WCM

1. Discuss the factors to be considered while determining working capital

requirements
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1. Nature of the Business:

o Different industries have varying working capital requirements. For example,
a manufacturing business may require higher working capital due to longer
production cycles and inventory holding periods, while a service-oriented
business may have lower working capital needs.
2. Business Cycle:
o Understanding the business cycle is crucial. Companies in cyclical industries
may experience fluctuations in sales and cash flows, impacting their working
capital needs. It's important to align working capital levels with the peaks and
troughs of the business cycle.
3. Sales and Revenue Patterns:
o Seasonal businesses may experience periods of high demand followed by
slower periods. Working capital requirements should account for these
fluctuations in sales and revenue.
4. Credit Policy:
o The credit terms offered to customers and the credit terms negotiated with
suppliers affect the cash conversion cycle. Striking a balance between
receivables and payables is essential to optimize working capital.
5. Inventory Management:
o Efficient inventory management is critical. Businesses need to find the right
balance between having enough stock to meet demand and minimizing excess
inventory that ties up capital.
6. Supplier Relationships:
o Negotiating favorable payment terms with suppliers can positively impact
working capital. Longer payment terms provide more time for the business to
generate cash from sales before paying suppliers.
7. Operating Efficiency:
o Streamlining operations and improving efficiency can reduce the need for
excessive working capital. This includes optimizing production processes,
reducing lead times, and minimizing waste.
8. Cash Reserves:
o Maintaining an adequate cash reserve is important for unforeseen
circumstances or emergencies. It acts as a buffer to cover unexpected expenses
and ensures the continuity of business operations.
9. Interest Rates and Financing Costs:
o The cost of financing working capital, including interest rates on loans and
other forms of financing, affects the overall financial health of the business.
Lower financing costs can positively impact working capital management.
10. Economic Conditions:
o External economic factors, such as inflation rates, interest rates, and overall
economic stability, can influence working capital requirements. Businesses
should be mindful of macroeconomic conditions when planning for their
working capital needs.
11. Technology and Automation:
o Implementing technology and automation can improve efficiency in managing
working capital. Automated systems can provide real-time data, helping
businesses make informed decisions and respond quickly to changes in
working capital requirements.
12. Regulatory Environment:
o Compliance with regulatory requirements and industry standards is crucial.
Changes in regulations can impact the financial structure of a business and its
working capital needs.

2. Sources of working capital

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1. Permanent or Long-Term Sources:

o These are funds that are used for permanent working capital requirements,
which are needed to carry out regular business activities. Long-term sources of
working capital include:
 Equity Capital: Funds provided by the owners or shareholders of the
company.
 Retained Earnings: Profits that are reinvested back into the business
rather than distributed as dividends.
 Long-Term Loans: Borrowings with a maturity period exceeding one
year.
2. Temporary or Short-Term Sources:
o These are funds used to meet temporary or seasonal fluctuations in working
capital needs. Short-term sources of working capital include:
 Short-Term Loans: Borrowings with a maturity period of one year or
less, often used to address temporary cash flow gaps.
 Trade Credit: The credit extended by suppliers, allowing the
company to defer payments for goods or services received.
 Bank Overdrafts: A short-term borrowing arrangement that allows a
company to overdraw its bank account up to a predetermined limit.
 Commercial Paper: Short-term unsecured promissory notes issued by
highly-rated companies to raise funds in the money market.
 Factoring and Receivables Financing: Selling accounts receivable to
a third party (factor) to obtain immediate cash.
3. Spontaneous Sources:
o These are sources of working capital that arise automatically in the normal
course of business operations. They include:
 Trade Creditors: Amounts owed to suppliers for goods and services
purchased on credit.
 Accrued Liabilities: Unpaid expenses that accumulate over time but
have not yet been settled.
 Taxes Payable: Amounts owed to tax authorities.
4. Internal Sources:
o Internal sources of working capital are generated from within the business.
These include:
 Depreciation Reserves: Accumulated reserves from setting aside a
portion of profits to replace assets.
 Sale of Assets: Selling surplus or non-essential assets to generate cash.
5. External Sources:
o External sources involve obtaining funds from outside the company. Examples
include:
 Bank Loans and Overdrafts: Borrowing from financial institutions.
 Public Deposits: Accepting deposits from the public, which is more
common in certain financial industries.
 Commercial Paper: As mentioned earlier, short-term unsecured
promissory notes issued to investors.

