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WCMWCMWorking CapitalWorking Capital
ManagementManagement
Working CapitalWorking Capital
ManagementManagement
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Working capitalWorking
capital
x capital required for the day to
day operations of the business
enterprises
x current assets- current liabilities
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Working Capital ConceptsWorking Capital Concepts
Net Working CapitalNet Working
Capital
Current Assets - Current Liabilities.
Gross Working CapitalGross Working
Capital
The firms investment in current assets.
Working Capital ManagementWorking
Capital ManagementThe administration of the firms current assets and
the financing needed to support current assets.
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Need for Working CapitalNeed for Working Capital
x Shareholders wealth
x
Time lag- sales activity and reciepts of cash
x Operating cycle.
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Classifications ofClassifications of
Working CapitalWorking Capital
x TimeTime
x Permanent
x Temporary
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Working Capital IssuesWorking Capital Issues
Assumptions
x 50,000 maximumunits of production
x Continuous
production
x Three differentpolicies for current
asset levels are
possible
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASS
ET
LEVEL
($)
Current Assets
Policy
CPolicy C
Policy APolicy A
Policy BPolicy B
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Impact on LiquidityImpact on Liquidity
Liquidity Analysis
PolicyPolicy LiquidityLiquidity
AA HighHigh
BB AverageAverage
CC LowLow
Greater current asset
levels generate more
liquidity; all other
factors held constant.
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASS
ET
LEVEL
($)
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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Impact onImpact on
Expected ProfitabilityExpected Profitability
Return on InvestmentReturn on Investment=
Net ProfitNet Profit
Total AssetsTotal Assets
Let Current AssetsCurrent Assets =
(Cash + Rec. + Inv.)
Return on InvestmentReturn on Investment=
Net ProfitNet Profit
CurrentCurrent + Fixed AssetsFixed Assets
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASS
ET
LEVEL
($)
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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Impact onImpact on
Expected ProfitabilityExpected Profitability
Profitability Analysis
PolicyPolicy ProfitabilityProfitability
AA LowLow
BB AverageAverage
CC HighHigh
As current asset levels
decline, total assets will
decline and the ROI will
rise.
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASS
ET
LEVEL
($)
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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0
Impact on RiskImpact on Risk
x Decreasing cash
reduces the firms abilityto meet its financial
obligations. More risk!More risk!
x Stricter credit policies
reduce receivables and
possibly lose sales andcustomers. More risk!More risk!
x Lower inventory levels
increase stockouts and
lost sales. More risk!More risk!
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASS
ET
LEVEL
($)
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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1
Impact on RiskImpact on Risk
Risk Analysis
PolicyPolicy RiskRisk
AA LowLow
BB AverageAverage
CC HighHigh
Risk increases as the
level of current assets
are reduced.
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSET
LEVEL
($)
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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2
Summary of the OptimalSummary of the Optimal
Amount of Current AssetsAmount of Current Assets
SSUMMARYUMMARYOOFF OOPTIMALPTIMAL CCURRENTURRENT AASSETSSET AANALYSISNALYSIS
PolicyPolicy LiquidityLiquidity ProfitabilityProfitability RiskRisk
AA HighHigh LowLow LowLowBB AverageAverage AverageAverage AverageAverage
CC LowLow HighHigh HighHigh
1. Profitability varies inversely withliquidity.
2. Profitability moves together with risk.
(risk and return go hand in hand!)
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3
Determinants of workingDeterminants of working
capitalcapitalxGeneral nature of business
x
Production cyclexBusiness cycle
x
Production policyxCredit policy
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4
Determinants(cont)Determinants(cont)
xGrowth and expansion
x
Vagaries in the availability of rawmaterials
xProfit level
xLevel of taxes
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Determinants(cont..)Determinants(cont..)
xDividend policy
x
Depreciation policyxPrice level changes
x
Operating efficiency
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Financing mixFinancingmix
Three basic approaches of
financing mix:
x hedging approach
xConservative approach
x trade-off
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Components of workingComponents of working
capitalcapitalxCash management
x
Inventoriesx receivables
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Cash managementCash management
xMotives:
transactionprecautionary
speculative
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ReceivablesReceivables
xCOSTS OF MAINTAING
RECEIVABLES
capital costs
administrative costs
collection costs
defaulting costs
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0
INVENTORIESINVENTORIES
xOBJECTIVES:
continuous supply of materialssufficient stock of raw materials
and finished goods
minimising carrying costs