Transcript
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WorkingWorking
CapitalCapital
ManagemeManagementnt
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Definition of Workingefinition of WorkingCapitalapital
Working Capital refers to that part of theWorking Capital refers to that part of the
firms capital, which is required forfirms capital, which is required for
financing short-term or current assets such afinancing short-term or current assets such a
cash marketable securities, debtors andcash marketable securities, debtors and
inventories. Funds thus, invested in currentinventories. Funds thus, invested in current
assets keep revolving fast and areassets keep revolving fast and are
constantly converted into cash and this cashconstantly converted into cash and this cash
flow out again in exchange for other currentflow out again in exchange for other current
assets. Working Capital is also known asassets. Working Capital is also known as
revolving or circulating capital or short-revolving
or circulating capital or short-
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KINDS OF WORKING CAPITALKINDS OF WORKING CAPITAL
WORKINGCAPITAL
BASIS OF
CONCEPT
BASIS OF
TIME
Gross
Working
Capital
Net
Working
Capital
Permanent
/ Fixed
WC
Temporary
/ Variable
WC
Regular
WC
Reserve
WC
Special
WC
Seasonal
WC
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Significance of Gross WCignificance of Gross WC Optimum investment in CAOp
timum investment in CA
Investment in CA must be adequate CA investment should not beInvestment in CA must be adequate CA investment should not beinadequate or excessive inadequate WC can disturb production andinadequate or excessive inadequate WC can disturb production andcan also threaten the solvency of firm , if it fails to meet its currentcan also threaten the solvency of firm , if it fails to meet its current
obligation excessive investment in CA should be avoided , since itobligation excessive investment in CA should be avoided , since itimpairs firms profitabilityimpairs firms profitability
Financing of CAFinancing
of CA
Need for WC arises due to increasing level of business activity & it isNeed for WC arises due to increasing level of business activity & it isto provided quickly some time surplus fund may arises which shouldto provided quickly some time surplus fund may arises which should
be invested in Short term securities , they should not be kept idlebe invested in Short term securities , they should not be kept idle
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Significance of Net Working CapitalSignificance of Net Working Capital
Maintaining Liquidity positionMaintaining
Liquidity position
For maintaining liquidity position there is a need toFor maintaining liquidity position there is a need to
maintain CA sufficiently in excess of CLmaintain CA sufficiently in excess of CL
Judge Financial Soundness of a firmJudg
e Financial Soundness of a firm
The Net working capital helps creditors andThe Net working capital helps creditors and
investors to judge financial soundness of a firminvestors to judge financial soundness of a firm
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BALANCE SHEET OF ABC COMPANY AS ON 31-3-2000BALANCE SHEET OF ABC COMPANY AS ON 31-3-2000
LiabilitiesLiabilities RsRs AssetsAssets RsRs
Equity SharesEquity Shares 200000200000 GoodwillGoodwill 2000020000
8% Debentures8% Debentures 100000100000 Land and BuildingLand and Building 150000150000
Reserve & SurplusReserve & Surplus 5000050000 Plant andPlant andMachineryMachinery
100000100000
Sundry CreditorsSundry Creditors 150000150000 InventoriesInventories
Bills PayableBills Payable 3000030000 Finished GoodsFinished Goods 6000060000
OutstandingOutstandingExpensesExpenses
2000020000 Work in processWork in process 4000040000
Bank OverdraftBank Overdraft 5000050000 Prepaid ExpensesPrepaid Expenses 2000020000
Provision forProvision forTaxationTaxation
2000020000 MarketableMarketableSecuritiesSecurities
6000060000
Proposed DividendProposed Dividend 3000030000 Sundry DebtorsSundry Debtors 9000090000
Bills ReceivablesBills Receivables 2000020000Cash & BankCash & Bank 9000090000
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Difference between permanent &Difference between permanent &
temporary working capitaltemporary working capital
Amount Variable Working CapitalAmount Variable Working Capitalofof
WorkingWorking
CapitalCapital
Permanent Working CapitalPermanent Working Capital
TimeTimePermanent and temporary working capital for Stable firm
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Variable Working Capital
Amount
ofWorking
Capital
Permanent Working Capital
Time
Permanent and temporary working capital for Growing firm
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Operating cycle conceptperating cycle concept Maximization of share holders wealth of a firm is possibleMaximization of share holders wealth of a firm is possible
only when there are sufficient return from the operationsonly when there are sufficient return from the operations Successful sales activity is necessary for earning profitSuccessful sales activity is necessary for earning profit
sales do not convert into cash immediatelysales do not convert into cash immediately There is invisible time lap between the sale of good and There is invisible time lap between the sale of good and