3. Different methods of estimating working capital requirement

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1. Operating Cycle Method:

o The operating cycle is the time it takes for a company to convert its
investments in inventory and other resources back into cash. The operating
cycle method involves estimating the time it takes for cash to be converted
into inventory, then into accounts receivable, and finally back into cash. The
working capital requirement is calculated based on this cycle.
2. Cash Forecasting Method:
This method of estimating working capital requirements involves forecasting of cash
receipts and disbursements during a future period of time. Cash forecast will include
all possible sources from which cash will be received and the channels in which
payments are to be made so that a consolidated cash position is determined.

3. Percentage of Sales Method:

o This method involves estimating the working capital requirement as a
percentage of sales. The percentage is based on historical patterns or industry
benchmarks. The formula is:
Working Capital Requirement=Percentage of Sales×SalesWorking Capital Re
quirement=Percentage of Sales×Sales
4. Balance Sheet Method:
o The balance sheet method involves analyzing the components of the balance
sheet, focusing on current assets and liabilities. It considers the relationship
between these items and estimates the working capital requirement as the
difference between current assets and current liabilities.
5. Turnover Method:
o The turnover method calculates working capital based on the turnover ratios of
various components such as inventory turnover and receivables turnover. It
considers the number of times certain assets are converted into cash during a
specific period.
 6. Minimum Cash Balance Method:
o This method determines the working capital requirement by maintaining a
minimum cash balance that a company needs to cover day-to-day expenses. It
considers the required cash reserves to ensure liquidity.
7. Regression Analysis:
o Regression analysis uses statistical techniques to identify relationships
between working capital and relevant variables such as sales, production
levels, or other operational factors. This method is more quantitative and relies
on historical data.

4. Baumol’s model of cash management

= It was introduced by William J Baumol. The Baumol model helps in determining the
minimum amount of cash that a manager can obtain by converting securities into cash. The
model helps in determining the cash conversion size which means how much cash should be
arranged by selling marketable securities in each transaction. This model assumes that cash
can be arranged through selling marketable securities which the firms hold in the time of
needs.

Baumol model is an approach to establish a firm’s optimum cash balance under certainty. As
such, firms attempt to minimise the sum of the cost of holding cash and the cost of converting
marketable securities to cash.

Baumol model of cash management trades off between opportunity cost or carrying cost or
holding cost and the transaction cost

The primary objective of Baumol's model is to minimize the total cost of holding and
acquiring cash. This involves finding the optimal order quantity (cash balance) that
minimizes the sum of the transaction costs and the opportunity cost of holding cash.

Components of the Model:

 The model considers two main components:

o Transaction Costs : The cost associated with acquiring or replenishing cash.
It is assumed to be a fixed cost per transaction.
o Opportunity Cost : The cost of holding cash rather than investing it in
interest-bearing securities. It is determined by the average cash balance held
during the period.

Assumptions of the model

• The requirement for cash for a given period is known.

• The requirement of cash is distributed evenly throughout the period.

• Selling of securities can be done immediately (There is no delay in placing and receiving
orders).
 • There are two distinguishable costs associated with cash holding: opportunity cost and
transaction cost.

• The cost per transaction is constant regardless of the size of transaction.

• The opportunity is a fixed percentage of the average value of cash holding.

5. Miller and orr model of cash management

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The Miller-Orr model of cash management is developed for businesses with uncertain
cash inflows and outflows. This approach allows lower and upper limits of cash
balance to be set and determine the return point (target cash balance). This is different
from the Baumol model, which is based on the assumption that the cash spending rate
is constant, it is an improvement over Baumol’s model
Developed by Merton H. Miller and Daniel Orr, this model is designed to minimize
the total cost of managing cash while maintaining a target cash balance. The model is
particularly useful for managing uncertainty in cash flows and helps businesses make
decisions on when to buy or sell short-term marketable securities to maintain their
desired cash level.

