By:Abhinav Bhansali (13020243001)

Ashwin Jacob (13020243004)Apurva Mehta (13020243033)

Nilesh Dayalapvar (13020243031)Ritu Singh (13020243019)Srihrasha (13020243025)

+

Cash@Risk

• Necessary for any Business To sustain!!• Managing working capital: for better

and for worse

Definition• “Working Capital is

Current Assets minus Current Liabilities.”

Implication• “Working Capital is

a Balance Sheet Issue.”

3

Risk• “Ignores operational drivers

and opportunities (e.g., customer service, revenue growth, profit enhancement)

A Narrow “Accounting” Definition of Working Capital can lead to unforeseen risks

A Business Process Definition of Working Capital can identify and avoid risks.

Definition• Working Capital Management is the

act of bringing under control all processes involving Receivables, Payables & Inventory through:

Quote-to-Cash Purchase-to-Pay Order-to-Delivery (Supply Chain)

Implication• Working Capital Management is:

Determined by business owners and processes outside of Finance’s control

A driver of revenue and expense A driver of cash flow A driver of customer service A driver of Shareholder Value

Concepts of Working Capital

Net Working CapitalCurrent Assets - Current Liabilities

Gross Working Capital

The firm’s investment in current assets

Zero Working Capital

The administration of the firm’s current assets and the financing needed to support current assets

Inventories + Receivables - Payables

1. Nature of business2. Production cycle3. Business cycle4. Production Policy5. Credit Policy6. Growth and expansion7. Availability of Raw materials8. Profit level

• Level of taxes• Dividend policy• Depreciation Policy

9. Price level changes10. Operating efficiency

Determinants of working capital

Matching approach to asset financing

Fixed Assets

Permanent Current Assets

Total Assets

Fluctuating Current Assets

Time

$

Short-termDebt

Long-termDebt +EquityCapital

Conservative approach to asset financing

Fixed Assets

Permanent Current Assets

Total Assets

Fluctuating Current Assets

Time

$

Short-termDebt

Long-termDebt +Equity capital

Aggressive approach to asset financing

Fixed Assets

Permanent Current Assets

Total Assets

Fluctuating Current Assets

Time

$

Short-termDebt

Long-termDebt +Equity capital

A firm has following data for year ending March ,2013

Management of Working Capital

• Working capital in general practice refer to the excess of CA over CL.

• Management of working capital therefore is concerned with the problems that arise in attempting to manage the CA, the CL and the inter-relationship that exists between them.

• The basic goal of WCM is to manage the CA & CL of a firm in such a way that a satisfactory level of WC is maintained.

• Working Capital Management Policies of a firm have a great effect on its profitability, liquidity and structural health of the organization

Permanent current assets

TIME

AM

OU

NT

The amount of current assets required to meet a firm’s long-term minimum needs

The amount of current assets that varies with seasonal requirements.

Permanent current assets

TIME

AM

OU

NT

Temporary current assets

Permanent & Temporary Working Capital

Impact on Liquidity

0 25,000 50,000OUTPUT (units)

ASS

ET L

EVEL

($)

Current Assets

Policy C

Policy A

Policy B

Policy Liquidity A High B Average C Low

Greater current asset levels generate more liquidity; all other factors held constant.

Return on Investment =

Net ProfitTotal Assets

Let Current Assets =

(Cash + Rec. + Inv.)

Return on Investment =

Net ProfitCurrent + Fixed Assets

Impact on Expected Profitability

Policy Profitability A Low BAverage C High

As current asset levels decline, total assets will decline and the ROI will

rise.

• Decreasing cash reduces the firm’s ability to meet its financial obligations. More risk!

• Stricter credit policies reduce receivables and possibly lose sales and customers. More risk!

• Lower inventory levels increase stockouts and lost sales. More risk!

Impact on Risk

0 25,000 50,000OUTPUT (units)

ASS

ET L

EVEL

($)

Current Assets

Policy C

Policy A

Policy B

Policy Risk A Low B Average C High

Risk increases as the level of current assets are reduced.

Summary of the Optimal Amount of Current Assets

SUMMARY OF OPTIMAL CURRENT ASSET ANALYSIS

Policy Liquidity Profitability Risk A High Low Low B Average Average Average C Low High High

1. Profitability varies inversely with liquidity.

2. Profitability moves together with risk.(risk and return go hand in hand!)

Disadvantages of Redundant or Excess Working Capital

Idle funds, non-profitable for business, poor ROI.

Unnecessary purchasing & accumulation of inventories over required level . Excessive debtors and defective credit policy, higher incidence of B/D.

Overall inefficiency in the organization.

When there is excessive working capital, Credit worthiness suffers. Due to low rate of return on investments, the market value of shares may fall.

