Working Capital Management

There are two concept of working Capital, Gross Working Capital and net Working Capital Gross Working capital is the total of all current assets; net working Capital is the difference between current and current liabilities Management of working capital refer to the Management of current assets as well as Current liabilities, The major thrust, of course is on the management of current assets; This is understandable because current liabilities.

 Current Assets Inventories Raw Material other Component Work in process

Current Liabilities
Sundry Trade Advances Borrowings (short commercial banks & other) Provision

Finished Goods Others Trade debtors Loans and advances Cash & bank balances

Financial manager spend a great deal of time in managing current assets and Current liabilities, arranging short term finance, negotiating favorable credit terms, Controlling the movement of Cash , administering accounts receivable etc.. While Managing Working capital, Bear in Mind two Character tics of current assets. Short Life span Swift transformation in to other asset forms. Cash Balance may be held idle for a weak or two, account receivable may have life span of 30 to 60 days and inventories may be held for 1 to 60 days

The life span of current assets depend upon the time required in the activities of procurement, production, sales and collection and the degree of synchronization among item. All in above point have certain implications Decision relating to working Capital are repetitive and frequent. The Difference between profit and present values is insignificant Management of one component cannot be undertaken, without simultaneous consideration of other component.

Assets Receivable Wages

FG

Supplier

Cash

W/P R.M

FACTORS INFLUENCING WORKING CAPITAL MANAGEMENT

THE WORKING CAPITAL NEEDS OF A FIRM ARE INFLUENCED BY NUMEROUS FACTORS: NATURE OF BUSINESS:- OPERATING CYCLE, SHORT, LONG SEASONALITY OF OPERATIONS:- CEILING FANS, FLUCTUATING WORKING CAPITAL PRODUCTION POLICY MARKET CONDITIONS:- COMPETION, LARGE INVENTORY. CONDITIONS OF SUPPLY:- PROMPT+ADEQUATE SUPPLY OF RAW MATERIAL, SPARES AND STORES.

OBJECTIVES OF WORKING CAPITAL MANAGEMENT

THE BASIC OBJECTIVE OF WORKING CAPITAL IS TO PROVIDE ADEQUATE SUPPORT FOR SMOOTH FUNCTIONING OF NORMAL BUSINESS OPERATIONS OF A COMPANY THE QUANTUM OF INVESTMENTS IN CURRENT ASSETS HAS TO BE MADE IN A MANNER THAT IS NOT ONLY MEETS THE NEEDS OF THE FORECASTED SALES BUT ALSO PROVIDES A BUILT-IN CUSHION IN THE FORM OF SAFETY STOCKS TO MEET UNFORSEEN CONTEGENCIES ARISING OUT OF FACTORS SUCH AS:- DELAYS IN ARRIVAL OF RAW MATERIALS; SUDDEN SPURT IN SALES DEMAND CONSEQUENTLY, THE INVESTMENT IN CURRENT ASSETS FOR A GIVEN LEVEL OF FORCASTED SALES WILL BE HIGHER IF THE MANAGEMENT FOLLOWS AN AGGRESSIVE ATTITUDE

 THUS A COMPANY

FOLLOWING CONSERVATIVE APPROACH IS SUBJECTED TO A LOWER DEGREE OF RISK, THEN THE ONE FOLLOWING AN AGGRESSIVE APPROACH. SO HIGH AMOUNT OF INVESTMENTS IN CURRENT ASSETS IMPARTS GREATER DEGREE OF LIQUIDITY TO THE COMPANY.
THE LARGER THE AMOUNT OF INVESTMENT IN CURRENT ASSETS, THE SMALLER WILL BE THE AMOUNT AVAILABLE FOR INVESTMENT IN OTHER PROFITABLE AVENUES. THEREFORE THE FIRM FOLLOWING A CONSERVATIVE POLICY WILL HAVE A LOW PERCENTAGE OF OPERATING PROFITABLITY COMPARED TO ITS COUNTER-PARTS FOLLOWING AN AGGRESSIVE APPROACH.

CHOOSING THE PATTERN OF FINANCING

IN THE NORMAL COURSE OF BUSINESS THE COMPANY WILL USSUALLY HAVE ACCESS TO NON-INTEREST BEARING SHORT TERM LIABILITIES SUCH AS SUNDRY CREDITORS; ACCRUED EXPENSES; AND OTHER CURRENT LIABILITIES AS ALSO PROVISIONS TOWARDS FINANCING CURRENT ASSETS. THESE ARE CALLED SPONTANEOUS LIABILITIES AS THEY ARISE MORE OR LESS AUTOMATICALLY IN THE CONTEXT OF CURRENT ASSTES THE DIFFERENCE BETWEEN THE AMOUNTS OF CURRENT ASSETS AND SPONTANEOUS LIABILITIES NEEDS TO BE FINANCED BY COMBINATION OF BANK BORROWING IN THE FORM OF CASH CREDITS/OVERDRAFT ARRANGEMENT AND LONG TERM SOURCES OF FINANCE SUCH AS DEBENTURE AND EQUITY CAPITAL.

An aggressive financing policy will tend to financing mix tilted in favour of bank borrowings and public deposits compared to a conservative policy tilted more towards long term sources So , we can conclude that working capital management encompasses the management of current assets and means of financing them. The objective is to balance the liquidity and profitability criteria , while taking into consideration the attitude of management towards risk and constraints imposed by the banking sector while providing short term finance in the form of cash credit / bank overdraft .

