Unit 2 - WORKING Capital-1

Sri Krishna College of Technology
School of Management
UNIT 2 –
WORKING
CAPITAL

Karthikeyan N- Asst. Prof/ SoM-SKCT

Contents
• Working Capital
• Operating Cycle
• Receivables and Payables Management
• Cash Management
• Inventory Management
• Sources of Finance

Session No.- 1
• Topics to be covered:
• Working Capital Management

• Learning Objectives
- What is Working Capital
- How can Working Capital be managed

- OBE- Understand

WORKING CAPITAL
• Fixed Capital –
• Required for Establishment of
Business
• Working Capital-
Capital • Required to Utilize the Fixed
Assets/ Operate a Business

Meaning of W/C
• Short Term Funds to meet Operating Expenses
• Cash that business requires to run its day-to-day

operations
Definition- “Funds available for day-to-day operations of

an Enterprise”-ICAI

W/C Components
W/C
Current Current
Assets Liabilities

W/C Concepts
W/C
Gross W/C Net W/C

Gross W/C
• Firm’s investment in short-term assets such as
• Cash
• Short-term Securities
• Accounts Receivables
• Inventories
Gross W/C= CA or Circulating Capital

Net W/C
• The amount of CA that would remain after paying all CL
Net W/C= CA - CL

Characteristics of W/C
• Short term needs
• Circular Movement
• Element of Permanency
• Element of Fluctuation
• Liquidity
• Less Risky
• Special Accounting system is not needed.

Items that come under W/C

• Current Liabilities • Current Assets
• Bills Payable • Bills Receivables
• Sundry Creditors/ • Sundry Debtors/ Accounts
Accounts Payables Receivables
• Short term loans • Short Term Deposits
• Advances Received • Cash in Hand and Bank
• Accrued or O/S Expenses • Prepaid Expenses
• Bank O/S • Accrued Incomes
• Provision of Taxation • Inventories
• Dividends Payable

Need for W/C

• Replenishment of Inventory
• Provision for Operating Expenses
• Support for Credit Sales
• Provision of Safety of Margin

Classification of Kinds of Working Capital
Concept Time
Based Based
Gross Temporary
Permanent or
Net W/C Regular W/C or Variable
W/C W/C
Regular Seasonal
W/C W/C
Reserve Special
W/C W/C

Permanent W/C
• Minimum W/C to be maintained for
uninterrupted operations of the firm
Temporary W/C
• Additional W/C to be maintained to
meet seasonal demand or some
special circumstances
Objectives of W/C Management

• To ensure optimum investment in CA.
• To strike a balance between liquidity & profitability in
use of funds.
• To ensure adequate flow for current operations.
• To speed up the flow of funds.
• To minimize the stagnation of funds.
• To ensure that availability of W/C is neither inadequate
nor excessive.

Factors Influencing/Determinants of W/C

• Nature of Business. • Rate of Stock of Turnover.
• Size of the business. • Credit Policy.
• Production Policy. • Business Cycle.
• Manufacturing Process. • Rate of Growth of Business
• Seasonal Variations. • Earning Capacity and
• W/C Cycle. Dividend Policy.

• Price level changes. • Profit Level.

• Tax Level. • Depreciation Policy.
• Growth and Expansion • Operating Efficiency
• Scarce of Availability of • Availability of Credit.
RM. • Production Cycle Process

Points to Ponder
• Required to Utilize the Fixed Assets/ Operate a Business
• Short Term Funds to meet Operating Expenses
• Cash that business requires to run its day-to-day operations
• Current Assets
• Current Liabilities
• Gross W/C
• Net W/C
• Net W/C= CA - CL

Key words
• Operate
• Short Term Funds
• day-to-day operations
• Net W/C= CA - CL

MCQ
1. Gross Working capital refers to ……………………….(CL/CA)
2.Net Working capital refers to …………………….(CA+CL / CA-CL)
3.Cash in hand a…………………asset ( CA/CL)
4.Prepaind expenses is a……………………asset ( CA/CL)
5.Working capital is ……………………………..(Short Term /long term
Investment)
6. Inventory is listed as a part of current assets. Stock or inventory in
an organization means……………….
a. Goods that are readily available for sale b.All the assets available
for sale
C .All the raw material, Semi finished and the finished goods in the
organization d. Goods that can be sold within a short span of time

Learning Outcomes
• At the end of the course, a student will be able
• To understand working capital and its components
• To understand forms of working capital.

Topics to be covered in the next session

• Operating Cycle
• Receivables Management

Session No.- 2
• Operating Cycle

- What is Operating Cycle
- Impact of Operating cycle in taking decisions related
to WC
- How to manage Receivables effectively.

- OBE- Understand, Apply

Operating Cycle/ Working Capital Cycle
Cash
Accounts Accounts
Receivab Payables
les/ /Creditor
Debtors s
Finished Raw
Goods Materials
W-I-P

Receivables Management (Debtors Management)
• Receivables
“Debt Owned to the firm by customers arising from sale
of goods and services in the ordinary course of
business”
Characteristics of Receivables
• Risk Involvement
• Based on the Economic Value (Amount/Price)
• Implies Futurity

Optimize the sale at the minimum possible cost of
credit.
Goods offered on credit must not only optimise the sale
but also maximize the overall return on investment.

• Objectives of Receivables Management
Maximizing the value of the firm.
Optimizing the investment in Sundry Debtors.
Control the cost of Credit.

• Costs of Receivables Management
Opportunity Cost- cost involved in financing the
receivables
Collection Cost
Bad Debts.

• Benefits of Receivables Management
Increased in sales.
Market Share increases.
Increase in profits.

• Factors influencing the size of investments in
Receivables Management
Volume of Credit Sales.
Credit Policy of the firm.
Trade terms.
Seasonality of the business.
Collection Policy.
Bills discounting and endorsement.

Factoring
• A business sells its accounts receivables (bills,
invoice) to a third party (called as factor) at a
discount in exchange for immediate money.

• Mode of payments in Receivables Management
Cash mode.
Open account.
Bills of Exchange.
Letter of Credit
Consignment.

Points to Ponder
• Working Capital Cycle
• Debt Owned
• Optimize the sale at the minimum possible cost of credit.
• Opportunity Cost- cost involved in financing the receivables

Key words
• Working Capital Cycle
• Debt Owned
• Optimize the sale

MCQ
1. WIP Refers to ……………………..( Work in Product / Work in Progress)
2. Operating cycle is also known as …………………( Business cycle /
operating cycle)
3. One of the objective of receivable management is
………………..(Maximizing the value of the firm / Minimizing the value of the
firm)
4. A business sells its accounts ………………………to a third party (called
as factor) at a discount in exchange for immediate money. ( Receivable or
Payable)
5. Companies provide credit system as it is……………
a. An essential tool for alluring and holding the valuable clients
b. feasible for the managers c. needed by the suppliers
d. a way to organize the capital of the organization

Learning Outcomes
• At the end of the course, a student will come
• To understand operating cycle
• To understand receivables and its management

Session No.- 3
• Payables Management
• Cash Management

- What is Payables Management
- How to manage Payables effectively.

- OBE- Understand, Apply, Analyse


• Payables Management
• Cash Management

Payables Management (Creditors Management)
• Payables
“Credit Owned by the firm to its suppliers of arising
from purchase of goods for production process in the
ordinary course of business”
Characteristics of Payables
• Non requirement of cash for immediate consumption
• Purely internal control
• Helps to determine the cash requirement

Payable Management (Creditors Management)

• Objectives of Creditors Management
Maximizing the period of credit
Ensure smooth flow of required raw materials

Cash Management
• Cash is a component of CA.
• Cash acts a medium of exchange.
• Cash Management is one of the key areas of W/C

Management

Motives for Holding Cash

• The Transaction Motive:
The requirement of cash to meet routine cash needs
Holding up of cash to meet the anticipated obligations
e.x- Purchase of Raw Materials/ Payment of Business

Expenses etc.


• The Precautionary Motive:
The requirement of cash to meet unexpected cash

needs
Holding up of cash to withstand unexpected emergency
e.x Strike/ Bills presented earlier than expected/ slow

down in collection process/ Sudden increase in RM
price


• The Speculative Motive:
The requirement of cash to invest in profitable

opportunities as and when they arise.
Holding up of cash to gain in speculative transactions
e.x Purchase of RM at reduced price on immediate

payment

Objectives of Cash Management

• To meet cash payments needs- Payment for RM,
wages, EB bills, telephone bills etc.
• To maintain Minimum Cash Balance Reserve- Optimum

cash balance should be maintained i.e. neither excess
cash balance nor low cash balance

Aspects/Techniques of Cash Management

• Cash Planning- Preparing Cash Budget
• Cash Flow Management- Accelerate Cash Inflow and

slow down the cash outflow
• Determination of Optimum Cash Balance- Neither high

nor low
• Investment of Surplus Funds- invest in short term

Factors determining cash needs

• Synchronisation of Cash
• Short Costs
• Cost of Transaction- Brokerage Fee
• Cost of Borrowing- Interest and other expenses to loan
• Cost of Deterioration of Credit Rating-
• Cost of loss of cash discount
• Cost of penalty rates
• Surplus Cash balance cost
• Management Cost

Managing Cash Collections
• A.) Accelerating Cash Collections
• Prompt Payments of Customers.
• Early Conversion of Payments into cash.
• Concentration Banking/ Decentralised Collections
• Lock Box System- Post office Box

Managing Cash Collections
• B.) Slowing Down Cash Payments
• Paying on the last date.
• Centralised Payments
• Cheque Kitting/PDC

Computation of Optimum Cash Balance
• Baumol Model ( Inventory Model)- William J.
Baumol Model
• Miller-Orr (Statistical Model)

What happens if Cash is held in excess?
• If Cash is held in excess- the carrying cost/holding

cost/opportunity cost occurs.
• This cost should also be included total cost.

What happens if Cash is held in less?

• If the cash is held in deficit- Transactions cost occurs
i.e cost that is involved to convert the cash equivalents
to cash which involves
- clerical cost,
- brokerage cost,
- registration cost.

What is Optimum Cash Balance under Baumol Model?

• Cash Level at which the opportunity cost and
transaction cost are minimum that is called as Optimum
Cash Balance
• Total Cost= Opportunity Cost+ Transaction Cost

Baumol Model
• Assumptions
• The firm knows its cash needs with certainty.
• The cash Payments occurs uniformly over a period of
time and it is known with certainty.
• The opportunity cost is known and it remains stables.
• The transaction cost is know and remains stable

Miller-Orr Model
• This is statistical model.
• This can be used when the cash flows are uncertain.
• This model provides 2 limits- UCL and LCL
• UCL –Upper Control Limit
• LCL- Lower Control Limit
• Spread- Return Point which defines when to buy and
when to sell

Points to Ponder
• Credit Owned by the firm to its suppliers
• Determine The Cash Requirement
• Cash Management is one of the key areas of W/C Management
• The requirement of cash to meet routine cash needs-Transaction motive
• The requirement of cash to meet unexpected cash needs- precautionary motive
• The requirement of cash to invest in profitable opportunities as and when they arise.
Speculative Motive.
Optimum cash balance should be maintained i.e. neither excess cash balance nor low
cash balance

Points to Ponder
• Optimum Cash Balance- Cash Level at which the opportunity cost and transaction
cost are minimum that is called as Optimum Cash Balance
• UCL –Upper Control Limit
• LCL- Lower Control Limit
• Spread- Return Point which defines when to buy and when
to sell

Key words
• Credit Owned
• Cash Requirement
• routine cash needs
• unexpected cash needs-
• invest in profitable opportunities
• Optimum cash balance

MCQ
1.Miller-Orr Model can be used when ………………. ( Cash flow is certain
/Cash flow is uncertain)
2. In Miller-Orr Model the Spread refers ……….. ( when to buy a / when to
sell / when to buy and sell )
3. Total Cost is ……………………. ( Opportunity Cost- Transaction Cost/
Opportunity Cost- Transaction Cost, Opportunity Cost divided by
Transaction Cost)
4. The requirement of cash to invest in profitable opportunities as and when
they arise is called as ……………………..( Transaction motive / Speculative
Motive)
5. The requirement of cash to meet unexpected cash needs is know as
……………….
(Precautionary motive /Speculative Motive)

Learning Outcomes
• To understand payables management
• To understand cash management
• To determine the optimum cash balance required by
a firm


• Source of Finance

Session No.- 4
• Source of Finance

- What is Inventory Management
- How to manage Inventory effectively.
- What is various sources of finance available for a
firm to employ in its business.

- OBE- Remember, Understand

Inventory = List of things that are available
An aggregated of those
items of tangible
personal property which
- are to be currently
- are held for sale in - are in the process of consumed in the
ordinary course of production for such production of
business. sales. production/services to
be available for sale”

Forms of Inventory (Components of Inventory)
Inventory
Raw- Work-in Finished Stores and

Materials Progress Goods Spares

Inventory Management Motives

• Transaction Motive
• To meet the supply and the orders
• Precautionary Motive
• To meet contingency
• Speculative Motive
• To hold back goods so as to make huge profit at time
of huge demand

Inventory Management- Objectives

• Ensure Continues supply of Raw materials
• Maintain Sufficient stock of Raw materials
• Maintain sufficient Finished Goods inventory
• Minimize carrying cost
• Control investment in inventories and keep it an
optimum level.
• Control Material Cost.
• Supply right quantity of goods.

Inventory Management- Tools and techniques

1. ABC Analysis- (Selective Inventory Control)
The firm should put maximum control on those items whose
A- High Value Items- High Control-Less quantity but

consumption value is high
B-Medium Value Items-Medium Control- Medium Control
C- Low Value Items-Low Control-more quantity whose annual

consumption is low


2. Economic Order Quantity (EOQ):
The level at which the total cost of inventory is minimum i.e
ordering cost and carrying cost should be minimum
2𝐴𝑂
𝐶𝐶
A- Annual Usage, O- Ordering Cost, CC- Carrying Cost


3. Ordering Point Problem
- Minimum Level: The level that must be maintained in
order to have an uninterrupted production.
- Reorder Level- The level of Inventory at which order
should be placed for replenishing.
- Maximum Level: The level of stock beyond which a firm
should not maintain the stock.
-Average Stock: The level of stock that has to maintained
between minimum and maximum stock.
-Danger Level: The level at which stock should not fall in
any situation


4. Two bin technique
Stock
Bin 1 Bin 2
Bin 1- Contains stock just enough to last from the date a new
order is placed until it is received with inventory.
Bin2- Contains stock which is enough to meet current demand
over the period of replenishmnet

5. VED Classification- Inventories are classified as Vital,
Essential, Desirable
6.HML Classification- Inventories are classified as High Value,

Medium Value, Low Value
7. SDE Classification- Inventories are classified as Scarce,

Difficulty, Easy
8. FSN Classification- Inventories are classified as Fast Moving,

Slow Moving, Non-Moving


9. Order Cycling System
Order
Fixed Order Point Fixed Order

System (P Quantity
System) (Q System)
Quantity is fixed based

Period is fixed based on
on which order is placed.
which order is placed. e.g- 2
e.g- After 50 kgs are over
months once
then place the order

10. JIT- Just in time: The inventories are procured just a few
hours before they are put to use.
The key objective to follow JIT is to reduce holding cost.
No inventories are held back in the store.
Inventories arrive as and then it is needed.
“Toyota, Ford are the early companies to adopt JIT concept”

Sources of
Funds
Long-
Equity Preference Short-Debt
Term Debt

Points to Ponder
• List of things that are available
• ABC Analysis- (Selective Inventory Control) The firm should put maximum
control on those items whose
• Economic Order Quantity (EOQ):The level at which the total cost of inventory
is minimum i.e ordering cost and carrying cost should be minimum
• Two bin technique
• Inventories are classified as Vital, Essential, Desirable
• Inventories are classified High Value, Medium Value, Low Value
• Inventories are classified Scarce, Difficulty, Easy
• Inventories are classified Fast Moving, Slow Moving, Non-Moving
• Fixed Order Point System (P System), Fixed Order Quantity (Q System)
• Just in time: The inventories are procured just a few hours before they are put
to use.
Points to Ponder
• Sources of funds
• Equity – Owners Capital
• Preference Share
• Long term Debt
• Short term Debt

Key words
• Things • Fast
• ABC • Moving
• EOQ • Slow
• Two bin • Moving
• Vital • Non-Moving
• Essential • P System
• Desirable • Q System
• High Value • Just in time Sources of funds
• Medium Value • Equity – Owners Capital
• Low Value • Preference Share
• Scarce • Long term Debt
• Difficulty • Short term Debt
• Easy
MCQ
1.LIFO refers to ……………… (Last in Fast out / Last in first out)
2.EOQ refers to ………………( Efficient order quantity / Economic Order

Quantity )
3.JIT refers to ……………….( Joint in Time / Just in Time)
4.Carrying cost refers to transportation cost ( True / False )
5.The main objective of EOQ is ………………… ( To know the quality of the

inventory / To know quantity of the Inventory)
6. The purpose of buffer stock in inventory management is ………………….. (

To use surplus raw material to increase the production / To manage the
shortage of raw material in crisis period)

Learning Outcomes
• To remember inventory management
• To understand the various methods of inventory
management
• To remember the various sources of funds

Topics to be covered in next session

• Unit 3- Capital Structure

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Sri Krishna College of Technology

Sri Krishna College of Technology

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

• Cash that business requires to run its day-to-day

Definition- “Funds available for day-to-day operations of

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Gross W/C Net W/C

Karthikeyan N- Asst. Prof/ SoM-SKCT

Gross W/C= CA or Circulating Capital

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Items that come under W/C

Karthikeyan N- Asst. Prof/ SoM-SKCT

Need for W/C

• Provision for Operating Expenses

• Support for Credit Sales

• Provision of Safety of Margin

Karthikeyan N- Asst. Prof/ SoM-SKCT

Classification of Kinds of Working Capital

Karthikeyan N- Asst. Prof/ SoM-SKCT

Objectives of W/C Management

Karthikeyan N- Asst. Prof/ SoM-SKCT

Factors Influencing/Determinants of W/C

Karthikeyan N- Asst. Prof/ SoM-SKCT

• Price level changes. • Profit Level.

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Topics to be covered in the next session

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

- OBE- Understand, Apply

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT

- OBE- Understand, Apply, Analyse

Karthikeyan N- Asst. Prof/ SoM-SKCT

Topics to be covered in the next session

Karthikeyan N- Asst. Prof/ SoM-SKCT

Karthikeyan N- Asst. Prof/ SoM-SKCT