fm working capital

8/4/2019 Fm Working Capital

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Working Capital

Management

There are two concept of working Capital, GrossWorking Capital and net Working Capital

Gross Working capital is the total of all current

assets; net working Capital is the differencebetween current and current liabilities

Management of working capital refer to theManagement of current assets as well as Current

liabilities, The major thrust, of course is on themanagement of current assets; This isunderstandable because current liabilities.


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Current Assets Current LiabilitiesInventories Sundry

Raw Material other Component Trade AdvancesWork in process Borrowings (short

commercial banks & other)Finished Goods Provision

OthersTrade debtorsLoans and advancesCash & bank balances


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Financial manager spend a great deal of timein managing current assets and Current

liabilities, arranging short term finance,negotiating favorable credit terms, Controllingthe movement of Cash , administeringaccounts receivable etc..

While Managing Working capital, Bear in Mindtwo Character tics of current assets. Short Life span Swift transformation in to other asset forms. Cash Balance may be held idle for a weak or

two, account receivable may have life span of30 to 60 days and inventories may be held for1 to 60 days


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The life span of current assets depend uponthe time required in the activities ofprocurement, production, sales and collectionand the degree of synchronization among item.All in above point have certain implications

Decision relating to working Capital arerepetitive and frequent.The Difference between profit and presentvalues is insignificant

Management of one component cannot beundertaken, without simultaneousconsideration of other component.


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Assets Receivable FG

Wages W/P

Supplier Cash R.M


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FACTORS INFLUENCING WORKING CAPITAL

MANAGEMENT

THE WORKING CAPITAL NEEDS OF A FIRM AREINFLUENCED BY NUMEROUS FACTORS: NATURE OF BUSINESS:- OPERATING CYCLE, SHORT,LONG SEASONALITY OF OPERATIONS:- CEILING FANS,FLUCTUATING WORKING CAPITAL PRODUCTION POLICY

MARKET CONDITIONS:- COMPETION, LARGEINVENTORY. CONDITIONS OF SUPPLY:- PROMPT+ADEQUATESUPPLY OF RAW MATERIAL, SPARES AND STORES.


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OBJECTIVES OF WORKING CAPITAL

MANAGEMENT

THE BASIC OBJECTIVE OF WORKING CAPITAL IS TO PROVIDEADEQUATE SUPPORT FOR SMOOTH FUNCTIONING OF NORMALBUSINESS OPERATIONS OF A COMPANY

THE QUANTUM OF INVESTMENTS IN CURRENT ASSETS HAS TO

BE MADE IN A MANNER THAT IS NOT ONLY MEETS THE NEEDS OFTHE FORECASTED SALES BUT ALSO PROVIDES A BUILT-INCUSHION IN THE FORM OF SAFETY STOCKS TO MEETUNFORSEEN CONTEGENCIES ARISING OUT OF FACTORS SUCHAS:- DELAYS IN ARRIVAL OF RAW MATERIALS; SUDDEN SPURT IN

SALES DEMAND

CONSEQUENTLY, THE INVESTMENT IN CURRENT ASSETS FOR AGIVEN LEVEL OF FORCASTED SALES WILL BE HIGHER IF THEMANAGEMENT FOLLOWS AN AGGRESSIVE ATTITUDE


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THUS A COMPANY FOLLOWING CONSERVATIVE APPROACHIS SUBJECTED TO A LOWER DEGREE OF RISK, THEN THEONE FOLLOWING AN AGGRESSIVE APPROACH.

SO HIGH AMOUNT OF INVESTMENTS IN CURRENT ASSETSIMPARTS GREATER DEGREE OF LIQUIDITY TO THECOMPANY.

THE LARGER THE AMOUNT OF INVESTMENT IN CURRENTASSETS, THE SMALLER WILL BE THE AMOUNT AVAILABLEFOR INVESTMENT IN OTHER PROFITABLE AVENUES.

