors ( for months sales)(a) Raw Materials -----


(c) Overheads -----

(v) Payments in Advance (if any) -----

(iv) Balance of Cash for daily expenses -----

(vii)Any other item -----


(i) Creditors (For.. Months Purchases) -----

(ii) Lag in payment of expenses -----

(iii) Any other -----

WORKING CAPITAL ( CA CL )xxxx

Add : Provision / Margin for Contingencies -----


P ti t f W ki it l i tP ti t f W ki it l i t


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Prepare an estimate of Working capital requirementPrepare an estimate of Working capital requirement

from the following information of a trading concern:from the following information of a trading concern:

Projected annual salesProjected annual sales 100000 units100000 unitsSelling priceSelling price Rs 8 per unitRs 8 per unit

% age of Net profit on sales% age of Net profit on sales 25%25%

Average Credit Period allowed toAverage Credit Period allowed tocustomercustomer

8 weeks8 weeks

Average Credit Period allowed byAverage Credit Period allowed by

suppliersupplier

4 weeks4 weeks

Average stock holding in terma of salesAverage stock holding in terma of sales

requirementrequirement12 weeks12 weeks

contingenciescontingencies 10%10%


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Points to be remembered whileoints to be remembered whileestimating WCstimating WC (1) Profits should be ignored while calculating working capital(1) Profits should be ignored while calculating working capital

requirements for the following reasons.requirements for the following reasons.

(a) Profits may or may not be used as working capital(a) Profits may or may not be used as working capital

(b) Even if it is used, it may be reduced by the amount of Income tax,(b) Even if it is used, it may be reduced by the amount of Income tax,

Drawings, Dividend paid etc.Drawings, Dividend paid etc.

(2) Calculation of WIP depends on the degree of completion as regards(2) Calculation of WIP depends on the degree of completion as regards

to materials, labour and overheads. However, if nothing is mentionedto materials, labour and overheads. However, if nothing is mentionedin the problem, take 100% of the value as WIP. Because in such ain the problem, take 100% of the value as WIP. Because in such a

case, the average period of WIP must have been calculated ascase, the average period of WIP must have been calculated as

equivalent period of completed units.equivalent period of completed units.

(3) Calculation of Stocks of Finished Goods and Debtors should be(3) Calculation of Stocks of Finished Goods and Debtors should be

made at cost unless otherwise asked in the question.made at cost unless otherwise asked in the question.


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Prepare statement ofrepare statement ofworking capital requirement,orking capital requirement,Profit &Loss A/C, Balancerofit &Loss A/C, BalanceSheet Assumingheet Assuming

Share CapitalShare Capital 150000150000 8% Debentures8% Debentures 200000200000 Fixed assetFixed asset 130000130000

MaterialMaterial 40%40% Direct lab ourDirect lab our 20%20% OverheadsOverheads 20%20%


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The following further particular are availableThe following further particular are available It is proposed to maintain a level of activity ofIt is proposed to maintain a level of activity of

2,00,000 units2,00,000 units

Selling price is Rs 12/- per unitSelling price is Rs 12/- per unit Raw Material are expected to remain in stores for anRaw Material are expected to remain in stores for an

average period of one monthaverage period of one month Material will be in process , on average half a monthMaterial will be in process , on average half a month

Finished goods are required to be in stock for anFinished goods are required to be in stock for anaverage period of one monthaverage period of one month Credit allow to debtors is two monthCredit allow to debtors is two month Credit allow by supplier is one monthCredit allow by supplier is one month


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Working Capital Financing MixWorking Capital Financing Mix

Approaches to Financing

Mix

The Hedging orMatching Approach

The ConservativeApproach

The AggressiveApproach


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Hedging approach to assetHedging approach to asset

financingfinancing

Fixed Assets

Permanent Current Assets

Total Assets

Fluctuating Current Assets

Time

Short-term

Debt

Long-term

Debt +

Equity

Capital


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The Hedging approachThe Hedging approach Hedging approach refers to a process of matchingHedging approach refers to a process of matching

maturities of debt with the maturities of financialmaturities of debt with the maturities of financial

need . In this approach maturity of source of fundneed . In this approach maturity of source of fundshould match the nature of asset to be financedshould match the nature of asset to be financed

This approach is also known as matching approach.This approach is also known as matching approach.

The hedging approach suggests that the permanentThe hedging approach suggests that the permanent

working capital requirement should be financed withworking capital requirement should be financed withfund from long term sources while the temporaryfund from long term sources while the temporary

working capital requirement should be financed withworking capital requirement should be financed with

short term funds.short term funds.