receipt of cashreceipt of cash The time taken to convert raw material into cash is knownThe time taken to convert raw material into cash is known
as operating cycleas operating cycle Conversion of cash into raw materialConversion of cash into raw material Conversion of raw material into work in progressConversion of raw material into work in progress
Conversion of Work in progress into finished goodsConversion of Work in progress into finished goods Conversion of finished good into Sales ( Debtors and cash )Conversion of finished good into Sales ( Debtors and cash )
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Operating Cycle inOperating Cycle in
Manufacturing firmManufacturing firmCash
Raw
MaterialsW I P
Finished
Goods
DebtorsSALES
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Operating cycle oferating cycle oNon Manufacturingon ManufacturingFirmirm
cash
Receivables
Stock of finished goods
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Formula for calculatingormula for calculatingOperating cycle forperating cycle forManufacturing firmanufacturing firm OC = ICP+ARPOC = ICP+ARP
OC = Operating cycleOC = Operating cycle
ICP = Inventory Conversion periodICP = Inventory Conversion period
ARP = Account Receivable PeriodARP = Account Receivable Period
ICP =ICP = Average InventoryAverage Inventory
Cost of good sold /365Cost of good sold /365ARP =ARP = Average Account ReceivableAverage Account Receivable
Sales/365Sales/365
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ABC Company Provide theABC Company Provide the
following information , Computefollowing information , Compute
the operating cyclethe operating cycle Sales 3000 LakhsSales 3000 Lakhs
Inventory Opening Rs 610 Lakhs ;Inventory Opening Rs 610 Lakhs ;
closing Rs 475 Lakhsclosing Rs 475 Lakhs
Receivable opening Rs 915 Lakhs;Receivable opening Rs 915 Lakhs;
Closing Rs 975 LakhsClosing Rs 975 Lakhs
Cost of Goods Sold Rs 2675 LakhsCost of Goods Sold Rs 2675 Lakhs
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CASH CONVERSION CYCLECASH CONVERSION CYCLE
The amount of time a firms resources are tied upThe amount of time a firms resources are tied upcalculated by subtracting the average payment periodcalculated by subtracting the average payment periodfrom the operating cycle the time period between thefrom the operating cycle the time period between thedate a firm pays its supplier and the date it receives cashdate a firm pays its supplier and the date it receives cashfrom its customerfrom its customer
CCC = OC APPCCC = OC APP
AAI =AAI = Average InventoryAverage Inventory
Cost of good sold /365Cost of good sold /365ARP =ARP = Average Account ReceivableAverage Account Receivable
Annual Sales/365Annual Sales/365
APP =APP = Account Payable PeriodAccount Payable Period
Cost of good sold /365Cost of good sold /365
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Calculate CCCalculate CCC(CASH CONVERSION CYCLE)CASH CONVERSION CYCLE) Average use of Inventory 80 daysAverage use of Inventory 80 days
Account receivable collection period 50 daysAccount receivable collection period 50 days
Account payable period is 40 daysAccount payable period is 40 days
CCC= OC- APPCCC= OC- APP
OC = AAI+ARPOC = AAI+ARP
80+50=13080+50=130
CCC =130-40 =90 daysCCC =130-40 =90 days
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Purchase of Sale of GoodsPurchase of Sale of Goods Collection ofCollection of
Raw MaterialRaw Material on Crediton Credit Account ReceivablesAccount Receivables
On creditOn credit
Average age ofAverage age of Account receivableAccount receivable
InventoryInventory (AII)(AII) periodperiod (ARP)(ARP)
Account PayableAccount PayablePeriodPeriod (APP)(APP)
Payment toPayment to
supplierssuppliers
Receipt of InvoiceReceipt of Invoice Operating Cycle (OC)Operating Cycle (OC)
Cash Conversion cycleCash Conversion cycle
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Resource flows for aResource flows for a
manufacturing firmmanufacturing firm
FixedAssets
Production
Process
Generates
Inventory
Via Sales Generator
Accounts
receivable
Used in
Accrued Direct
Labour and
materials
Accrued Fixed
Operating
expenses
Cash and
Marketable
Securities
Suppliers
Of Capital
External Financing
Return on Capital
Collection
process
Used to
purchase
Used to
purchase
Used in
Working
Capital
cycle
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Calculate cash conversion cyclealculate cash conversion cycle Sales Rs 1587.95Sales Rs 1587.95
Cost of Good sold Rs 1406.27Cost of Good sold Rs 1406.27 Inventory opening 195.82, closing 202.29Inventory opening 195.82, closing 202.29
Account receivables opening 423.03Account receivables opening 423.03
closing 449.46closing 449.46 Account payable opening 140.40, closingAccount payable opening 140.40, closing
168.33168.33
CCC = OC APPCCC = OC APP
OC = AAI + ARPOC = AAI + ARP
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WORKING CAPITALORKING CAPITALREQUIREMENTSEQUIREMENTSFactors to be consideredFactors to be considered
Total costs incurred on materials, wages and overheadsTotal costs incurred on materials, wages and overheads
The length of time for which raw materials remain in stores before they are issued toThe length of time for which raw materials remain in stores before they are issued to
production.production.
