KDFEF WORKING CAPITAL Unit : I V - shasuncollege.edu.in · the inflow and outflows of cash on a...

KDFEF

WORKING CAPITAL

Unit : I – V

KDFEF – Working Capital Management 2

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Unit I –Syllabus

Working Capital Policy

Importance of Working Capital Management

Concept of Working Capital

Risk and Return Trade off Financing Capital Requirements

Issues in working capital policy

Size of Working Capital

Forecasting & Management of Working capital.

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Two types of capital is required by every business firm to run its

business operations.

(i) Fixed capital

(ii) working capital

Meaning Of Working Capital Working capital refers to the capital that is required for day-to-day

working in a business firm such as purchasing raw materials, for meeting

day-to-day expenditures on salaries, wages, rents,etc.

DEFINITION

ICAI – working capital means the funds available for day-to-day

operations of an enterprise.

Working capital management –

An Overview

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Higher Return On Capital

Improved Credit Profile And Solvency

Higher Profitability

Higher Liquidity

Increased Business Value

Favorable Financing Conditions

Uninterrupted Production

Ability To Face Shocks And Peak Demand

Competitive Advantage

CONCEPT OF WORKING CAPITAL

The funds invested in current assets are termed as working capital. It is the fund

that is needed to run the day-to-day operations. There are two concepts in

respect of working capital:

Gross Working Capital = Total current assets

Net Working Capital = Current Assets - Current liabilities

Importance Of Working Capital


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MEANING OF WORKING CAPITAL MANAGEMENT

Working capital management refers to a company's managerial

accounting strategy designed to monitor and utilize the two

components of working capital, current assets and current liabilities,

to ensure the most financially efficient operation of the company.

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The risk-return tradeoff is the principle that potential return rises with an

increase in risk. Low levels of uncertainty or risk are associated with low

potential returns, whereas high levels of uncertainty or risk are associated

with high potential returns. According to the risk-return tradeoff, invested

money can render higher profits only if the investor is willing to accept the

possibility of losses.

https://www.youtube.com/watch?v=ejpc9JS1GAw

Risk and Trade off

https://www.youtube.com/watch?v=ejpc9JS1GAw


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Determinants of working capital

KDFEF – Working Capital Management

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Issues In Working Capital Policy


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https://www.youtube.com/watch?v=38iYNkW28lw

https://www.youtube.com/watch?v=38iYNkW28lw


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Unit II–Syllabus

Cash Management

Factors influencing Cash Balance determining minimum cash balance

Cash Budgeting

Cash Control

Cash Management Models.


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Cash management is a broad term that refers to the collection,

concentration and disbursement of cash. It encompasses a firm‟s

level of liquidity, its management of cash balance and its short-term

investment strategies.

Meaning


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To make payment according to payment schedule

To minimise cash balance

Nature of cash management

The nature of cash management would depend upon the organizational structure of a firm. In a highly centralised organization, the central/head office controls the inflow and outflows of cash on a routine basis.In a decentralised organization, it may not be possible for central office to exercise control over cash flows.

https://www.slideshare.net/tamana2223/14685550-cashmanagementpresentation

Objectives Of Cash Management




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Profitability of business concept signifies the operational efficiency of the business organisation by value addition through the utilisation of resources i.e men, materials, money and machines.The liquidity refers to the ability of the organisation to realise value in money and its ability to pay in cash the obligations that one due for payment.There is an inverse relationship between profitability and liquidity.

Factors Determining Cash NeedsSynchronisation of cash flows.Consideration of short costs.Position of accounts receivableNature of product/business.Availability of other sources of fundsManagement‟s attitude regarding procurement.Operating and cash cycleMarket conditions in relation to assets.Control of cash disbursements

Profitability And Liquidity

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Help to increase efficiency of operations and higher productivity.

Ensures higher liquidity and enhances the rate of earnings

Ample cash helps to avail cash discounts and trade discount from

the suppliers.