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Estimated Total Investment in Current Asset of company X forEstimated Total Investment in Current Asset of company X for

the year 2000the year 2000

MonthMonth InvestmentInvestment

in Currentin CurrentAssetAsset

(R's )(R's )

Permanent orPermanent or

FixedFixedInvestmentsInvestments

(R's)(R's)

TemporaryTemporary

or seasonal Investor seasonal Invest(R's)(R's)

JanuaryJanuary 5040050400 4500045000 54005400

FebruaryFebruary 5000050000 4500045000 50005000

MarchMarch 4870048700 4500045000 37003700AprilApril 4800048000 4500045000 30003000

MayMay 4600046000 4500045000 10001000

JuneJune 4500045000 4500045000 --

JulyJuly 4750047500 4500045000 25002500

AugustAugust 4800048000 4500045000 30003000SeptemberSeptember 4950049500 4500045000 45004500

OctoberOctober 5070050700 4500045000 57005700

NovemberNovember 5200052000 4500045000 70007000

DecemberDecember 4850048500 4500045000 35003500

TOTALTOTAL 4430044300


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Conservative ApproachConservative ApproachThis approach suggested that the entireThis approach suggested that the entire

estimated investments in current asset should beestimated investments in current asset should befinance from long term source and short termfinance from long term source and short term

should be use only for emergency requirementshould be use only for emergency requirement

Distinct features of this approachDistinct features of this approach

Liquidity is greaterLiquidity is greater Risk is minimizedRisk is minimized

The cost of financing is relatively more asThe cost of financing is relatively more as

interest has to be paid even on seasonalinterest has to be paid even on seasonal

requirement for the entire periodrequirement for the entire period

i h


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Conservative approach to assetConservative approach to asset

financingfinancing

Fixed Assets


Total Assets


Time

Short-term

Debt

Long-term

Debt +

Equity

capital


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Hedging andHedging and

conservative approachesconservative approaches

The hedging approaches implies low cost , highThe hedging approaches implies low cost , highprofit and high risk while the conservativeprofit and high risk while the conservative

approach leads to high cost , low profit , low riskapproach leads to high cost , low profit , low risk

Both the approaches are the two extreme andBoth the approaches are the two extreme and

neither of them serve the purpose of efficientneither of them serve the purpose of efficient

working capital managementworking capital management

A trade off between the two will then be anA trade off between the two will then be an

acceptable approach , One way of determiningacceptable approach , One way of determining

the trade off is by finding the AVG of maximumthe trade off is by finding the AVG of maximumand minimum requirement of current asset orand minimum requirement of current asset or

working capitalworking capital

i hA i h


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Aggressive approach to assetAggressive approach to asset

financingfinancing

Fixed Assets


Total Assets


Time

Short-term

Debt

Long-term

Debt +

Equity

capital


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Aggressive approachAggressive approach

The aggressive approach suggests that theThe aggressive approach suggests that the

entire estimated requirement of current assetentire estimated requirement of current asset

should be financed from short-term sources andshould be financed from short-term sources and

even a part of fixed asset investment beeven a part of fixed asset investment be

financed from short - term sourcesfinanced from short - term sources

This approach make the finance mix :This approach make the finance mix :

More RiskyMore Risky

Less costlyLess costly More ProfitableMore Profitable


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Prepare a projected balancerepare a projected balancesheet , profit and loss a/cheet , profit and loss a/cand then an estimation ofnd then an estimation ofworking capital .orking capital . Issued Share CapitalIssued Share Capital 300000300000 6% Debentures6% Debentures 200000200000

Fixed assetFixed asset 200000200000 Raw MaterialRaw Material 50%50% Lab ourLab our 20%20% OverheadsOverheads 20%20% ProfitProfit 10%10% There is a regular production andThere is a regular production and

sales cyclesales cycle


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Raw Material are kept in stores for an averageRaw Material are kept in stores for an averageperiod of two monthperiod of two month

Finished goods remain in stock for an averageFinished goods remain in stock for an average

period of three monthperiod of three month Production during the previous year was 180000Production during the previous year was 180000

units and it is planned to maintain the same in theunits and it is planned to maintain the same in thecurrent year alsocurrent year also