The length of the production cycle or WIP, i.e., the time taken for conversion of RM intoThe length of the production cycle or WIP, i.e., the time taken for conversion of RM into
FG.FG.
The length of the Sales Cycle during which FG are to be kept waiting for sales.The length of the Sales Cycle during which FG are to be kept waiting for sales.
The average period of credit allowed to customers.The average period of credit allowed to customers.
The amount of cash required to pay day-to-day expenses of the business.The amount of cash required to pay day-to-day expenses of the business.
The amount of cash required for advance payments if any.The amount of cash required for advance payments if any.
The average period of credit to be allowed by suppliers.The average period of credit to be allowed by suppliers.
Time lag in the payment of wages and other overheadsTime lag in the payment of wages and other overheads
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PROFORMA - WORKING CAPTIALPROFORMA - WORKING CAPTIAL
ESTIMATESESTIMATES
1.1. TRADING CONCERNTRADING CONCERN
STATEMENT OF WORKING CAPITAL REQUIREMENTS
Amount (Rs.)
Current Assets
(i) Cash ----
(ii) Receivables ( For..Months Sales)---- ----
(iii) Stocks ( ForMonths Sales)----- ----(iv)Advance Payments if any ----
Less : Current Liabilities
(i) Creditors (For.. Months 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..Months Sales)---- ----
(iii) Stocks ( ForMonths Sales)----- ----(iv)Advance Payments if any ----
Less : Current Liabilities
(i) Creditors (For.. Months Purchases)- ----
(ii) Lag in payment of expenses -----_
WORKING CAPITAL ( CA CL ) xxxAdd : Provision / Margin for Contingencies -----
NET WORKING CAPITAL REQUIRED XXX
1 MANUFACTURING CONCERN1 MANUFACTURING CONCERN
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1. MANUFACTURING CONCERN1. MANUFACTURING CONCERN
STATEMENT OF WORKING CAPITAL REQUIREMENTS
Amount (Rs.)
Current Assets
(i) Stock of R M( for .months consumption) -----
(ii)Work-in-progress (formonths)(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(iii) Stock of Finished Goods ( for months sales)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(iv) Sundry Debtors ( for months 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.. Months Purchases) -----
(ii) Lag in payment of expenses -----
(iii) Any other -----
WORKING CAPITAL ( CA CL )xxxx
Add : Provision / Margin for Contingencies -----
NET WORKING CAPITAL REQUIRED XXX
P ti t f W ki it l i tP ti t f W ki it l i t
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Prepare an estimate of Working capital requirementPrepare an estimate of Working capital requirement
from the following information of a trading concern:from the following information of a trading concern:
Projected annual salesProjected annual sales 100000 units100000 unitsSelling priceSelling price Rs 8 per unitRs 8 per unit
% age of Net profit on sales% age of Net profit on sales 25%25%
Average Credit Period allowed toAverage Credit Period allowed tocustomercustomer
8 weeks8 weeks
Average Credit Period allowed byAverage Credit Period allowed by
suppliersupplier
4 weeks4 weeks
Average stock holding in terma of salesAverage stock holding in terma of sales
requirementrequirement12 weeks12 weeks
contingenciescontingencies 10%10%
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Points to be remembered whileoints to be remembered whileestimating WCstimating WC (1) Profits should be ignored while calculating working capital(1) Profits should be ignored while calculating working capital
requirements for the following reasons.requirements for the following reasons.
(a) Profits may or may not be used as working capital(a) Profits may or may not be used as working capital
(b) Even if it is used, it may be reduced by the amount of Income tax,(b) Even if it is used, it may be reduced by the amount of Income tax,
Drawings, Dividend paid etc.Drawings, Dividend paid etc.
(2) Calculation of WIP depends on the degree of completion as regards(2) Calculation of WIP depends on the degree of completion as regards
to materials, labour and overheads. However, if nothing is mentionedto materials, labour and overheads. However, if nothing is mentionedin the problem, take 100% of the value as WIP. Because in such ain the problem, take 100% of the value as WIP. Because in such a
case, the average period of WIP must have been calculated ascase, the average period of WIP must have been calculated as
equivalent period of completed units.equivalent period of completed units.
(3) Calculation of Stocks of Finished Goods and Debtors should be(3) Calculation of Stocks of Finished Goods and Debtors should be
made at cost unless otherwise asked in the question.made at cost unless otherwise asked in the question.
