Capital Structure Capital Budgeting

Decisions in Corporate Finance / Finance Functions

1. Capital Budgeting Decisions ( Investing )

2. Dividend Decisions
3. Working Capital Decisions
4. Capital Structure Decisions ( Financing )
Working Capital Management
It is required to enable
It is required for carrying out
commencement of
or day to day operations
operations
 Fixed Capital Vs Working Capital
Working Capital / Current
Fixed Capital / Fixed Assets
Assets
• Fixed Capital is the amount • Working Capital is the
invested in Fixed Assets. amount invested in Current
Assets.

• The amount of Fixed

Capital does not change. • The amount of Working
Capital changes and it
depends upon the
operations.
• Fixed Assets are not
expected to be converted • Current Assets are expected
into cash till the business is to be converted into cash at
running. the earliest.
 Working Capital
• Gross Working Capital is the firm’s investment in
Current Assets.

• Current Assets are those assets that get

converted into cash within a year or within one
operating cycle.

• Current Assets include

a) Inventory
b) Debtors
c) Cash/ Bank Balance & Short Term Securities
 Working Capital
• Net Working Capital is the difference between
Current assets and Current liabilities.

• Current Liabilities include :

1) Creditors
2) Outstanding Expenses

• Net Working Capital can be positive or

negative.
 Determinants of Working Capital
• Working Capital requirement of a firm
depends upon various factors :
1) Nature of Business ie. Manufacturing, Retail, Services, Cash and Carry etc.
2) Production Cycle ie. time taken to convert raw material into finished goods
3) Business Cycle ie. Recession, Depression, Boom etc.
4) Production Policy ie. single shift, double shift etc.
5) Availability of Raw Materials ie. seasonality, reach etc.
 Need for Working Capital
• Objective of corporate finance is to enhance
the shareholder value.

• Shareholder vale is enhanced only with

efficient utilization of capital and consistency
in operations.

• A firm has to invest in current assets to ensure

consistency in sales and operations.
 Working Capital Management
• It focuses on

1) How much Funds to be invested in Current

Assets ?

2) How much Funds to be invested in each type of

Current Assets ?

3) Proportion of long term and short term capital

to be used to finance Current Assets.

4) Type / Source of Financing to be availed.

 Need for Working Capital Management
• Working Capital of a firm should neither be excessive
nor inadequate.

• Excessive investment in current assets impacts the

profitability of the firm.

• Inadequate investment in current assets affects the

solvency of the firm.

• Working Capital requirement depends upon the

business activity and therefore could fluctuate.

• Imbalances in the requirement have to be frequently

corrected.
 Estimation of Working Capital
• The following are the popular methods of
estimating working capital :
1) Estimation Method
2) Percentage of Sales Method
3) Operating Cycle Method
Operating Cycle
 Operating Cycle
Gross Operating Cycle

It is the number of days taken from the day raw material enters the godown till the
finished good is sold and cash received towards it.

It includes :
a) Inventory Conversion Period
b) Receivables Conversion Period

Gross Operating Cycle = Inventory Conversion Period + Receivables Conversion Period

Inventory has the following elements:

1. Raw Materials
2. Work in Progress
3. Finished Goods
Inventory Conversion Period =
Raw Material Conversion Period + Work in Progress Conversion Period + Finished Goods Conversion Period
 Operating Cycle
Operating Cycle = Inventory Conversion Period + Receivables Conversion Period

Inventory Conversion Period = Raw Material Conversion Period +

Work In Progress Conversion Period +
Finished Goods Conversion Period

Raw Material Conversion Period =

(Average Raw Material Inventory x 365)/ Raw Material Consumed for the Year

Work in Progress Conversion Period =

(Average WIP Inventory x 365)/Cost of Production for the Year

Finished Goods Conversion Period =

(Average Finished Goods Inventory x 365)/Cost of Goods Sold for the Year

Receivables Conversion Period =

(Average Book Debts x 365)/Credit Sales for the Year
 Per
Day in
Compute the Operating Cycle from the particulars given below : Rs
Amount in Rs Lacs Lacs
Raw Materials Consumed for the Year 4400 4400/365 12.0
Total Cost of Production for the Year 10000 10000/365 27.4
Total Cost of Sales for the Year 10500 10500/365 28.7
Total Sales for the Year 16000 16000/365 43.8