THEREFORE THE FIRM FOLLOWING A CONSERVATIVEPOLICY WILL HAVE A LOW PERCENTAGE OF OPERATINGPROFITABLITY COMPARED TO ITS COUNTER-PARTSFOLLOWING AN AGGRESSIVE APPROACH.


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CHOOSING THE PATTERN OF FINANCING

IN THE NORMAL COURSE OF BUSINESS THE COMPANY

WILL USSUALLY HAVE ACCESS TO NON-INTEREST BEARINGSHORT TERM LIABILITIES SUCH AS SUNDRY CREDITORS;ACCRUED EXPENSES; AND OTHER CURRENT LIABILITIES ASALSO PROVISIONS TOWARDS FINANCING CURRENT ASSETS.

THESE ARE CALLED SPONTANEOUS LIABILITIES AS THEYARISE MORE OR LESS AUTOMATICALLY IN THE CONTEXT OFCURRENT ASSTES

THE DIFFERENCE BETWEEN THE AMOUNTS OF CURRENT

ASSETS AND SPONTANEOUS LIABILITIES NEEDS TO BEFINANCED BY COMBINATION OF BANK BORROWING IN THEFORM OF CASH CREDITS/OVERDRAFT ARRANGEMENT ANDLONG TERM SOURCES OF FINANCE SUCH AS DEBENTUREAND EQUITY CAPITAL.


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An aggressive financing policy will tend tofinancing mix tilted in favour of bank borrowings

and public deposits compared to a conservativepolicy tilted more towards long term sources

So , we can conclude that working capitalmanagement encompasses the management of

current assets and means of financing them.The objective is to balance the liquidity and

profitability criteria , while taking into

consideration the attitude of managementtowards risk and constraints imposed by thebanking sector while providing short termfinance in the form of cash credit / bank

overdraft .


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STATIC VIEW Gross working capital is equal to the total of all current

assets . Net working capital is difference between gross w/cand current liabilities

An important characteristics of C/A is conventionallyconsidered to be their convertibility into cash within a singleaccounting year unlike fixed assets which provide the

production capacity for the manufacture of finished goodsfor sale . Current liabilities arise in the context and henceare derived from current assets

Conventionally current liabilities are of short term nature andcome up for payment within a single accounting year

Consequently lot of emphasis is traditionally placed on thecurrent assets vis a vis current liabilities usually 2 : 1 currentratio is considered ideal


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The view has manylimitations :

1. C/A , C/L are on a specified data , they fail to givedynamic view.

2. Balance sheet of a company is prepared as per

schedule vi of companies act ; therefore followingdeficiencies remain3. C/C and O/D are of short term borrowings , they do

not figure in C/L4. Unsecured short term loans such as public

deposits are also shown separately under the headunsecured loans

5. C/A do not include the short term treasurysecurities which are marketable and the main aimwas to improve liquidity


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6. All these points distort the W/C

7. A negative working capital indicates thesiphoning off a short term funds for thefinancing of long term or fixed assets whichwhen continued for long lead to problems ofliquidity for organization

Cont.


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W/C can be viewed as capital required for thesmooth and uninterrupted functioning of normalbusiness operations of a company ranging fromprocurement of raw materials converting the

same into finished product for sale , realizingthe cash along with profit from accountrecievable that arise from the sale of finishedgoods on credit.

Quantum of raw materials depends on numberof factors , discount offered ,seasonal avalibility ,imported or indigeneous , expected price rise.

DYNAMIC VIEW


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Nature of process technology has bearing ontime taken for conversion.

Quantum of finished good will depend onaccurate prediction, festival seasons , durabilityor perishabilty etc.

To keep cash for meeting liabilities, cushions,

unanticipated demand for cash /bank balance. Company also receives credit from suppliers. To conclude , we have seen how important role

w/c plays in a manufacturing or trading

concerns.


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OPERATING CYCLE AND

CASH CYCLE

The investment in w/c is influenced by thefollowing events in the operating cycle of the

firm:-a) Purchase of raw material.

b) Payment of raw material.

c) Manufacture of goods.d) Sales of finished goods.

e) Collection of cash from sales.