Each unit of production is expected to be inEach unit of production is expected to be inprocess for half a monthprocess for half a month Credit allow to customer is three month and givenCredit allow to customer is three month and given

by supplier is two monthby supplier is two month

Selling price is Rs 4 per unitSelling price is Rs 4 per unit Calculation of debtors may be made at sellingCalculation of debtors may be made at selling

priceprice


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Management of WorkingManagement of Working

CapitalCapital Working capital in general practice refer to theWorking capital in general practice refer to the

excess of CA over CL.excess of CA over CL. Management of working capital therefore isManagement of working capital therefore is

concerned with the problems that arise inconcerned with the problems that arise inattempting to manage the CA, the CL and theattempting to manage the CA, the CL and the

inter-relationship that exists between them.inter-relationship that exists between them. The basic goal of WCM is to manage the CA & CLThe basic goal of WCM is to manage the CA & CLof a firm in such a way that a satisfactory level ofof a firm in such a way that a satisfactory level ofWC is maintained.WC is maintained.

Working Capital Management Policies of a firmWorking Capital Management Policies of a firmhave a great effect on its profitability, liquidityhave a great effect on its profitability, liquidity

and structural health of the organizationand structural health of the organization


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Working capital management is 3Working capital management is 3

dimensional in Naturedimensional in Nature

Dimension I

Profitability,

Risk, & Liquidity

Dimension I

Profitability,

Risk, & Liquidity

Dimensi

onII

Compositio

n&Lev

el

ofCA

Dimensi

onII

Composit

ion&L

evel

ofCA

DimensionIII

Composition&Level

ofCL

DimensionIII

Composition&Level

ofCL


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Working Capital IssuesWorking Capital Issues

AssumptionsAssumptions

50,000 maximum50,000 maximumunits of productionunits of production

ContinuousContinuous

productionproduction

Three differentThree different

policies for currentpolicies for current

asset levels areasset levels are

possiblepossible

Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets

0 25,000 50,000OUTPUT (units)

A

SSET

LEVEL

Current Assets

Policy CPolicy C

Policy APolicy A

Policy BPolicy B


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Impact on LiquidityImpact on Liquidity

Liquidity AnalysisLiquidity Analysis

PolicyPolicyLiquidityLiquidityAA HighHigh

BB AverageAverage

CC LowLow

Greater current assetGreater current assetlevels generate morelevels generate more

liquidity; all otherliquidity; all other

factors held constant.factors held constant.


0 25,000 50,000OUTPUT (units)

A

SSET

LEVEL

Current Assets

Policy CPolicy C

Policy APolicy A

Policy BPolicy B

Impact onImpact on


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Impact onImpact onExpectedExpected

ProfitabilityProfitability

Return on InvestmentReturn on Investment==

Net ProfitNet ProfitTotal AssetsTotal Assets

LetLet Current AssetsCurrent Assets = (Cash= (Cash

+ Rec. + Inv.)+ Rec. + Inv.)

Return on InvestmentReturn on Investment

==

Net ProfitNet Profit

CurrentCurrent ++ Fixed AssetsFixed Assets


0 25,000 50,000OUTPUT (units)

A

SSET

LEVEL

Current Assets

Policy CPolicy C

Policy APolicy A

Policy BPolicy B

Impact onImpact on


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Impact onImpact onExpectedExpected

ProfitabilityProfitability

Profitability AnalysisProfitability Analysis

PolicyPolicy ProfitabilityProfitabilityAA LowLow

BB AverageAverage

CC HighHigh

As current asset levelsAs current asset levelsdecline, total assets willdecline, total assets will

decline and the ROI willdecline and the ROI will

rise.rise.


0 25,000 50,000OUTPUT (units)

A

SSET

LEVEL

Current Assets

Policy CPolicy C

Policy APolicy A

Policy BPolicy B


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Impact on RiskImpact on Risk

Decreasing cashDecreasing cash

reduces the firmsreduces the firms

ability to meet itsability to meet its

financial obligations.financial obligations.

More risk!More risk!

Stricter credit policiesStricter credit policies

reduce receivablesreduce receivables andand

possibly lose sales andpossibly lose sales andcustomers.customers. More risk!More risk!

Lower inventory levelsLower inventory levels

increase stockouts andincrease stockouts and

lost sales.lost sales. More risk!More risk!


0 25,000 50,000OUTPUT (units)

A

SSET

LEVEL

Current Assets

Policy CPolicy C

Policy APolicy A

Policy BPolicy B


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Impact on RiskImpact on Risk

Risk AnalysisRisk Analysis

PolicyPolicy RiskRiskAA LowLow

BB AverageAverage

CC HighHigh

Risk increases as theRisk increases as the

level of current assetslevel of current assets

are reduced.are reduced.


