ppt on wc mgt

8/7/2019 PPT on WC MGT

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Why should managers be familiar

with working capital management?



What is Working capital

management?� working capital management involves the

relationship between a firm's short-term assetsand its short-term liabilities. The basic goal of

working capital management is to ensure that afirm is able to continue its operations and that ithas sufficient ability to satisfy both maturingshort-term debt and upcoming operational

expenses. The management of working capitalinvolves managing inventories, accountsreceivable, accounts payable and cash



Working Capital management is concerned

with the problems that arise in attempting tomanage the Current Assets, the Current

Liabilities and the interrelationship that exists

between them.



Current Assets� Current Assets are the assets which can be converted into cash

within an accounting year (or operating cycle) and include cash,short-term securities, debtors, (accounts receivable or bookdebts) bills receivable and stock (inventory).

CURRENT ASSETS constitute the following:

� Inventories: Inventories represent raw materials and components, work-in-

progress and finished goods.� Trade Debtors: Trade Debtors comprise credit sales to customers.

� Prepaid Expenses: These are those expenses, which have been paid for goodsand services whose benefits have yet to be received.

� Loan and Advances: They represent loans and advances given by the firm toother firms for a short period of time.

� Investment: These assets comprise short-term surplus funds invested ingovernment securities, shares and short-terms bonds.

� Cash and Bank Balance: These assets represent cash in hand and at bank,which are used for meeting operational requirements. One thing you can seehere is that this current asset is purely liquid but non-productive.



Current Liabilities� Current liabilities (CL) are those claims of outsiders which are

expected to mature for payment within an accounting yearand include creditors (accounts payable), bills payable, andoutstanding expenses.

CURRENT LIABILITIES comprise the following:

� Sundry Creditors: These liabilities stem out of purchase of

raw materials on credit terms usually for a period of one totwo months.

� Bank Overdrafts: These include withdrawals in excess of credit balance standing in the firms current accounts withbanks

� Short-term Loans: Short-terms borrowings by the firm frombanks and others form part of current liabilities as short-termloans.

� Provisions: These include provisions for taxation, proposeddividends and contingencies.



Concepts of Working Capital

�

Gross working capital (GWC) GWC refers to the firms total investment in current

assets.

� GWC focuses on

± Optimization of investment in current

± Financing of current assets



� The planning should be done keeping in mind two dangerpoints i.e. excessive and inadequate investment in currentassets. Investment in current assets needs to be adequate

as it affects the profitability, solvency and liquidity. Why thisissue comes up because it ultimately affects the objectivesof financial management.

Danger points to be kept in mind while planning

� 1. Excessive investment

± It results in unnecessary accumulation of inventories. Thus,chances of inventory mishandling, waste, theft & lossesincrease.

± It is an indication of defective credit policy & slack collectionperiod.

± ExcessiveWC makes management complacent, whichdegenerates into managerial inefficiency.

± Tendencies of accumulating inventories tend to makespeculative profits grow.



� 2. Inadequate investment

± It stagnates growth.

±It become difficult to implement operating plansand achieve the firms operating profit target.

± Operating inefficiencies creep in when it becomesdifficult even to meet day-to-day commitments.

± Fixed assets are not efficiently utilized for the lackof working capital funds. Thus, the firmsprofitability would deteriorate.

± Paucity of WC funds render the firm unable to

avail attractive credit opportunities. ± The firm loses its reputation when it is not in a

position to honour its short-term obligations.



Net working capital (NWC)

� NWC refers to the difference between current

assets and current liabilities.

� NWC focuses on

± Liquidity position of the firm

±Judicious mix of short-term and long-tern financing

� NWC can be positive or negative. ± Positive NWC = C A > C L

± Negative NWC = C A < C L



Operating Cycle

� Operating cycle is the time duration required to convert sales,

after the conversion of resources into inventories, into cash.

The operating cycle of a manufacturing company involves

three phases:

± Acquisition of resources such as raw material, labour, power and fuel

etc.

± Manuf acture of the product which includes conversion of raw

material into work-in-progress into finished goods.

± Sal e of the product either for cash or on credit. Credit sales createaccount receivable for collection.