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Prepare statement ofrepare statement ofworking capital requirement,orking capital requirement,Profit &Loss A/C, Balancerofit &Loss A/C, BalanceSheet Assumingheet Assuming
Share CapitalShare Capital 150000150000 8% Debentures8% Debentures 200000200000 Fixed assetFixed asset 130000130000
MaterialMaterial 40%40% Direct lab ourDirect lab our 20%20% OverheadsOverheads 20%20%
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The following further particular are availableThe following further particular are available It is proposed to maintain a level of activity ofIt is proposed to maintain a level of activity of
2,00,000 units2,00,000 units
Selling price is Rs 12/- per unitSelling price is Rs 12/- per unit Raw Material are expected to remain in stores for anRaw Material are expected to remain in stores for an
average period of one monthaverage period of one month Material will be in process , on average half a monthMaterial will be in process , on average half a month
Finished goods are required to be in stock for anFinished goods are required to be in stock for anaverage period of one monthaverage period of one month Credit allow to debtors is two monthCredit allow to debtors is two month Credit allow by supplier is one monthCredit allow by supplier is one month
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Working Capital Financing MixWorking Capital Financing Mix
Approaches to Financing
Mix
The Hedging orMatching Approach
The ConservativeApproach
The AggressiveApproach
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Hedging approach to assetHedging approach to asset
financingfinancing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-term
Debt
Long-term
Debt +
Equity
Capital
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The Hedging approachThe Hedging approach Hedging approach refers to a process of matchingHedging approach refers to a process of matching
maturities of debt with the maturities of financialmaturities of debt with the maturities of financial
need . In this approach maturity of source of fundneed . In this approach maturity of source of fundshould match the nature of asset to be financedshould match the nature of asset to be financed
This approach is also known as matching approach.This approach is also known as matching approach.
The hedging approach suggests that the permanentThe hedging approach suggests that the permanent
working capital requirement should be financed withworking capital requirement should be financed withfund from long term sources while the temporaryfund from long term sources while the temporary
working capital requirement should be financed withworking capital requirement should be financed with
short term funds.short term funds.
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Estimated Total Investment in Current Asset of company X forEstimated Total Investment in Current Asset of company X for
the year 2000the year 2000
MonthMonth InvestmentInvestment
in Currentin CurrentAssetAsset
(R's )(R's )
Permanent orPermanent or
FixedFixedInvestmentsInvestments
(R's)(R's)
TemporaryTemporary
or seasonal Investor seasonal Invest(R's)(R's)
JanuaryJanuary 5040050400 4500045000 54005400
FebruaryFebruary 5000050000 4500045000 50005000
MarchMarch 4870048700 4500045000 37003700AprilApril 4800048000 4500045000 30003000
MayMay 4600046000 4500045000 10001000
JuneJune 4500045000 4500045000 --
JulyJuly 4750047500 4500045000 25002500
AugustAugust 4800048000 4500045000 30003000SeptemberSeptember 4950049500 4500045000 45004500
OctoberOctober 5070050700 4500045000 57005700
NovemberNovember 5200052000 4500045000 70007000
DecemberDecember 4850048500 4500045000 35003500
TOTALTOTAL 4430044300
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Conservative ApproachConservative ApproachThis approach suggested that the entireThis approach suggested that the entire
estimated investments in current asset should beestimated investments in current asset should befinance from long term source and short termfinance from long term source and short term
should be use only for emergency requirementshould be use only for emergency requirement
Distinct features of this approachDistinct features of this approach
Liquidity is greaterLiquidity is greater Risk is minimizedRisk is minimized
The cost of financing is relatively more asThe cost of financing is relatively more as
interest has to be paid even on seasonalinterest has to be paid even on seasonal
requirement for the entire periodrequirement for the entire period
i h
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Conservative approach to assetConservative approach to asset
financingfinancing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-term
Debt
Long-term
Debt +
Equity
capital
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Hedging andHedging and
conservative approachesconservative approaches
The hedging approaches implies low cost , highThe hedging approaches implies low cost , highprofit and high risk while the conservativeprofit and high risk while the conservative
approach leads to high cost , low profit , low riskapproach leads to high cost , low profit , low risk
Both the approaches are the two extreme andBoth the approaches are the two extreme and
neither of them serve the purpose of efficientneither of them serve the purpose of efficient
working capital managementworking capital management
A trade off between the two will then be anA trade off between the two will then be an
acceptable approach , One way of determiningacceptable approach , One way of determining
the trade off is by finding the AVG of maximumthe trade off is by finding the AVG of maximumand minimum requirement of current asset orand minimum requirement of current asset or
working capitalworking capital
i hA i h
