Working Capital-An initial thought

ÎThe amount of funds, which a company must

have to finance its day-to-day operations.

ÎThat p proportion
p of the company’s
p y total
capital, which is employed in short term
operations

Dr. Irala 1 Working Capital

 Working Capital –Static View
ÎGross Working Capital
„ Sum total of all Current Assets ((including
g loans &
advances)
„ also known as “Current Capital (or) Circulating
Capital”.
Capital”
ÎNet Working Capital
„ Difference between the current assets and
Current Liabilities(including provisions)
„ also known as Net Current Assets

Dr. Irala 2 Working Capital

 Working Capital –Static View
Î Current Assets
Î Convertible into cash with a single accounting period
ÎCurrent Liabilities
Î Arise in the context of CA and come up for payment within a
single account period
ÎMaintain a current ratio of 2 :1
Î Company
p y can meet all its current liabilities by
y liquidating
q g CA
even at half of their recoded value without any financial
embarrassment

Dr. Irala 3 Working Capital

 Static View-Limitations
ÎCA and CL are Balance sheet data
„ Valid
V lid for
f the
th day
d
ÎCA and CL presented in accordance with
schedule Vi requirements of the Indian
companies Act
„ Not included under CL
ÎBank borrowings (credit/OD) -shown under
secured loans
ÎPublic deposits -shown
shown under unsecured loans
„ Not included under CL
ÎMarketable securities such as treasury bills -
shown under Investments

Dr. Irala 4 Working Capital

 WCM-Dynamic View
ÎThe amount of capital required for smooth
and uninterrupted functioning of normal
business activities

Realizing Cash

Procurement
Sales
of RM

Production of
Finished Goods

Dr. Irala 5 Working Capital

Composition of Working Capital
ÎNature of Business
„ Manufacturing Vs. Trading Vs. Services
ÎRaw Material
„ Availability
ÎDomestic Vs Imports
ÎSeasonal Vs Round the year
„ Carrying costs
„ Lead time
„ Shelf -life
„ Price sensitivity/Inflation
„ Bulk Purchases and discounts
„ Govt. Regulation /Quotas
Dr. Irala 6 Working Capital
Composition of Working Capital
ÎNature of Production Process
„ Pre Production Processing
„ Work-In-Progress
ÎFinished Goods
„ Shelf –life
„ Utility
ÎSeasonal
„ Accuracy of sales forecasts
„ Ability to meet sudden demand
„ Stock out costs
ÎAccounts Receivables
„ Competition
Dr. Irala 7 Working Capital
 Interdependence among WC
Components
Accounts Accounts
Sales
p y
payables Receivables

Procurement of Cash
RM

S&D
Wages & Mfg. Gen. Admn.
Costs Financial Costs

WIP Fi i h d G
Finished Goods
d

Dr. Irala 8 Working Capital

 Operating Cycle
TIME LINE
Purchase of Payment of Sale of Cash
Raw cash to raw finished received for
Materials materials goods Sales

INVENTORY
CONVERSION PERIOD RCP

GROSS OPERATING CYCLE (GOC)

PDP NET OPERATING CYCLE (NOC)

NOC = GOC - PDP

Dr. Irala 9 Working Capital
 Operating Cycle

ÎThe operating cycle is the time duration

required to convert the resources into
inventories, into sales and finally into cash

ÎThe OC consists of two periods

p
„ 1) Inventory Conversion Period (ICP)
„ 2) Receivables conversion period (RCP)

Î OC = ICP + RCP

Dr. Irala 10 Working Capital

Inventory Conversion Period (ICP)
The ICP is the time required to convert raw
materials, into work-in-progress and into
finished goods. The ICP is the sum of Raw
materials conversion period (RMCP), Work in
progress conversion period (WIPCP) and
finished goods conversion period.(FGCP)

ICP = RMCP + WIPCP + FGCP

Dr. Irala 11 Working Capital

Inventory Conversion Period (ICP)
Î Raw Material Conversion Period
Closing
g RM Inventory
y
Î RMCP =
RM Consumption per day

Î Work –in-progress conversion period

Closing WIP Inventory
Î WIPCP =
Cost of production per day

Î Finished Goods conversion period

Closing FG Inventory
Î FGCP =
COGS pper day
y

Dr. Irala 12 Working Capital

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

Closing Receivables
ÎRCP =
Cost of sales per day

Dr. Irala 13 Working Capital

 The payables deferral period (PDP)

