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WCMWCMWorking CapitalWorking Capital

ManagementManagement

Working CapitalWorking Capital

ManagementManagement

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Working capitalWorking

capital

x capital required for the day to

day operations of the business

enterprises

x current assets- current liabilities

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Working Capital ConceptsWorking Capital Concepts

Net Working CapitalNet Working

Capital

Current Assets - Current Liabilities.

Gross Working CapitalGross Working

Capital

The firms investment in current assets.

Working Capital ManagementWorking

Capital ManagementThe administration of the firms current assets and

the financing needed to support current assets.

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Need for Working CapitalNeed for Working Capital

x Shareholders wealth

x

Time lag- sales activity and reciepts of cash

x Operating cycle.

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Classifications ofClassifications of

Working CapitalWorking Capital

x TimeTime

x Permanent

x Temporary

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Working Capital IssuesWorking Capital Issues

Assumptions

x 50,000 maximumunits of production

x Continuous

production

x Three differentpolicies for current

asset levels are

possible

Optimal Amount (Level) of Current Assets

0 25,000 50,000

OUTPUT (units)

ASS

ET

LEVEL

($)

Current Assets

Policy

CPolicy C

Policy APolicy A

Policy BPolicy B

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Impact on LiquidityImpact on Liquidity

Liquidity Analysis

PolicyPolicy LiquidityLiquidity

AA HighHigh

BB AverageAverage

CC LowLow

Greater current asset

levels generate more

liquidity; all other

factors held constant.

Optimal Amount (Level) of Current Assets

0 25,000 50,000

OUTPUT (units)

ASS

ET

LEVEL

($)

Current Assets

Policy CPolicy C

Policy APolicy A

Policy BPolicy B

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Impact onImpact on

Expected ProfitabilityExpected Profitability

Return on InvestmentReturn on Investment=

Net ProfitNet Profit

Total AssetsTotal Assets

Let Current AssetsCurrent Assets =

(Cash + Rec. + Inv.)

Return on InvestmentReturn on Investment=

Net ProfitNet Profit

CurrentCurrent + Fixed AssetsFixed Assets

Optimal Amount (Level) of Current Assets

0 25,000 50,000

OUTPUT (units)

ASS

ET

LEVEL

($)

Current Assets

Policy CPolicy C

Policy APolicy A

Policy BPolicy B

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Impact onImpact on

Expected ProfitabilityExpected Profitability

Profitability Analysis

PolicyPolicy ProfitabilityProfitability

AA LowLow

BB AverageAverage

CC HighHigh

As current asset levels

decline, total assets will

decline and the ROI will

rise.

Optimal Amount (Level) of Current Assets

0 25,000 50,000

OUTPUT (units)

ASS

ET

LEVEL

($)

Current Assets

Policy CPolicy C

Policy APolicy A

Policy BPolicy B

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0

Impact on RiskImpact on Risk

x Decreasing cash

reduces the firms abilityto meet its financial

obligations. More risk!More risk!

x Stricter credit policies

reduce receivables and

possibly lose sales andcustomers. More risk!More risk!

x Lower inventory levels

increase stockouts and

lost sales. More risk!More risk!

Optimal Amount (Level) of Current Assets

0 25,000 50,000

OUTPUT (units)

ASS

ET

LEVEL

($)

Current Assets

Policy CPolicy C

Policy APolicy A

Policy BPolicy B

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1

Impact on RiskImpact on Risk

Risk Analysis

PolicyPolicy RiskRisk

AA LowLow

BB AverageAverage

CC HighHigh

Risk increases as the

level of current assets

are reduced.

Optimal Amount (Level) of Current Assets

0 25,000 50,000

OUTPUT (units)

ASSET

LEVEL

($)

Current Assets

Policy CPolicy C

Policy APolicy A

Policy BPolicy B

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2

Summary of the OptimalSummary of the Optimal

Amount of Current AssetsAmount of Current Assets

SSUMMARYUMMARYOOFF OOPTIMALPTIMAL CCURRENTURRENT AASSETSSET AANALYSISNALYSIS

PolicyPolicy LiquidityLiquidity ProfitabilityProfitability RiskRisk

AA HighHigh LowLow LowLowBB AverageAverage AverageAverage AverageAverage

CC LowLow HighHigh HighHigh

1. Profitability varies inversely withliquidity.

2. Profitability moves together with risk.

(risk and return go hand in hand!)

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3

Determinants of workingDeterminants of working

capitalcapitalxGeneral nature of business

x

Production cyclexBusiness cycle

x

Production policyxCredit policy

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4

Determinants(cont)Determinants(cont)

xGrowth and expansion

x

Vagaries in the availability of rawmaterials

xProfit level

xLevel of taxes

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5

Determinants(cont..)Determinants(cont..)

xDividend policy

x

Depreciation policyxPrice level changes

x

Operating efficiency

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6

Financing mixFinancingmix

Three basic approaches of

financing mix:

x hedging approach

xConservative approach

x trade-off

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7

Components of workingComponents of working

capitalcapitalxCash management

x

Inventoriesx receivables

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8

Cash managementCash management

xMotives:

transactionprecautionary

speculative

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9

ReceivablesReceivables

xCOSTS OF MAINTAING

RECEIVABLES

capital costs

administrative costs

collection costs

defaulting costs

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0

INVENTORIESINVENTORIES

xOBJECTIVES:

continuous supply of materialssufficient stock of raw materials

and finished goods

minimising carrying costs