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Aggressive approach to assetAggressive approach to asset
financingfinancing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-term
Debt
Long-term
Debt +
Equity
capital
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Aggressive approachAggressive approach
The aggressive approach suggests that theThe aggressive approach suggests that the
entire estimated requirement of current assetentire estimated requirement of current asset
should be financed from short-term sources andshould be financed from short-term sources and
even a part of fixed asset investment beeven a part of fixed asset investment be
financed from short - term sourcesfinanced from short - term sources
This approach make the finance mix :This approach make the finance mix :
More RiskyMore Risky
Less costlyLess costly More ProfitableMore Profitable
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Prepare a projected balancerepare a projected balancesheet , profit and loss a/cheet , profit and loss a/cand then an estimation ofnd then an estimation ofworking capital .orking capital . Issued Share CapitalIssued Share Capital 300000300000 6% Debentures6% Debentures 200000200000
Fixed assetFixed asset 200000200000 Raw MaterialRaw Material 50%50% Lab ourLab our 20%20% OverheadsOverheads 20%20% ProfitProfit 10%10% There is a regular production andThere is a regular production and
sales cyclesales cycle
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Raw Material are kept in stores for an averageRaw Material are kept in stores for an averageperiod of two monthperiod of two month
Finished goods remain in stock for an averageFinished goods remain in stock for an average
period of three monthperiod of three month Production during the previous year was 180000Production during the previous year was 180000
units and it is planned to maintain the same in theunits and it is planned to maintain the same in thecurrent year alsocurrent year also
Each unit of production is expected to be inEach unit of production is expected to be inprocess for half a monthprocess for half a month Credit allow to customer is three month and givenCredit allow to customer is three month and given
by supplier is two monthby supplier is two month
Selling price is Rs 4 per unitSelling price is Rs 4 per unit Calculation of debtors may be made at sellingCalculation of debtors may be made at selling
priceprice
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Management of WorkingManagement of Working
CapitalCapital Working capital in general practice refer to theWorking capital in general practice refer to the
excess of CA over CL.excess of CA over CL. Management of working capital therefore isManagement of working capital therefore is
concerned with the problems that arise inconcerned with the problems that arise inattempting to manage the CA, the CL and theattempting to manage the CA, the CL and the
inter-relationship that exists between them.inter-relationship that exists between them. The basic goal of WCM is to manage the CA & CLThe basic goal of WCM is to manage the CA & CLof a firm in such a way that a satisfactory level ofof a firm in such a way that a satisfactory level ofWC is maintained.WC is maintained.
Working Capital Management Policies of a firmWorking Capital Management Policies of a firmhave a great effect on its profitability, liquidityhave a great effect on its profitability, liquidity
and structural health of the organizationand structural health of the organization
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Working capital management is 3Working capital management is 3
dimensional in Naturedimensional in Nature
Dimension I
Profitability,
Risk, & Liquidity
Dimension I
Profitability,
Risk, & Liquidity
Dimensi
onII
Compositio
n&Lev
el
ofCA
Dimensi
onII
Composit
ion&L
evel
ofCA
DimensionIII
Composition&Level
ofCL
DimensionIII
Composition&Level
ofCL
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Working Capital IssuesWorking Capital Issues
AssumptionsAssumptions
50,000 maximum50,000 maximumunits of productionunits of production
ContinuousContinuous
productionproduction
Three differentThree different
policies for currentpolicies for current
asset levels areasset levels are
possiblepossible
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
0 25,000 50,000OUTPUT (units)
A
SSET
LEVEL
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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Impact on LiquidityImpact on Liquidity
Liquidity AnalysisLiquidity Analysis
PolicyPolicyLiquidityLiquidityAA HighHigh
BB AverageAverage
CC LowLow
Greater current assetGreater current assetlevels generate morelevels generate more
liquidity; all otherliquidity; all other
factors held constant.factors held constant.
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
0 25,000 50,000OUTPUT (units)
A
SSET
LEVEL
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
Impact onImpact on
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Impact onImpact onExpectedExpected
ProfitabilityProfitability
Return on InvestmentReturn on Investment==
Net ProfitNet ProfitTotal AssetsTotal Assets
LetLet Current AssetsCurrent Assets = (Cash= (Cash
+ Rec. + Inv.)+ Rec. + Inv.)
Return on InvestmentReturn on Investment
==
Net ProfitNet Profit
CurrentCurrent ++ Fixed AssetsFixed Assets
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
0 25,000 50,000OUTPUT (units)
A
SSET
LEVEL
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
Impact onImpact on
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Impact onImpact onExpectedExpected
ProfitabilityProfitability
Profitability AnalysisProfitability Analysis
PolicyPolicy ProfitabilityProfitabilityAA LowLow
BB AverageAverage
CC HighHigh
As current asset levelsAs current asset levelsdecline, total assets willdecline, total assets will
decline and the ROI willdecline and the ROI will
rise.rise.