• Operating cycle concept

• Maximization of share holder’s wealth of a firm is possible only when there are sufficient return from the operations

• Successful sales activity is necessary for earning profit sales do not convert into cash immediately

• There is invisible time lap between the sale of good and receipt of cash

• The time taken to convert raw material into cash is known as operating cycle

• Conversion of cash into raw material • Conversion of raw material into work in progress• Conversion of Work in progress into finished goods • Conversion of finished good into Sales ( Debtors and

cash )

Operating Cycle in Manufacturing firm

Cash

RawMaterials

W I P

Finished Goods

Debtors SALES

Operating cycle of Non Manufacturing Firm

Cash

Receivables

Stock of finished goods

Formula for calculating Operating cycle for Manufacturing firm

OC = ICP+ARPOC = Operating cycle ICP = Inventory Conversion period ARP = Account Receivable Period

ICP = Average Inventory Cost of good sold /365

ARP = Average Account Receivable Sales/365

Understanding Quote to Cash - Definition

DefinitionQuote to Cash - The processes and activities ranging from issuing a sales quote through collecting the cash which resulted from the delivery of products and services.

ImplicationQuote to Cash is:

Controlled by processes outside of Finance A driver of revenue and expense A driver of cash flow A driver of customer service A driver of Shareholder Value

Understanding Quote to Cash - Improvement Areas

1- A well defined Executive driven Sales and Marketing Strategy 2- Established working capital Targets and Metrics 3- 80/20 Prioritization Rule with a focus on high value accounts4- Risk Assessment and Control to minimize company’s exposure5- Proactive Collection program to contact key accounts 6- Integrated Systems for all revenue management processes7- Dispute Management to eliminate discrepancies at the source8- Customer Master File integrity9- Automation of low value, high volume transactions10- Reconciliation Program focused on past due accounts

Improving the Quote to Cash process requires an integrated program, not a point solution. Companies can be evaluated against the Top 10 Best Practices

Understanding Quote to Cash - Improvement Areas

COST• Time required per FTE

to process transactions• Streamline processes

CASH FLOW Improved DSO Increased

collection rate Reduced bad debt

PRODUCTIVITY # of transaction

per FTE (invoice, collections)

% Electronic transaction (EDI, Others,…)

First time match rate

CUSTOMER SERVICE Cycle time actual vs.

target (dispute resolution)

Exception and Discrepancy Key Performance Indicators

Delivery lead time vs. agreed lead time

Delivery quantity vs. actual quantity

What are the benefits?

Marketing& Sales

Order EntryBilling / Invoicing

Cash Application

Collections Dispute Management

Understanding Purchase to Pay - Definition

A narrow definition• The steps and processes

from raising a purchase order to paying an invoice

An extended definition• The steps and processes from defining and

agreeing on a need to buy, selecting the best supplier, through the actual payment of that supplier and the tracking of that expenditure against a budget

By defining Purchase to Pay too narrowly companies will ignore the root causes of profit leakage and process inefficiencies

Implications : The Purchase to Pay Cycle is A comprehensive program rather than a point solution Controlled by business owners and processes outside of

Finance A driver of profitability, cash flow, customer service and

ultimately Shareholder Value

Understanding Purchase to Pay - Improvement Areas

1- Executive driven adherence to strong purchasing principles2- Strategic alliances and preferred vendor programs3- Integrated systems, including on-line requisition and procurement4- Requester-focused ordering; Purchasing-focused sourcing5- Purchasing involvement in budgeting and planning of total spend6- Performance tracking, spend analysis and process measurement7- Automation/Outsourcing of small value, high volume transactions8- AP and Purchasing as information providers to decision makers9- Co-ordinated Purchasing, Receiving and Payable processes10-Authorization managed at budget-holder level

Improving the Purchase to Pay process requires an integrated Program rather than a point solution. The following are the top 10 high level best practices against which companies may be evaluated

Budgeting and Forecasting(Strategy)

Supplier Selection and Negotiation

Ordering and Contracting

Receiving and Evaluating

PaymentProcessing

Continuous improvement

OriginatingRequirements

Understanding Purchase to Pay - Improvement Areas

PURCHASING COST- 3% to 5% by consolidating expenditure on preferred suppliers and changing buying habits

• Volume rebate• Price discount

CASH FLOW+ 10% to 25%

Better negotiated terms (including term discounts)

Increased early payment discount effectiveness

Reduce premature payment

PRODUCTIVITY+ 25% to 50%

Transactions processed, automated match rate within payables

Rework reduction, by preventing root cause of discrepancies

CUSTOMER SERVICEImproved Quality and Customer Service

Approval cycle time reduction, improve visibility of requisition

Reduce void checks and duplicate payment

Where are the benefits?