0 25,000 50,000OUTPUT (units)

A

SSET

LEVEL

Current Assets

Policy CPolicy C

Policy APolicy A

Policy BPolicy B

Summary of theSummary of the


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Summary of theSummary of theOptimal Amount ofOptimal Amount of

Current AssetsCurrent AssetsSSUMMARYUMMARY OOFF OOPTIMALPTIMAL CCURRENTURRENTAASSETSSETAANALYSISNALYSIS

PolicyPolicy LiquidityLiquidity ProfitabilityProfitability RiskRisk

AA HighHigh LowLow LowLowBB AverageAverage AverageAverage AverageAverage

CC LowLow HighHigh HighHigh

1. Profitability varies inversely with1. Profitability varies inversely with

liquidity.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!)

Techniques of analysis ofTechniques of analysis of


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Techniques of analysis ofTechniques of analysis of

working capitalworking capitalThe analysis of working capital can be conductedThe analysis of working capital can be conductedthrough a number of devices such asthrough a number of devices such as

Ratio analysisRatio analysis

Fund flow analysisFund flow analysis

Working capital BudgetingWorking capital Budgeting Ratio analysis : A ratio is a simple arithmeticalRatio analysis : A ratio is a simple arithmetical

expression of the relationship of one number toexpression of the relationship of one number to

another , this technique can be employed foranother , this technique can be employed for

measuring short term liquidity or working capitalmeasuring short term liquidity or working capitalposition of a firm.position of a firm.

h f ll i i bTh f ll i i b


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The following ratios may beThe following ratios may be

calculated for this purposecalculated for this purpose Liquidity RatioLiquidity Ratioa)a) Current RatioCurrent Ratio

b)b) Acid test ratio/quick ratio/liquid ratioAcid test ratio/quick ratio/liquid ratio

c)c) Cash Position ratio/absolute liquid ratioCash Position ratio/absolute liquid ratio Inventory turnover ratioInventory turnover ratio

Receivable turnover ratioReceivable turnover ratio

Payable turnover ratioPayable turnover ratio Working capital turnover ratioWorking capital turnover ratio


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Current ratio may be define as theCurrent ratio may be define as the

relationship between CA and CLrelationship between CA and CL

This ratio is also known as WCR.This ratio is also known as WCR.

(Working capital ration).(Working capital ration).

It is helpful to measure short It is helpful to measure short

term financial position or liquidityterm financial position or liquidity

of a firmof a firm

Current ratio:Current ratio: Current assetCurrent assetCurrent liabilitiesCurrent liabilities


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CURRENT ASSETS CURRENT LIABILITIES

Cash in hand Bills Payable

Cash at bank Sundry Creditors

Sundry Debtors Accrued or OutstandingExpenses

Marketable securities(Short term)

Short term loan andadvances

Bills Receivable Dividend payable

Inventories of Stock Bank OverdraftWork in progress

Finished goods

Prepaid Expenses

Q i k A id t tQ i k A id t t


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Quick or Acid test orQuick or Acid test or

Liquid RatioLiquid Ratio An asset is said to be liquid if it can beAn asset is said to be liquid if it can be

convert into cash with in a short period withconvert into cash with in a short period with

out loss of valueout loss of value

Inventory cannot be termed to be liquid assetInventory cannot be termed to be liquid assetbecause they cannot be convert into cashbecause they cannot be convert into cash

immediatelyimmediately

The quick ratio can be calculatedThe quick ratio can be calculated

Quick ratio:Quick ratio: liquid assetliquid assetCurrent liabilitiesCurrent liabilities


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Quick or liquid Current Liabilities

Cash in handBills Payable

Cash at bank Sundry Creditors

Sundry Debtors Accrued or OutstandingExpenses

Marketable securitiesShort term advances

Temporary

Investments

Dividend payable

Bank Overdraft

Income tax payable

Convection quick ratio of 1:1 is consider

satisfactory


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Cash Position ratio/absolute liquidCash Position ratio/absolute liquid

ratioratio

Absolute Liquid assets include cash in hand andAbsolute Liquid assets include cash in hand and

cash at bank and marketable securities orcash at bank and marketable securities or

temporary investmentstemporary investments

The acceptable norms for this ratio is 50% or .05%The acceptable norms for this ratio is 50% or .05%