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
0 25,000 50,000OUTPUT (units)
A
SSET
LEVEL
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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Impact on RiskImpact on Risk
Decreasing cashDecreasing cash
reduces the firmsreduces the firms
ability to meet itsability to meet its
financial obligations.financial obligations.
More risk!More risk!
Stricter credit policiesStricter credit policies
reduce receivablesreduce receivables andand
possibly lose sales andpossibly lose sales andcustomers.customers. More risk!More risk!
Lower inventory levelsLower inventory levels
increase stockouts andincrease stockouts and
lost sales.lost sales. More risk!More risk!
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
0 25,000 50,000OUTPUT (units)
A
SSET
LEVEL
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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Impact on RiskImpact on Risk
Risk AnalysisRisk Analysis
PolicyPolicy RiskRiskAA LowLow
BB AverageAverage
CC HighHigh
Risk increases as theRisk increases as the
level of current assetslevel of current assets
are reduced.are reduced.
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
0 25,000 50,000OUTPUT (units)
A
SSET
LEVEL
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
Summary of theSummary of the
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Summary of theSummary of theOptimal Amount ofOptimal Amount of
Current AssetsCurrent AssetsSSUMMARYUMMARY OOFF OOPTIMALPTIMAL CCURRENTURRENTAASSETSSETAANALYSISNALYSIS
PolicyPolicy LiquidityLiquidity ProfitabilityProfitability RiskRisk
AA HighHigh LowLow LowLowBB AverageAverage AverageAverage AverageAverage
CC LowLow HighHigh HighHigh
1. Profitability varies inversely with1. Profitability varies inversely with
liquidity.liquidity.
2. Profitability moves together with risk.2. Profitability moves together with risk.
(risk and return go hand in hand!)(risk and return go hand in hand!)
Techniques of analysis ofTechniques of analysis of
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Techniques of analysis ofTechniques of analysis of
working capitalworking capitalThe analysis of working capital can be conductedThe analysis of working capital can be conductedthrough a number of devices such asthrough a number of devices such as
Ratio analysisRatio analysis
Fund flow analysisFund flow analysis
Working capital BudgetingWorking capital Budgeting Ratio analysis : A ratio is a simple arithmeticalRatio analysis : A ratio is a simple arithmetical
expression of the relationship of one number toexpression of the relationship of one number to
another , this technique can be employed foranother , this technique can be employed for
measuring short term liquidity or working capitalmeasuring short term liquidity or working capitalposition of a firm.position of a firm.
h f ll i i bTh f ll i i b
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The following ratios may beThe following ratios may be
calculated for this purposecalculated for this purpose Liquidity RatioLiquidity Ratioa)a) Current RatioCurrent Ratio
b)b) Acid test ratio/quick ratio/liquid ratioAcid test ratio/quick ratio/liquid ratio
c)c) Cash Position ratio/absolute liquid ratioCash Position ratio/absolute liquid ratio Inventory turnover ratioInventory turnover ratio
Receivable turnover ratioReceivable turnover ratio
Payable turnover ratioPayable turnover ratio Working capital turnover ratioWorking capital turnover ratio
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Current ratio may be define as theCurrent ratio may be define as the
relationship between CA and CLrelationship between CA and CL
This ratio is also known as WCR.This ratio is also known as WCR.
(Working capital ration).(Working capital ration).