Cont

� The length of the operating cycle of amanufacturing firm is the sum of:

± Inventory conversion period (ICP).

±Debtors (receivable) conversion period (DCP).

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Gross Operating Cycle (GOC)

� The firms gross operating cycle (GOC) can be

determined as inventory conversion period

(ICP) plus debtors conversion period (DCP).

Thus, GOC is given as follows:

12



Inventory conversion period

� Inventory conversion period is the total

time needed for producing and selling the

product. Typically, it includes:

± raw material conversion period (RMCP)

± work-in-process conversion period (WIPCP)

± finished goods conversion period (FGCP)

13



Debtors (receivables) conversion period

(DCP)

� Debtors conversion period (DCP) is the

average time taken to convert debtors into

cash. DCP represents the average collection

period. It is calculated as follows:

14



Creditors (payables) deferral period (CDP)

� Creditors(payables) deferral period (CDP) is

the average time taken by the firm in

paying its suppliers (creditors). CDP is given

as follows:

15



Cash Conversion or Net Operating

Cycle

� Net operating cycle (NOC) is the difference between

gross operating cycle and payables deferral period.

� Net operating cycle is also referred to as cashconversion cycle.

16



PERMANENT AND VARIABLE WORKING

CAPITAL

� Permanent or fixed working capital

A minimum level of current assets, which iscontinuously required by a firm to carry on

its business operations, is referred to aspermanent or fixed working capital.

� Fluctuating or variable working capital

The extra working capital needed tosupport the changing production and salesactivities of the firm is referred to asfluctuating or variable working capital.

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Determinants of Working Capital

1. Nature of business

2. Market and demand

3. Technology and manufacturing policy4. Credit policy

5. Supplies credit

6. Operating efficiency

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Estimating Working capital

C urrent assets hol ding period

� To estimate working capital requirements on the basis of averageholding period of current assets and relating them to costs based onthe companys experience in the previous years. This method is

essentially based on the operating cycle concept.

Ratio of sal es

� To estimate working capital requirements as a ratio of sales on theassumption that current assets change with sales.

Ratio of fixed investment

� To estimate working capital requirements as a percentage

of fixed investment.

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Formulas

� Current assets

1. Raw Material

= Budgeted production X Cost of raw material Per unit X Raw material holding Period

12 Months/ 360 days/ 52W

eeks2.Work-in-progress

= Budgeted production X Cost of Production X Raw material holding Period

12 Months/ 360 days/ 52 Weeks

3. Finished Product= Credit sales X Cost of sales X Debtors Collection Period


4. Cash and bank balance

Total Current assets= 1+2+3+4

X % of Completion



Cont

� Current Liabilities

1. Creditors= Credit Purchase X cost of Raw Material X Creditors payment period

12 Months/ 360 days/ 52 weeks

2. Out Standing Wages/ Time lag in payment of wages

= Budgeted production X Cost of Labour Per unit X Time lag


3. Time lag in Payment of Overheads= Budgeted production X Over head Per unit X Time lag




Working Capital Finance Policies

� Long-term

� Short-term

� Spontaneous

22



Working Capital Finance Policies

� Matching

� Conservative

�Aggressive

23



Matching Approach

24

F inancing under matching plan

A firm can meet its financing needs by using a matching approach in which

the maturity structure of the firms liabilities is made to correspond exactlyto the life of its assets. If you refer to the above diagram, the fixed working

capital is financed with the long-term capital& equity funds, whereas

fluctuating current assets are financed with short-term debt.



Conservative Approach

25

C onserv ative financing

A firm in practice may adopt a conservative approach in financing its

working capital where it depends on more of long-term funds. As you

can see in the diagram, the firm is financing its fixed /permanent

working capital and also a part of its fluctuating working capital withlong-term financing. Only a small portion is being financed through

short-term financing.



Aggressive Approach

26

Aggressive financing

W

hen a firm uses more of short-term sources for financing working capital;it is said to be followed aggressive policy. As it can be seen from the

diagram, the fixed working capital and a portion of fluctuating working

capital is finance by short-term funds. Only a small portion of fluctuating

working capital is being financed by short-term funds.

ppt on wc mgt

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