wcm module 1

8/8/2019 Wcm Module 1

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According to modern definition of financial management duties of financemanager is categorized in to followingfive heads.

1. Capital budgeting ( Management of fixed assets)

2. Capital structure

3. Cost of capital4. Dividend decision

5. Working capital management( Currentassets management)

Introduction



Working capital management

Working capital management involvesthe relationship between a firm's short-term assets and its short-term liabilities.

The basic goal of working capitalmanagement is to ensure that a firm isable to continue its operations and thatit has sufficient ability to satisfy bothmaturing short-term debt and

upcoming operational expenses. The management of working capital

involves managing inventories,accounts receivable, accountspayable and cash



CONCEPTS OF WORKING

CAPITAL 1. GROSS WORKING CAPITAL

It refers to the firm¶s investment in

current assets. Current assets are theassets, which can be converted intocash within an accounting year orwithin an operating cycle. You can

include here cash, short-termsecurities, debtors (accountsreceivable & book debts), bills

receivable and stock.



NET WORKING CAPITALBut the net working capital refers to

the difference between current assets

and current liabilities.Current liabilities are those claims of

outsider, which are expected to maturefor payment within an accounting year & include creditors, bills payable & theoutstanding expenses. In other wordsyou can say that this is the excess of current assets over current liabilities.



CURRENT ASSETS constitute the following

1 Inventories: Inventories represent raw materials andcomponents, work-in-progress and finished goods.

2 Trade Debtors: Trade Debtors comprise credit sales tocustomers.

3 Prepaid Expenses: These are those expenses, which have

been paid for goods and services whose benefits haveyet to be received.

4 Loan and Advances: They represent loans and advancesgiven by the firm to other firms for a short period of time.

5 Investment: These assets comprise short-term surplusfunds invested in government securities, shares andshort-terms bonds.

6 Cash and Bank Balance: These assets represent cash inhand and at bank, which are used for meetingoperational requirements. One thing you can see here

is that this current asset is purely liquid but non-productive.



CURRENT LIABILITIESI . Sundry Creditors: These liabilities stem

out of purchase of raw materials on creditterms usually for a period of one to twomonths.

II. Bank Overdrafts: These includewithdrawals in excess of credit balancestanding in the firm¶s current accounts withbanks

III. Short-term Loans: Short-termsborrowings by the firm from banks andothers form part of current liabilities asshort-term loans.



Proforma for Computation of NWC

Particulars Amount

I. Current Assetsa. Raw Material( opening inventory)

b. Work in Process

RM xx

Labor xx

Overheads xx

c. Finished goods

RM xxLabor xx

Overheads xx

d. Debtors

RM xx

Labor xx

Overheads xx

e. Others like cash, prepaid expensesTOTAL CURRENT ASSETS

II Current Liabilities

a. Creditors based on credit purchases

b. Lag in payments

c. Other expenses

TOTAL CURRRENT LIABILITIES

NET WORKING CAPITAL (CA- CL)

Xxxxx

Xxxx

xxxx

Xxxx

XxxxXXXX

Xxx

Xxx

Xxx

Xxx

XXX



Calculation of amount

= Cost per unit x No of units x Avg Period of holding

OR= Cost of production x Avg holding period



Operating CycleApart from net working capital

estimation operating cycle is also oneof the methods of determiningworking capital requirements.

Operating cycle- It refers to thetime period required to convert rawmaterial to WIP, to finished goods, todebtors( accounts receivables) andback in to cash



OPER

ATING CYCLE

Finished

goods

Debtors

WIP

Cash

Raw Material

DEBTORS

CASH

INVENTORY



Stages of Operating cycle..There are following stages

1. Conversion of cash in to Inventory- This includespurchase of RM , conversion of RM into WIP and WIPin to FG. Finally transfer of finished goods to stock a

the end of manufacturing process.2. Conversion of inventory in to receivables- Inventory

is converted in to receivables as credit sales aremade to customers. Firms which do not sell on creditbasis will not have this stage.

3. Conversion of receivables in to cash- Herereceivables are collected from customers. This phasecompletes the operating cycle.



Significance

For any firm it is not possible to convert thecash instantly in to cash. Since it is notpossible , the firm is forced to have currentassets.

Firms must have adequate inventory to meetthe demand for the products and if the firmwants to be competitive they should sell oncredit which necessitates creation of bills

receivables. Cash inflows and outflows do not match, firms

have to necessarily keep cash or invest in shortterm liquid securities so that they will be in aposition to meet obligations when they becomedue.



1. Inventory period= Average inventory

Annual cost of goods sold/ 365

2. A /c receivables period= Average ReceivablesAnnual sales/365

3. A /c payable period = Average a/c payable

Annual cost of goods sold/365

Calculations



Operating Cycle= Inventory period+ A /c rec period

Cash Cycle= Inventory period+ A /c rec period- A /cpayables period



Permanent and Temporary working capital

Type of working capital The operating cycle creates the need for current assets (working

capital). However the need does not come to an end after thecycle is completed to explain this continuing need of current assetsa distinction should be drawn between permanent and temporary

working capital.1) Permanent working capital

The need for current assets arises, as already observed,because of the cash cycle. To carry on business certain minimumlevel of working capital is necessary on continuous anduninterrupted basis. For all practical purpose, this requirement willhave to be met permanent as with other fixed assets. Thisrequirement refers to as permanent or fixed working capital

2) Temporary working capitalAny amount over and above the permanent level of working

capital is temporary, fluctuating or variable, working capital. Thisportion of the required working capital is needed to meetfluctuation in demand consequent upon changes in production andsales as result of seasonal changes



Graph showing working capital requirement

Permanent WC

Temporary WC

WC Required



Changes in WCChanges in working capital occur for the followingreasons

1. Changes in the level of sales and operatingexpenses- it may be due to increase in prices, or

seasonality in sales activities.2. Policy changes- Policies like maintenance of high or

low level of current assets and policies in relation toinventory management and credit salesmanagement.

3. Changes in technology- New technology likemechanization and involvement of new process willaffect the working capital



Financing mix (Approaches of WC)

One of the most important decision is how thecurrent assets are to be financed. Broadly there aretwo sources to raise the funds

1. Short term sources- short term debt or current

liabilities.2. Long term sources ± like share capital, long term

borrowings, retained earnings etc

What is the proportion of financing, decision onsuch questions determine financing mix. There are 3

approaches to determine this.a. Hedging approach

b. Conservative approach

c. Trade off between hedging and conservative.



1. Hedging approachAccording to this approach

Long term funds should be used to financethe fixed portion of current assets

The seasonal variation over and above thepermanent working capital should befinanced by short term funds.

This approach there fore divides the

requirement of total funds in to permanentand seasonal requirements each beingfinanced by different source.



Cost calculations under hedging plan1. Cost of short term funds

=Avg annual short term loan x

interest rate2. Cost of long term funds

=Avg annual long term funds x

Interest rate3. Total cost =Cost of short term funds

+ cost of long term funds

wcm module 1

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