Financial Management

(PGDM: 2021-23)

Session-4: Working Capital Planning

Sriranga Vishnu
Faculty (F&A Area)
 Working Capital Planning
• Working Capital: Short-term assets

• Working Capital: Gross and Net WC

• Working Capital Planning:

– Level of Current Assets required

– Financing of Current Assets

• Importance of Working Capital Planning & Management:

– Liquidity and Solvency

– Financial Efficiency
 Working Capital Planning
• Differences in Management of Fixed and Current Assets:
• In managing fixed assets, discounting and compounding
techniques play a significant role in capital budgeting. In
management of current assets, time factor has lesser role
• Second, the large holding of current assets, reduces the overall
profitability. Thus, a risk-return trade-off is involved in
holding current assets
• Third, levels of fixed as well as current assets depend upon
expected sales, but it is only the current assets which can be
adjusted with sales fluctuations in the short run. Thus, the firm
has a greater degree of flexibility in managing current assets
 Working Capital Planning
• Current Assets – Convertible into cash within one year
– Cash, Marketable Securities, Receivables, Inventory, Prepaid
Expenses, etc.

• Current Liabilities – Obligations maturing within one

year
– Creditors, Outstanding expenses, Short-term Borrowings,
Advances received, Taxes and Dividends payable

• Permanent and Temporary Working Capital

 Working Capital Planning
• Permanent or fixed working capital
– A minimum level of current assets, which is continuously
required by a firm to carry on its business operations, is
referred to as permanent or fixed working capital

• Fluctuating or variable working capital

– The extra working capital needed to support the changing
production and sales activities of the firm is referred to as
fluctuating or variable working capital
 Working Capital Planning
• Factors determining Working Capital needs:
– Nature of Business
– Market and Demand Conditions
– Production Technology
– Manufacturing Policy – level production
– Credit Policy
– Credit availability from suppliers
– Operating Efficiency of the firm
– Price changes
 Working Capital Planning
• Financing Current Assets:
– Long-term Financing

– Short-term Financing

– Spontaneous Financing

• Approaches to Financing Current Assets :

– Matching or Hedging Approach

– Conservative Approach

– Aggressive Approach
 Working Capital Planning
• Matching Approach
 Working Capital Planning
• Conservative Approach

Conservative financing
 Working Capital Planning
• Aggressive Approach

Aggressive financing
 Working Capital Planning
• Operating Cycle: Cash -> Conversion -> Sales
• Operating cycle is the time duration required to convert sales,
after the conversion of resources into inventories, into cash.
The operating cycle of a manufacturing company involves
three phases:
– Acquisition of resources such as raw material, labour, power& fuel etc.

– Manufacture of the product which includes conversion of raw material

into work-in-progress into finished goods.

– Sale of the product either for cash or on credit. Credit sales create
account receivable for collection.
 Working Capital Planning
• Operating Cycle: Inventory conversion period + Debtors
conversion period (ICP + DCP); Also Gross OC (GOC)

• DCP: Time required to collect outstanding from customer

• Creditors Deferral Period: Length of time for which a

firm is able to defer payments to suppliers

• Net Operating Cycle: Cash collection to cash payments

• NOC OR Cash Conversion Cycle =GOC - CDP

 Working Capital Management
• Cash Conversion Cycle:

• Inventory Conversion Period + Receivables Collection Period

– Payables Deferral Period

• Inventory Conversion Period = Inventory / CoGS per day

• Receivables Collection Period = Receivables / Sales per day

• Payables Deferral Period = Payables /CoGS per day

• Days in Cash Conversion = Cash inflow delay – Payment

delay (ICP + RCP – PDP)
 Working Capital Estimation
• Ratio of Sales Method :- Estimation of working capital
requirements as a ratio of sales on the assumption that current
assets change with sales

• Ratio of Fixed Investment Method :- Estimation of

working capital requirements as a percentage of fixed
investment

• Regression Method :- Y = α + βx