CP Days

Average Raw Material Inventory 320 320/12.0 26.6

Average WIP Inventory 350 350/27.4 12.7
Average Finished Goods Inventory 260 260/28.7 9.0
Average Debtors 480 480/43.8 10.90
ICP RCP
26.6+12.7+9 10.90
Operating Cycle ( in Days ) = 48.30 + 10.90 = 59.20 Days
 Compute the Gross Operating Cycle using the below provided information:
In Rs. Crs.
Average Debtors Outstanding 6.0
Raw Material Consumed for the Year 60.0
Cost of Production for the Year 145.0
Cost of Goods Sold for the Year 157.5
Sales 200.0
Average Stock of Raw Materials 5.75
Average Stock of Work in Progress 6.75
Average Stock of Finished Goods 4.8
Computation
Raw Material
Consumed for the
Daily Consumption of R M Year/365 60/365 0.164 Crs

Avg. RM/Daily
RM Conversion Period Consumption 5.75/0.164 34.5 Days
Cost of Production
Daily Cost of Production for Year /365 145/365 0.397 Crs
Avg. WIP/ Daily
WIP Conversion Period Cost of Production 6.75/0.397 17 Days
Cost of Goods Sold
Daily Cost of Goods Sold for Year / 365 157.5/365 0.432 Crs
Avg. Finished
Finished Goods Conversion Goods /Daily Cost
Period of Goods Sold 4.8/0.432 11 Days
 Compute the Operating Cycle using the below provided information:
in Crs
Average Debtors Outstanding 6.0
Raw Material Consumed for the Year 60.0
Cost of Production for the Year 145.0
Cost of Goods Sold for the Year 157.5
Sales 200.0
Average Stock of Raw Materials 5.75
Average Stock of Work in Progress 6.75
Average Stock of Finished Goods 4.8
Computation
Avg. RM/Daily
RM Conversion Period Consumption 5.75/0.164 34.5 Days
Avg. WIP/ Daily
WIP Conversion Period Cost of Production 6.75/0.397 17 Days
Avg. Finished
Finished Goods Conversion Goods /Daily Cost
Period of Goods Sold 4.8/0.432 11 Days

Inventory Conversion
Period 34.5+17+11 62.5 Days
Sales for the Year
Daily Sales /365 200/365 0.55 Crs
Avg. Debtors /
Debtors Collection Period Daily Sales 6/0.55 10.9 Days

Gross Operating Cycle 62.5+10.9 73.4 Days

 Net Operating Cycle / Cash Cycle

Gross Operating Cycle – Creditors Payment Period = Net Operating Cycle / Cash Cycle
• It is the amount of time for which the business has to fund the working capital from its sources

# assuming all costs incurred are obtained on credit

Creditors Payment Period = (Avg. Accounts Payable x365)/ Cost of Goods Sold #
# assuming only Raw Material is obtained on credit
Creditors Payment Period = (Avg. Accounts Payable x365)/ Raw Material Consumed for Year
 Computation of Creditors Payment Period and Cash Cycle

A business has an Operating Cycle of 65 Days. It procures all its

Raw Materials on Credit. The total raw materials consumed for
the year 2019-20 was Rs 400 Crs. The business had an Average
Payables of Rs 10 Crs for the year. Using the above information
compute the Cash Cycle of the business.
Cash Cycle = Operating Cycle – Creditors Payment Period

Creditors Payment Period = (Avg. Accounts Payable x365)/ Raw Material Consumed for Year

