MANAGEMENT OF WORKING CAPITAL

1. Meaning and Types of Finance: Finance
- Finance is the Art & Science of Managing Money - Finance is the Art of passing currency from hand to hand until it finally disappears

Types & Sources of Finance
____________________________________________________________________ Long Term Sources of Finance
- Finance required to meet Capital Expenditure - Also, known as Fixed Capital Finance

Short Term Sources of Finance
- Finance required to meet day-to-day Business requirements - Also, known as Working Capital Finance

2. Working Capital Management: Working Capital (WC)
________________________________________________________________________________________ Basics regarding WC Meaning of WC Working Capital Concept Factors Affecting WC Meaning of WC Management Importance of WC Management Classification/Type of WC A On the Basis of Concept
(i) (ii)
Gross Working Capital Net Working Capital (Positive & Negative Working Capital)

Methods of estimating WC Conventional Method Operating Cycle Method Cash Cost Method Balance Sheet Method

B On the Basis of Periodicity
(i) (ii)
Fixed / Permanent Working Capital (Regular & Reserve Margin/ Cushion WC) Variable Working Capital (Seasonal & Special Working Capital)

Parag Nalin Doshi

1/12/2009

www.CAalley.com

e.Working Capital refers to that part of the firm’s Capital. Debtors and Inventories. This method ignores Time Value of Money .Cash Raw-Materials Work-in-Process Finished Goods Cash Factors affecting Working Capital/ Determinants of Working Capital: Nature of Business/Industry.Working Capital is the difference between resources in cash or readily convertible into cash (Current Assets) and organizational commitments for which cash will soon be required (Current Liabilities) . Growth prospects Business Cycle. Operating Efficiency.Meaning of Working Capital: .Operating Cycle Method: Debtors + Stock (RM/WIP/FG) . Size of Business/Scale of Operations. CA . This is knows as Qualitative aspect of Working Capital (Focus is on (i) Liquidity Position of the Firm and (ii) WC Amount that can be financed by Permanent sources of Funds) Meaning of Operating Cycle/Working Capital Cycle: . . resources to final product. taking B/S items into account) Parag Nalin Doshi 1/12/2009 www.Net Concept: It means difference between Currents Assets & Current Liabilities. Working Capital is also known as Revolving or Circulating Capital or Short-Term Capital Working Capital Concepts: . Profit Margin.e. Manufacturing Cycle. This is knows as Quantitative aspect of Working Capital (Focus is on (i) Optimum Investment in Current Assets and (ii) Financing of Current Assets) .Working Capital is the amount of Capital that a Business has available to meet the day-to-day cash requirements of its operations .e.Conventional Method: Matching of Cash Inflows & Outflows. Operating Cycle & Rapidity of Turnover.CAalley. which is required for Financing Short-Term or Current Assets such as Cash. Profit Appropriation Depreciation Policy.Balance Sheet Method: Working Capital forecast is done on various Assets & Liabilities (i.CL) . Marketable Securities.It refers to the amount of Current Assets that exceeds Current Liabilities (i. This method takes into Account length of Time which is required to convert cash into resources.Creditors.com .Cash Cost Technique: Working Capital forecast is done on Cost Basis (i. taking P&L items into account) .Gross Concept: It means Current Assets. final product to Debtors and Debtors to Cash again. Dividend Policy and Government Regulations Approaches (Methods) of estimating Working Capital: . Taxation Policy.