Components of the Model:

 The model involves three main components:

o Target Cash Balance : The desired level of cash that a company aims to
maintain.
o Upper Limit : The upper limit at which the company should invest excess
cash in marketable securities to avoid holding too much cash.
o Lower Limit : The lower limit at which the company should sell marketable
securities to replenish cash and avoid stockouts

Assumptions

1. The cash inflows and cash outflows are stochastic. In other words, each day a
business may have both different cash payments and different cash receipts.
2. The daily cash balance is normally distributed, i.e., it occurs randomly.
3. There is a possibility to invest idle cash in marketable securities.
4. There is a transaction fee when marketable securities are bought or sold.
5. A business maintains the minimum acceptable cash balance, which is called the lower
limit
 6. Importance of five C’s in context to formulating a credit policy
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 Character:

Character refers to the borrower's reputation, integrity, and willingness to repay debts.
It involves assessing the borrower's credit history, payment behavior, and overall
financial responsibility.

 Capacity:

Capacity assesses the borrower's ability to repay the debt based on their income, cash
flow, and existing financial commitments. It considers the borrower's financial
stability and ability to generate sufficient income to meet debt obligations.

 Capital:

Capital represents the borrower's financial reserves and equity. It reflects the financial
cushion or safety net that the borrower has to absorb losses or financial setbacks.

 Collateral:

Collateral refers to assets that the borrower pledges as security for the loan. It
provides a source of repayment for the lender in case of default.

 Conditions:

 Conditions refer to the economic, industry, and market conditions that may impact the
borrower's ability to repay the debt. This includes factors such as interest rates,
inflation, and the overall economic environment.

Importance of five C’s in formulating a credit policy

 Assesses borrower's track record: Payment history, past defaults, and

overall financial responsibility are vital indicators of their willingness and
ability to repay.

 Estimates ability to repay: Income, employment stability, and debt-to-

income ratio determine whether the borrower can afford the loan payments.

 Evaluates borrower's existing financial resources: Savings, investments,

and other assets can act as a buffer against financial setbacks.

 Offers additional security for lenders: In case of default, capital assets can
be liquidated to recover some of the outstanding debt.

 Can improve loan terms: Borrowers offering valuable collateral may qualify
for lower interest rates or better loan terms
7. Types of factoring. Also explain the mechanism of factoring
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 Recourse and Non-recourse Factoring: In this type of arrangement, the financial

institution, can resort to the firm, when the debts are not recoverable. So, the credit
risk associated with the trade debts are not assumed by the factor.

On the other hand, in non-recourse factoring, the factor cannot recourse to the firm, in
case the debt turn out to be irrecoverable.

 Disclosed and Undisclosed Factoring: The factoring in which the factor’s name is
indicated in the invoice by the supplier of the goods or services asking the purchaser
to pay the factor, is called disclosed factoring.

Conversely, the form of factoring in which the name of the factor is not mentioned in
the invoice issued by the manufacturer is known as Undislocsed factoring. In such a
case, the factor maintains sales ledger of the client and the debt is realized in the name
of the firm. However, the control is in the hands of the factor.

 Domestic and Export Factoring: When the three parties to factoring, i.e. customer,
client, and factor, reside in the same country, then this is called as domestic factoring.

Export factoring, or otherwise known as cross-border factoring is one in which there

are four parties involved, i.e. exporter (client), the importer (customer), export factor
and import factor. This is also termed as the two-factor system.

 Advance and Maturity Factoring: In advance factoring, the factor gives an advance
to the client, against the uncollected receivables.

In maturity factoring, the factoring agency does not provide any advance to the firm.
Instead, the bank collects the sum from the customer and pays to the firm, either on
the date on which the amount is collected from the customers or on a guaranteed
payment date.