It helps in maintaining the goodwill of the concern.Ensures credit worthiness and financial soundness of a concern, regular flow of raw materials to the process of production. Facilitates new investments and in expanding its future market. Creates good confidence among the investors, creditors, customers, employees and general public. Ensures steady supply of inventories to meet the needs of customers. Helps to overcome the short-term crises caused by depression. It facilitates to enjoy new business opportunities

Advantages Of Maintaining Optimum Or

Adequate Cash

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1. Controlling inflow of cash or sources of cash.

(a) Accelerating collection

(b) Concentration banking

(c) Lock-box system

(d) Efficient inventory production management

2. Control over cash outflows or application of cash

Functions of cash management

a) Billing float

b) Mail float

c) Cheque processing float

d) Bank processing float

3. Optimum investment of surplus cash

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4. Controlling level of cash

a) Preparing cash budget

b) Providing unpredictable discrepancies

c) Consideration of short cost

d) Exploring other sources of finance.

Cash management planning

The first step in cash management is to estimate the requirement of

cash in the firm. For this purpose, cash budget is to be prepared.

Cash Budget:

Cash budget shows the cash inflows and outflows expected in a

budget period and net effect of these flows on cash balances.

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Cash management controlThe finance manager has to control the levels of cash balance at various units of the firm. He should devise a system whereby each division of a firm retains enough cash to meet its day-to-day requirements without having surplus balance on hand. For this, methods have to be employed to(a) speed up the mailing time of payment from

customers(b) reduce the time during which payments

received by the firm remain uncollected and speed up the movement of funds to disbursement banks.

Cash management models https://www.slideshare.net/godfreouseph/cash-management-model

https://www.slideshare.net/godfreouseph/cash-management-model






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Unit III –Syllabus

Inventory Management

Need for inventories & importance

Techniques for Managing Inventory

Materials & valuation of stock

Monitoring & control of inventories.

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Inventory refers to the stock pile of the product a firm is offering for sale

and the components that make up the product. In other words,

inventory is composed of assets that will be sold off in future in the

course of business operation.

Definition International Accounting Standards Committee defines inventory as

“Inventory is a tangible property (a) held for sale in the ordinary course

of business; (b) in the process of production of such sale or to be

consumed in the production of goods or services for sale”.

Inventory includes raw material, purchased parts.

Inventory includes raw material, purchased parts, work-in-progress,

finished goods and supplies.

Meaning Of Inventory

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Inventory ensures in maintaining undisturbed production and employment rates.

Inventory require valuable space and consumes taxation and insurance charges.

It provides production economies. It is the physical stock of items of tangible assets. Inventories are the result of many inter-related decisions and policies

within an organisation. Inventories are used in the production for sale in the ordinary course of

business.

Characteristics Of Inventory


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Need Of Holding Inventory

Transaction motive

Precautionary motive

Speculative motive

Factors Affecting Volume Of Inventory

Availability of financeQuantity discounts allowedStorage space availableOrdering costReceiving costRisk of loss due to price fluctuationsRisk of loss due to evaporation, obsolescence, theft, deterioration, etc.Economic ordering quantityTime to obtain delivery or lead time.

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It helps to avoid over-investment or under-investment in inventories.It helps to reduce the carrying cost and to maintain the optimum level of inventory management.It ensures uninterrupted production.Effective material handling/control is possibleLots of manual work may be eliminated.

Ensures minimum wastages

Facilitates prompt flow of finished goods for immediate sales

Effective utilisation of floor space.

Better forecasting is possible

Inventories reduce the risk of closing down the plant or keeping

workers and machine idle.https://www.youtube.com/watch?v=GutCKICOESw

Benefits Of Holding Inventory

https://www.youtube.com/watch?v=GutCKICOESw

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Excessive level of inventories consumes the funds of the firm, which

cannot be used for any other purpose.

Increase cost of storage, materials handling, insurance, transportation

and inspection.