Liquidity V/s Profitability Objectives of Working Capital Management: .Decide Optimal Mix of Short Term and Long Term Capital . relating to the next one year period .Determining the Sources of Working Capital Different Aspects of Working Capital Management: Management of Inventory Management of Receivables/Debtors Management of Cash Management of Payables/Creditors Parag Nalin Doshi 1/12/2009 www.Two Steps involved in the Working Capital Management: (i) Forecasting the Amount of Working Capital (ii) Determining the Sources of Working Capital Importance of Working Capital Management: .Working Capital is the Life Blood of the Business .Working Capital Management means the deployment of current assets and current liabilities efficiently so as to maximize short-term liquidity .Working Capital Management is concerned with the problems that arise in attempting to manage the Current Assets. Current Liabilities and the interrelationship that exists between them .com .CAalley.Decide Appropriate means of Short Term Financing Process/Steps Involved in Working Capital Management: .which are "reversible" .Forecasting the Amount of Working Capital .Meaning of Working Capital Management: .Deciding Optimum Level of Investment in various WC Assets .generally.Working capital management entails short term decisions .Fixed Assets (Long Term Assets) can be purchased on Lease/Hire Purchase but Current Assets cannot be .

. Consumables etc.com . Inventory Management means: .e.CAalley. WIP) for Sale OR. Parag Nalin Doshi 1/12/2009 www. For Consumption in the production of good & services which will be used for sale in the ordinary course of Business Inventory Includes Raw-Material.In the process of Production (i. Spares. WIP. Meaning of the Term Inventory Magt. FG.Striking balance between Adequate Stock & Investment Maintain Adequate Stock and that too by keeping Investment at Minimum Level. Meaning of Inventory and Inventory Management: Inventory ____________________________________________________________________ Meaning of the Term Inventory Inventory means Tangible property which is held: . It is also known as Optimum Level of Inventory Maintaining Inventory at the Optimum Level is called Inventory Magt.An Optimum Investment in the Inventories .MANAGEMENT OF INVENTORY 1.For Sale in the ordinary course of Business OR.

Re-order and Danger Level Small.Minimizing the Wastage . Slow Moving & Non Moving Annual Stock Taking Ordering Cost & Carrying Cost High.2.Control of Production Level Optimum Level of Inventories Financial Objectives . Minimum. Medium & High Number/Usage Restoration of the Stock Issued Vital.com .Attitude of the Management Specific Factors Seasonal Nature of Raw Materials and Demand for Finished Goods Length & Technical Nature of the Production process Style factor in the End Product Terms of Purchase Supply conditions Time Factor Price Level Variation Loan Facility Management Policies Other Factors - - Tools Fixation of Levels of Inventory ABC Analysis Perpetual inventory System VED Analysis FSN Analysis Periodical Inventory Valuation Economic Order Quantity (EOQ) Analysis HML Tool SDE Tool Meaning/Importance Maximum. Difficult & Easy (Procurement Difficulty) Parag Nalin Doshi 1/12/2009 www. Medium & Low (Unit Price) Scarce.Operations Level .Promotion of Manufacturing Efficiency .CAalley.Economy in Purchasing .Minimizing Cost Tools of Inventory Management Factors Determining Optimum Level of Inventory ______________________________________ General Factors . Essential and Desirable Fast Moving.Availability of Funds .Anticipated Volume of Sales .Nature of Business . Various Aspects relating to Inventory Management: Various Aspects of Inventory Management ______________________________________________________________________ Objectives of Inventory Management __________________________________ Operating Objectives .Reasonable Price .Better Service to Customer .Price Level Variations .Availability of Materials .Optimum Investment & Efficient use of Capital .

