Financial management working capital

working capital management

1. FINANCIAL MANAGEMENT “WORKING CAPITAL MANAGEMENT” Prepared and presented by:- Group no. 4 (roll no. 28 to 36)

2. INTRODUCTION OF WORKING CAPITAL Working capital management involves management of current assets as well as current liabilities. Current assets are the assets, which in the ordinary course of business, can be converted into cash within a year. Major current assets involves Cash, Accounts Receivables and inventory(stock in trade).

3. Current liabilities are the liabilities which are intended to be paid, in the ordinary course of the business, within a year. Major current liabilities involves the Accounts payables, Bank overdraft, Bills payables etc.

4. MEANING OF WORKING CAPITAL Working capital is that capital which is involved in the current assets of the business. Basically it is the capital which is required to meet the day to day expenses of the business.

5. DEFINITION Working capital is short term finance for the origination to run its day to day operation.

6. CONCEPT OF WORKING CAPITAL Gross working capital:- The concept of gross working capital refers to total value of current assets. In other words, gross working capital is the total amount available for financing of current assets ,it does not reveal the true financial position of an enterprise. A borrowing will increase current assets and thus will increase current liabilities.

7. Net working capital:- The net working capital is an accounting concept which represents the excess of current assets over current liabilities. The ratio of 2:1 between current assets and current liabilities is considered as optimum or sound.

8. KIND OF WORKING CAPITAL Gross Working Capital Net Working Capital Permanent Working Capital Temporary Working Capital

9. GROSS WORKING CAPITAL: Current assets Short term assets which can be converted into case within a period of one year 2. NET WORKING CAPITAL: Net working capital = Total current assets - Total current liabilities

10. 3. PERMANENT WORKING CAPITAL: Hard core working capital All type of current resources 4 . TEMPORARY WORKING CAPITAL: Close relationship between temporary working capital and level of production and sales.

11. IMPORTANCE OF WORKING CAPITAL Working capital is part of the total capital employed by a company and is often defined as the difference between short-term liabilities and short-term assets. Practically speaking, it is the cash required to run the daily, weekly and monthly operations of a business. Working capital management is, therefore, the process of managing the short-term assets and liabilities so that a firm has sufficient liquidity to run its operations smoothly.

12. 1. Smooth Flow of Production 2 . Increase in Liquidity and Solvency Position 3 . Goodwill 4 . Advantages of Cash Discount 5. Easy Loan 6. Regular Payment of Wages and Salaries

13. 7. Security and Confidence 8. Efficient Use of Fixed Assets 9 . Meeting of Contingencies 10 . Completing operating cycle 11 . Timely Payment of Dividend

14. OBJECTIVES OF WORKING CAPITAL 1. Optimization of working capital operating cycle: In simple terms, working capital cycle starts from the day raw materials are acquired and completes when the finished products are sold. The major objective of working capital management is to ensure that there is no hindrance during the above mentioned process. It includes collecting and processing raw materials and other initial investment in time, placing all the essentials for production beforehand, selling finished products as soon as possible, collecting account receivables on time and clearing all the account payable’s in time.

15. 2. Balance Working Capital: The net working capital mentioned above is required to stay in a stable equilibrium. The ratio of current assets and current liabilities should be optimized. Because the lower value of this ratio implies that company is not financially stable to clear its current debts, higher value is also not an indication of prosperity, it suggests that company has too many inventories and they are not investing in excess cash.

16. 3. Minimize cost of capital Working capital management focuses on minimizing cost of capital, rate of interest. It is only when the cost of capital will be lesser than revenue, one can earn profit. Utilization of long-term funds (in proper mix) is one way of minimizing capital cost. The fundamental principle of financial management should be followed sincerely while deciding the finance mix, always. The principle states that long term sources should finance fixed assets and permanent assets. Also, the short-term or temporary assets should be financed by short-term sources of finance.

17. 4. Optimal Return on Current Asset Investment :- The return on the investment infused on short term assets must exceed the average cost of capital to ensure wealth maximization. In other words, the rate of return earned from the investment in short term assets should exceed the rate of interest or cost of capital. Working capital management aims to extract maximum from an investment in current assets to ensure higher profitability.

18. Conclusion: So, by now you know that working capital management is a managerial accounting strategy that aims to optimize higher ROI (return on investment) and minimize cost of capital. During any financial crisis, the accounting team focuses on enhancing the company’s working capital management to normalize day to day business activity .

19. NEED FOR WORKING CAPITAL As profits earned depend upon magnitude of sales and they do not convert into cash instantly, thus there is a need for working capital in the form of CA so as to deal with the problem arising from lack of immediate realizations of cash against goods sold. This is referred to as “operating or cash cycle” . It is defined as “The continuing flow from cash to supplier, to inventory, to account receivable & back into cash ”.

20. Thus the need of working capital arises from cash or operating cycle of a firm. Which refers to length of time required to complete the sequence of events. Thus, operating cycle creates the need for working capital & its length in terms of time span required to complete the cycle is the major determinant of the firm’s working capital needs.

21. FACTORS INFLUENCING WORKING CAPITAL Nature of business Size of business Production policy Seasonal variation Credit policy Business cycle

22. Nature of business : Public undertaking need very limited working capital since they offer cash sales only. Trading and finance firm require less investment in fixed capital and will have more investment in working capital.

23. Size of business : Working capital requirement is directly influenced by size of business. Greater the size larger will be the requirement of working capital. In some cases even small concern may need more working capital due to high overhead charges, inefficient use of available resources and other economic disadvantage of small size.

24. Production policy: The production could be curtailed during the slack season and increase during the peak season. If the policy is to keep production steady by accumulating inventories it will require higher working capital.

25. Seasonal variation : In certain industries raw material is not available throughout the year. The raw materials is bought in bulk. Huge amount is blocked in the form of material inventories during such seasons demanding more working capital requirement.

26. Credit policy : Credit policy of a concern means how firm deal with their debtors and creditors. Concern on credit sells its product on cash require less working capital. B usiness cycle : Business cycle refers to alternate expansion and contraction in general business activity. During boom there is need for more working capital due to increase in sale, rise in price, optimistic expansion of business etc.

27. SOURCES OF WORKING CAPITAL

28. A. SPONTANEOUS SOURCES Finance which naturally arise in the course of business is called as spontaneous financing. B. NEGOTIATED SOURCES Financing which has negotiated with lenders , say commercial bank , financial institutions , general public is called as negotiated sources.

29. 1. SHORT-TERM SOURCES Short term sources can be further divided into internal and external sources of working capital. Internal sources include tax provisions, divided provisions etc. External sources include short term working capital financing from bank overdraft , case credit ,public deposits , bills discounting , short term loans.

30. 2 . LONG TERM SOURCES Long term sources can also divided into internal and external sources. Internal sources of finance are retained profit and provision for depreciation. External sources are share capital , long term loan , and debenture.

31. OPERATING CYCLE

32. A continues process starting from payment of cash for purchasing raw material, production, stocking, selling until obtaining money from debtors . It is a cycle involving, Conversation of cash into raw material Conversation of raw material in WIP Conversation of WIP into finished goods Conversation of finished goods into debtors Conversation of debtors into cash

33. To forecast the optimum working capital requirement the following formula may be used: ( Estimated cost of good sold * Operating cycle) + Desired cash balance Operating cycle O = R +W+ F + D – C Where, O= Duration Of Operating Cycle R= Raw Material Storage Period W= Work In Process Period F= Finished Goods Storage Period D= Debtors Collection Period C= Creditors Payment Period

34. EXAMPLE:-

35. THANK YOU!