Delay and inconvenience because of over crowding of materials.

High risk of liquidity due to inadequate inventories Inadequate inventories will affect continuous flow of production. Inadequate inventories fail to meet the delivery commitments. Ineffective supervision of stores due to mishandling and improper storage facilities. Losses, damages, deterioration of materials will be high when there are excessive inventories in storage. Failure to meet the demands of consumers needs due to inadequate finished goods inventories. Greater risk of loss due to devaluation through changes in price of production cost.

Demerits of excessive or inadequate

inventories

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Inventory control means control over materials lying in store.

Inventory control keeps continuous track of inventories. But it is not

merely record keeping. Inventory control aims to achieve maximum

possible inventory turnover.

Meaning Of Inventory Control

Definition Of Inventory ControlAccording to Jhon L.Burbridge, “Inventory control is concerned with

the control of quantities and monetary value of these items at

predetermined level or within safe limits”.

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Availability of materialsMinimising the wastageBetter services to customersIncrease operational efficiencyAchieving efficient production levelsOptimum level of inventoriesEconomy in purchasingOptimum level investment in raw materialsOptimum level investment in work-in-progressOptimum level investment in finished goods.

Risk Of Holding Inventory

Price decline

Product Deterioration

Product Obsolescence

Objectives of inventory control management

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Ordering costs

This cost includes the variable cost associated with placing an order

for the materials.

Inventory Carrying costs

Inventory carrying cost includes the expenses in keeping the

materials in stores.

Stock out cost

These include loss of sales if there were no stock of finished goods,

cost of production stoppage for want of material and costs

associated with placing urgent orders for replenishment.

Over stock cost

Another kind of cost associated with carrying inventory results when

there is a stock left on hand after the demand for the item has

terminated.

COSTS OF HOLDING INVENTORIES

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ABC stands for Always Better Control technique. ABC analysis is an

inventory management technique where inventory items are classified into

three categories namely: A, B, and C.

ABC Analysis

Just In Time (JIT)In Just in time method of inventory control, the company keeps only

as much inventory as it needs during the production process. With no

excess inventory in hand, the company saves the cost of storage and

insurance.

Material Requirements Planning (MRP)

Method Material Requirements Planning is an inventory control method in

which the manufacturers order the inventory after considering the

sales forecast. MRP system integrates data from various areas of the

business where inventory is utilized.

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Economic Order Quantity technique focuses on taking a decision

regarding how much quantity of inventory should the company order at

any point of time and when should they place the order.

Minimum Safety StocksThe minimum safety stock is the level of inventory which an organization

maintains to avoid stock out situation. It is the level at which the new

order is placed before the existing inventory is over.

VED AnalysisVED stands for Vital essential and desirable. Organizations mainly use

this technique for controlling spare parts of inventory.

https://www.youtube.com/watch?v=1_1nqU3lZh4

Economic Order Quantity (EOQ) Model



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Methods of pricing of materials issuesAll receipts and issues of materials are the important aspects to

continuous flow of production. A systematic procedure should be

adopted for movement of materials from one place to another place.

Materials received and stores are issued on the basis of stores

requisition, bills of materials, stock in balance, etc.

Ascertainment of accurate material cost, fixing of material issue and

effective cost control are the primary objectives to fulfill the needs of the

management. For these reasons the following aspects are considered:

1. valuation of total cost of materials purchased.

2. materials issue procedure

3. important methods of pricing of materials issued.

https://www.slideshare.net/Kalpanaudhay/inventory-pricing-valuation







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Unit IV –Syllabus

Receivables management

Credit policy

Credit evaluation credit granting decisions

Control receivables

Collection policy.

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The term „Receivables‟ refers to the sum of all monies owned to the

firm by its customers arising from sale of goods or services in the

ordinary course of business.

Meaning of receivable management Receivable management is the

process of making decisions relating to the investment of funds in the

assets which will result in maximising the overall return on the

investment of the firm.