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The firm begins with the purchase of raw material which are paidfor after a delay which represents the account payableperiod.The firm converts the raw material into finished goods

and then sells the same . The time lag between the purchase ofraw material and sale of finished goods is the inventoryperiod.Customers pay their bill sometime after the sales .Theperiod elapses between the date of sale and date of collection ofreceiavables in the account receivable period.

The time that elapses between the raw material and collection ofcash for sales is referred to as the operating cycle whereas thetime length between the payment for raw material for purchaseand collection of cash for sales is referred to as the cash cycle

Thus operating cycle is the sum of the Inventory period and theaccounts receivable period, whereas the cash cycle is equal tothe operating cycle less the accounts payable period .

From financial statements, we can estimate the Inventory period,

the accounts receivable period and the accounts payable period.


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ILLUSTRATION:-

P + L a/c Rs. (in Lacs)2009

Sales 800Cost of

Goods sold 720

Bal. Sheet2008 2009

Inventory 96 102A/c Receivable 86 90A/c Payable 56 60


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Solution:-

(1.) Inventory period = Avg. InventoryAnnual costof goods sold 365

= (96 + 102) / 2720/365

= 50.1 DAYS

(2.) A/c Receivable Period = Avg. A/c ReceivableAnnual Sales / 365

= ( 86 +90 ) / 2

800/365

= 40.2 DAYS


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(3.) A/c Payable Period = Avg. A/c PayableAnnual Costof goods sold 365

= ( 56 + 60 ) / 2720/365

= 29.4 DAYS

Operating Cycle = Inventory + A/c Receivableperiod period

= 50.1 + 40.2= 90.3 DAYS

Cash Cycle = Operating A/c PayableCycle period= 90.3 29.4= 60.9 DAYS


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ILLUSTRATION

Following are the figures of xyz company:-

(Rupees)

Sales (at two months credit) 36,00,000

Material consumed(two months suppliers credit) 9,00,000

Wages paid (monthly in arrear) 7,20,000

Manufacturers exp outstanding at the end

Of the year(cash expenses are paid 1 month arrear) 80,000

Total administrative expenses (paid as above) 2,40,000

Sales promotion expenses,(paid quarterly in advance) 1,20,000


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1. Company sells its products on gross profit of25% counting depreciation as part of cost ofproduction.

2. It keeps one months stock each of raw material

and finished goods, and a cash balance ofrupees 100000.

3. Assuming 20% safety margin .

Calculate the working capital

requirements of the company on cash costbasis , ignore work in progress.

ADDITIONAL INFORMATION:


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Solution

Working notes :Manufacturing expenses :

sales 3600000less : gross profit 25% 900000total manufacturing cost 2700000less : material : 900000

wages : 720000 1620000

manufacturing expenses 1080000Cash manufacturing expenses80000 * 12 960000Depreciation(1-2) 120000as aboveTotal cash costTotal manufacturing expenses 2700000

Less: depreciation 1200002580000

Add : total administrative expenses 240000sales promotion expenses 120000 360000

2940000


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CURRENT ASSETS

a) Debtors total cash cost* 212

294000*2 = 4900000

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b) Raw material material cost *112

900000 = 7500012

c) Finished goods stock cash manufacturing exp*112

2580000 = 215000012


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d) prepaid sales

promotional exp. (quaterly sales in advance) = 1,20,000 = 30000

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cash balance (given) 100000

current assets 9100000


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CURRENT LIABILITIES

A.)SUNDRY CREDITORS= MATERIAL COST x 212=900000x2 = 1,50,000

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B.) MANUFACTURING EXPENDITURE

ONE MONTH CASH(GIVEN) 80,000

C.)WAGES OUTSTANDING

720000 = 60,00012


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d.)TOTAL ADMINISTRATION EXPENSES

OUTSATNDING = 24000

12 20,000TOTAL 310000

WORKING CAPITAL=

CURRENT ASSETS - CURRENT LIABILITIES910000 - 310000 = 600000

ADD 20% SAFETY MARGIN = 120000

Net working capital 720000


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fm working capital

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