It is helpful to measure short It is helpful to measure short
term financial position or liquidityterm financial position or liquidity
of a firmof a firm
Current ratio:Current ratio: Current assetCurrent assetCurrent liabilitiesCurrent liabilities
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CURRENT ASSETS CURRENT LIABILITIES
Cash in hand Bills Payable
Cash at bank Sundry Creditors
Sundry Debtors Accrued or OutstandingExpenses
Marketable securities(Short term)
Short term loan andadvances
Bills Receivable Dividend payable
Inventories of Stock Bank OverdraftWork in progress
Finished goods
Prepaid Expenses
Q i k A id t tQ i k A id t t
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Quick or Acid test orQuick or Acid test or
Liquid RatioLiquid Ratio An asset is said to be liquid if it can beAn asset is said to be liquid if it can be
convert into cash with in a short period withconvert into cash with in a short period with
out loss of valueout loss of value
Inventory cannot be termed to be liquid assetInventory cannot be termed to be liquid assetbecause they cannot be convert into cashbecause they cannot be convert into cash
immediatelyimmediately
The quick ratio can be calculatedThe quick ratio can be calculated
Quick ratio:Quick ratio: liquid assetliquid assetCurrent liabilitiesCurrent liabilities
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Quick or liquid Current Liabilities
Cash in handBills Payable
Cash at bank Sundry Creditors
Sundry Debtors Accrued or OutstandingExpenses
Marketable securitiesShort term advances
Temporary
Investments
Dividend payable
Bank Overdraft
Income tax payable
Convection quick ratio of 1:1 is consider
satisfactory
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Cash Position ratio/absolute liquidCash Position ratio/absolute liquid
ratioratio
Absolute Liquid assets include cash in hand andAbsolute Liquid assets include cash in hand and
cash at bank and marketable securities orcash at bank and marketable securities or
temporary investmentstemporary investments
The acceptable norms for this ratio is 50% or .05%The acceptable norms for this ratio is 50% or .05%
Cash ratio:Cash ratio: Cash & bank + Short term securitiesCash & bank + Short term securities
Current liabilitiesCurrent liabilities
Calculate all the threeCalculate all the three
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Calculate all the threeCalculate all the threeratioratioLiabilities Rs Assets Rs
9%
preferenceshare
500000Goodwill 100000
Equity share
capital
1000000Land and
building
650000
8%
debentures
200000Plant 800000
Long term
loan
100000Furniture and
fixtures
150000
Bills payable 60000Bills
receivable
70000
Sundry
creditors
70000Sundry
debtors
90000
Bank over
draft
30000Bank balance 45000
Outstanding 5000short term 25000
CO C S OCONCLUSION
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CONCLUSION:CONCLUSION:
Current ratio of the company is notCurrent ratio of the company is not
satisfactory because the ratio 1:6 is muchsatisfactory because the ratio 1:6 is much
below then the expected Standards .below then the expected Standards .
Acid test ratio on the other hand is moreAcid test ratio on the other hand is more
than the normal standard of 1:1than the normal standard of 1:1
Absolute ratio is slightly low because it isAbsolute ratio is slightly low because it is0.42 where as the accepted standard is 0.50.42 where as the accepted standard is 0.5
In this company need to improve its shortIn this company need to improve its short
term financial positionterm financial position
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Inventory turnover ratioInventory turnover ratioInventory turn over ratio =Inventory turn over ratio = Cost of good soldCost of good sold
Average Inventory at costAverage Inventory at cost
Generally , the cost of good sold may not be known fromGenerally , the cost of good sold may not be known from
the published financials , in such circumstancesthe published financials , in such circumstances
Inventory turn over ratio =Inventory turn over ratio =
Net SalesNet Sales
Average Inventory at costAverage Inventory at cost
Inventory turn over ratio =Inventory turn over ratio = Cost of good soldCost of good sold
Average Inventory at selling priceAverage Inventory at selling price
Inventory conversionInventory conversion
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Inventory conversionInventory conversion
periodperiodInventory conversion period =Inventory conversion period = Days in a yearDays in a year
Inventory Turnover RatioInventory Turnover Ratio
M/s Rakesh & Co supplies you the followingM/s Rakesh & Co supplies you the following
information for the year ending 31information for the year ending 31stst
Dec 1999Dec 1999Credit Sales Rs 150000Credit Sales Rs 150000
Cash SalesCash Sales Rs 250000Rs 250000
Return Inward Rs 25000Return Inward Rs 25000
Opening Stock Rs 25000Opening Stock Rs 25000
Closing Stock Rs 35000Closing Stock Rs 35000
Debtor/Receivable turnover ratioDebtor/Receivable turnover ratio
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Debtor/Receivable turnover ratioDebtor/Receivable turnover ratio
/Debtor velocity/Debtor velocityDebtor(Receivable) =Debtor(Receivable) = Net credit Annual salesNet credit Annual sales
Average Trade debtorsAverage Trade debtorsTrade debtors = Sundry debtor + Bill Receivable andTrade debtors = Sundry debtor + Bill Receivable and
account receivable saccount receivable s
Average Trade Debtors = Opening Trade debtor +Average Trade Debtors = Opening Trade debtor +
Closing Trade Debtor /2Closing Trade Debtor /2
Note : Debtor should always be taken at gross value ,Note : Debtor should always be taken at gross value ,
No provision for doubtful debt be deducted from themNo provision for doubtful debt be deducted from them
but when the information about opening and closingbut when the information about opening and closing
balance of trade debtor and credit sales is not availablebalance of trade debtor and credit sales is not available
, then the debtors turnover ratio calculated by dividing, then the debtors turnover ratio calculated by dividingthe total sales by the balance of debtors(inclusive ofthe total sales by the balance of debtors(inclusive of
Bills receivables) givenBills receivables) given
Debtors turn over Ratio =Debtors turn over Ratio =Total salesTotal sales
DebtorsDebtors
Average CollectionAverage Collection
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Average CollectionAverage Collection
PeriodPeriodThe average collection period represent theThe average collection period represent the
average number of days for which a firm hasaverage number of days for which a firm has
to wait before its receivable are converted intoto wait before its receivable are converted into
cashcash
Average Collection period =Average Collection period =
Average Trade Debtors (Drs + B/R)Average Trade Debtors (Drs + B/R)
Sales per daySales per day
Sales Per daySales Per day == Net SalesNet SalesNo of working daysNo of working days
OO
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OrOr
Average collection period =Average collection period =Average tradeAverage trade
debtorsdebtors Net SalesNet SalesNo of working daysNo of working days
If the period is in months:If the period is in months:
Average collection period =Average collection period =No of workingNo of workingdaysdays Debtors turnover ratioDebtors turnover ratio
The two basis component of the ratio areThe two basis component of the ratio are
debtors and sales per daydebtors and sales per day
Creditor/Payablere tor aya e
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Creditor/Payablere tor aya eturnover ratioturnover ratio
The analysis for credit turnover is basically theThe analysis for credit turnover is basically the
same as of debtors turnover ratio except thatsame as of debtors turnover ratio except thatin place of trade debtor, the trade creditor arein place of trade debtor, the trade creditor are
taken and in place of sales , average dailytaken and in place of sales , average daily
purchase are taken as the other component ofpurchase are taken as the other component of
the ratio.the ratio.Creditors turnover ratioCreditors turnover ratio
== Net credit annual purchaseNet credit annual purchase
Average Trade creditorsAverage Trade creditors
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Average Payment period RatioAverage Payment period Ratio
= Average Trade Creditors( Creditors+ Bills= Average Trade Creditors( Creditors+ Billspayable)/Average Daily purchases.payable)/Average Daily purchases.
Average daily purchase = Annual PurchaseAverage daily purchase = Annual Purchase
/No of working days in a year./No of working days in a year.
Average Payment Period = Trade creditor *Average Payment Period = Trade creditor *
No of working days / Net annual purchase.No of working days / Net annual purchase.
Average Payment Period = No of workingAverage Payment Period = No of working
days / Credit turnover Ratio.days / Credit turnover Ratio.
Working capital turnoverWorking capital turnover
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Working capital turnoverWorking capital turnoverratioratio
Working capital of a concern is directly related toWorking capital of a concern is directly related to
sales and current asset like debtors , billssales and current asset like debtors , billsreceivable , cash , stock etc .receivable , cash , stock etc .
Working capital turnover ratio = Cost of Sales /Working capital turnover ratio = Cost of Sales /
Average working capitalAverage working capital
Average working capital = Opening workingAverage working capital = Opening workingcapital + Closing Working capital/2capital + Closing Working capital/2
** If cost of sales is not given , then the figure of** If cost of sales is not given , then the figure of
sale can be used . O n the other hand ifsale can be used . O n the other hand if
opening working capital is not disclosed thenopening working capital is not disclosed thenworking capital at the end of the year will beworking capital at the end of the year will be
used.used.
Cost of sale /Net working capitalCost of sale /Net working capital
The following information is givenThe following information is given
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g gg g
about M/s S.P Ltd for the year endingabout M/s S.P Ltd for the year ending
Dec 31 2000Dec 31 2000
Stock turnover ratio = 6timesStock turnover ratio = 6times Gross Profit ratio = 20% on salesGross Profit ratio = 20% on sales
Sales for 2000 = Rs 300000Sales for 2000 = Rs 300000
Closing stock is Rs 10000 more thanClosing stock is Rs 10000 more than
the opening stockthe opening stock
Opening Creditors = Rs 20000Opening Creditors = Rs 20000
Closing Creditors = Rs 30000Closing Creditors = Rs 30000
Trade debtor at the end = Rs 60000Trade debtor at the end = Rs 60000
Net Working Capital = Rs 50000Net Working Capital = Rs 50000
FIND OUTFIND OUT
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FIND OUTFIND OUT
Average StockAverage Stock
PurchasesPurchases
Credit turnover ratioCredit turnover ratio
Average Payment PeriodAverage Payment PeriodAverage Collection PeriodAverage Collection Period
Working Capital turnoverWorking Capital turnoverratioratio
Fund flow analysisFund flow analys
is : Fund flow analysis is a: Fund flow analysis is a
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Fund flow analysisFund flow analysis : Fund flow analysis is a: Fund flow analysis is atechnical device designated to study thetechnical device designated to study the
sources from which additional fund weresources from which additional fund were
derived and the use to which these sourcesderived and the use to which these sourceswere put . It is an effective management toolwere put . It is an effective management tool
to study change in the financial position ofto study change in the financial position of
businessbusiness
The fund flow analysis consists ofThe fund flow analysis consists of Preparing schedule of change in workingPreparing schedule of change in working
capitalcapital
Statement of sources and application ofStatement of sources and application offundsfunds
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