working capital-an initial thought

Working Capital-An initial thoughtThe amount of funds, which a company musthave to finance its day-to-day operations.

That proportion of the company’s totalp p p ycapital, which is employed in short termoperations

Dr. Irala 1 Working Capital

Working Capital –Static ViewGross Working Capital

Sum total of all Current Assets (including loans &( gadvances)also known as “Current Capital (or) CirculatingCapital”Capital”.

Net Working CapitalDifference between the current assets andDifference between the current assets andCurrent Liabilities(including provisions)also known as Net Current Assets


Working Capital –Static ViewCurrent Assets

Convertible into cash with a single accounting period

Current LiabilitiesArise in the context of CA and come up for payment within asingle account periodsingle account period

Maintain a current ratio of 2 :1Company can meet all its current liabilities by liquidating CAp y y q geven at half of their recoded value without any financialembarrassment


Static View-Limitations

CA and CL are Balance sheet dataV lid f th dValid for the day

CA and CL presented in accordance withschedule Vi requirements of the Indianschedule Vi requirements of the Indiancompanies Act

Not included under CLNot included under CLBank borrowings (credit/OD) -shown undersecured loansPublic deposits shown under unsecured loansPublic deposits -shown under unsecured loans

Not included under CLMarketable securities such as treasury bills -shown under Investments


WCM-Dynamic ViewThe amount of capital required for smoothand uninterrupted functioning of normalbusiness activities

Realizing CashRealizing Cash

Procurement of RM Sales

Production of Finished Goods


Finished Goods

Composition of Working CapitalNature of Business

Manufacturing Vs. Trading Vs. ServicesRaw Material

AvailabilityDomestic Vs ImportsSeasonal Vs Round the year

Carrying costsCarrying costsLead timeShelf -lifePrice sensitivity/InflationBulk Purchases and discountsGovt. Regulation /Quotas


Composition of Working CapitalNature of Production Process

Pre Production ProcessingWork-In-Progress

Finished GoodsShelf –lifeUtility

SeasonalSeasonalAccuracy of sales forecastsAbility to meet sudden demandAbility to meet sudden demandStock out costs

Accounts ReceivablesCompetition


Interdependence among WC ComponentsComponents

SalesAccountsReceivables

Accounts payablesp y

Procurement of RM

Cash

Wages & Mfg. Costs

S & DGen. Admn.

Financial Costs

WIP Fi i h d G d

Costs Financial Costs


WIP Finished Goods

TIME LINE

Operating CyclePurchase of

Raw Materials

Payment of cash to raw materials

Sale of finished

goods

Cash received for

Sales

TIME LINE

RCPINVENTORY CONVERSION PERIOD

GROSS OPERATING CYCLE (GOC)

PDP NET OPERATING CYCLE (NOC)

NOC GOC PDPNOC = GOC - PDP


Operating Cycle

The operating cycle is the time durationThe operating cycle is the time durationrequired to convert the resources intoinventories, into sales and finally into cash

The OC consists of two periodsp1) Inventory Conversion Period (ICP)2) Receivables conversion period (RCP)

OC = ICP + RCP


Inventory Conversion Period (ICP)The ICP is the time required to convert raw

materials, into work-in-progress and intofinished goods. The ICP is the sum of Rawmaterials conversion period (RMCP), Work inprogress conversion period (WIPCP) andprogress conversion period (WIPCP) andfinished goods conversion period.(FGCP)

ICP = RMCP + WIPCP + FGCP


Inventory Conversion Period (ICP)

Raw Material Conversion PeriodClosing RM Inventoryg y

RMCP =RM Consumption per day

Work –in-progress conversion periodClosing WIP Inventory

WIPCPWIPCP =Cost of production per day

Finished Goods conversion periodFinished Goods conversion periodClosing FG Inventory

FGCP =COGS per dayp y


Receivables conversion period (RCP)The RCP is the time required to convert the

Receivables into cash

Closing ReceivablesRCPRCP =

Cost of sales per day


The payables deferral period (PDP)

PDP is the length of time the firm is able todefer payments on various resourcedefer payments on various resourcepurchases

Closing PayablesPDP = Cost of sales per dayPDP = Cost of sales per day


WCM-Objective

Liquidity Vs. ProfitabilityL l f W ki C it lLevel of Working Capital

Pattern of financingSource mixSource mix


Fixed Vs. Variable Working CapitalFixed Working Capital

constant or minimum level, below, which the totalinvestment in current assets does not fall.

