WORKING CAPITAL MANAGEMENT

Topics To Be Covered Concept Definitions Types Factors Affecting WK Requirements Operating Cycle Approach Dangers of Excessive and Inadequate

WK Practical Exercises

Nature of Working Capital Managing the current assets, current

liabilities and their inter-relationships Current Assets:

Assets that can be converted into cash within 1 year ( marketable securities, cash, inventory, accounts receivables)

Current Liabilities: Obligations to be paid within a year from

current assets or earnings (accounts payable, bills, Bank OD, O/s Expenses)

Contd.. Goal of WK management: to manage

the current assets and liabilities so that a satisfactory level of WK is maintained

WHY? To avoid insolvency To avoid bankruptcy Efficient business operations

Right mix of current assets and liabliites

“The interaction between current assets and liabilities is the main theme of WK management”

Concepts and Definitions

Gross Working Capital Net Working Capital

Gross Working Capital

The current assets which represent the proportion of investment that circulates from one form to another in ordinary course of business

TOTAL CURRENT ASSETS

Net Working Capital

NWK = CA – CL

Tool to measure the liquidity (like CR, Acid Test Ratio) Non-synchronous cash flows CA > CL More ability to meet obligations

Net Working Capital (contd.)

That portion of current assets which is financed with long term funds CL represents short term sources of

finance If CA > CL then the excess is financed

by long term sources

TRADE OFF BETWEEN PROFITABILITY AND RISK

Profits measured by revenues and costs

Risk of technical insolvency Probability that a firm will be unable

to meet its obligation as they become due

Effect of level of CA and CLon Profitability-Risk Trade Off

Assumptions: We are dealing with a manufacturing

concern CA are less profitable than fixed

assets Short term funds are less expensive

than long term funds

PROFITS RISK of insolvency

CA + _ _

CA _ + +

CL + + +

CL - _ _

NEED FOR WORKING CAPITAL

Goal of FM : Share-holder Wealth Maximization

Profits Sales Time lag involved need for

WK

OPERATING CYCLE/ CASH CYCLE

The continuing flow from cash to suppliers, to inventory, to accounts receivable and back into cash

Operating cycle

RECEIVABLESCASH

INVENTORY

Cash Cycle

The length of time necessary to complete the cycle of events

TYPES OF WK

Permanent / Fixed WK Temporary / Fluctuating / Variable

WK

CHANGES IN WK

Changes in Sales and Operating Expenses

Policy Changes Technological Changes

DETERMINANTS OF WK

General Nature of Business Production Cycle Business Cycle Production Policy Credit Policy Growth and Expansion

Vagaries in availability of raw materials

Profit Level Level of taxes Dividend policy Depreciation policy

Price level changes Operating efficiency

DANGERS OF EXCESSIVE WK Accumulation of inventory – waste,

theft, loss Defective credit policy and slack

collection period – bad debts Complacency and inefficiency Affects dividend policy – speculative

profits in inventory tends to liberal dividend policy- future?

INADEQUATE WK - PROBLEMS Stagnates growth Difficult to achieve target profit levels

and operational plans Operating inefficiency Inefficient utilization of fixed assets Inability to avail attractive opportunities

Buy raw materials at low rates Sell on credit to a big buyer

Loss of reputation- inability to meet obligations- tight credit terms