CAalley.com .3. Important Formulas: (a) Maximum Level: (Maximum Quantity of Stock to be held) Maximum Level = (Reorder Level + Reorder Quantity) – (Minimum Usage x Minimum Reorder Period) (b) Minimum Level: (Minimum Quantity of Stock to be held) Minimum Level = (Reorder Level) – (Normal Usage x Normal Reorder Period) (c) Reorder Level: (Demand in the Lead Time) Reorder Level = (Maximum Consumption x Maximum Reorder or Delivery Period) OR Reorder Level = (Minimum Level) + (Normal Consumption x Normal Delivery Period) (d) Danger Level: Danger Level = (Minimum Rate of Consumption x Emergency Delivery Time) OR Danger Level = (Average Consumption x Maximum Reorder period for Emergency Purchases) (e) Lead Time: Time Lag between the Indenting and Receipt of Materials OR Time normally required for obtaining fresh supply of Materials (f) Economic Order Quantity: EOQ = 2AB CS = 2 x Ordering Cost x Demand Holding Cost = Lowest of (Carrying Cost + Ordering Cost) Where. A = Annual Usage/Annual Consumption B = Buying Cost/Ordering Cost C = Cost Per Unit S = Storage Cost/Cost of Carrying Inventory Assumptions of EOQ Model: (i) Known and Constant Demand (iii) Instantaneous receipt of material (v) Only order (setup) Cost and holding cost (vii)Supply of the Goods is Satisfactory (ii) Known and Constant lead time (iv) No quantity discounts (vi) No stock-outs (viii)Prices of the goods are Stable Parag Nalin Doshi 1/12/2009 www.

Maintain Receivables at a level at which there is a trade-off between Profitability & Cost This is called Optimum Level of Receivables Three Aspects of Managing Accounts Receivalbes _____________________________________________________ Characteristics It Involves an Element of Risk It is based on Economic Value Cash Payment will be made in Future Objectives Increase Sales Increase in Profit (Volume Increase & Margin Increase) Strategy to Face Competition Costs of Maintaining Cost of Financing Administrative Cost Collection Costs Defaulting Costs - ____________________________________________________________________________________ Establishing Collection Policy of Concern Determining Policy & Procedures to be followed for the collection of the Account Receivables Control of the Account Receivables It Means maintaining of the Account Receivables at the Minimum possible Level - - Establishing Credit Policy Determining the Level of Credit Sales Determining of the Credit Standards Determining of the Credit Terms - - Parag Nalin Doshi 1/12/2009 www.com . Debtors.MANAGEMENT OF RECEIVABLES 1. Sundry Debtors. Meaning of Receivables and Receivables Management: Receivables ________________________________________________________________ Meaning of the Receivables It is amount/Debt which is receivable for the goods or Services provided on Credit Also known as Trade.CAalley. Trade Receivables. Book Debts - Meaning of the Term Receivables Magt.

2.Volume of the Business - Price-Level Variations Availability of Funds Attitude of the Executives - Volume of Credit Sales - Credit Policies ________________________________________________________ Credit Standards Credit Terms Credit Rating ___________________________ Credit Period Discount Terms Trade Discount Cash Discount Quantity Discount 5 C’s Character Capacity Capital Collateral Conditions - - - Parag Nalin Doshi 1/12/2009 www.Volume of Anticipated Sales .CAalley. Factors Determining Size of Investment in Receivables: Factors ____________________________________________ General Factors ______________________________________________ Specific Factors _________________________________________ .com .Type & Nature of Business .

com . Meaning & Importance of Cash & Cash Management: Cash & Cash Management .MANAGEMENT OF CASH 1.CAalley.Cash means Liquid Assets that a Business Owns. It includes Cheques. Money Orders & Bank Drafts Cash Management means efficient Collection & Disbursement of cash and any Temporary Investment of Cash (Maintaining Optimum Level of Cash in an Organization is called Cash Management) __________________________________________________________________________________ Objectives of Cash Management To meet Cash Disbursement as per Payment Schedule To meet Cash Collection as per Repayment Schedule To minimize funds locked up as Cash Balance by maintaining Optimum Cash Balance - - Motives of Holding Cash Transaction Motive Speculative Motive Precautionary Motive - Importance of Cash Management Most Significant & Least Productive Asset Difficult to predict Cash Flows (Inflows & Outflows) Smallest Portion of Total Current Assets Cash Planning Cash Forecasting: (a) Receipt & Disbursement Method (b) Adjusted Net Income Method Parag Nalin Doshi 1/12/2009 www.