Also called as “Fixed “ or “Constant” or “Permanent”working capital.

bl k lVariable Working CapitalThe amount of funds needed over and above the “FixedWorking Capital” to take care of seasonal and other shifts

Also referred to as “Fluctuating” or “Temporary” WorkingCapital.


Sources of Financing Current Assets■ Long term financing

Shares, debentures, preference shares,retained earnings and long-term debt fromretained earnings and long-term debt fromfinancial institutions

■ Short term financingShort-term bank loans, commercial papers,factoring receivables etc.factoring receivables etc.

■ Spontaneous financingTrade credit and outstanding expenses

Dr. Irala 17 Financing Current Assets

Approaches to Financing Current Assets

Matching ApproachC i A hConservative ApproachAggressive Approach


Matching Approach

VARIABLECURRENT ASSETS SHORT

TERM F

LEV CURRENT ASSETS TERM

SOURCESFINA

VEL

FIXED

LONG ANCI

OF

CURRENT ASSETS TERM

SOURCES

INGA

SFIXED ASSETS

SOURCES

TIME

SSET TIMETS


Conservative Approach

LVARIABLE

CURRENT ASSETS FS T SOURCES

eve

CURRENT ASSETS

LONG

FINAe

l

FIXEDTERM

ANCIo

f CURRENT ASSETS

SOURCES

ING

Ass

FIXED ASSETSTIMEs

et

TIME


Aggressive Approach

VARIABLECURRENT ASSETS F

LSHORTCURRENT ASSETS F

INA

eve

SHORT

TERM

SOURCES

FIXED LONG

ANCI

el

o

SOURCES

CURRENT ASSETS LONG

TERM

ING

of

FIXED ASSETS SOURCES

TIME

Ass TIMEsets


Working Capital ManagementDays Weeks Months Annual Average

Current AssetsFinished GoodsStores, materialDebtors (domestic)Debtors (exports)Ad P t F dAdv. Pmt. For sundry exp.

Current LiabilitiesCurrent LiabilitiesWagesStocks, MaterialRent, RoyaltiesClerical StaffMangerMisc.

Dr. Irala 22 Receivables Management

Net Working Capital

Working Capital ManagementDays Weeks Months Annual Average

Current AssetsFinished Goods 5 000 5 000Stores, material 8 000 8 000Debtors (domestic) 6 3 12 000 36 000Debtors (exports) 1.5 78 000 2 250Ad P t F d 3 8 000 2 000Adv. Pmt. For sundry exp. 3 8 000 2 000

53 250

Current LiabilitiesCurrent LiabilitiesWages 1.5 2 60 000 7 500Stocks, Material 1.5 48 000 1 385Rent, Royalties 6 10 000 5 000Clerical Staff 0.5 62 000 2 583Manger 0.5 4 800 200Misc. 1.5 48 000 6 000

22 668


22 668Net Working Capital 30 582

Working Capital Management

Units Produced & Sold 1 04 000Units Produced & Sold 1 04 000

Per Unit Rs. Per anumRaw Material 80 83 20 000Direct labour 30 31 20 000Overheads 60 62 40 000Cost of Production 170 176 80 000P fit 30 31 20 000Profit 30 31 20 000Selling Price 200 208 00 000

Cash Sales 52 00 000Credit Sales 156 00 000


Working Capital ManagementDays

Current AssetsRaw material inventory 30 6 93 333 RMMaterial in Process 15 7 36 667 COPFinished Goods 30 14 73 333 COPDebtors 60 26 00 000 Credit SalesCash Balance 25 000Cash Balance 25 000

55 28 333

Current LiabilitiesCreditors 30 6 93 333 RMWages 10 86 667 Direct LabourOverheads 30 5 20 000

13 00 00013 00 000

Net working Capital 42 28 333Add: 10% Contingencies 4 22 833


46 51 167


Units Produced & Sold 1 00 000

Per Unit Rs. Per anumRaw Material 42.40 42 40 000Direct labour 15 90 15 90 000Direct labour 15.90 15 90 000Overheads 31.80 31 80 000Cost of Production 90.10 90 10 000Profit 15 90 15 90 000Profit 15.90 15 90 000Selling Price 106.00 106 00 000

