FINANCIAL MANAGEMENT

Unit-v
Liquidity decision
Prepared by
Mr. M. Vasudeva Rao,
Asst. Professor, DMS
BITS-VIZAG
Liquidity decision:

The short-term of financial investment decision is

known as “Liquidity decision”.

Working Capital: is a capital or amount required to meet day to day
expenses in one financial year.
Working capital : According to the definition of Weston and Brigham,
“Working Capital refers to a firm’s investment in short-term assets,
cash, short-term securities, accounts receivables and inventories”.
Classification of working capital

Types of working capital

Based on time period:

Based on concept: I. Permanent/ Fixed W.C
I. Gross working capital II. Temporary/ variable
II. Net working capital W.C
Based on concept:

I. Gross working capital: It refers to all total current assets .

II. Net working capital: It refers to the difference between current

assets and current liabilities. Or The excess of current assets over

current liabilities.
Gross working capital= only current assets
Net working capital = current asset – current liabilities
Current assets: are those assets which can be easily converted into
cash within one financial year.

Current liabilities: are those liabilities which can be clear or repay

within one financial year.
Based on time period:
I. Permanent / Fixed working capital:
It represents the current assets required on a continuing basis over
the entire year.
II . Temporary/ variable working capital:
It is the amount of working capital maintains on fluctuating from
time to time on the basis of business activities.
Determinants or factors of working capital:
1. Nature of business
2. Size of the business
3. Production cycle
4. Business cycle
5. Credit policy
6. Growth and expansion of business
7. Proper availability of raw materials
8. Profit level
9. Inflation
10. Operating efficiency
***Basis for working capital calculation:
I. Inventory or stock: includes raw materials, work in process (WIP),
finished goods
a. Raw materials should be calculate on storage period.
b. WIP should be calculate on total cost or cost of sales or process
time..
c. Finished goods should be calculated on total cost or cost of sales or
process time.

If only stock should be calculate on total cost or cost of sales.

2. Debtors: should be calculated on credit sales or cost of sales and

time allowed to customers.

3. Creditors: should be calculated on credit purchases or cost of sales

and time allowed by suppliers.

4. Outstanding Wages: should be calculated on direct wages for time

period.

5. Outstanding expenses: should be calculated on overheads or

expenditure and time period.

Prroblem-1:
Prepare an estimation of working capital requirement from the
following information:
Annual sales 1,00,000 units
Selling price Rs.8 per unit
Net profit on sales 25%
Average credit period allowed to customers 8 weeks
Average credit period allowed by suppliers 4 weeks
Average stock holding in terms of sales requirements 12 weeks
Allow 10% for contingencies.
Solution:
Working note:
Sales = 100000 x 8 = Rs. 8,00,000
Profit = 25% on sales = 25% x 8,00,000 = 2,00,000
Cost of sales= sales – profit = 800000 – 200000 = 600000
Net working capital = Current Assets – Current Liabilities
Statement of working capital requirements:
Current Assets: Rs.
Debtors= (cost of sales x 8 weeks/52 weeks)= 600000 x 8/52
Stock = (cost of sales x 12 weeks/52 weeks)= 600000 x 12/52
Total current assets (CA)
Current Liabilities:
Creditors = (cost of sales x 4 weeks/52 weeks)= 600000 x 4/52
Total current Liabilities (CL)
Net working capital = CA – CL =(230770-46154)
Add: 10% for contingencies
(10% on 184616)
Working capital required
Problem-2:
From the following information of Ravi Teja & Co.,
You are asked to prepare a statement of working capital requirement.
Production units per year 100000 units
Raw material per unit Rs 6.00
Direct Labour Rs.4.00
Overheads Rs. 5.00
Total cost Rs.15.00
Profit Rs. 5.00
Selling price Rs.20.00
Additional information:
1. Raw materials are kept in stock on average of 1 month.
2. WIP is on average of 3 weeks.
3. Finished goods are kept in store on average of 1 month
4. Credit allowed to debtors is 2 months
5. Credit allowed by creditors is 1 month
6. Lag in payment of wages to workers is 2 weeks
Solution:
Working notes: Calculation of sales: Rs.
Raw materials ( 100000x6) =
Direct Labour (100000x4) =
Overheads (100000x5) = ________
Total cost
Add: profit (100000x5) = ________
Sales ( 100000 x 20) = ________
Net working capital = Current Assets – Current Liabilities
Statement of working capital requirements:
Particulars Amounts (Rs.)
Current Assets:
Raw materials= Raw materials x 1/12
WIP = Total cost x 3/52 weeks
Finished good = total cost x 1/12
Debtors= sales x 2/12
Total current Assets (CA)
Current Liabilities:
Creditors = Raw materials x 1/12
Outstanding wages = Direct Labour x 2/52
Total Current Liabilities (CL)
Net working capital = CA - CL
THANK YOU