Mechanism of factoring or factoring process-

1. Agreement between Business and Factor:

o The process begins with the business (seller) and the factor entering into a
factoring agreement. This agreement outlines the terms and conditions of the
factoring arrangement, including fees, responsibilities, and the scope of
services provided by the factor.
2. Credit Assessment:
o The factor conducts a credit assessment of the business's customers to evaluate
their creditworthiness. This assessment helps determine the risk associated
with the invoices and may influence the terms of the factoring arrangement.
3. Submission of Invoices:
o Once the agreement is in place, the business submits its eligible invoices to the
factor. Eligibility criteria may vary but generally include factors such as the
 creditworthiness of the customers, the nature of the products or services, and
the absence of disputes.
4. Verification and Approval:
o The factor verifies the submitted invoices to ensure accuracy and authenticity.
This may involve confirming that the goods or services have been delivered or
performed, and the customer is obligated to pay. Approved invoices move
forward in the factoring process.
5. Advance Payment:
o Upon approval, the factor provides an advance payment to the business,
typically ranging from 70% to 90% of the invoice value. This immediate cash
infusion helps the business address its working capital needs without waiting
for customer payments.
6. Collection Process:
o The factor assumes responsibility for collecting payments from the business's
customers. The factor's collection team contacts the customers to secure
payment within the agreed-upon terms. In non-recourse factoring, the factor
bears the credit risk associated with customer non-payment.
7. Rebate or Settlement:
o Once the customer pays the invoice, the factor deducts its fees and any
advance provided, and the remaining balance is returned to the business. The
factor's fees typically consist of a discount fee, expressed as a percentage of
the invoice value, and interest on the advance.
8. Reporting:
o The factor provides regular reports to the business, detailing the status of
invoices, collections, and any deductions made. Transparency in reporting
helps the business track its receivables and understand the cost of factoring
services.
9. Continuation or Termination:
o The factoring arrangement continues as an ongoing financial solution, with the
business submitting new invoices as needed. Alternatively, either party may
choose to terminate the factoring agreement based on the terms outlined in the
agreement.

8. Factors that will help in forecasting receivables

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1. Historical Data:
o Analyzing past receivables data provides valuable insights into payment
patterns, seasonality, and trends. Historical data serves as a foundation for
developing forecasting models and making realistic predictions about future
cash inflows.
2. Sales Forecasts:
o Projected sales figures directly influence receivables. Reliable sales forecasts
help estimate the volume of credit sales, allowing businesses to anticipate the
corresponding accounts receivable. Coordination between sales and finance
teams is crucial for accurate forecasting.
 3. Credit Policies:
o The credit terms offered to customers, such as payment periods and credit
limits, significantly affect receivables. Monitoring and adjusting credit policies
based on market conditions, customer creditworthiness, and the business's risk
tolerance are essential for accurate forecasting.
4. Industry and Economic Trends:
o Economic conditions and industry trends can impact customer payment
behavior. A robust forecasting model considers external factors, such as
economic indicators, interest rates, and market dynamics, to provide a more
comprehensive view of receivables expectations.
5. Customer Relationships:
o The strength of relationships with customers influences payment reliability.
Communication, negotiation, and proactive management of customer
relationships can positively impact receivables forecasting by reducing the
likelihood of late or delinquent payments.
6. Payment Terms and Discounts:
o The terms offered to customers, such as early payment discounts or extended
payment periods, affect payment timing. Adjusting these terms strategically
can influence customer behavior and impact the timing and amounts of
receivables.
7. Collection Efficiency:
o The efficiency of the collections process directly impacts the speed at which
receivables are converted into cash. Regularly assessing and improving
collection procedures can enhance forecasting accuracy by reducing the
average collection period.
8. Government Policies and Regulations:
o Changes in government policies, tax regulations, or industry-specific
regulations can impact customer payment behavior. Staying informed about
relevant regulatory changes is crucial for adjusting receivables forecasts
accordingly.

9. Explain economic order quantity (EOQ) with example

= The economic order quantity (EOQ) refers to the ideal order quantity a company should
purchase in order to minimize its inventory costs, such as holding costs, shortage costs, and
order costs. EOQ is necessarily used in inventory management, which is the oversight of the
ordering, storing, and use of a company's inventory. Inventory management is tasked with
calculating the number of units a company should add to its inventory with each batch order
to reduce the total costs of its inventory.1

The EOQ model seeks to ensure that the right amount of inventory is ordered per batch so a
company does not have to make orders too frequently and there is not an excess of inventory
sitting on hand. It assumes that there is a trade-off between inventory holding costs and
inventory setup costs, and total inventory costs are minimized when both setup costs and
holding costs are minimized.
For example, consider a retail clothing shop that carries a line of men’s shirts. The shop sells
1,000 shirts each year. It costs the company $5 per year to hold a single shirt in inventory,
and the fixed cost to place an order is $2.

