WORKING CAPITAL management PPT UPDATED.ppt

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2. TYPES OF WORKING CAPITAL
WORKING CAPITAL
NET WORKING
CAPITAL
GROSS WORKING
CAPITAL
BASIS OF
CONCEPT
BASIS OF
TIME
PERMANENT /
FIXED WORKING
CAPITAL
TEMPORARY /
VARIABLE
WORKING
CAPITAL

3. Working capital
Working capital is the
amount of a company’s
current assets 
minus the
amount of its
 
current
abilities.

4. The adequacy of a company's working capital
depends on the industry in which it competes, its
relationship with its customers and suppliers, and
more. Here are some additional factors to consider:
a) The types of current assets and how quickly
they can be converted to cash. If the majority of
the company's current assets are
 
cash and cash equivalents 
and marketable
investments, a smaller amount of working capital
may be sufficient. However, if the current assets
include slow-moving inventory items, a greater
amount of working capital will be needed.

5. b) The nature of the company's sales and how
customers pay. If a company has very consistent
sales via the Internet and its customers pay with
credit cards at the time they place the order, a
small amount of working capital may be
sufficient. On the other hand, a company in an
industry where the credit terms are net 60 days
and its suppliers must be paid in 30 days, the
company will need a greater amount of working
capital.
c) The existence of an approved credit line and
no borrowing. An approved credit line and no
borrowing allows a company to operate
comfortably with a small amount of working
capital.

7. Sources of working capital

8. Spontaneo
us Sources
Short
Term
Sources
Short Term
Sources
Long Term
Sources
Long Term Sources
Trade
Credit
Internal
Sources
External
Sources
Internal
Sources
External Sources
Sundry
Creditors
Tax
Provisions
Bank
Overdraft
Retained
Profits
Share Capital
Bills
Payable
Dividend
Provisions
Trade
Deposits
Depreciatio
n Provision
Long Term Loans
Notes
Payable
Public
Deposits
Debentures
Accrued
Expenses
Bills
Discounting
Short Term
Loans

9. Spontaneous Sources of Working Capital Finance:
 The word ‘spontaneous’ itself explains that this source
of working capital is readily or easily available to the
business in the normal course of business affairs. The
quantum and terms of this credit depends on the
industry norms and relationship between buyer and
seller. These sources include trade credit allowed by the
sundry creditors, credit from employees, and other trade
related credits. The biggest benefit of spontaneous
sources as working capital is its effortless raising and
insignificant cost compared to traditional ways of
financing.

10. Short Term Sources of Working Capital Finance: 
Short term sources can be further divided into internal
and external sources of working capital finance. Short
term internal sources include tax provisions, dividend
provisions etc. Short term external sources include short
term working capital financing from banks such as bank
overdrafts, cash credits, trade deposits, bills
discounting, short-term loans, inter-corporate loans,
commercial paper, etc.
Tax and dividend provisions are current liabilities and
cannot be delayed. The fund that would have been used
in paying these provisions act as working capital till the
point these are not paid.

11. Long Term Sources of Working Capital
Financing: 
Long term sources can also be divided into internal
and external sources. Long term internal sources of
finance are retained profits and provision for
depreciation whereas external sources are share
capital, long term loan, and debentures.
Retained profits and accumulated depreciation are as
good as funds available to the business without any
explicit cost. These are the funds completely earned
and owned by the business itself. They are utilized for
expansion as well as working capital finance. Long
term external sources of finance like share capital is a
cheaper source of finance but are not commonly used
for working capital finance.

12. Working capital can be classified into temporary
working capital and permanent working capital.
It is advisable to use long term sources for
permanent and short term sources for temporary
working capital requirements. This will optimize
the working capital cost and enforce good working
capital management practices.

16.  Permanent or fixed working capital:
A part of the investment in current assets is as
permanent as the investment in fixed assets. It covers
the minimum amount necessary for maintaining the
circulation of the current assets. Working capital
invested in the circulation of the current assets and
keeping it moving is permanently locked up.
The permanent or fixed working capital is of two
kinds:
(a) Regular working capital, and
(b) Reserve margin or cushion working capital.

17. Working capital cycle

18. What is working capital cycle ?
The working capital cycle (WCC) is the amount of time
it takes to turn the net current assets and current
liabilities into cash. The longer the cycle is, the longer a
business is tying up capital in its working capital
without earning a return on it. Therefore, companies
strive to reduce its working capital cycle by collecting
receivables quicker or sometimes stretching accounts
payable.

