Theory of working capital

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1. Theory of Working Capital Institute of Business Management C.S.J.M. University Campus, Kanpur UNDER THE GUIDANCE OF: Prof. J.V. Vaishampayan ( Vice Chancellor) Faculty of IBM, CSJMU Kanpur PRESENTED BY: Jai Prakash MBA (FT) 2 nd sem. Batch: (2015-17)

2. Working capital is two types of assets. The first are fixed assets like land, building, fixture, plant & machinery etc. The second are current assets like raw material, cash, and receivable etc. Example = A car without petrol. DEFINITION OF WORKING CAPITAL

3. The total value of current assets or the total value of funds needed to acquire the aggregate of current assets is known as the Gross Working Capital. GROSS WORKING CAPITAL

4. It is the difference between current asset and current liabilities. NWC = Current Assets – Current Liabilities NET WORKING CAPITAL

5. Inventories Cash Receivable TYPES OF CURRENT ASSETS

6. Operating cycle Definition:- Conversion of cash into cash through the whole cycle (cash to raw material to semi finished goods to finished to receivable to cash again) with in a period of time is called operating cycle.

7. Time duration of operating cycle is longer in manufacturing and in trading operating cycle time is shorter . Operating cycle determines the time period for conversion of cash into cash through several process. CONTD ...

8. Inventory of Raw Material Cash Semi-Finished Goods Finished Goods Receivables Purchase Manufacturing Manufacturing Sales Collection CONTD ...

9. FINANCING WORKING CAPITAL SOURCES SHORT TERM SOURCES LONG TERM SOURCES

10. APPROACHES OF WORKING CAPITAL MATCHING APPROACH CONSERVATIVE APPROACH AGGRESSIVE APPROACH

11. MATCHING APPROACH For financing working capital , long term assets should be financed by long term sources and short term assets should be financed by short tern sources . This is called matching approach or matching principle for financing working capital.

12. CONTD ... That minimum level of current assets which will always be maintain by an organization is called “permanent working capital”. When the business follows matching approach, long-term sources shall be used for financing fixed assets and permanent current assets and short-term sources is used for financing temporary or variable assets.

13. Fixed Assets Permanent Current Assets Time Short term Sources Long term Sources Level of Assets MATCHING APPROACH Temporary Current Assets

14. Conservative approach Under this approach, the entire estimated finance in current assets should be financed from long-term sources and the short-term sources should be used only for emergency requirements. This approach is called as “ Low Profit – Low Risk ” concept.

15. CONTD ... In conservative approach of financing working capital instead of permanent current assets, fluctuating assets or temporary current assets are also financed by long term sources . When we have adequate cash(from long term fund) we are more secure because short term sources may or may not be available. So, it is less risky .

16. Permanent Current Assets CONSERVATIVE APPROACH Fixed Assets Time Short term Sources Long term Sources Level of Assets Temporary Current Assets

17. AGGRESSIVE APPROACH Under this approach, the entire estimated requirement of current assets should be financed from short-term sources and even a part of fixed assets financing be financed from short- term sources. This approach is high risky, less costly and high profitable.

18. CONTD... In aggressive approach of financing working capital short term sources are used for both permanent working capital and temporary working capital . It is risky but also have high profit because short term sources have low pricing cost.

19. Permanent Current Assets Fixed Assets Time Short term Sources Long term Sources Level of Assets Aggressive approach Temporary Current Assets

20. Short term sources Bank Over-Draft Cash Credit Bills Discounting Factoring Commercial Paper Bills Payables or Suppliers Credit