The EOQ formula is the square root of (2 x 1,000 shirts x $2 order cost) / ($5 holding cost),
or 28.3 with rounding. The ideal order size to minimize costs and meet customer demand is
slightly more than 28 shirts.

10.Explain the utility of cash budget as a tool of cash management. Also

discuss the cash concentration strategies
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A cash budget is a financial planning tool that provides a detailed projection of a business's
expected cash inflows and outflows over a specific period. It serves as a crucial component of
cash management, offering several utilities and benefits for businesses. Here's an explanation
of the utility of a cash budget as a tool of cash management:

1. Cash Planning and Forecasting:

o A cash budget helps businesses plan and forecast their cash position. By
estimating expected cash inflows and outflows, businesses can anticipate
periods of surplus or shortage. This foresight enables proactive decision-
making to address potential cash flow challenges and capitalize on
opportunities.
2. Working Capital Management:
o Effective working capital management is essential for the day-to-day
operations of a business. A cash budget assists in optimizing working capital
by ensuring that there is sufficient liquidity to cover operational expenses,
manage inventory, and meet short-term liabilities.
3. Identifying Cash Gaps and Surpluses:
o Through the cash budgeting process, businesses can identify periods of
potential cash shortages or surpluses. This information is valuable for making
 adjustments to financing arrangements, negotiating credit terms, or
considering investment opportunities during periods of excess cash.
4. Credit Policy Decisions:
o Businesses often extend credit to customers, and a cash budget helps in
determining the appropriate credit policies. By analyzing the impact of credit
terms on cash flows, businesses can strike a balance between attracting
customers and managing their own liquidity.
5. Investment and Financing Decisions:
o The insights gained from a cash budget influence investment and financing
decisions. Businesses can evaluate the need for external financing or assess
opportunities for investing excess cash. Strategic decisions related to loans,
investments, or capital expenditures can be better informed with a well-
prepared cash budget.
6. Performance Monitoring:
o Comparing actual cash flows against the budgeted figures helps monitor
financial performance. Variances between projected and actual cash flows can
provide insights into the effectiveness of cash management strategies and
areas that may require attention.
7. Enhancing Communication and Coordination:
o A cash budget serves as a communication tool within the organization. It
ensures that different departments are aligned in terms of financial
expectations, helping to coordinate efforts toward common cash management
goals.
8. Facilitating Strategic Planning:
o A cash budget is an integral part of strategic planning. It assists businesses in
aligning their financial goals with broader strategic objectives, helping to
ensure that cash management practices support the overall strategic direction
of the company.

Cash concentration strategies

 Zero Balance Account (ZBA):

 In a ZBA structure, funds from subsidiary accounts are automatically transferred to a

central concentration account at the end of each business day. The goal is to maintain
a zero balance in the subsidiary accounts, minimizing idle cash and maximizing
interest earnings in the central account.

 Target Balancing:

 Target balancing involves maintaining a predetermined target balance in each

subsidiary account. Excess funds are transferred to the central account, while any
deficiencies are covered by transferring funds from the central account to the
subsidiary accounts. This strategy helps optimize cash levels across accounts.

 Notional Pooling:

 Notional pooling is a virtual cash concentration method where the balances of

multiple accounts are notionally offset against each other. While physical transfers do
 not occur, interest is calculated on the net position, providing businesses with interest
optimization benefits.

 Sweep Accounts:

 Sweep accounts automatically transfer excess funds from subsidiary accounts to an

investment account, such as a money market fund, at the end of each day. This
strategy allows businesses to earn interest on idle cash while maintaining sufficient
liquidity for daily operations.

