Working Capital-An initial thought

The amount of funds, which a company must have to finance its day-to-day operations. That proportion of the company’s total p p p y capital, which is employed in short term operations

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Working Capital

Working Capital –Static View
Gross Working Capital
Sum total of all Current Assets (including loans & ( g advances) also known as “Current Capital (or) Circulating Capital”. Capital”

Net Working Capital
Difference between the current assets Current Liabilities(including provisions) also known as Net Current Assets and

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Working Capital

Working Capital –Static View
Current Assets
Convertible into cash with a single accounting period

Current Liabilities
Arise in the context of CA and come up for payment within a single account period

Maintain a current ratio of 2 :1
Company can meet all its current liabilities by liquidating CA p y y q g even at half of their recoded value without any financial embarrassment

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Working Capital

Static View-Limitations
CA and CL are Balance sheet data
Valid for the day V lid f th d

CA and CL presented in accordance with schedule Vi requirements of the Indian companies Act
Not included under CL
Bank borrowings (credit/OD) -shown under secured loans Public deposits -shown under unsecured loans shown

Not included under CL
Marketable securities such as treasury bills shown under Investments
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WCM-Dynamic View
The amount of capital required for smooth and uninterrupted functioning of normal business activities
Realizing Cash

Procurement of RM

Sales

Production of Finished Goods
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Composition of Working Capital
Nature of Business
Manufacturing Vs. Trading Vs. Services

Raw Material
Availability
Domestic Vs Imports Seasonal Vs Round the year

Carrying costs Lead time Shelf -life Price sensitivity/Inflation Bulk Purchases and discounts Govt. Regulation /Quotas
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Composition of Working Capital
Nature of Production Process
Pre Production Processing Work-In-Progress

Finished Goods
Shelf –life Utility
Seasonal

Accuracy of sales forecasts Ability to meet sudden demand Stock out costs

Accounts Receivables
Competition
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Interdependence among WC Components
Accounts p y payables Accounts Receivables Sales

Procurement of RM

Cash
S&D Gen. Admn. Financial Costs

Wages & Mfg. Costs

WIP
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Finished Goods Fi i h d G d
Working Capital

Operating Cycle
TIME LINE
Purchase of Raw Materials Payment of cash to raw materials INVENTORY CONVERSION PERIOD Sale of finished goods Cash received for Sales

RCP

GROSS OPERATING CYCLE

(GOC)

PDP

NET OPERATING CYCLE (NOC)

NOC = GOC - PDP
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Operating Cycle
The operating cycle is the time duration required to convert the resources into inventories, into sales and finally into cash The OC consists of two periods p
1) Inventory Conversion Period (ICP) 2) Receivables conversion period (RCP)

OC =
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ICP + RCP
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Inventory Conversion Period (ICP)
The ICP is the time required to convert raw materials, into work-in-progress and into finished goods. The ICP is the sum of Raw materials conversion period (RMCP), Work in progress conversion period (WIPCP) and finished goods conversion period.(FGCP) ICP = RMCP + WIPCP + FGCP

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Working Capital

Inventory Conversion Period (ICP)
Raw Material Conversion Period Closing RM Inventory g y RMCP = RM Consumption per day Work –in-progress conversion period Closing WIP Inventory WIPCP = Cost of production per day Finished Goods conversion period Closing FG Inventory FGCP = p y COGS per day
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Receivables conversion period (RCP)
The RCP is the time required to convert the Receivables into cash Closing Receivables RCP = Cost of sales per day

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Working Capital

The payables deferral period (PDP)
PDP is the length of time the firm is able to defer payments on various resource purchases Closing Payables Cost of sales per day

PDP

=

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Working Capital

WCM-Objective
Liquidity Vs. Profitability
Level of W ki C it l L l f Working Capital

Pattern of financing
Source mix

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Working Capital

Fixed Vs. Variable Working Capital
Fixed Working Capital
constant or minimum level, below, which investment in current assets does not fall. the total

Also called as “Fixed “ or “Constant” or “Permanent” working capital.