Creditors Payment Period = (10 x365)/ 400 = 9.1 Days

Cash Cycle = 65 – 9.1 = 55.9 Days

Alternative Formula
Average Raw Material Consumed Per Day = 400/365 = 1.096 Crs

Creditors Payment Period = Avg. Payables / Avg. Raw Material consumed per Day

Creditors Payment Period = 10 / 1.096 = 9.1 Days

 Practice Question Solution
What is the Operating Cycle and Cash Cycle of the • Raw Material Consumed per day = ?
Company • = (750/365)
Amount ( Rs. Lacs ) • =2.05 lacs per day
Op Bal Cl Bal • RM Conversion Period = ?
• 70/2.05 =
Raw Materials 60 80 • = 34.15 Days
Work in Progress 80 120 • Cost of Production per day = ?
Finished Goods 120 140 • = (750+650)/365)
Accounts Receivable 220 280 • =3.84 lacs per day
Accounts Payable 180 200 • WIP Conversion Period = ?
• 100/3.84 =
• = 26.04 Days
For the Year • Cost of Goods Sold per day = ?
Raw Materials Consumed 750 • = (750+650+450)/365)
Manufacturing • =5.07 lacs per day
Overheads 650 • FG Conversion Period = ?
Admin Overheads 450 • 130/5.07 =
• = 25.64 Days
Sales 3400 Inventory Conversion Period = ?
Operating Cycle = 85.8 + 26.8 = 112.6 Days 34.15+26.04+25.64 = 85.83 Days
• Raw Material Consumer per day = 2.05 Lacs
• Sales per day = 3400 / 365 = 9.315 Lacs
• Creditors Payment Period = ?
• Receivables Conversion Period = ?
• 190/2.05
• 250 / 9.315 = ?
• = 92.68 Days
Cash Cycle = 112.6 – 92.7 = 19.9 Days • 26.84 Days
Computing Working Capital
Requirement
Find the Working Capital Requirement for a Annual Activity Level of 156000 Units
based on the following information :
Cost Break Up Rs
Raw Material 90
Direct Labour 40
Overheads 75
Total Costs 205
Profit 60
Selling Price 265

Raw Material Storage Period 1 Month

Work in Progress Period 1/2 Month
Finished Goods Storage Period 1 Month
Credit Allowed by Suppliers of RM 1 Month
Debtors Collection Period 2 Months

Lag in Payment of Wages 1/2 Month

Lag in Payment of Overheads 1 Month

20% of Output is sold for Cash

Cash to be kept for Contingencies Rs 100000

Assume WIP consists of 50% of costs

 Annual Activity Level of 156000
units Solution
Cost Break Up Rs Per Unit
Raw Material 90 Units Period Cost Rs. Amount
Direct Labour 40 Raw
Overheads 75 Materials 13000 1 Month 90 1170000
Total Costs 205
Profit 60
WIP 13000 0.5 Months
Selling Price 265
RM 90 585000
Labour 20 130000
Raw Material Storage Period 1 Month Overheads 37.5 243750
Work in Progress Period 1/2 Month WIP 958750
Finished Goods Storage Period 1 Month
Credit Allowed by Suppliers of Finished
RM 1 Month Goods 13000 1 Month 205 2665000
Debtors Collection Period 2 Months Debtors
(26000x.8) 20800 2 Months 265 5512000
Lag in Payment of Wages 1/2 Month
Lag in Payment of Overheads 1 Month Creditors 13000 1 Month 90 1170000

20% of Output is sold for Cash Wages 13000 0.5 Months 40 260000

Overheads 13000 1 Month 75 975000

Cash to be kept for
Contingencies Rs 100000
Assume WIP consists of 100% of RM
and 50% of Labor and Overheads
 Statement of Working Capital Required Rs
Current Assets
Cash 100000
Stock
Raw Materials 1170000
WIP 958750
Finished Goods 2665000 4593750
Sundry Debtors 5512000
Gross Working Capital Required 10405750
Current Liabilities
Sundry Creditors 1170000
Wages Payable 260000
Overheads 975000 (2405000)
Net Working Capital Required 8000750
 Prepare a Working Capital Budget for a Year based on the Annual Budget
Total Sales expected Rs 46.80 Lacs 78000 Units
25% of Sales in Cash

Raw Materials 60% of Sales Value

Labour Rs 6 Per Unit
Variable Overheads Rs 1 Per Unit
Fixed Overheads including Depreciation of Rs 110000 500000

Stock Levels
Raw Materials 3 Weeks
WIP ( RM = 100%, Labor & Overheads = 50% ) 1 Week
Finished Goods 2 Weeks

