unit i- mwc basics

7/29/2019 Unit I- MWC Basics

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Dr. Vivek Sharma

Working CapitalManagement


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Topics

Concept of working capital

Operating and cash conversion cycle

Permanent and variable working capital

Balanced working capital Determinants of working capital

Issues In working capital management

Estimating working capital Policies of working capital finance


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Introduction

Working capital is the amount of fundsnecessary to cover the cost of operatingthe enterprise.

Working capital is descriptive of thatcapital which is not fixed.

But, the more common use of workingcapital is to consider it as the:

Current assets minus Current liabilities.


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Objective of Working Capital

Primary Objective(s) Maintenance of Working Capital to pay for the

expenses Availability of ample Funds at the time of need

Explanation: For the purchase of raw materials, components

and spares. To pay wages and salaries. To incur day to day expenses and overhead

costs such as fuel, power, and office expensesetc.

To provide credit facilities to customers etc.


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Concepts of Working Capital

Gross Working Capital (GWC)

GWC refers to the firms total investment in current

assets.

GWC focuses upon Optimization of investment in current assets

Financing of current assets

Net Working Capital (NWC).

NWC refers to the difference between current assetsand current liabilities.

NWC focuses upon Liquidity position of the firm

Judicious mix of short-term and long-term financing.


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Current Assets and Its Components

Current assets are the assets which can be

converted into cash within an accounting

year.

Constituents of Current AssetsCash in Hand and Cash at Bank,

Investment in Marketable securities,

Debtors, Bills Receivable,Prepaid Expenses,

Closing Stock (Inventory) Raw Material,

Work in Progress, Finished Goods.6


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Characteristics of Current Assets

Short life span

Swift transformation into other asset forms

Easily convertible into Cash

Repetitive and frequent Nature Substantial portion of Total Investments

Depends upon changes in the level of business

activity Indicator of the nature of financial planning

Reveals the creditworthiness of the firm

Current asset is identified as working capital 7


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Current Liabilities and Its

Components Current liabilities(CL) are those claims ofoutsiders which are expected to mature for

payment within an accounting year.

Constituents of Current LiabilitiesTrade Creditors (Accounts payable), Bills

payable (Notes payable)

Short-term Public deposits, Short-term LoansBank Overdraft,

Outstanding expenses

Provision for Tax

Un aid on unclaimed dividends8


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Operating Cycle

Operating cycle is the time duration required to

convert sales, after the conversion of

resources into inventories, into cash. The

operating cycle of a manufacturing companyinvolves three phases: Acquis i t ion of resources such as raw material, labour,

power and fuel etc.

Manu facture of the produ ctwhich includes conversion ofraw material into work-in-progress into finished goods.

Sale of the producteither for cash or on credit. Credit sales

create account receivable for collection.


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Operating Cycle

The length of the operating cycle of a

manufacturing firm is the sum of:

Inventory conversion period (ICP) plus

Debtors (receivable) conversion period(DCP).


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Operating Cycle

Inventory Conversion Period

Inventory conversion period is the total time needed

for producing and selling the product. Typically, it

includes: Raw material conversion period (RMCP)

Work-in-process conversion period (WIPCP)

Finished goods conversion period (FGCP)

Debtors Conversion Period

The debtors conversion period is the time

required to collect the outstanding amount from

the customers.


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Creditors or Payables DeferralPeriod Creditors orpayables deferralperiod

(CDP) is the length of time the firm is able to

defer payments on various resource

purchases.


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Operating Cycle

Gross operating cycle(GOC)

The total of inventory conversion period and debtors

conversion period is referred to as gross operating

cycle (GOC). Net operating cycle(NOC)

NOC is the difference between gross operating

cycle (GOC) and creditors or payables deferral

period (CDP). Cash conversion cycle (CCC)

CCC is the difference between NOC and non-cash

items like depreciation.


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Operating Cycle

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Types of Working Capital

Permanent orfixed working capital

A minimum level of current assets, which iscontinuously required by a firm to carry on its

business operations, is referred to aspermanent or fixed working capital.

Fluctuating orvariable working capital

The extra working capital needed to support

the changing production and sales activitiesof the firm is referred to as fluctuating orvariable working capital.


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Permanent Working

Capital

The amount of current assets required tomeet a firms long-term minimum needs.

Permanent current assets

TIME

RUPE

EAMOUNT


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Temporary Working

Capital

The amount of current assets that varies withseasonal requirements.

Permanent current assets

TIME

Temporary current assets

RUPE

EAMOUNT


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Positive and Negative Working

Capital Whenever the total Current Assets exceedthe total Current Liabilities, it results in a

positive Working Capital.

Positive Working Capital= CA > CL

Whenever the total Current Liabilities exceed

the total Current Assets, it results in anegative Working Capital.

Negative Working Capital

= CA < CL18


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Determinants of Working Capital

Nature of business

Scale of Operations(Size of Business)

Manufacturing Cycle and Time lag in

Production and Sales

Sales Volume and Turnover of Working

Capital

Credit Policy(terms of Sales and Purchase) Production Policy

Business Cycle


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Determinants of Working Capital

Seasonal Fluctuations

Operating Efficiency

Growth and Expansion

Price level Changes and Adjustments thereto

Taxation

Dividend & Retention Policy


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Issues in Working Capital Management

Levels of current assets

Current assets to fixed assets

Liquidity Vs. profitability

Cost trade-off


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Importance of Working Capital

Cash Discount

Liquidity & Solvency

Meeting Unforeseen Contingencies

High Morale

Good Bank Relations

Increased Productivity in Fixed Assets

Research & Development

Expansion Facilitated

Profitability Increased


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Estimating Working capital

Current assets ho ld ing per iod

To estimate working capital requirements on the basisof average holding period of current assets and relatingthem to costs based on the companys experience in

the previous years. This method is essentially based onthe operating cycle concept.

Ratio of sales

To estimate working capital requirements as a ratio of

sales on the assumption that current assets changewith sales.

Ratio of f ixed investment

To estimate working capital requirements as apercentage of fixed investment.


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Scope/Goals of Working Capital

ManagementPolicy

Policy

Media

SAFETY LIQUIDITY PROFITABILITY

eCASH

Deficiency

Decelerate

Outflow

Accelerate

Inflows

Excess

Credit

Management

Minimize Time

Bank

Management

Minimize Cost

A/C Receivables

Management

Minimize Time

A/C Payables

Management

optimize Time


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Working Capital Finance Policies

Long-term

Short-term

Spontaneous

Short-term Vs.

Long-term

financing

Cost Flexibility

Risk


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Working Capital Finance Policies

Matching

Conservative

Aggressive


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THANK YOU

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unit i- mwc basics

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