financial management unit i: nature of financial management: meaning – nature – objectives –...
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FINANCIAL MANAGEMENT
Unit I: Nature of Financial Management: Meaning – Nature – Objectives – Scope- Functions of Financial Management – Financial forecasting – Financial Planning – Time Value of Money (NP) Unit II: Financing Decisions: Sources of Finance - Cost of Different Sources of Finance - Cost of Debt - Cost of Preference Capital - Cost of Equity Share - Cost of Retained Earnings - Weighted Average Cost of Capital – Capital structure – financial and operational Leverage (NP) Unit III: Investment Decision: Basics of Capital Budgeting - Appraisal and Evaluation of Long Term Investment Proposals - Pay Back Method - Accounting Rate of Return - Internal Rate of Return - Net Present Value - Profitability Index. (NP)
Unit IV: Working Capital Management: Concept of Working Capital - Determinants of Working Capital - Operating Cycle – Computation of Working Capital Requirements (NP) Unit V: Dividend Policy: Stable Dividend – Dividend Theories - Factors Influencing Dividend Policy – Issues in Dividend Policy - Bonus Shares.
Working Capital Management
Definition of Working Capital
Working capital is the amount of funds necessary to cover the cost operating the enterprise
Circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another.
Concepts of working capitalBalance sheet conceptOperating cycle or circular flow concept
Current Liabilities Current Assets Bank Overdraft Cash and Bank Balance Creditors Inventories: Raw-
Materials Outstanding Expenses Work-in-progress Bills Payable Finished Goods Short-term Loans Bills
Receivables Proposed Dividends Accrued
Income Provision for Taxation, etc. Prepaid
Expenses Accounts
Receivables Short-term
Investments
Balance sheets of a company as on 31 March 2007 as follows :Equity Share Capital 10,00,000 Goodwill 80,0008% P.S. Capital 2,00,000 Land andGeneral Reserve 1,20,000 Building 6,50,000 11% Debenture 5,00,000 Plant andProfit & Loss A/c 2,10,000 Machinery 6,60,000Bills Payable 30000 Investments 2,20,000
Creditors 2,15,000 Marketable securities 60,000Provisions for tax 80,000 Stock 3,85,000Proposed Dividend1,36,000 Debtors 4,15,000O/s expenses 20000 Bills Receivable
50,000 Cash and Bank 93,000
Prepaid Expenses 11,000
25,34,000 25,34,000
THE WORKING CAPITAL CYCLE
(OPERATING CYCLE)
Accounts Payable
Cash
RawMaterials
W I P
Finished Goods
Value Addition
AccountsReceivable
SALES
Operating CycleGross operating cycle = RMCP + WIPC +
FGCP + RCPNet operating cycle = Gross operating cycle –
Payable deferral period
FormulasRaw Material conversion = Average stock of
raw material /Raw material consumption per day*365
Work in process conversion period = Average stock of work in progress/Total cost of production per day*365
Finished goods conversion period = Average stock of finished goods/Total cost of goods sold per day*365
Receivables conversion period = Average receivables/Net credit sales per day*365
Payables deferral period = Average payables/ net credit purchases per day*365
ProblemPeriod covered 365 daysAverage period of credit allowed by suppliers 16 daysAverage total of debtors out standings Rs. 4,80,000Raw material consumption Rs. 44,00,000Total production cost 1,00,00,000Total cost of goods sold Rs. 1,05,00,000Sales for the year Rs. 1,60,00,000Value of average stock maintained- Raw material Rs. 3,20,000- WIP Rs. 3,50,000- Finished goods Rs. 2,60,000
Raw Material conversion = 320000/4400000 * 365 = 27 days
Work in process conversion period = 350000/10000000*365 = 13 days
Finished goods conversion period = 260000/10500000*365 = 9 days