PDP is the length of time the firm is able to

defer payments on various resource
purchases

Closing Payables
ÎPDP = Cost of sales per day

Dr. Irala 14 Working Capital

 WCM-Objective
ÎLiquidity Vs. Profitability
„ Level
L l off Working
W ki Capital
C it l
ÎPattern of financing
„ Source mix

Dr. Irala 15 Working Capital

Fixed Vs. Variable Working Capital
ÎFixed Working Capital
„ constant or minimum level, below, which the total
investment in current assets does not fall.

„ Also called as “Fixed “ or “Constant” or “Permanent”

working capital.
bl Working
ÎVariable k Capitall
„ The amount of funds needed over and above the “Fixed
Working Capital” to take care of seasonal and other shifts

„ Also referred to as “Fluctuating” or “Temporary” Working

Capital.

Dr. Irala 16 Working Capital

Sources of Financing Current Assets
■ Long term financing
Shares, debentures, preference shares,
retained earnings and long-term debt from
financial institutions

■ Short term financing

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

■ Spontaneous financing
Trade credit and outstanding expenses

Dr. Irala 17 Financing Current Assets

Approaches to Financing Current Assets

ÎMatching Approach
ÎC i Approach
ÎConservative A h
ÎAggressive Approach

Dr. Irala 18 Financing Current Assets

 Matching Approach
L
E VARIABLE
SHORT
V CURRENT ASSETS TERM F
E SOURCES
I
L N
A
LONG
N
O
C
F FIXED I
CURRENT ASSETS TERM
N
A G
S SOURCES
S FIXED ASSETS
E
T TIME
S
Dr. Irala 19 Financing Current Assets
 Conservative Approach

VARIABLE
L CURRENT ASSETS S T SOURCES
F
e
I
v LONG N
e A
l N
TERM C
FIXED I
o CURRENT ASSETS N
f SOURCES G

A
s FIXED ASSETS
s TIME
e
Dr.tIrala 20 Financing Current Assets
 Aggressive Approach
VARIABLE
L CURRENT ASSETS
e SHORT F
I
v TERM
N
e SOURCES A
l N
C
FIXED I
o LONG
CURRENT ASSETS N
f G
TERM
A SOURCES
s FIXED ASSETS
s TIME
e
t
Dr. Irala 21 Financing Current Assets
s
 Working Capital Management
Days Weeks Months Annual Average
Current Assets
Finished Goods
Stores, material
Debtors (domestic)
Debtors (exports)
Ad P t F
Adv. Pmt. For sundry exp.
d

Current Liabilities
Current Liabilities
Wages
Stocks, Material
Rent, Royalties
Clerical Staff
Manger
Misc.

Net Working Capital

Dr. Irala 22 Receivables Management

 Working Capital Management
Days Weeks Months Annual Average
Current Assets
Finished Goods 5 000 5 000
Stores, material 8 000 8 000
Debtors (domestic) 6 3 12 000 36 000
Debtors (exports) 1.5 78 000 2 250
Ad P t F
Adv. Pmt. For sundry exp.
d 3 8 000
8 000 2 000
2 000
53 250

Current Liabilities
Current Liabilities
Wages 1.5 2 60 000 7 500
Stocks, Material 1.5 48 000 1 385
Rent, Royalties 6 10 000 5 000
Clerical Staff 0.5 62 000 2 583
Manger 0.5 4 800 200
Misc. 1.5 48 000 6 000
22 668
22 668
Net Working Capital 30 582

Dr. Irala 23 Receivables Management

 Working Capital Management

Units Produced & Sold

Units Produced & Sold 1 04 000
1 04 000

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

Cash Sales 52 00 000
Credit Sales 156 00 000

Dr. Irala 24 Receivables Management

 Working Capital Management
Days
Current Assets
Raw material inventory 30 6 93 333 RM
Material in Process 15 7 36 667 COP
Finished Goods 30 14 73 333 COP
Debtors 60 26 00 000 Credit Sales
Cash Balance
Cash Balance 25 000
25 000
55 28 333

Current Liabilities
Creditors 30 6 93 333 RM
Wages 10 86 667 Direct Labour
Overheads 30 5 20 000
13 00 000
13 00 000