STATIC VIEW

Gross working capital is equal to the total of all current assets . Net working capital is difference between gross w/c and current liabilities An important characteristics of C/A is conventionally considered to be their convertibility into cash within a single accounting year unlike fixed assets which provide the production capacity for the manufacture of finished goods for sale . Current liabilities arise in the context and hence are derived from current assets Conventionally current liabilities are of short term nature and come up for payment within a single accounting year Consequently lot of emphasis is traditionally placed on the current assets vis a vis current liabilities usually 2 : 1 current ratio is considered ideal

The view has many limitations :

1. C/A , C/L are on a specified data , they fail to give dynamic view. 2. Balance sheet of a company is prepared as per schedule vi of companies act ; therefore following deficiencies remain 3. C/C and O/D are of short term borrowings , they do not figure in C/L 4. Unsecured short term loans such as public deposits are also shown separately under the head unsecured loans 5. C/A do not include the short term treasury securities which are marketable and the main aim was to improve liquidity

Cont.
6. All these points distort the W/C 7. A negative working capital indicates the siphoning off a short term funds for the financing of long term or fixed assets which when continued for long lead to problems of liquidity for organization

DYNAMIC VIEW

W/C can be viewed as capital required for the smooth and uninterrupted functioning of normal business operations of a company ranging from procurement of raw materials converting the same into finished product for sale , realizing the cash along with profit from account recievable that arise from the sale of finished goods on credit. Quantum of raw materials depends on number of factors , discount offered ,seasonal avalibility , imported or indigeneous , expected price rise.

Nature of process technology has bearing on time taken for conversion. Quantum of finished good will depend on accurate prediction, festival seasons , durability or perishabilty etc. To keep cash for meeting liabilities, cushions, unanticipated demand for cash /bank balance. Company also receives credit from suppliers. To conclude , we have seen how important role w/c plays in a manufacturing or trading concerns.

OPERATING CYCLE AND CASH CYCLE

The investment in w/c is influenced by the following events in the operating cycle of the firm:a) Purchase of raw material. b) Payment of raw material. c) Manufacture of goods. d) Sales of finished goods. e) Collection of cash from sales.

The firm begins with the purchase of raw material which are paid for after a delay which represents the account payable period.The firm converts the raw material into finished goods and then sells the same . The time lag between the purchase of raw material and sale of finished goods is the inventory period.Customers pay their bill sometime after the sales .The period elapses between the date of sale and date of collection of receiavables in the account receivable period. The time that elapses between the raw material and collection of cash for sales is referred to as the operating cycle whereas the time length between the payment for raw material for purchase and collection of cash for sales is referred to as the cash cycle Thus operating cycle is the sum of the Inventory period and the accounts receivable period, whereas the cash cycle is equal to the operating cycle less the accounts payable period .

From financial statements, we can estimate the Inventory period, the accounts receivable period and the accounts payable period.

ILLUSTRATION:P + L a/c Rs. (in Lacs) 2009 800 720 Bal. Sheet 2008 Inventory 96 A/c Receivable 86 A/c Payable 56 2009 102 90 60

Sales Cost of Goods sold

Solution:(1.) Inventory period = Avg. Inventory Annual cost of goods sold (96 + 102) / 2 720/365 50.1 DAYS

365

(2.) A/c Receivable Period =

Avg. A/c Receivable Annual Sales / 365

( 86 +90 ) / 2 800/365 40.2 DAYS

(3.) A/c Payable Period

Avg. A/c Payable Annual Cost of goods sold 365 ( 56 + 60 ) / 2 720/365

29.4 DAYS

Operating Cycle

= =

Inventory period 50.1 + 40.2 90.3 DAYS Operating Cycle 90.3 29.4 60.9 DAYS

+ A/c Receivable period

Cash Cycle

= = =

A/c Payable period

ILLUSTRATION

Following are the figures of xyz company:(Rupees) 36,00,000 9,00,000 7,20,000

Sales (at two months credit) Material consumed(two months suppliers credit) Wages paid (monthly in arrear) Manufacturers exp outstanding at the end Of the year(cash expenses are paid 1 month arrear) 80,000 Total administrative expenses (paid as above) 2,40,000 Sales promotion expenses,(paid quarterly in advance) 1,20,000

ADDITIONAL INFORMATION:
Company sells its products on gross profit of 25% counting depreciation as part of cost of production. 2. It keeps one months stock each of raw material and finished goods, and a cash balance of rupees 100000. 3. Assuming 20% safety margin . Calculate the working capital requirements of the company on cash cost basis , ignore work in progress.
1.

Solution
Working notes : Manufacturing expenses : sales less : gross profit 25% total manufacturing cost less : material : 900000 wages : 720000 manufacturing expenses Cash manufacturing expenses 80000 * 12 Depreciation (1-2) as above Total cash cost Total manufacturing expenses Less: depreciation Add : total administrative expenses sales promotion expenses 240000 120000 3600000 900000 2700000 1620000 1080000

960000
120000

2700000 120000 2580000 360000 2940000


a)

CURRENT ASSETS
Debtors total cash cost* 2 12 294000*2 12 material cost *1 12 900000 12 = 75000 = 4900000

b)

Raw material

c) Finished goods stock

cash manufacturing exp*1 12 2580000 12 = 2150000

d) prepaid sales promotional exp.

(quaterly sales in advance) = 1,20,000 = 30000 4

cash balance

(given)
current assets

100000 9100000

CURRENT LIABILITIES
A.)SUNDRY CREDITORS= MATERIAL COST x 2
12 =900000x2 = 12

1,50,000

B.) MANUFACTURING EXPENDITURE ONE MONTH CASH(GIVEN) C.)WAGES OUTSTANDING 720000 12

80,000

60,000

d.)TOTAL ADMINISTRATION EXPENSES

OUTSATNDING TOTAL

= 24000
12 20,000 310000

WORKING CAPITAL=
CURRENT ASSETS - CURRENT LIABILITIES

910000
Net working capital

ADD 20% SAFETY MARGIN

310000 = =

600000 120000 720000