Css 11 working capital management

WORKINGCAPITAL

MANAGEMENT

amitabha maheshwari 1

Concept of working capital

Importance of working capital

Determents of working capital

Source of working capital financing

Determination of Operating Cycle


Gross working capital (GWC) GWC refers to the firm’s total investment in

current assets.

Current assets are the assets which can be converted into cash within an accounting year (or operating cycle) and include cash, short-term securities, debtors, (accounts receivable or book debts) bills receivable and stock (inventory).


Net working capital (NWC).NWC

refers to the difference between current assets and current liabilities.

It is the excess of current assets over current liabilities.

It is that portion of a firm’s current assets which is financed by long-term funds.


Net working capital (NWC). Current liabilities (CL) are those claims of

outsiders which are expected to mature for payment within an accounting year and include creditors (accounts payable), bills payable, and outstanding expenses.

NWC can be positive or negative. Positive NWC = CA > CL Negative NWC = CA < CL


GWC focuses onOptimization of investment in current liabilities

Financing of current assets NWC focuses on Liquidity position of the firmJudicious mix of short-term and long-tern financing


Nature of business Manufacturing cycle Production process Business cycle Seasonal variation Scale of Operation Inventory policy Credit policy Depreciation policy


Business Standing Growth of business Market condition Supply Situation Nature of Raw Material Used Process Technology Used Nature of Finished Goods Degree of Competition in the Market Profit level Dividend policy


Liquidity vs. Profitability

Choosing the Pattern of Financing



Working capital management refers to the administration of all components of working capital-cash , marketable securities, debtors (receivables), stock (inventories),creditors (payables).

The financial manager must determine the levels and composition of current assets.

He must see that right sources are tapped to finance current assets, and that current liabilities are paid in time.


There are many aspects of working capital management which make it an important function of the financial manager.◦Time: Working capital management requires much of the

financial manager's time. ◦Investment: Working capital represents a large portion of

the total investment in assets. ◦Criticality: Working capital management has great

significance for all. Firms but it is very critical for small firms.

◦Growth The need for working capital is directly related to the firm's growth.


The financial manager should determine the optimum level of current assets so that the wealth of shareholders is maximized.

A firm needs fixed and current assets to support a particular level of output.

However, to support the same level of output, the firm can have different levels of current assets.

As the firm's output and sales increase, the need for current assets increases.


Generally, Current assets do not increase in direct proportion to output.

Current assets may increase at a decreasing rate with output.

The level of the current assets can be measured by relating current assets to fixed assets. Dividing current assets by fixed assets gives CA/FA ratio. Assuming a constant level of fixed assets,


A higher CA/FA ratio indicates a conservative current assets policy. It implies greater liquidity and lower risk;

A lower CA/FA ratio means an aggressive current assets policy, it indicates higher risk and poor liquidity.

Moderate Coverage current assets policy falls in the middle of conservative and aggressive policies. The current assets policy of the most firms may fall between these two extreme policies.


Gross working capital and Net working capital.

Gross working capital is equal to the total of all currentassets (including ‘loans and advances’) of a company.

Net working capital is defined as the differencebetween gross working capital and current liabilities(including ‘provisions’). Sometimes net working capitalis also referred to as ‘net current assets.’


Working capital can be viewed as the amount of capital required for the smooth and uninterrupted functioning of the normal business operations of a company ranging from the procurement of raw materials, converting the same into finished products for sale and realizing cash along with profit from the accounts receivables that arise from the sale of finished goods on credit.


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 company involves three phases:

Acquisition of resources such as raw material, labour, power and fuel etc.

Manufacture of the product which includes conversion of raw material into work-in-progress into finished goods.

Sale of the product either for cash or on credit. Credit sales create account receivable for collection.


The length of the operating cycle of a manufacturing firm is the sum of:

inventory conversion period (ICP).

Debtors (receivable) conversion period (DCP).

Creditors or payables deferral period (CDP)


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)



raw material conversion period (RMCP)Average Raw Materials

=------------------- x 365Raw material consumed






work-in-process conversion period (WIPCP)Average work in process

=------------------- x 365Total cost of production






finished goods conversion period (FGCP) Average stock (FG)

=------------------- x 365Total cost of goods sold


The debtors conversion period is the time required to collect the outstanding amount from the customers.

Average debtors=------------------- x 365

Total credit sales


Creditors or payables deferral period (CDP) is the length of time the firm is able to defer payments on various resource purchases.

Average Creditors=------------------- x 365

Total credit Purchases


Gross operating cycle (GOC)The total of inventory conversion period and debtors conversion period is referred to as gross operating cycle (GOC).