19. Working capital cycle: How
healthy is your business ?
Any business needs a working capital to fund the
day-to-day operations, which include debts and
expenses, and forms a major component of the
operating liquidity. Apart from the fixed assets such
as plant and machinery, equipment, land etc. the
working capital also is an integral part of the
operating capital.

20. We can understand the concept of working capital
by understanding the terms working capital gap and
short-term borrowings. Companies define current
assets and current liabilities in their balance sheets
with respect to the assets and liabilities that are
expected to be realized or settled within the normal
operating cycle (i.e. 12 months after the balance
sheet date). This is where the concept of working
capital arises from.
 

21. We can now define the working capital as follows:
Working capital gap = (aggregate of current assets –
interest free credit)
Net Working Capital (NWC) = (working capital gap –
short-term borrowings)
The aggregate of current assets is known as Gross
Working Capital.
For example, say the current assets of company XYZ
are $10,000,000 and the interest free credit is
$2,000,000 and short-term borrowing is $5,000,000.

22. Then we shall calculate the net working capital as
follows:
Gross working capital = $10,000,000
Working capital gap = $ (10,000,000 – 2,000,000) =
$8,000,000
Net working capital = $(8,000,000 – 5,000,000) =
$3,000,000

23. What is the optimum level of
working capital ?
If the working capital is too high, then your business
has surplus funds that are not earning any returns,
unless they are invested in short-term securities etc.
If the working capital is too low, then your business
faces the threat of financial difficulties and this will
not send out a positive signal to the market. So how
do you decide what is the right level of working
capital for your business?

24. To find out the right amount of working capital needed,
you need to look at your recent balance sheet and take into
the account the current assets and current liabilities for
calculations. Once you have found the working capital
required, you also need to know whether the safety margin
is wide enough to operate efficiently. For this, you need to
calculate the ‘working capital ratio’.
Working capital ratio (or current ratio) = current assets /
current liabilities.

25. How to calculate working capital

28. Ilustration of working capital
The following particulars are available from cost records of a company:
Elements of costs Amount per unit
Raw materials Rs.24
Labour Rs.9
Overheads Rs. 18
Total costs Rs. 51
Profit Rs. 9
Selling price Rs. 60

29. Further information:
1. Raw material are in stock – 1 month.
2. Material are in process – 0.5 month.
3. Finished goods are in stock – 1 month
4.Credit allowed by suppliers – 1 month
5. Credit allowed to debtors – 2 months.
6. Lag in payment of wages – 1.5 weeks
7. Lag in payment of overhead expenses – 1 month.
8. 25% of output is sold against cash
9. Cash on hand and bank is expected to be Rs.10,000.

30. You are required to prepare a statement showing
working capital needed to finance a level of
activity of 1,56,000 units of production. It may
assume that the production is carried on evenly
thourghout the year, wages and overhead accure
similarly and a time period of 4 weeks is
equivalent to a month.

31. SOLUTION :
Weekly production unit = 1,56,000/52 = 3000
units.
Analysis of sales
Raw material(24*3000) = Rs 72,000
Labour(9*3000) = Rs 27,000
Overhead(18*3000) = Rs 54,000
Total cost = Rs 1,53,000
Profit(9*3000) = Rs 27,000
Sales = Rs 1,80,000

32. PARTICULARS AMOUN
TS
(in Rs)
AMOUN
TS
(in Rs)
Stock(72000*4) 2,88,000
WIP:
Raw material(72000*2)
Labour(27000*1)
Overhead(54000*)
1,44,000
27,000
54,0002,25,000
Finished goods:
Raw material(72000*4)
Labour(27000*4)
Overhead(54000*4)
2,88,000
1,08,000
2,16,0006,12,000

33. Debtors( at sales):
Raw material(72000*8*75%)
Labour(27000*8*75%)
Overhead(54000*8*75%)
Profit(27000*8*75%)
4,32,000
1,62,000
3,24,000
1,62,000
10,80,000
Cash 10,000
Current assets(A) 22,15,000

34. Less: Current liabilities(B)
Creditors:
Raw material(72000*4)
Labour(27000*4)
Overhead(54000*4)
2,88,000
40,500
2,16,000
5,44,500
Working Capital(A-B) 16,70,500

35. N
eed for Working Capital
1. For the purchase of raw material, components and spares.
2. To incur day to day expenses and overhead costs such as fuel,
power and
office expenses, etc.
3. To meet selling costs as packing, advertisement etc.
4. To provide credit facilities to the customers.
5. To maintain the inventories of raw material, work in progress,
stores and
spare and finished goods.
6. To pay wages and salaries.

