Working Capital Management

Dr. Vivek Sharma

Topics

Concept of working capital Operating and cash conversion cycle Permanent and variable working capital Balanced working capital Determinants of working capital Issues In working capital management Estimating working capital Policies of working capital finance

Introduction
Working capital is the amount of funds

necessary to cover the cost of operating the enterprise. Working capital is descriptive of that capital which is not fixed. But, the more common use of working capital is to consider it as the: Current assets minus Current liabilities.

Objective of Working Capital

Primary Objective(s) Maintenance of Working Capital to pay for the expenses Availability of ample Funds at the time of need

Explanation: For the purchase of raw materials, components and spares. To pay wages and salaries. To incur day to day expenses and overhead costs such as fuel, power, and office expenses etc. To provide credit facilities to customers etc.

Concepts of Working Capital

Gross Working Capital (GWC)

GWC refers to the firms total investment in current assets.

GWC focuses upon Optimization of investment in current assets Financing of current assets

Net Working Capital (NWC). NWC refers to the difference between current assets and current liabilities.
NWC focuses upon

Liquidity position of the firm Judicious mix of short-term and long-term financing.

Current Assets and Its Components

Current assets are the assets which can be

converted into cash within an accounting year. Constituents of Current Assets Cash in Hand and Cash at Bank, Investment in Marketable securities, Debtors, Bills Receivable, Prepaid Expenses, Closing Stock (Inventory) Raw Material, Work in Progress, Finished Goods.
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Characteristics of Current Assets

Short life span

Swift transformation into other asset forms

Easily convertible into Cash Repetitive and frequent Nature

Substantial portion of Total Investments

Depends upon changes in the level of business

activity Indicator of the nature of financial planning Reveals the creditworthiness of the firm Current asset is identified as working capital
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Current Liabilities and Its Components

Current liabilities (CL) are those claims of

outsiders which are expected to mature for payment within an accounting year. Constituents of Current Liabilities Trade Creditors (Accounts payable), Bills payable (Notes payable) Short-term Public deposits, Short-term Loans Bank Overdraft, Outstanding expenses Provision for Tax Unpaid on unclaimed dividends

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. Manufacture of the product which includes conversion of raw material into work-in-progress into finished goods. Sale of the product either for cash or on credit. Credit sales create account receivable for collection.

Operating Cycle
The length of the operating cycle of a

manufacturing firm is the sum of: Inventory conversion period (ICP) plus Debtors (receivable) conversion period (DCP).

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Operating Cycle
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) Debtors Conversion Period The debtors conversion period is the time required to collect the outstanding amount from the customers.
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Creditors or Payables Deferral Period

Creditors or payables deferral period

(CDP) is the length of time the firm is able to defer payments on various resource purchases.

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Operating Cycle
Gross operating cycle (GOC) The total of inventory conversion period and debtors conversion period is referred to as gross operating cycle (GOC). Net operating cycle (NOC) NOC is the difference between gross operating cycle (GOC) and creditors or payables deferral period (CDP).

Cash conversion cycle (CCC) CCC is the difference between NOC and non-cash items like depreciation.
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Operating Cycle

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Types of Working Capital

Permanent or fixed working capital

A minimum level of current assets, which is continuously required by a firm to carry on its business operations, is referred to as permanent or fixed working capital. Fluctuating or variable working capital The extra working capital needed to support the changing production and sales activities of the firm is referred to as fluctuating or variable working capital.
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Permanent Working Capital

The amount of current assets required to meet a firms long-term minimum needs.

RUPEE AMOUNT

Permanent current assets

TIME

Temporary Working Capital

The amount of current assets that varies with seasonal requirements.
Temporary current assets RUPEE AMOUNT

Permanent current assets

TIME

Positive and Negative Working Capital

Whenever the total Current Assets exceed

the total Current Liabilities, it results in a positive Working Capital. Positive Working Capital = CA > CL Whenever the total Current Liabilities exceed the total Current Assets, it results in a negative Working Capital. Negative Working Capital = CA < CL
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Determinants of Working Capital

Nature of business
Scale of Operations(Size of Business) Manufacturing Cycle and Time lag in

Production and Sales Sales Volume and Turnover of Working Capital Credit Policy(terms of Sales and Purchase) Production Policy Business Cycle
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Determinants of Working Capital

Seasonal Fluctuations
Operating Efficiency Growth and Expansion

Price level Changes and Adjustments thereto

Taxation Dividend & Retention Policy

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Issues in Working Capital Management

Levels of current assets

Current assets to fixed assets

Liquidity Vs. profitability Cost trade-off

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Importance of Working Capital

Cash Discount

Liquidity & Solvency

Meeting Unforeseen Contingencies High Morale Good Bank Relations Increased Productivity in Fixed Assets Research & Development Expansion Facilitated Profitability Increased

Estimating Working capital

Current assets holding period

To estimate working capital requirements on the basis of average holding period of current assets and relating them to costs based on the companys experience in the previous years. This method is essentially based on the operating cycle concept. Ratio of sales To estimate working capital requirements as a ratio of sales on the assumption 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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Scope/Goals of Working Capital Management

SAFETY Credit Management Minimize Time
Policy

LIQUIDITY
Policy

PROFITABILITY Bank Management Minimize Cost

Excess

Accelerate Inflows

CASH

Decelerate Outflow

Deficiency A/C Receivables Management Minimize Time

Media

A/C Payables Management optimize Time

Working Capital Finance Policies

Long-term Short-term Vs.

Short-term
Spontaneous

Long-term financing

Cost Flexibility Risk

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Working Capital Finance Policies

Matching

Conservative
Aggressive

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THANK YOU

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