Net working Capital 42 28 333
Add: 10% Contingencies 4 22 833
46 51 167

Dr. Irala 25 Receivables Management

 Working Capital Management

Units Produced & Sold 1 00 000

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

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

Dr. Irala 26 Receivables Management

 Working Capital Management
Weeks
Current Assets
R
Raw material inventory
t i li t 4 3 26 154
3 26 154 RM
Material in Process 2 3 46 538 COP
Finished Goods 4 6 93 077 COP
Debtors
ebtors 8 12 23 077
3 077 Credit Sales
Credit Sales
Cash Balance 1 25 000
27 13 846

Current Liabilities
Creditors 4 3 26 154 RM
Wages 2 61 154 Direct Labour
3 87 308
3 87 308

Net working Capital 23 26 538
Add: 10% Contingencies 2 32 654
25 59 192

Dr. Irala 27 Receivables Management

 Working Capital Management

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
0.70 1100 830 1930
1.00 2200 690 2890
1.50 4140 550 4690
2.50 6890 276 7166

Dr. Irala 28 Receivables Management

 Working Capital Management
8000

7000

6000

5000

Cost of Liquidity
4000
Cost of Illiquidity
Total Cost
3000

2000

1000

0
0.1 0.25 0.4 0.7 1 1.5 2.5

Dr. Irala 29 Receivables Management

 Working Capital Management
Int. 
Int on LTD 
Long Term 
g Investm Income  Net Int. 
M th
Month WC @
@ 
debt ent @1%p. Exp
1.17%p.m
m
1January 72.65 92.02 1.077 19.37 0.194 0.883
2F b
2February 58 13
58.13 92 02
92.02 1 077 33.89
1.077 33 89 0.339
0 339 0.738
0 738
3March 29.06 92.02 1.077 62.96 0.630 0.447
4April 24.22 92.02 1.077 67.8 0.678 0.399
5Mayy 33.9 92.02 1.077 58.12 0.581 0.495
6June 43.6 92.02 1.077 48.42 0.484 0.592
7July 58.12 92.02 1.077 33.9 0.339 0.738
8August 72.66 92.02 1.077 19.36 0.194 0.883
9September
b 82.3 92.02 1.077 9.72 0.097 0.979
10October 87.19 92.02 1.077 4.83 0.048 1.028
11November 92.02 92.02 1.077 0 0.000 1.077
12December 87.17 92.02 1.077 4.85 0.048 1.028
Total 741.02 1104.24 12.92 363.22 3.63 9.29

Dr. Irala 30 Receivables Management

 Working Capital Management

Int on STL @ 
Month WC ST Loan
1 33%p m
1.33%p.m
1January 72.65 72.65 0.966
2February 58.13 58.13 0.773
3March 29 06
29.06 29 06
29.06 0 386
0.386
4April 24.22 24.22 0.322
5May 33.9 33.9 0.451
6June 43.6 43.6 0.580
7July 58.12 58.12 0.773
8August 72.66 72.66 0.966
9September 82.3 82.3 1.095
10October 87 19
87.19 87 19
87.19 1 160
1.160
11November 92.02 92.02 1.224
12December 87.17 87.17 1.159
Total 741.02 741.02 9.86

Dr. Irala 31 Receivables Management

 Working Capital Management

Aggressiv Moderat Conserva

e e tive Remarks
1Current Assets 252 270 288 Given
2Fixed Assets 180 180 180 Given
3Total Assets
3Total Assets 432 450 468 1+2

4Current Liabilities 150 150 150 Given

5Short ‐term
5Short  term Debt
Debt 216 162 108 Given
6Long Term Debt 43.2 108 172.8 7‐‐5
7Total Debt 259.2 270 280.8 as 60% of Total Assets

8Equity 22.8 30 37.2 9‐‐7‐‐4

p
9Total capital 432 450 468 equals total assets
q

Dr. Irala 32 Receivables Management

 Working Capital Management

10Sales 531 540 549 Given

11EBIT 53 54 55 Given
Int. on short term 
12 debt @ 16%p.a 34.56 25.92 17.28
Int. on long term 
13 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 0.62
17CA/CL 1.68 1.80 1.92
18NWC 102 120 138

Dr. Irala 33 Receivables Management