Working Capital Concept

• Working Capital plays a very vital role in the Day

to Day operations of organisation. It occupies a
large portion of the Total Assets and needs to be
controlled in a proper way to maximise Output
while minimising Cost of Working Capital.
• The Various components of WC are required to be
analysed, controlled and managed separately. The
combination of all these components make
Working Capital effective.
 Components of WC
Current Assets :
• Accounts Receivable : Amount Receivable
against Sales. It represents Credit given by
us to our customers. It is the amount of
Funds equal to Cost of Goods sold invested
in the Receivables. Credit period, cost of
credit and recovery of receivables has to be
critically defined and designed.
 Components of WC
Current Assets :
• Inventory : This represents amount of
funds Invested by the organisation in
Stocks so the goods can be produced as
per demand and sold to generate funds.
Raw Material : Stock of basic Materials
required for Production of Goods
 Components of WC
Current Assets : Inventory
• Work in Progress : This is the amount of Stocks
which are half way through the process of
Production. It is the Raw Material which is not
yet completely processed.
Finished Goods : Stock of Goods produced
completely and which are in Saleable Form.
 Working Capital Components
• Current Assets : Cash and Bank Balances :
This is hard money available for spending
at any time. It is the most liquid form of
asset available in the hands of the
Company.
Idle and excess Cash balance is most non
productive components, but it also
strengthens the Liquidity position of
company.
 WC - Liabilities
Current Liabilities:
• Accounts Payable : Amount payable
against Purchases to our suppliers. This is
the amount of Funds available for shorter
period which can be used for Production.
• Short Term Borrowings : Borrowings from
Banks & Financial Institutions as Stop Gap
arrangement for Day to Day activities.
 WC – A Case Study
• Monthly Sales : Rs. 200000
• Monthly Cost of Production : Rs.144000
• Raw Material : Rs.100000/month
• Stocks : Raw material 2 Months, WIP 15
days, Finished Goods 1 month.
• Credit given to Customers = 1 month
• Credit Received by Suppliers = 15 days.
 Computation of WC
• Current Assets • Current Liabilities
Stocks Payables (1/2 of COGS)
Raw Material = 200000 = 144000
WIP(1/2 of COGS)
WC = CA – CL
= 72000 200000+72000+144000
Finished Goods(Equal to +200000 – 144000
COGS) = 144000 = 472000.
Receivables = 200000
 WC – Inventory Management
• Inventory is almost 60-70% of Ideal WC
composition if WC is managed properly. It is the
largest component of WC having direct impact on
Operations of Company and also direct Impact on
Demand and other Components.
• Management of Inventory, its Logistics, Cost of
Carrying Inventory is matter of great concern in
Manufacturing Organisation.
 Inventory Control – Economic
Order Quantity ( EOQ )
• Major Components of Inventory Cost are
2. Purchase Cost : Uncontrollable
3. Ordering Cost : Cost per order : Can be
managed through Controlled Orders
4. Carrying Cost : Cost of Stocking and
Maintaining Inventory, Handling Cost,
Space Cost etc. : Can be managed through
Ideal and Optimum Stock Level in Store.
 EOQ : Control of Inventory
Costs
• Economic Order Quantity is an approach which
aims at Balancing both the costs namely Ordering
Cost and Carrying Cost.
• Both the Costs are controversial to each other, as
if Ordering Cost reduced, more Stocks are
required and increase Carrying Cost, and if
Carrying Cost is reduced, number of Order
increase.
• EOQ aims at finding the Quantity to be ordered to
such Volume that Both the costs will be almost
minimum and will balance each other.
 EOQ - Formula
• EOQ = Root of
2 X Annual Consumption X
Ordering Cost Per Order
Inventory Carrying Cost Per Unit
Find EOQ for
Monthly Consumption = 200 Units
Ordering Cost Per Order = Rs.100
Carrying Cost = Rs.12 Per Unit
 Inventory Levels : Managing
Logistics & Controlling Costs
• Maximum Order Level : No Order above
this Level
• Minimum Order Level : Stock must not go
below this Level. An Order is a Must
• Danger Level : A zone below Minimum
Order Level, which alerts of Out of Stock
• Re-Order Level : Level at which New Order
or Periodic Order is due.
 Inventory Appraisal – ABC
Analysis
• Inventory is divided in to very varied and
versatile range of products and goods.
• It is very important to have catagorisation
of Inventory Products in to different
catagories based on the Materiality &
Significance
• ABC analysis aims at Catagorisation of all
the Inventory items in to 3 catagories based
upon their Value and Importance
 Inventory Appraisal – ABC
Analysis
Division of Inventory under ABC
• A : These are the Products having Minimum
Quantity but Maximum Value per unit. Most Imp.
Products. All main Raw Materials.
• B : These are those which occupy middle position
in terms of Value as well as Quantity. Spares,
Packing Materials, Tools etc.
• C : Products having large Volume but least Value
per unit, supporting or maintenance products.
Stores and Consumables.
 Inventory Appraisal – ABC
Analysis
Uses of ABC Analysis
• After catagorisation, Storage and Identification of
all the Products becomes effective and efficient
• Logistics and Material handling can be defined
and specialised for each category depending upon
the Preference and Importance
• Inventory Control Systems which are very costly
can be used more prudently if catagorisation is
done as per ABC.
• Inventory Storage, Carrying and Handling Costs
can be controlled effectively.
 Inventory Appraisal – ABC
Analysis
Modality of ABC Analysis
• A Category : Products that are around 70%
in Value but 10% in Volume
• B Category : Products that are around 20%
in Value but 20% in Volume
• C Category : Products that are 10% in
Value but 70% in Volume.