 Electronic Funds Transfer (EFT) Systems:

 EFT systems facilitate the electronic transfer of funds between accounts. Businesses
can leverage EFT to concentrate funds from multiple accounts into a central account
efficiently. This approach is suitable for companies with electronic banking systems
in place.

 International Cash Concentration:

 For multinational corporations, cash concentration strategies may involve cross-

border cash concentration to centralize funds held in different currencies. This
requires navigating international banking systems and complying with currency
exchange regulations.

11.Short notes:-
A) ABC Analysis

ABC analysis, also known as Pareto analysis or the ABC classification system, is a method
used in inventory management and other areas to categorize items based on their importance
and value. The technique derives its name from the three categories it creates: A, B, and C,
with A items being the most significant, B items having moderate importance, and C items
having the least significance. ABC analysis is often employed to prioritize resources, focus
efforts, and optimize decision-making in various business processes

Segment A: Products included in category A are the most essential goods with the highest
value. Segment A goods consist of approximately 20% of the total products with 80% of
revenue generation for your business. It is considered as a small category with minimal
goods, but maximum revenue.

Segment B: Products included in category B have a slightly higher value than segment B. It
approximately regulates 30% of goods with 15% revenue generation. Not to mention, the
goods included in this category are more in number but less in utility.

Segment C: Products included in category C are more in numbers but least valuable when it
comes to generating revenue. As compared to category A & B, segment C has the maximum
share of 50% of the stock, generating just 5% revenue
Benefits of ABC Analysis:

 Resource Optimization: ABC analysis enables businesses to allocate resources

efficiently by directing more attention and resources to items that have a greater
impact on overall performance.
 Risk Mitigation: By identifying and closely monitoring high-value items (A items),
businesses can mitigate the risks associated with stockouts, shortages, or disruptions
in the supply chain.
 Cost Reduction: Effective management of high-value items helps minimize holding
costs, reduce excess inventory, and optimize overall inventory carrying costs.
 Strategic Decision-Making: ABC analysis supports strategic decision-making by
providing insights into the critical components of various business processes,
allowing organizations to focus on areas that significantly contribute to their success.

B) Just In Time inventory control system

Just-In-Time (JIT) is an inventory management philosophy and system that emphasizes
producing goods or services exactly when they are needed in the production process and not
before. The goal of JIT is to minimize inventory levels, reduce carrying costs, and improve
overall efficiency. JIT is often associated with lean manufacturing and is widely used in
industries seeking to streamline operations and eliminate waste.

Benefits of Just-In-Time Inventory Control:

 Cost Reduction: JIT helps reduce carrying costs associated with holding excess
inventory, such as storage, insurance, and obsolescence costs.
 Improved Efficiency: By focusing on on-demand production and minimizing waste,
JIT improves overall efficiency in the production process.
 Enhanced Quality: The emphasis on quality control and continuous improvement in
JIT leads to higher-quality products.
 Increased Flexibility: JIT allows for greater flexibility in responding to changes in
customer demand, market conditions, and product mix.
 Space Optimization: With reduced inventory levels, businesses can optimize storage
space and use facilities more efficiently.

Disadvantages of JIT:

1. Supply Chain Vulnerability:

o JIT relies heavily on a steady and reliable supply chain. Any disruptions, such
as delays in material deliveries, quality issues, or changes in supplier
circumstances, can have an immediate impact on production schedules and
customer orders.
2. Stockouts and Production Disruptions:
o Since JIT aims to minimize inventory levels, the risk of stockouts is higher.
Any unexpected surge in demand or disruptions in the supply chain can lead to
production delays and potential customer dissatisfaction.
3. Dependence on Suppliers:
o JIT requires close collaboration with suppliers, and any issues with suppliers,
such as financial instability, quality problems, or delivery delays, can directly
affect the production process.
4. Increased Transportation Costs:
o JIT often requires frequent, small deliveries of raw materials and components.
While this minimizes inventory holding costs, it can result in higher
transportation costs due to the need for more frequent and smaller shipments.
5. Difficulty in Forecasting:
o JIT systems assume a stable and predictable demand. In industries with high
demand variability or seasonal fluctuations, accurate forecasting becomes
challenging, potentially leading to under or overproduction.