Understanding Order to Distribution - Definition

A narrow definition• The processes and steps

from receiving a customer order to distributing the ordered product to the customer

An extended definition• Working with customers to understand

their production/customer forecasts to plan your own operations, thus making the “supply chain” more effective and efficient

By defining Order to Distribution too narrowly, companies will miss opportunities to gain full inventory reduction opportunities as well as minimizing profit leakage and process inefficiencies

Implications : The Order to Distribution Cycle is A comprehensive program and not a point solution Operates on processes outside of finance, and even the

business (customers & suppliers) A driver of profitability, cash flow, customer service and

ultimately Shareholder Value

Understanding Order to Distribution - Improvement

1- Executive driven adherence to strong supply chain objectives2- High Customer Service Levels and accurate available-to-promise3- Inventory Levels, in accordance with corporate targets4- Strategic alliances with both suppliers and customers5- Integrated systems, including sales, inventory, shipping, & purchasing6- Performance tracking, and process measurement7- High Data Integrity, inventory accuracy, Bill of Materials, lead times8- Co-ordinated supply chain processes - forecasting, purchasing,

planning, manufacturing and shipping9- Balanced production, based on capacity constraints 10- Product rationalization, reducing low margin, low selling products

Improving the Order to Distribution process requires an integrated Program rather than a point solution. The following are high level best practices against which companies may be evaluated

Understanding Order to Distribution - Improvement Areas

OPERATING COST-3% to -5%• Improved productivity

will reduce labor hours (FTE and overtime)

• Improved forecasting and inventory management will require less “re-balancing” of product between warehouses (transportation costs)

• Elimination of distribution costs will reduce operating costs

CASH FLOW+ 10% to 25%

Improved inventory management

Improved forecasting Calculated

manufacturing and purchasing lot sizes

Reduced leadtimes

ADMINISTRATION PRODUCTIVITY+ 10% to 15%

Increased information sharing

Administrative time spent more effectively managing important items rather than “fire-fighting”

CUSTOMER SERVICEImproved Quality and Customer Service

Cycle time reduction resulting in reduced lead times

Better order fill rates increase customer satisfaction and customer retention

Where are the benefits?

Forecasting(Strategy)

Master Planning

Production Scheduling

Warehousing & Distribution

Continuous improvement

OrderEntry

PurchasingRequirements

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

2. MANUFACTURING CONCERNSTATEMENT OF WORKING CAPITAL REQUIREMENTS

Amount (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

• Raw material inventory:Budgeted production * Cost of raw mat * Avg inventory holding period/ 12 months / 365

• Work in Progress Inventory:Budgeted production * Estimated work in progress cost per unit * Avg time span of WIP Inventory / 12 months / 365

• Finished goods inventory:Budgeted production * Cost of goods produced per unit* Finished goods holding period / 12 months / 365

• Debtors:Budgeted credit in sales * Cost of sales per unitexcluding depreciation * Avg debt collection period / 12 months/365

Estimation of Current Assets

1. Trade creditors:Budgeted yearly production * Raw material cost per unit

* Credit period allowed by creditors / 12 months / 365

2. Debtors:Budgeted yearly production* Direct labour cost per unit

* Avg time lag in payment of wage / 12 months / 365 3. Overheads:

Budgeted yearly production* Overhead cost per unit * Avg time lag in payment of overheads / 12 months / 365

Estimation of Current Liabilities

TIME IS MONEY You can get money to move faster around the cycle or reduce the amount of money tied up. Then, business will generate more cash or it will need to borrow less money to fund working capital.

As a consequence, you could reduce the cost of bank interest or you'll have additional free money available to support additional sales growth or investment.

Similarly, if you can negotiate improved terms with suppliers e.g. get longer credit or an increased credit limit, you effectively create free finance to help fund future sales.

If you Then ......

Collect receivables (debtors) faster

You release cash from the cycle

Collect receivables (debtors) slower

Your receivables soak up cash

Get better credit (in terms of duration or amount) from suppliers

You increase your cash resources

Shift inventory (stocks) faster

You free up cash

Move inventory (stocks) slower

You consume more cash

• Sales and costs and, therefore, profits do not necessarily coincide with their associated cash inflows and outflows.

• The net result is that cash receipts often lag cash payments and, whilst profits may be reported, the business may experience a short-term cash shortfall.

• For this reason it is essential to forecast cash flows as well as project likely profits.

• Bear in mind that more businesses fail for lack of cash than for want of profit!!

Microsoft Excel Worksheet

Sources of Finance

• Spontaneous Sources of Finance• Trade Credit:• Bills Payable:• Accrued Expenses-Short term Financing• Inter corporate loans & Deposits :

Surplus Funds –Short term• Commercial Papers : Unsecured

promissory note• Funds Generated from operations:• Public Deposits:

• Bills Discounting: Short financial Institute.

• Bills Rediscounting Schemes : Offer Bill of Exchange to the RBI for rediscount.

• Factoring : Is a method of Financing whereby a firm sells its trade at a discounting to FI.

• Working capital Finance from Banks• Assessment of working capital• Forms of Bank Credit:• Cash credit:• Bank Overdraft:• Bills Discounting:• Bills Acceptance:• Line of credit :• Bank Guarantees: