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Working Capital Management A perspective
21

Working Capital Mgt

Aug 17, 2014

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Economy & Finance

Sunny Sabharwal

Working Capital Management
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Page 1: Working Capital Mgt

Working Capital Management

A perspective

Page 2: Working Capital Mgt

Some basics

•Business requires money to generate more money

•Tasks of Entrepreneur to –- envisage the process- accumulate resources- take risks - enjoy the return

•Resources and their funding is primarily of two types: BUSINESS

Short-term AssetsLong-term Assets

Long-term Funds Short-term Assets

Page 3: Working Capital Mgt

Working Capital

•Centuries old concept•Necessity of every business•Needed for various purposes•Requirement varies according to industry,

size, technology, creditability, etc.•Available from numerous sources

Page 4: Working Capital Mgt

•Working capital typically means the firm’s holding of current or short-term assets such as cash, receivables, inventory and marketable securities.

•These items are also referred to as circulating capital

•Corporate executives devote a considerable amount of attention to the management of working capital.

Working Capital

Page 5: Working Capital Mgt

•Working Capital refers to that part of the firm’s capital, which is required for financing short-term or current assets such a cash marketable securities, debtors and inventories. Funds thus, invested in current assets keep revolving fast and are constantly converted into cash and this cash flow out again in exchange for other current assets. Working Capital is also known as revolving or circulating capital or short-term capital.

•Part of long term finance is locked in and used for supporting current activities

Definition of Working Capital

Page 6: Working Capital Mgt

• Two possible interpretations :- Balance sheet concept- Operating cycle concept

• Balance sheet concept- There are two interpretations of working capital

under the balance sheet concept. o Excess of current assets over current liabilities (Net

working capital)o Gross or total current assets.

- The definition is meaningful only as an indication of the firm’s current solvency in repaying its creditors.

- When firms speak of shortage of working capital they in fact possibly imply scarcity of cash resources.

Concept of working capital …1

Page 7: Working Capital Mgt

Concept of working capital …2

•Operating cycle concept- A company’s operating cycle typically consists of

three primary activities:o Purchasing resources,

- The firm has to maintain cash balance to pay the bills as they come due

o Producing the product and- In addition, the company must invest in inventories to fill

customer orders promptlyo Distributing (selling) the product.

- And finally, the company invests in accounts receivable to extend credit to customers

- Operating cycle is equal to the length of inventory and receivable conversion periods.

Page 8: Working Capital Mgt

WORKING CAPITAL

BASIS OF CONCEPT

BASIS OF TIME

Gross Working Capital

Net Working Capital

Permanent / Fixed WC

Temporary / Variable WC

TYPES OF WORKING CAPITAL

Page 9: Working Capital Mgt

Payable Deferral period

Inventory conversionperiod

Cash conversioncycle

Operating cycle

Pay forResourcespurchases

Receive CashPurchase

resources

SellProductOn credit

Receivable Conversion period

Importance of working capital• Risk and uncertainty involved in managing the cash flows• Uncertainty in demand and supply of goods, escalation in cost both

operating and financing costs.

Operating cycle of a typical company

Page 10: Working Capital Mgt

THE WORKING CAPITAL CYCLE

(OPERATING CYCLE)Accounts Payable

Cash

RawMaterials

W I P

Finished Goods

AccountsReceivable

SALES

Page 11: Working Capital Mgt

Fixed Assets

Permanent Current Assets

Total Assets

Fluctuating Current Assets

Time

Rs

Short-termDebt

Long-termDebt +EquityCapital

Matching approach to asset financing

Page 12: Working Capital Mgt

•How to manage the current assets, the current liabilities and the inter-relationship that exists between them.

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

MANAGEMENT OF WORKING CAPITAL

Page 13: Working Capital Mgt

Dimension IProfitability,

Risk, & Liquidity

Dimension II

Composition & Level

of CA

Dimension IIIComposition & Level

of CL

Nature of Working Capital Management

Page 14: Working Capital Mgt

• Factors to be considered- Total costs incurred on materials, wages and overheads- The length of time for which raw materials remain in stores

before they are issued to production.- The length of the production cycle or WIP, i.e., the time taken for

conversion of RM into FG.- 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 amount of cash required to pay day-to-day expenses of the

business.- The amount of cash required for advance payments if any.- The average period of credit to be allowed by suppliers.- Time – lag in the payment of wages and other overheads

Estimation of working capital requirements

Page 15: Working Capital Mgt

1. Importance of CashWhen planning the short or long-term funding requirements of a business, it is more important to forecast the likely cash requirements than to project profitability etc.

More businesses fail for lack of cash than for want of profit.

Management of cash

Page 16: Working Capital Mgt

•Cash flow planning entails forecasting and tabulating all significant cash inflows relating to sales, new loans, interest received etc., and then analyzing in detail the timing of expected payments relating to suppliers, wages, other expenses, capital expenditure, loan repayments, dividends, tax, interest payments etc.

Calculating Cash Flows

Page 17: Working Capital Mgt

• Cash Management will be successful only if cash collections are accelerated and cash payments, as far as possible, are delayed

• Methods of ACCELERATING CASH INFLOWS- Prompt payment from customers (Debtors)- Quick conversion of payment into cash- Decentralized collections- Lock Box System (collecting centers at different locations)

• Methods of DECELERATING CASH OUTFLOWS- Paying on the last date- Payment through Cheques and Drafts- Adjusting Payroll Funds (Reducing frequency of payments)- Centralization of Payments- Inter-bank transfers- Making use of Float

MANAGING CASH FLOWS

Page 18: Working Capital Mgt

Sources of Working Capital

• Cash Credit / Overdraft• Cash Management• Working Capital Demand Loan• Bill Discounting / Receivable Discounting• Export Finance / Bill Negotiation• Term Loans• Letter of Credit• Bank Guarantee• Foreign Currency Loans

Page 19: Working Capital Mgt

Bank criteria for typical WC lending

•Age of Business > 2 years•Turnover > Rs. 2 cr.•Tangible Net Worth > Rs.1 cr.•EBITDA margin > 5%•PAT margin : profitable operations for the

last 2 years•Receivables beyond 6 months < 5% of

annual revenues

Page 20: Working Capital Mgt

Usual Qualitative Assessment by Banks

Borrower/ Promoter

Experience in Industry; commitment to timely order execution; consistency in quality

Factor Parameter

ScaleLarge scale servicing capability for different clients; location of base in areas of good quality labour, rentals & power

Capabilities Wide range of services; USP in the services offered; value added/ premium services

PartnersKey management must be technically qualified; relevant domain knowledge pool; reputation of promoters

Company Profile Long term buyers; clients well distributed

Page 21: Working Capital Mgt

THANK YOU