Cash Sales 26 50 000Cash Sales 26 50 000Credit Sales 79 50 000



WeeksCurrent AssetsR t i l i t 4 3 26 154 RMRaw material inventory 4 3 26 154 RMMaterial in Process 2 3 46 538 COPFinished Goods 4 6 93 077 COPDebtors 8 12 23 077 Credit Salesebtors 8 3 077 Credit SalesCash Balance 1 25 000

27 13 846

Current LiabilitiesCreditors 4 3 26 154 RMWages 2 61 154 Direct Labour

3 87 3083 87 308

Net working Capital 23 26 538Add: 10% Contingencies 2 32 654


25 59 192


CA/FA Cost of Liquidity Cost of Illiquidity Total Cost

0.10 138 2200 2338

0.25 275 1650 1925

0.40 550 1100 1650

0 70 1100 830 19300.70 1100 830 1930

1.00 2200 690 2890

1.50 4140 550 4690

2.50 6890 276 7166



7000

8000

5000

6000

3000

4000Cost of Liquidity

Cost of Illiquidity

Total Cost

1000

2000

0

0.1 0.25 0.4 0.7 1 1.5 2.5



M th WCLong Term

Int on LTD @

InvestmInt.

Income Net Int. Month WC

gdebt

@ 1.17%p.m

ent @1%p.m

Exp

1January 72.65 92.02 1.077 19.37 0.194 0.8832F b 58 13 92 02 1 077 33 89 0 339 0 7382February 58.13 92.02 1.077 33.89 0.339 0.7383March 29.06 92.02 1.077 62.96 0.630 0.4474April 24.22 92.02 1.077 67.8 0.678 0.3995May 33.9 92.02 1.077 58.12 0.581 0.495y6June 43.6 92.02 1.077 48.42 0.484 0.5927July 58.12 92.02 1.077 33.9 0.339 0.7388August 72.66 92.02 1.077 19.36 0.194 0.883

b9September 82.3 92.02 1.077 9.72 0.097 0.97910October 87.19 92.02 1.077 4.83 0.048 1.02811November 92.02 92.02 1.077 0 0.000 1.07712December 87.17 92.02 1.077 4.85 0.048 1.028


12December 87.17 92.02 1.077 4.85 0.048 1.028Total 741.02 1104.24 12.92 363.22 3.63 9.29


Month WC ST LoanInt on STL @ 1 33%p m1.33%p.m

1January 72.65 72.65 0.9662February 58.13 58.13 0.7733March 29 06 29 06 0 3863March 29.06 29.06 0.3864April 24.22 24.22 0.3225May 33.9 33.9 0.4516June 43.6 43.6 0.5807July 58.12 58.12 0.7738August 72.66 72.66 0.9669September 82.3 82.3 1.09510October 87 19 87 19 1 16010October 87.19 87.19 1.16011November 92.02 92.02 1.22412December 87.17 87.17 1.159

Total 741.02 741.02 9.86



Aggressive

Moderate

Conservative Remarkse e tive Remarks

1Current Assets 252 270 288 Given2Fixed Assets 180 180 180 Given3Total Assets 432 450 468 1+23Total Assets 432 450 468 1+2

4Current Liabilities 150 150 150 Given5Short ‐term Debt 216 162 108 Given5Short term Debt 216 162 108 Given6Long Term Debt 43.2 108 172.8 7‐‐57Total Debt 259.2 270 280.8 as 60% of Total Assets

8Equity 22.8 30 37.2 9‐‐7‐‐4

9Total capital 432 450 468 equals total assets


p q


10Sales 531 540 549 Given11EBIT 53 54 55 Given

12Int. on short term debt @ 16%p.a 34.56 25.92 17.28

13Int. on long term debt @ 18%p.a 7.776 19.44 31.104

14PBT 10.664 8.64 6.616

15ROE 46.77% 28.80% 17.78%16CA/TA 0.58 0.60 0.6217CA/CL 1.68 1.80 1.9218NWC 102 120 138


working capital-an initial thought

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