Meaning of Receivables

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Growth in sales

Increase in profits

Capability to face competition

Helps to increase customer satisfaction

Takes control of sales processes

Benefits Of Receivable Management

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Capital costs:

The increased level of accounts receivable as an investment in current

assets results in blocking of the firm‟s capital. There is a time lag

between the sale of goods and payments for them. Meanwhile, the firm

has to arrange for additional funds while waiting for payment from its

customers. The firm incurs a cost on account of raising additional capital

to support credit sales, the capital which alternatively could be earned

profitably if employed elsewhere.

Administration costs

This cost is involved in the form of clerical working involved in checking

additional accounts serving the added volume of receivables,

maintaining accounting records and cost of conducting investigation to

assess the credit worthiness of the customers.

Cost Of Maintaining Receivables

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Some costs are to be incurred by the firm for collecting the amount

from the customers on account of credit sales. Sometimes, additional

expenses involves sending frequent follow-up letters, cost of collection

of exchange or cost of discounting bills, expenses of stringent action

against default customers, etc

Delinquency cost

These cost are incurred by the firm when extending credit to the

defaulting customers:

The delinquency costs include the following:

Committing funds to the investments, additional receivables for

extended credit period.

Cost involved in putting extra effort to recover the overdues from the

customers

Cost associated with frequent reminders.

Cost incurred on account of legal charges

Collection cost

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Credit policy(i) Credit standards

a. collection costb. investment in receivables or the average collection periodc. bad debtsd. sales volume

(ii) Credit termsa. credit periodb. cash discount

Credit analysisCredit ratingDecision tree analysis of credit granting

Control of receivablesCollection policyMonitoring of receivables

Aspect Of Management Receivables


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Published information

Bank reference

Trade reference

Salesman‟s interview and report

Credit bureau reports

Reports from other agencies

Past experience

Sources to collect credit information


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Unit V –Syllabus

Financing Current Assets

Trade Credit

Short term Bank Finance

Committees on Working Capital

Regulation of Bank credit

Recommendation

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Funds are required to meet the day to day expenses of the firm. For example, raw materials, wages, power charges etc.Purpose of short term finance:It facilitates smooth running of operationsEnables to hold stock of raw materials and finished product.Goods can be sold on credit.To increase the volume of production at a short notice.It allows flow of cash during the operating cycle. Operating cycle refers to the time gap between production and sales.

Short Term Finance


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Trade credit: it is the credit extended by the suppliers of goods in the

normal course of business. The period of credit is 15 to 90 days. The

credit is given without security. No interest is charged.

MERITS OF SHORT TERM FINANCE

Easy to purchase goods on an open book account.

Spontaneous source of financing compared to other sources

Small firms are benefited if they cannot get credit elsewhere

No need to create any charge against assets.

Sources of short term finance


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https://www.youtube.com/watch?v=aiGcXd2_u7I

https://www.youtube.com/watch?v=aiGcXd2_u7I

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It a “promissory note” issued by a firm, approved by RBI, negotiable by endorsement and delivery, issued at such discount on the face value as may be determined by the issuing firm. These are issued by a firm to raise funds for a short period varying from few days to few months.No cp can be issued for a period less that 15 days from the date of issue.The issuing firm should have tangible net worth of not less than Rs. 4 croresWorking capital of not less then Rs. 4 crores.Current ratio to be 1.33 atleastMinimum p2/A2 rating from CRISIL.

Commercial paper

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Companies accepts deposits for short periods from their members,

directors and the general public.

According to the existing provisions, a company cannot accept deposits

for a period of not less than 6 months and not more than 36 months.

However, deposits up to 10% of the paid up capital and free reserves can

be accepted for a minimum period of three months for short term

requirement. Moreover, a company cannot accept or renew deposits in

excess of 35% of its paid-up capital and free reserves.

