mba 2009 working capital management 2

8/3/2019 MBA 2009 Working Capital Management 2

1/25

Prof. SB Mishra

WORKING CAPITAL MANAGEMENT


2/25

OUTLINE

Characteristics of Current Assets

Factors Influencing Working Capital Requirements

Level of Current Assets

Current Assets Financing Policy

Profit Criterion for Current Assets

Operating Cycle Analysis

Cash Requirement for Working Capital


3/25

CHARACTERISTICS OF CURRENT ASSETS

Short life span

Swift transformation into other asset forms

Current Assets Cycle

Accounts

receivable

Finished

goods

Wages, salaries,

factory overheads

Work-in-

process

Raw

materials

Cash Suppliers


4/25

Concepts- Static View

Gross Working Capital. Refers to investment in Current Assets.

Net Working capital. Refers to difference between Current Assets (

CA) and Current Liabilities ( CL)


5/25

Concepts- CURRENT ASSETS

Inventories:

Sundry Debtors/ Accounts Receivable

Cash and Bank BalanceShort Term Investments.

Loans and Receuivable including BillsReceivable.

Prepaid ExpensesAccrued Incomes


6/25

Concepts- CURRENT

LIABILITIESSundry Creditors:

Provisions

Short Term Bank Loans.

Bank Overdrafts

Outstanding Expenses.


7/25

Concepts- Dynamic ViewWorking Capital Investment =

Investment in Raw Material

+

Investment in Work In Process

+Investment in Finished Goods

+

Investment in Accounts Receivable

+

Investment in Minimum Cash Balance

-

Accounts Payables


8/25

FACTORS INFLUENCING WORKING CAPITAL

REQUIREMENTS

Nature of Business

Seasonality of Operations

Production Policy

Market Conditions

Conditions of Supply


9/25

WORKING CAPITAL POLICY

Two important issues in working capital policy are:

What should be the level of investment in current

assets?

What mix of long-term and short-term financing should

the firm employ to support current assets?


10/25

LEVEL OF CURRENT ASSETS

Flexible Restrictive

(Conservative) (Aggressive)Policy Policy

Liquidity High Low

Inventories Large Small

Debtors High Low

A flexible policy results in fewer production stoppages, ensures

quicker deliveries to customers, and stimulates sales .. but

HIGHER INVESTMENT IN CURRENT ASSETS

A restrictive policy leads to more production stoppages, delayed

deliveries to customers, and lost sales but

LOWER INVESTMENT IN CURRENT ASSETS


11/25

CAPITAL REQUIREMENTS

AND THEIR FINANCING

Capital

requirements

Fluctuating currentasset requirement

Permanent current

asset-requirement

Fixed asset

requirement

Time

A

B

C


12/25

CURRENT ASSETS FINANCING

POLICY

According to the matching principle, fixed assets and

permanent current assets should be supported by long-

term sources of finance whereas fluctuating current assets

must be supported by short-term sources of finance.


13/25

PROFIT CRITERION FOR

WORKING CAPITAL

Investment in current assets is easily reversible.

For reversible investments, the criterion of net profit per

period (which here means residual income) is equivalent

to the criterion of net present value


14/25

OPERATING CYCLE AND CASH CYCLE

Order placed Stock arrives Goods sold Cash received

Inventory period Accounts

receivable period

Accounts

payable period

Firm receives Cash paid for

invoice materials

Operating cycle

Cash cycle

Average inventory

Inventory period =

Average COGS / 365

Average accounts receivable

Accounts receivable period =

Annual sales / 365

Average accounts payable

Average payable period =

Average COGS / 365


15/25

Raw Material

Consumption

Period=

Average Raw MaterialInventory

(Annual RawMaterial

Consumption ) /360

=

Average WIP

Inventory

(Cost of Production)/360

Work in Process

Conversion Period

FORMULA


16/25

Finished Goods

Conversion Period =

Average Finished GoodsInventory

(Cost of Goods

sold) /360

=

Average Sundry

Debtors

(Credit Sales)/360

Debtors Conversion

Period

FORMULA


17/25

Creditors Payment

Period=

Average Creditors

(Credit

Purchases) /360

FORMULA


18/25

FORMULA contd..

Annual Consumption of Raw Material=

Opening stock of Raw Material +

Purchases Closing stock of

Raw materialsAnnual Cost of Production =

Opening stock of WIP + Annual

Consumption of Raw material +

Production Cost + Depreciation

Closing WIP


19/25

Cost of Sales= Opening inventory of

Finished Goods+ Annual Cost of

Production +Sales and Distrn Cost + Excise

Duty -Closing stock of Finished Goods


20/25


21/25

ILLUSTRATION

Financial Information for Horizon Limited

Balance Sheet Data

Profit and Loss Beginning of End of

Account Data 20X0 20X0

Sales 800 Inventory 96 102

Cost of goods 720 Accounts receivable 86 90

Sold Accounts payable 56 60

(96 + 102) / 2Inventory period = = 50.1 days

720 / 365


22/25

(86 + 90) / 2

Accounts receivable period = = 40.2 days

800 / 365

(56 + 60) / 2

Accounts payable period = = 29.4 days

720 / 365

Operating cycle = 50.1 + 40.2 = 90.3 daysInventory Accounts

period receivable

period

Cash cycle = 90.3 - 29.4 = 60.9 days

Operating Accounts

cycle payable period


23/25

CASH REQUIREMENT FOR

WORKING CAPITAL

Step 1 : Estimate the cash cost of various current assets

required by the firm.

Step 2 : Deduct the spontaneous current liabilities from

the cash cost of current assets


24/25

SUMMING UP

Current assets have a short life span and are swiftly

transformed into other asset forms.

The working capital needs of a firm are influenced by

numerous factors : nature of business, seasonality of

operations, production policy, market conditions, andsupply conditions.

Determining the optimal level of current assets involves

a tradeoff between carrying costs and shortage costs.

According to the matching principle, the maturity of the

sources of finance should match the maturity of assets

being financed.

Th ti l f fi b i ith th i iti


25/25

The operating cycle of a firm begins with the acquisition

of raw materials and ends with the collection of

receivables.

The cash requirement of working capital is calculated by

estimating the cash cost of various current assets

required by the firm and deducting the spontaneous

current liabilities from the cash cost of current assets.

mba 2009 working capital management 2

Documents