Cash ratio:Cash ratio: Cash & bank + Short term securitiesCash & bank + Short term securities

Current liabilitiesCurrent liabilities

Calculate all the threeCalculate all the three


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Calculate all the threeCalculate all the threeratioratioLiabilities Rs Assets Rs

9%

preferenceshare

500000Goodwill 100000

Equity share

capital

1000000Land and

building

650000

8%

debentures

200000Plant 800000

Long term

loan

100000Furniture and

fixtures

150000

Bills payable 60000Bills

receivable

70000

Sundry

creditors

70000Sundry

debtors

90000

Bank over

draft

30000Bank balance 45000

Outstanding 5000short term 25000

CO C S OCONCLUSION


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CONCLUSION:CONCLUSION:

Current ratio of the company is notCurrent ratio of the company is not

satisfactory because the ratio 1:6 is muchsatisfactory because the ratio 1:6 is much

below then the expected Standards .below then the expected Standards .

Acid test ratio on the other hand is moreAcid test ratio on the other hand is more

than the normal standard of 1:1than the normal standard of 1:1

Absolute ratio is slightly low because it isAbsolute ratio is slightly low because it is0.42 where as the accepted standard is 0.50.42 where as the accepted standard is 0.5

In this company need to improve its shortIn this company need to improve its short

term financial positionterm financial position


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Inventory turnover ratioInventory turnover ratioInventory turn over ratio =Inventory turn over ratio = Cost of good soldCost of good sold

Average Inventory at costAverage Inventory at cost

Generally , the cost of good sold may not be known fromGenerally , the cost of good sold may not be known from

the published financials , in such circumstancesthe published financials , in such circumstances

Inventory turn over ratio =Inventory turn over ratio =

Net SalesNet Sales

Average Inventory at costAverage Inventory at cost

Inventory turn over ratio =Inventory turn over ratio = Cost of good soldCost of good sold

Average Inventory at selling priceAverage Inventory at selling price

Inventory conversionInventory conversion


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Inventory conversionInventory conversion

periodperiodInventory conversion period =Inventory conversion period = Days in a yearDays in a year

Inventory Turnover RatioInventory Turnover Ratio

M/s Rakesh & Co supplies you the followingM/s Rakesh & Co supplies you the following

information for the year ending 31information for the year ending 31stst

Dec 1999Dec 1999Credit Sales Rs 150000Credit Sales Rs 150000

Cash SalesCash Sales Rs 250000Rs 250000

Return Inward Rs 25000Return Inward Rs 25000

Opening Stock Rs 25000Opening Stock Rs 25000

Closing Stock Rs 35000Closing Stock Rs 35000

Debtor/Receivable turnover ratioDebtor/Receivable turnover ratio


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Debtor/Receivable turnover ratioDebtor/Receivable turnover ratio

/Debtor velocity/Debtor velocityDebtor(Receivable) =Debtor(Receivable) = Net credit Annual salesNet credit Annual sales

Average Trade debtorsAverage Trade debtorsTrade debtors = Sundry debtor + Bill Receivable andTrade debtors = Sundry debtor + Bill Receivable and

account receivable saccount receivable s

Average Trade Debtors = Opening Trade debtor +Average Trade Debtors = Opening Trade debtor +

Closing Trade Debtor /2Closing Trade Debtor /2

Note : Debtor should always be taken at gross value ,Note : Debtor should always be taken at gross value ,

No provision for doubtful debt be deducted from themNo provision for doubtful debt be deducted from them

but when the information about opening and closingbut when the information about opening and closing

balance of trade debtor and credit sales is not availablebalance of trade debtor and credit sales is not available

, then the debtors turnover ratio calculated by dividing, then the debtors turnover ratio calculated by dividingthe total sales by the balance of debtors(inclusive ofthe total sales by the balance of debtors(inclusive of

Bills receivables) givenBills receivables) given

Debtors turn over Ratio =Debtors turn over Ratio =Total salesTotal sales

DebtorsDebtors

Average CollectionAverage Collection


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Average CollectionAverage Collection

PeriodPeriodThe average collection period represent theThe average collection period represent the

average number of days for which a firm hasaverage number of days for which a firm has

to wait before its receivable are converted intoto wait before its receivable are converted into

cashcash

Average Collection period =Average Collection period =

Average Trade Debtors (Drs + B/R)Average Trade Debtors (Drs + B/R)

Sales per daySales per day

Sales Per daySales Per day == Net SalesNet SalesNo of working daysNo of working days