MERITS OF PUBLIC DEPOSITS

Public Deposits

Not much complicated formalities involved. The company has to

advertise and inform the public that it is interested in and authorised to

accept public deposits.

It is less costly method for raising short-term as well medium term

funds required by the business.


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There is no need of creation of any charge against any of the

assets of the company for raising funds through public deposits.

The company take advantage of trading on equity since the rate

of interest and the period for which the public deposits have been

accepted are fixed.

DEMERITS

This type of finance is not suitable in a period of depression and

financial stringency. So raising funds through public deposits is not a

reliable and definite source of finance.

This mode of financing sometimes puts the company into serious

financial difficulties. i.e. slight rumor will lead to asking for premature

payment.

The system may prove injurious for the growth of a healthy capital

market. This would affect the supply of industrial securities, particularly

shares and debentures, to general public.


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REGULATION OF BANK CREDIT

Trade credit and bank credit are the important sources of working

capital finance. Guidelines are needed to be framed for effective

control and equitable productive distribution of resources to various

sectors of the Indian economy. The guidelines for working capital

financing have been formulated on the basis of the reports

submitted by the Tandon Committee(1975) and Chore Committee

(1980).

Tandon committee In July 1974, the Reserve Bank of India appointed a committee

under the chairmanship of Sri. P.L. Tandon to suggest guidelines for

the follow-up and supervision of bank credit.

The Tandon committee interviewed commercial banks, cutomers,

large number of professionals, industrialists and others before

formulating their recommendations.

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The committee framed the necessary guidelines on bank credit, particularly

the following:

To suggest guidelines for commercial banks for safety of the fund vis-à-

vis supervise credit for optimum end use of funds and to develop an

information base required by banks periodically from borrowers and also by

RBI from the lending banks.

To give recommendation on prescribed inventory norms for different

industries.

To make suggestions on sources for financing the minimum working

capital requirements.

To suggest criteria regarding satisfactory future credit norms.

To suggest / recommend any other related matters.

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Chore Committee In 1979, Reserve Bank of India appointed a committee under the

chairmanship of Shri. K.B.Chore to find out and review the system of

cash credit.

Terms of reference: To frame guidelines, the study group reviewed the

following aspects.

To analyze the gap between the credit limits sanctioned and credit

limits utilised.

To study on the limits fixed on the basis of the maximum

requirements of individual borrowers and draws are made according

to actual needs at any point of time.

To give suggestions for modification of existing cash credit system,

to ensure the effective utilisation of credit facilities and to increase the

output or other product ways.

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Martha committeeThis committee was constituted by the RBI to suggest measures for

giving meaningful directions to the credit management function of

RBI. The two major recommendations of this committee are:

(a) The third method of lending as suggested by Tandon Committee is

found to be impractical.

(b) „Fast track scheme‟ is to be introduced to improve the quality of

credit appraisal in banks. The commercial banks can release

without prior approval of the RBI 50% of the additional credit

required by the borrowers where the following requirements are

fulfilled.

(i) the estimates in regard to production, sales, current assets,

current liabilities other than bank borrowings and net working

capital are reasonable in terms of the past trendsand assumptions

regarding most likely trends during the future projected period.

(ii) the projected current ratio is not below 1.33:1

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(iii) the borrower has been submitting quarterly information and operating

statements for the past six months within the prescribed time. (iv) the

borrower undertakes to submit to the banks his annual accounts

regularly.

Dehejia committee This committee was constituted by National Credit Council under the

chairmanship of Shri. V.T. Dehejia in 1968. The following are the

findings

1. There was a tendency on the part of industry to avail of more short-

term credit than their actual requirement.

2. A diversion of short-term credit had taken place to the acquisition of

long term assets.

3. The credit limits related to the security offered not to the overall

financial position of the borrowers through a cash flow analysis.https://www.slideshare.net/rpadiaassociates/working-capital-finance

https://www.slideshare.net/rpadiaassociates/working-capital-finance





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