Receivables conversion period = 480000/16000000*365 = 11 days
From the following data compute the duration of operating cycle for each of the two companies
Xltd Y ltd
Stock: Raw Materials 40000 60000
Work in process 30000 45000
Finished goods 25000 38000
Purchase of raw material
160000 270000
Cost of goods produced
300000 380000
Sale (credit basis) 360000 432000
Debtors 72000 108000
creditors 20000 27000
Assume 360 days per year for computational purposes
Classification of working capitalWorking capital may be classified in two waysOn the basis of conceptOn the basis of time
On the basis of time
Permanent or fixed working capitalTemporary or variable working capital
Difference between permanent & temporary working capital
Amount Variable Working Capitalof WorkingCapital
Permanent Working Capital
Time
Variable Working CapitalAmount of WorkingCapital
Permanent Working Capital
Time
PROFORMA - WORKING CAPTIAL ESTIMATES
1. TRADING CONCERNSTATEMENT OF WORKING CAPITAL REQUIREMENTS
Amount (Rs.)Current Assets(i) Cash ----(ii) Receivables ( For…..Month’s Sales)---- ----(iii) Stocks ( For……Month’s Sales)----- ----(iv)Advance Payments if any ----Less : Current Liabilities(i) Creditors (For….. Month’s Purchases)- ----(ii) Lag in payment of expenses -----_WORKING CAPITAL ( CA – CL ) xxxAdd : Provision / Margin for Contingencies -----
NET WORKING CAPITAL REQUIRED XXX
STATEMENT OF WORKING CAPITAL REQUIREMENTS Amount (Rs.)
Current Assets(i) Cash ----(ii) Receivables ( For…..Month’s Sales)---- ----(iii) Stocks ( For……Month’s Sales)----- ----(iv)Advance Payments if any ----Less : Current Liabilities(i) Creditors (For….. Month’s Purchases)- ----(ii) Lag in payment of expenses -----_WORKING CAPITAL ( CA – CL ) xxxAdd : Provision / Margin for Contingencies -----
NET WORKING CAPITAL REQUIRED XXX
1. MANUFACTURING CONCERN
STATEMENT OF WORKING CAPITAL REQUIREMENTSAmount (Rs.)
Current Assets(i) Stock of R M( for ….month’s consumption) -----(ii)Work-in-progress (for…months) (a) Raw Materials ----- (b) Direct Labour ----- (c) Overheads -----(iii) Stock of Finished Goods ( for …month’s sales) (a) Raw Materials ----- (b) Direct Labour ----- (c) Overheads -----(iv) Sundry Debtors ( for …month’s sales) (a) Raw Materials ----- (b) Direct Labour ----- (c) Overheads -----(v) Payments in Advance (if any) -----(iv) Balance of Cash for daily expenses -----(vii)Any other item -----
Less : Current Liabilities(i) Creditors (For….. Month’s Purchases) -----(ii) Lag in payment of expenses -----(iii) Any other -----WORKING CAPITAL ( CA – CL )xxxxAdd : Provision / Margin for Contingencies -----
NET WORKING CAPITAL REQUIRED XXX
Adequate working capitalSolvencyGoodwill Easy loansCash discount
Disadvantages of excess working capital IdleUnnecessary inventoryTheft waste & lossesDefective credit policy
Dangers of inadequate working capitalCannot meet its short term obligationsCannot buy requirements in bulk to avail
discountsCannot utilize fixed assts effectively
Factors determining working capital requirementsNature of the businessSize of the business Production policy Length of production cycleSeasonal variations Stock turnoverCredit policyBusiness cyclesDividend policy
Contd., Prices level changesOther factors – operating efficiency,
management ability, irregularities of supply, import policy, labour
Important working capital ratios Current Ratio = Current assets/Current
liabilitiesAcid-test ratio = Quick assets/Current
liabilitiesInventory turnover ratio= Cost of goods
sold/Average inventoryDebtors turnover ratio= Net credit
sales/Average debtorCreditors turnover ratio = Net Credit
purchase/Average Creditors