Variable Working Capital bl k l
The amount of funds needed over and above the “Fixed Working Capital” to take care of seasonal and other shifts Also referred to as “Fluctuating” or “Temporary” Working Capital.

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Working Capital

Sources of Financing Current Assets
■ Long term financing Shares, debentures, preference shares, retained earnings and long-term debt from financial institutions ■ Short term financing Short-term bank loans, commercial papers, factoring receivables etc. ■ Spontaneous financing Trade credit and outstanding expenses

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Financing Current Assets

Approaches to Financing Current Assets
Matching Approach Conservative A C i Approach h Aggressive Approach

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Financing Current Assets

Matching Approach
L E V E L O F A S S E T S
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VARIABLE CURRENT ASSETS

SHORT TERM SOURCES

LONG FIXED CURRENT ASSETS TERM SOURCES

F I N A N C I N G

FIXED ASSETS
TIME
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Financing Current Assets

Conservative Approach
L e v e l o f A s s e Dr.t Irala
VARIABLE CURRENT ASSETS
S T SOURCES

LONG TERM FIXED CURRENT ASSETS SOURCES

F I N A N C I N G

FIXED ASSETS
TIME
20 Financing Current Assets

Aggressive Approach
L e v e l o f A s s e t Dr. Irala s
VARIABLE CURRENT ASSETS
SHORT TERM SOURCES

FIXED CURRENT ASSETS

LONG TERM

F I N A N C I N G

FIXED ASSETS
TIME
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SOURCES

Financing Current Assets

Working Capital Management
Days Current Assets Finished Goods Stores, material Debtors (domestic) Debtors (exports) Adv. Pmt. For sundry exp. Ad P t F d Weeks Months Annual Average

Current Liabilities Current Liabilities Wages Stocks, Material Rent, Royalties Clerical Staff Manger Misc. Net Working Capital
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Working Capital Management
Days Current Assets Finished Goods Stores, material Debtors (domestic) Debtors (exports) Adv. Pmt. For sundry exp. Ad P t F d Weeks Months Annual 5 000 8 000 3 12 000 78 000 8 000 8 000 Average 5 000 8 000 36 000 2 250 2 000 2 000 53 250

6 1.5 3

Current Liabilities Current Liabilities Wages Stocks, Material Rent, Royalties Clerical Staff Manger Misc. Net Working Capital
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1.5 1.5 6 0.5 0.5 1.5

2 60 000 48 000 10 000 62 000 4 800 48 000

7 500 1 385 5 000 2 583 200 6 000 22 668 22 668 30 582

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Receivables Management

Working Capital Management
Units Produced & Sold Units Produced & Sold Per Unit Raw Material Direct labour Overheads Cost of Production Profit P fit Selling Price Cash Sales Credit Sales 80 30 60 170 30 200 1 04 000 1 04 000 Rs. Per anum 83 20 000 31 20 000 62 40 000 176 80 000 31 20 000 31 20 000 208 00 000 52 00 000 156 00 000

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Receivables Management

Working Capital Management
Days Current Assets Raw material inventory Material in Process Finished Goods Debtors Cash Balance Cash Balance 30 15 30 60 6 93 333 7 36 667 14 73 333 26 00 000 25 000 25 000 55 28 333 RM COP COP Credit Sales

Current Liabilities Creditors Wages Overheads

30 10 30

6 93 333 86 667 5 20 000 13 00 000 13 00 000 42 28 333 4 22 833 46 51 167

RM Direct Labour

Net working Capital Add: 10% Contingencies

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Receivables Management

Working Capital Management
Units Produced & Sold Per Unit 42.40 15.90 15 90 31.80 90.10 15.90 15 90 106.00 1 00 000 Rs. Per anum 42 40 000 15 90 000 15 90 000 31 80 000 90 10 000 15 90 000 15 90 000 106 00 000 26 50 000 26 50 000 79 50 000

Raw Material Direct labour Direct labour Overheads Cost of Production Profit Selling Price Cash Sales Cash Sales Credit Sales

