WCM

Working
Working Capital
Capital
Management
Management

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 Working capital
◆ capital required for the day to
day operations of the business
enterprises
◆ current assets- current liabilities

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 Working Capital Concepts
Net Working Capital
Current Assets - Current Liabilities.

Gross Working Capital

The firm’s investment in current assets.

Working Capital Management

The administration of the firm’s current assets and
the financing needed to support current assets.
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 Need for Working Capital
◆ Shareholder’s wealth

◆ Time lag- sales activity and reciepts of cash

◆ Operating cycle.

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 Classifications of
Working Capital

◆ Time
◆ Permanent
◆ Temporary

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 Working Capital Issues
Optimal Amount (Level) of Current Assets

Assumptions
◆ 50,000 maximum Policy A

ASSET LEVEL ($)

units of production Policy B
◆ Continuous Policy C
production
◆ Three different Current Assets
policies for current
asset levels are
possible 0 25,000 50,000
OUTPUT (units)
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 Impact on Liquidity
Optimal Amount (Level) of Current Assets

Liquidity Analysis
Policy Liquidity Policy A

ASSET LEVEL ($)

A High Policy B

B Average Policy C

C Low
Current Assets
Greater current asset
levels generate more
liquidity; all other
0 25,000 50,000
factors held constant. OUTPUT (units)
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 Impact on
Expected Profitability
Optimal Amount (Level) of Current Assets
Return on Investment =
Policy A
Net Profit

ASSET LEVEL ($)

Total Assets Policy B

Let Current Assets = Policy C

(Cash + Rec. + Inv.)
Current Assets
Return on Investment =
Net Profit
Current + Fixed Assets
0 25,000 50,000
OUTPUT (units)
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 Impact on
Expected Profitability
Optimal Amount (Level) of Current Assets

Profitability Analysis
Policy Profitability Policy A

ASSET LEVEL ($)

A Low Policy B

B Average Policy C

C High
Current Assets
As current asset levels
decline, total assets will
decline and the ROI will
rise. 0 25,000 50,000
OUTPUT (units)
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 Impact on Risk
Optimal Amount (Level) of Current Assets
◆ Decreasing cash
reduces the firm’s ability Policy A

ASSET LEVEL ($)

to meet its financial
obligations. More risk! Policy B
◆ Stricter credit policies Policy C
reduce receivables and
possibly lose sales and
customers. More risk! Current Assets
◆ Lower inventory levels
increase stockouts and
lost sales. More risk! 0 25,000 50,000
OUTPUT (units)
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 Impact on Risk
Optimal Amount (Level) of Current Assets

Risk Analysis
Policy Risk Policy A

ASSET LEVEL ($)

A Low Policy B

B Average Policy C

C High
Current Assets
Risk increases as the
level of current assets
are reduced. 0 25,000 50,000
OUTPUT (units)
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 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!)
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 Determinants of working
capital
◆ General nature of business
◆ Production cycle
◆ Business cycle
◆ Production policy
◆ Credit policy

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 Determinants(cont…)
◆ Growth and expansion
◆ Vagaries in the availability of raw
materials
◆ Profit level
◆ Level of taxes

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 Determinants(cont..)
◆ Dividend policy
◆ Depreciation policy
◆ Price level changes
◆ Operating efficiency

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 Financing mix

Three basic approaches of

financing mix:
◆ hedging approach
◆ Conservative approach
◆ trade-off

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 Components of working
capital
◆ Cash management
◆ Inventories

◆ receivables

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 Cash management
◆ Motives:

transaction
precautionary
speculative

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 Receivables
◆ COSTSOF MAINTAING
RECEIVABLES
capital costs
administrative costs
collection costs
defaulting costs
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 INVENTORIES
◆ OBJECTIVES:

continuous supply of materials

sufficient stock of raw materials
and finished goods
minimising carrying costs

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