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Working Capital concepts Credit Management Inventory Management Cash Management Marketable Securities Working capital cycle Working Capital Finance
Working Capital Concepts
Gross Working Capital
The firm¶s investment in current assets
Net Working Capital
Current Assets - Current Liabilities.
Working Capital Management
The administration of the firm¶s current assets and the financing needed to support current assets
87 .26285.27 Rs.65 173214.85 29180.527089.81 = Rs.87 Rs.current liabilities) = 527089.235675.15 16957.53 30125.Working Capital Current assets and liabilities for Indian manufacturing firms (31 March.67 249097.89 155962.291414.74651.291414.88 63028. 2008)«Rs. Crores Current Assets Cash Other short-term financial investments Accounts receivable Inventories Total current assets Rs.81 Rs.06 crores .79 Current Liabilities Current portion of long-term debt Accounts payable Income tax provisions Dividend Provisions Other current liabilities Total current liabilities Net working capital (current assets .
Significance of Working Capital Management In a typical manufacturing firm. return. Current liabilities are the principal source of external financing for small firms. Requires continuous. day-to-day managerial day-tosupervision. . current assets exceed one-half of total assets. oneExcessive levels can result in a substandard Return on Investment (ROI). Working capital management affects the company¶s risk. and share price.
000 maximum units of production Continuous production Three different policies for current asset levels are possible Policy C Current Assets OUTPUT (units) .Working Capital Issues Optimal Amount (Level) of Current Assets Policy A Policy B ASSET LEVEL Assumptions 50.
all other factors held constant Policy A Policy B Policy C Current Assets OUTPUT (units) .Impact on Liquidity Optimal Amount (Level) of Current Assets ASSET LEVEL Liquidity Analysis Policy Liquidity A High B Average C Low Greater current asset levels generate more liquidity.
Impact on Expected Profitability Optimal Amount (Level) of Current Assets ASSET LEVEL Return on Investment = Net Profit Total Assets Let Current Assets = (Cash + Rec. + Inv.) Return on Investment = Net Profit (Current + Fixed Assets) OUTPUT (units) Policy A Policy B Policy C Current Assets .
Impact on Expected Profitability Optimal Amount (Level) of Current Assets ASSET LEVEL Profitability Analysis Policy Profitability A Low B Average C High As current asset levels decline. Policy A Policy B Policy C Current Assets OUTPUT (units) . total assets will decline and the ROI will rise.
More risk! Stricter credit policies reduce receivables and possibly lose sales and customers.Impact on Risk Optimal Amount (Level) of Current Assets ASSET LEVEL Decreasing cash reduces the firm¶s ability to meet its financial obligations. More risk! Policy A Policy B Policy C Current Assets OUTPUT (units) . More risk! Lower inventory levels increase stock outs and lost sales.
Impact on Risk Optimal Amount (Level) of Current Assets ASSET LEVEL Risk Analysis Policy Risk A Low B Average C High Risk increases as the level of current assets are reduced. Policy A Policy B Policy C Current Assets OUTPUT (units) .
2. Profitability varies inversely with liquidity. Profitability moves together with risk. (risk and return go hand in hand!) .Summary of the Optimal Amount of Current Assets SUMMARY OF OPTIMAL CURRENT ASSET ANALYSIS Policy A B C Liquidity High Average Low Profitability Low Average High Risk Low Average High 1.
Classifications of Working Capital Components ± Receivables. cash and marketable securities Time ± Permanent ± Temporary . inventory .
Permanent Working Capital The amount of current assets required to meet a firm¶s long-term minimum longneeds. RUPEE AMOUNT Permanent current assets TIME . needs.
Temporary Working Capital The amount of current assets that varies with seasonal requirements. requirements. Temporary current assets RUPEE AMOUNT Permanent current assets TIME .
discount.Credit Management Terms of Sale .Credit.percent discount for early payment 10 .number of days before payment is due . and payment terms offered on a sale. Example .number of days that the discount is available net 30 .5/10 net 30 5 .
is an implicit loan from the supplier. This.Terms of Sale A firm that buys on credit is in effect borrowing from its supplier. It saves cash today but will have to pay later. of course. We can calculate the implicit cost of this loan Effective annual rate = 1+ ( discount discounted price ) 365/extra days credit -1 .
Terms of Sale Example .100 sale.On a Rs. what is the implied interest rate on the credit given? ective annual rate !1 !. with terms 5/10 net 60.
365/extra days credit discount discounted price 5 365/50 95 -1 .1 = .4% . or 45.454.
Credit Agreements Terminology ± ± ± ± ± ± ± ± ± open account promissory note commercial draft sight draft time draft trade acceptance banker¶s acceptance irrevocable letter of credit conditional sale .
Credit Analysis Numerical Credit Scoring categories ± The customer¶s character ± The customer¶s capacity to pay ± The customer¶s capital ± The collateral provided by the customer ± The condition of the customer¶s business .
Financial ratios can be calculated to help determine a customer¶s ability to pay its bills.Credit Analysis Credit Analysis . . Credit agencies provide reports on the credit worthiness of a potential customer.Procedure to determine the likelihood a customer will pay its bills.
Credit Scoring ± What your lender won¶t tell you.The Credit Decision Credit Policy . Extending credit gives you the probability of making a profit. Denying credit guarantees neither profit or loss . not the guarantee. There is still a chance of default.Standards set to determine the amount and nature of credit to extend to customers.
Cost Refuse credit Payo = 0 .The Credit Decision The credit decision and its probable payoffs Customer pays = p Payo = Rev .Cost Offer credit Customer de aults = 1-p Payo = .
the expected profit can be expressed as: p x PV(Rev .The Credit Decision Based on the probability of payoffs.Cost) .p) x (PV(cost) The break even probability of collection is: PV(Cost) p = PV(Rev) .(1 .
Collection Policy Collection Policy .Classification of accounts receivable by time outstanding. Ageing Schedule . .Procedures to collect and monitor receivables.
000 s.15.000 0 0 * * * 6.000 s.000 More than 3 months 0 0 * * * 15.000 8.000 Total Owed 10.298.000 1-2 months 2-3 months 0 3.000 * * * 5.000 11.40.000 * * * 30.43.000 .000 s.200.000 s.000 s.000 * * * 4.Collection Policy Sample ageing schedule for accounts receivable Customer's Name A B * * * Z Total Less than 1 month 10.
Inventory Management Components of Inventory ± Raw materials ± Work in process ± Finished goods Goal = Minimize amount of cash tied up in inventory Tools used to minimize inventory ± Just-in-time Just-in± Lean manufacturing .
Cash Management Cash does not pay interest ± Move money from cash accounts into short term securities ± ³Sweep programs´ ± MMDAs ± Concentration banking ± Lock-box system Lock- .
Money Market Investments (India) Investment Borrower Treasury Bills Government of India Maturities When Issued Basis for Marketability Calculating Interest Comments Discount 14-day and 91-day T-Bills are auctioned weekly. 91Good days. 182-days. RBI is conducting Repo transactions every day under the Liquidity Adjustment Scheme . difference quoted as repo interest rate (adjusted for coupon) Since June 2000. financial institutions Commercial Papers apart from primary dealers and satellite dealers Banks and primary dealers. Secondary Market or 364 days 14 days to 1 year Fair secondary market Fair secondary market Certificates of Deposit Banks Discount Industrial firms. and all entities Repurchase agreements (repos) having SGL and current account with RBI 15 days to 1 year Discount Only companies with a CRISIL rating of P2 and above or equivalent rating can issue CPs 1 day (2 to 3 days if issued on Fridays or holidays) Excellent Secondary market Repurchase price set higher than selling price. The CDs are negotiable instruments 14-days. The 182-days and 364-days T-Bills are auctioned fortnightly.
WORKING CAPITAL CYCLE Receivable AR converted to Cash Collect AR Cash Deliver Goods or services Sales Order Goods or Services converted to Accounts Receivable AR Produce goods or Services Cash converted to prepaid expenses .
bills discounting etc.WORKING CAPITAL FINANCING Working Capital is financed by following sources: OWNED FUNDS A portion of long term funds. packing credit. BANK BORROWINGS CREDITORS Raw Materials W-I-P Finished Goods Debtors Trade Payables Long Term Funds + Bank Borrowings Funding the Cash Operating Cycle . equity share capital and reserves & surplus is utilized to fund working capital Various bank products like cash credit.
WORKING CAPITAL FINANCING Working Capital Products Non Fund Based Letter of Credit Bank Gaurantee Buyer & Suppliers credit Fund Based Structured Products Domestic Export Commercial Corporate Paper Loans Securitization Factoring Forfeiting Cash Credit PrePreshipment Overdraft Post shipment Bill Finance Documentary Clean .
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