Meaning of Cash Flows: Cash Flows .com .If Cash Inflows are more than Cash Outflows.2.CAalley. it is Positive Cash Flow and vice-versa _____________________________________________________ Methods of Accelerating Cash Inflows Prompt Payment by Customers Quick conversion of payment into Cash Decentralized Collection Lock Box System Method of Decelerating Cash Outflows Paying on Last Date Payable through Draft Adjusting Payroll Funds Centralization of Payments Inter-Bank Transfer Making use of Float Parag Nalin Doshi 1/12/2009 www.Cash Flows means Cash Inflows and Cash Outflows .

CAalley.3.com .Cash Budget is a forecast of future Cash Receipts and Cash Disbursement over various intervals of Time __________________________________________________________________________________ Functions/Importance of Cash Budget Helpful in Planning Forecasting the Future Needs of Funds Maintenance of Ample Cash Balance Controlling Cash Expenditure Evaluation of Performance Testing the Influence of Proposed Expansion Sound Dividend Policy Basis of Long Term Planning & Co-ordination - Methods of Preparing Cash Budget Receipts & Payment Method Adjusted Profit & Loss Account Method Balance Sheet Method - Investment of Surplus Cash Treasury Bills Negotiable Certificate of deposits Unit 1964 Scheme Ready Forwards Badla Financing Inter-Corporate Deposits Three Months Deposits Bill Discount Investment in Market Securities Parag Nalin Doshi 1/12/2009 www.Cash Budget means estimation of Cash Receipt and Cash Disbursement during a future period of Time . Meaning & Importance of Cash Budget: Cash Budget .

Credit Papers .Trade Credit (Provision for Tax) (Open Acct/Acceptance) .SOURCES OF WORKING CAPITAL FINANCE 1.Security from Employees .Loans from FI’s . Various Sources of securing Working Capital Finance: Sources of Finance ______________________________________________________________________ Long Term Sources (Regular Working Capital) _______________________ Internal Sources External Sources Other Sources Short Term Sources (Seasonal Working Capital) ____________________ Internal Sources External Sources .Issue of Equity Shares (Profit & Loss A/c) .Commercial Papers .Zero Coupon Bonds .Bank Credit (Loans/OD/CC/BD) .Business Finance Co’s Parag Nalin Doshi 1/12/2009 www.Retained Earnings .Customer Advances .CAalley.Accrual Accounts . Assistance .Sale of FA’s .Security from Customers .Indigenous Bankers (Private Individuals) .Govt.Issue of Debentures .Factoring (Recourse & Non Recourse) .Depreciation Funds .com .Public Deposit .Issue of Preference Shares .

Temporary WC (Financed from Short Term Funds) Conservative Approach .Avg.Short Term Funds to be used in case of Emergency Aggressive Approach .Avg. Approaches for Determining Financing Mix: Financing Mix ______________________________________________________________________________________ Hedging Approach . to be funded by Long Term Funds . of Maximum and Minimum WC requirement .2.Balance to be funded by Short Term Funds Parag Nalin Doshi 1/12/2009 www.All requirements from Long Term Funds .All requirements from Short Term Funds .CAalley.Permanent WC (Financed from Long Term Funds) .com .Only Part use of Long Term Funds Trade-off Approach .

3.CAalley.25% from Long Term Sources = MPBF x x xx x xx Method II Total Current Assets 25% from Long Term Sources Net Current Assets Total Current Liabilities# MPBF x x xx x xx Method III Total Current Assets Core Current Assets Net WC Current Assets 25% from Long Term Sources Net Currents Assets Total Current Liabilities# MPBF x x xx x xx x xx = = = = = # Note: Total Current Liabilities means Liabilities excluding Bank Borrowings to be taken into account for Calculation Parag Nalin Doshi 1/12/2009 www.com . Maximum Permissible Bank Finance (Tandon Committee Recommendation): MPBF Methods/Workings/Calculations __________________________________________________________________________________ Method I Total Current Assets .Total Current Liabilities# = Working Capital Gap .