36. Ex
cess and inadequate working capital
Disadvantages of Excess Working Capital:
1. Idle funds, non-profitable for business, poor ROI.
2. Unnecessary purchasing & accumulation of inventories over required level.
3. Excessive debtors and defective credit policy, higher incidence of bad debts.
4. Overall inefficiency in the organization.
5. When there is excessive working capital, Credit worthiness suffers.
6. Due to low rate of return on investments, the market value of shares may fall.
 

37. Ex
cess and inadequate working capital
Disadvantages of Inadequate Working Capital:
1.Can not pay off its short-term liabilities in time.
2. Economies of scale are not possible.
3. Difficult for the firm to exploit favorable market situations.
4. Day-to-day liquidity worsens.
5. Improper utilization of the fixed assets and ROA/ROI falls
sharply.

38. WORKING C
apital Management
Meaning of working capital management:
Working Capital Management is concerned with the problems
that arise in attempting to manage the Current Assets, Current
Liabilities and the inter-relationship that exists between them.
Working Capital Management means the deployment of
current assets and current liabilities efficiently so as to maximize
short-term liquidity.

39. WORKING C
apital Management
Steps involved in Working Capital Management:
I. Forecasting the Amount of Working Capital
II. Determining the Sources of Working Capital

40. N
ature of Working Capital Management
Profitability,
Risk &
Liquidity
Composition
& Level of
CL
Composition
& Level of
CA
Working
Capital
Management
Composition
& Level of
CL
Working
Capital
Management

41. W
orking Capital Cycle

42. I
f… Then Analysis
If Then
Collect receivables (debtors)
faster
Release cash from cycle
Collect receivables(debtors)
slower
Receivables soak up cash
Get better credit(in terms of
duration or
amount from suppliers)
Increase of cash resources
Shift inventory(stocks)fasterFree up cash
Move inventory(stocks) slowerConsume more cash

43. W
orking Capital Management of
Ratios associated with Working Capital Management:
Inventory Turnover Ratio
Debtor Turnover Ratio
Creditor Turnover ratio
Average Collection period
Average Payment Period
Working Capital Turnover Ratio
Current Asset Turnover Ratio

44. DEFINATION
• Working capital ratio is an indicator of the short term
financial credibility of a company.
• Working capital ratio is calculated to know whether a
business has sufficient short term assets to meet its short
term liabilities.
• The mathematical formula for calculating working capital
ratio is:
Working capital ratio = current assets / current liabilities

45. Importance of Working Capital Ratios
Ratio analysis can be used by financial executives to check
upon the efficiency with which working capital is being used in
the enterprise.
Ratio Formula Result
Stock turnover
(in days)
Average Stock * 365/
Cost of Goods Sold
= x days
Receivables Ratio
(in days)
Debtors * 365/
Sales
= x days
Payables Ratio
(in days)
Creditors * 365/
Cost of Sales
= x days
Current Ratio Total Current Assets/
Total Current Liabilities
= x times
Quick Ratio (Total Current Assets -
Inventory)/
Total Current Liabilities
= x times
Working Capital Ratio(Inventory + Receivables
- Payables)/sales
As % Sales

46. Estimation / forecast of working capital requirements
•"Working capital is the life blood & controlling nerve centre of a
business."
  No business can be successfully run without an adequate
amount of working capital.
•To avoid the shortage of working capital at once, an estimate of
working capital requirement should be made in advance.
•But estimation of working capital requirements is not an easy task &
a large no. of factors has to be considered before starting this.

47. Principles of working capital ratio

48. Example :-
Working capital
policy
Conservative A
Rs
Moderate B
Rs
Aggressive B
Rs
Sales 1,500,000 15,00,000 1,500,000
EBIT 150,000 150,000 150,000
Current assets 500,000 400,000 300,000
Fixed assets 500,000 500,000 500,000
Total assets 1,000,000 900,000 800,000
Return on total
assets
1.5% 16.67% 18.75%
Current assets/
Fixed assets
1.00 0.80 0.60

49. Factors requiring consideration while
estimating working capital.
 The average credit period expected to be allowed by
suppliers.
Total costs incurred on material, wages.
The length of time for which raw material are to
remain in stores before they are issued for
production.
The length of the production cycle (or) work in
process.
The length of sales cycle during which finished goods
are to be kept waiting for sales.
The average period of credit allowed to customers
The amount of cash required to make advance
payment

50. Factors determining working capital requirements
 Nature of business
Size of business
Production policy
Manufacturing process
Seasonal variations
Working capital cycle
Credit policy