Gross Operating Cycle = Raw Material Storage Period + Conversion period + Finished Goods Storage Period + Average Collection Period


Net operating cycle (NOC)NOC is the difference between GOC and CDP.

Net Operating Cycle = Gross Operating Cycle – Average Payment period


RMCP ----- +WPCP ----- +FGCP ----- +RCP(DCP) ----- TOCP(Gross operating cycle) ----- - CDP ----- NOC -----


What has been considered in figure above as working capital cycle is more popularly known as the operating cycle.

This title is more expressive in the sense that the normal business operations of a manufacturing and trading company start with cash, go through the successive segments of the operating cycle, viz, raw material storage period, conversion period, finished goods storage period and average collection period before getting back cash along with profit.

The total duration of all the segments mentioned above is known as ‘gross operating cycle period’.


Calculate operational cycle No.of days

requirement Inventory 60 Work-in-process 30 Finished products 30 Credit allowed to customers 30 Cash balance (approximate) 7 Creditors 30


From the following information, extracted from the books of a manufacturing company, compute the operational cycle in days.

Period covered : 365 days. Average Period of credit allowed by Suppliers - 16 days.


Rs.’000

Average total of debtors outstanding Raw-material consumption Total Production Cost Total Cost of Sales Sales for the year Value of Average Stock maintained -- Raw-material Work - in -Progress Finished Goods

480 4,400 10,000 10,500 16,000320350260

From the following details, prepare an estimate of the requirement of working Capital Production 60,000Units Selling price per unit Rs. 5 Raw Materials 60% of selling Price Direct wages 10% of selling Price Overheads 20% of selling Price Materials in hand 2 month’s requirements Production Time 1 month Finished Goods in Stores 3 months Credit for Material 2 months Credit allowed to Customers 3 months Average Cash Balance Rs. 20,000 Wages and overheads are paid at the beginning of the month following. in

production all the required materials are charged in the initial stage and wages and overheads accrue evenly.


Cash conversion cycle (CCC)CCC is the difference between NOP and non-cash items like depreciation.

#NOP: net operating profit

amitabha maheshwari

Gross Operating Cycle = Raw Material Storage Period + Conversion period + Finished Goods Storage Period + Average Collection Period

Net Operating Cycle = Gross Operating Cycle – Average Payment period


Current Assets:(i) Cash ----(ii) Debtors or Receivables(for ..month’s sales ) ----(iii)Stock (for…month’s sales) ----(iv)Advance payment, if any ----(v) Others ----Total Current Assets ----Less: Current Liabilities(i) Creditors (for..month’s Purchases) ----(ii) Lag in payment of expenses(o/s expenses, if any) ----Total Current Liabilities ----Working capital(C.A. – C.L. ) ----Add: Provision / Margin For Contingencies ----Net Working Capital Required ----


Current Assets

(i)Stock of Raw Material(for…month’s consumption) ----

(ii) Work – in- Process (For..month’s)

(a) Raw Materials ----

(b) Direct Labour ----

(c) Overheads ---- ----

(iii) Stock of finished Goods (For.. Month’s sales)




(iv) Sundry Debtors(For..month’s sales)




(V) Payment in advance ----

(vi) Balance of cash (Required to meet day-to-day exp.) ----

Total current Assets

Less: Current Liabilities:

(i) Creditors (for..month’s Purchases) ----(ii) Lag in payment of expenses(o/s expenses, if any) ---- ----Total Current Liabilities ----Working capital(C.A. – C.L. ) ----Add: Provision / Margin For Contingencies ----Net Working Capital Required -----


Prepare an estimate of working capital requirement from the following information of a trading concern

(a)Project annual sales 100000 units(b)Selling price Rs. 8 per unit(c)Net profit on sales 25%(d)Average credit period allowed to customers 8

weeks(e)Average credit period allowed by suppliers 4 weeks(f) Average stock holding in terms of sales

requirement 12 weeks(g) Allow 10% for contingencies


Current AssetsDebtors(8 weeks) 92,308Stock (12 weeks) 1,38,462

2,30,770Less: Current LiabilitiesCreditors(4 weeks) 46,154Net Working Capital 1,84,616Add 10% for Contingencies 18,462Working Capital Required 2,03,078


Liquidity

Availability of Cash

Inventory Turnover

Credit Extended to Customers

Credit Obtained from Suppliers


Current Ratio

Quick Ratio

Cash to Current Assets

Sales to Cash

Average Collection Period

Inventory Turnover Ratio

Working Capital to Sales amitabha maheshwari 40

Objective of Working Capital Management

Static view of Working Capital

Dynamic view of Working Capital

Determination of Operating Cycle

Evaluating Working Capital Management



Date post:	13-Sep-2014
Category:	Economy & Finance
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Css 11 working capital management

Economy & Finance