OO


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OrOr

Average collection period =Average collection period =Average tradeAverage trade

debtorsdebtors Net SalesNet SalesNo of working daysNo of working days

If the period is in months:If the period is in months:

Average collection period =Average collection period =No of workingNo of workingdaysdays Debtors turnover ratioDebtors turnover ratio

The two basis component of the ratio areThe two basis component of the ratio are

debtors and sales per daydebtors and sales per day

Creditor/Payablere tor aya e


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Creditor/Payablere tor aya eturnover ratioturnover ratio

The analysis for credit turnover is basically theThe analysis for credit turnover is basically the

same as of debtors turnover ratio except thatsame as of debtors turnover ratio except thatin place of trade debtor, the trade creditor arein place of trade debtor, the trade creditor are

taken and in place of sales , average dailytaken and in place of sales , average daily

purchase are taken as the other component ofpurchase are taken as the other component of

the ratio.the ratio.Creditors turnover ratioCreditors turnover ratio

== Net credit annual purchaseNet credit annual purchase

Average Trade creditorsAverage Trade creditors


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Average Payment period RatioAverage Payment period Ratio

= Average Trade Creditors( Creditors+ Bills= Average Trade Creditors( Creditors+ Billspayable)/Average Daily purchases.payable)/Average Daily purchases.

Average daily purchase = Annual PurchaseAverage daily purchase = Annual Purchase

/No of working days in a year./No of working days in a year.

Average Payment Period = Trade creditor *Average Payment Period = Trade creditor *

No of working days / Net annual purchase.No of working days / Net annual purchase.

Average Payment Period = No of workingAverage Payment Period = No of working

days / Credit turnover Ratio.days / Credit turnover Ratio.

Working capital turnoverWorking capital turnover


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Working capital turnoverWorking capital turnoverratioratio

Working capital of a concern is directly related toWorking capital of a concern is directly related to

sales and current asset like debtors , billssales and current asset like debtors , billsreceivable , cash , stock etc .receivable , cash , stock etc .

Working capital turnover ratio = Cost of Sales /Working capital turnover ratio = Cost of Sales /

Average working capitalAverage working capital

Average working capital = Opening workingAverage working capital = Opening workingcapital + Closing Working capital/2capital + Closing Working capital/2

** If cost of sales is not given , then the figure of** If cost of sales is not given , then the figure of

sale can be used . O n the other hand ifsale can be used . O n the other hand if

opening working capital is not disclosed thenopening working capital is not disclosed thenworking capital at the end of the year will beworking capital at the end of the year will be

used.used.

Cost of sale /Net working capitalCost of sale /Net working capital

The following information is givenThe following information is given


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g gg g

about M/s S.P Ltd for the year endingabout M/s S.P Ltd for the year ending

Dec 31 2000Dec 31 2000

Stock turnover ratio = 6timesStock turnover ratio = 6times Gross Profit ratio = 20% on salesGross Profit ratio = 20% on sales

Sales for 2000 = Rs 300000Sales for 2000 = Rs 300000

Closing stock is Rs 10000 more thanClosing stock is Rs 10000 more than

the opening stockthe opening stock

Opening Creditors = Rs 20000Opening Creditors = Rs 20000

Closing Creditors = Rs 30000Closing Creditors = Rs 30000

Trade debtor at the end = Rs 60000Trade debtor at the end = Rs 60000

Net Working Capital = Rs 50000Net Working Capital = Rs 50000

FIND OUTFIND OUT


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FIND OUTFIND OUT

Average StockAverage Stock

PurchasesPurchases

Credit turnover ratioCredit turnover ratio

Average Payment PeriodAverage Payment PeriodAverage Collection PeriodAverage Collection Period

Working Capital turnoverWorking Capital turnoverratioratio

Fund flow analysisFund flow analys

is : Fund flow analysis is a: Fund flow analysis is a


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Fund flow analysisFund flow analysis : Fund flow analysis is a: Fund flow analysis is atechnical device designated to study thetechnical device designated to study the

sources from which additional fund weresources from which additional fund were

derived and the use to which these sourcesderived and the use to which these sourceswere put . It is an effective management toolwere put . It is an effective management tool

to study change in the financial position ofto study change in the financial position of

businessbusiness

The fund flow analysis consists ofThe fund flow analysis consists of Preparing schedule of change in workingPreparing schedule of change in working

capitalcapital

Statement of sources and application ofStatement of sources and application offundsfunds


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working capital details

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