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Receivables Management

Working Capital Management
Weeks Current Assets Raw material inventory R t i li t Material in Process Finished Goods Debtors ebtors Cash Balance 4 2 4 8 3 26 154 3 26 154 3 46 538 6 93 077 12 23 077 3 077 1 25 000 27 13 846 RM COP COP Credit Sales Credit Sales

Current Liabilities Creditors Wages

4 2

3 26 154 61 154 3 87 308 3 87 308 23 26 538 2 32 654 25 59 192

RM Direct Labour

Net working Capital Add: 10% Contingencies

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Receivables Management

Working Capital Management
CA/FA 0.10 0.25 0.40 0.70 0 70 1.00 1.50 2.50 Cost of Liquidity Cost of Illiquidity 138 275 550 1100 2200 4140 6890 2200 1650 1100 830 690 550 276 Total Cost 2338 1925 1650 1930 2890 4690 7166

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Receivables Management

Working Capital Management
8000 7000 6000 5000 4000 3000 2000 1000 0 0.1 0.25 0.4 0.7 1 1.5 2.5 Cost of Liquidity Cost of Illiquidity Total Cost

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Receivables Management

Working Capital Management
Month M th 1January 2February 2F b 3March 4April 5May y 6June 7July 8August 9September b 10October 11November 12December Total
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WC 72.65 58.13 58 13 29.06 24.22 33.9 43.6 58.12 72.66 82.3 87.19 92.02 87.17 741.02

Int.  Int on LTD  Long Term  g Investm Income  Net Int.  @  @ ent @1%p. Exp debt 1.17%p.m m 92.02 1.077 19.37 0.194 0.883 92.02 92 02 1.077 33.89 0.339 0.738 1 077 33 89 0 339 0 738 92.02 1.077 62.96 0.630 0.447 92.02 1.077 67.8 0.678 0.399 92.02 1.077 58.12 0.581 0.495 92.02 1.077 48.42 0.484 0.592 92.02 1.077 33.9 0.339 0.738 92.02 1.077 19.36 0.194 0.883 92.02 1.077 9.72 0.097 0.979 92.02 1.077 4.83 0.048 1.028 92.02 1.077 0 0.000 1.077 92.02 1.077 4.85 0.048 1.028 1104.24 12.92 363.22 3.63 9.29
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Working Capital Management
Month 1January 2February 3March 4April 5May 6June 7July 8August 9September 10October 11November 12December Total WC 72.65 58.13 29.06 29 06 24.22 33.9 43.6 58.12 72.66 82.3 87.19 87 19 92.02 87.17 741.02 ST Loan 72.65 58.13 29.06 29 06 24.22 33.9 43.6 58.12 72.66 82.3 87.19 87 19 92.02 87.17 741.02 Int on STL @  1.33%p.m 1 33%p m 0.966 0.773 0.386 0 386 0.322 0.451 0.580 0.773 0.966 1.095 1.160 1 160 1.224 1.159 9.86

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Receivables Management

Working Capital Management
Aggressiv Moderat Conserva e e tive 252 270 288 180 180 180 432 450 468 150 216 43.2 259.2 22.8 432 150 162 108 270 30 450 150 108 172.8 280.8 37.2 468 Remarks Given Given 1+2 Given Given 7‐‐5 as 60% of Total Assets 9‐‐7‐‐4 equals total assets q

1Current Assets 2Fixed Assets 3Total Assets 3Total Assets 4Current Liabilities 5Short  term Debt 5Short ‐term Debt 6Long Term Debt 7Total Debt 8Equity p 9Total capital

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Receivables Management

Working Capital Management
10Sales 11EBIT Int. on short term  12 debt @ 16%p.a Int. on long term  13 debt @ 18%p.a 14PBT 15ROE 16CA/TA 17CA/CL 18NWC 531 53 34.56 7.776 10.664 540 54 25.92 549 55 17.28 Given Given

19.44 31.104 8.64 6.616

46.77% 28.80% 17.78% 0.58 0.60 0.62 1.68 1.80 1.92 102 120 138

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Receivables Management