Debtors Credit 4 Weeks

Creditors Payment 4 weeks
Lag in Wages 1/2 Week
Lag in Overheads 2 Weeks

Cash Required for Contingency Rs 50000

 Prepare a Working Capital Budget for a
Year based on the Annual Budget Calculation
Total Sales expected • (78000/52) = 1500
Rs 46.80 Lacs 78000 Units Raw • 1500 x 3 = 4500
25% of Sales in Cash Materials • 4500 x 36 ₹ 162000
Raw Materials 60% of Sales Value (78000/52) = 1500
Labour Rs 6 Per Unit 1500 x 1 = 1500
Variable Overheads Rs 1 Per Unit WIP 1500 x (36+(6+6).50) ₹ 63000
Fixed Overheads Cost Break Up • (78000/52) = 1500
including Unit Sales Finished • 1500 x 2 = 3000
Depreciation of Price 60 Goods • 3000 x 48 ₹ 144000
Rs 110000 500000 Raw Mat 36
Labour 6 Working Capital for Inventory = ₹ 369000
Stock Levels
Raw Materials 3 Weeks Variable Costs 1 • (78000x .75) = 58500
WIP ( RM = 100%,
Fixed 5 • 58500/52 = 1125
Profit 12
Labor & Overheads Sundry • 1125 x 4 = 4500
= 50% ) 1 Week Debtors • 4500 x 60 270000
Finished Goods 2 Weeks Gross Working Capital = ₹ 639000
Debtors Credit 4 Weeks
Creditors Payment Creditors • 1500 x 4 x 36 (216000)
for RM 4 weeks Net Working Capital = ₹ 423000
Cash Required for
Add: Cash for Contingency ₹ 50000
Contingency Rs 50000
Requirement of Working Capital = ₹ 473000
 Practice Question

Prepare a Working Capital forecast based on the following information for a production
level of 10 lac units:

Raw Materials conversion period is 3 months, Work in Progress (consisting of 100% raw
material, 50% of wages and 50% of overheads) conversion period is 2 months, and
Finished Goods Conversion Period is 3 months. Credit allowed by creditors is 4 months
and credit given to customers is 3 months. Wages and Overheads are paid with a lag of
15 days. The firm wishes to maintain a cash balance of Rs 1.5 lacs. The selling price per
unit is Rs 10. Ratio of cost to selling price Raw Material is 40%, Labor is 20% and
Overheads is 20%.
Rs Raw Material Storage
Selling Price 10 Period 3 months
Raw Material 4 Value of Raw Material in Rs 4 per unit x 83333 units per month x 3
Storage months
Wages 2
Work in Progress
Overheads 2 conversion period 2 months
Profit 2 WIP Breakup 100%RM, +50% Wages + 50% OH
(Rs 4 RM + Rs 1 Wages + Rs 1 OH ) x 83333
Production Value of WIP Units x 2
Level per Finished Goods
Annum (Units) 10,00,000 Conversion period 3 months
FG Breakup (Rs 4 Rm + Rs 2 Labor + Rs 2 OH)
Production Value of Finished Goods
in Storage Rs 8 x 83333 x 3
per month
(Units) 83333 Debtors Conversion
period 3 months
Value of Debtors
outstanding
 Working Capital Forecast - Solution
Raw Material Storage Period 3 months
Selling Price Rs 10 Value of Raw Material in Storage Rs 4 per unit x 83333 units per month x 3 months 999996
Raw Material Rs 4
Wages Rs 2
Work in Progress conversion
Overheads Rs 2 period 2 months
Profit Rs 2
WIP Breakup 100%RM, +50% Wages + 50% OH
Production Value of WIP (Rs 4 RM + Rs 1 Wages + Rs 1 OH ) x 83333 Units x 2 999996
Level per
Annum (Units) 1000000 units Finished Goods Conversion
Production per period 3 months
month (Units) 83333 units
RM Conversion FG Breakup (Rs 4 Rm + Rs 2 Labor + Rs 2 OH)
period 3 months Value of Finished Goods in
WIP Storage Rs 8 x 83333 x 3 1999992
Conversion Working Capital in Inventory 3999984
period (100 %
RM and 50% of Debtors Conversion period 3 months
Costs) 2 months Value of Debtors outstanding Rs 10 x 83333 units x 3 months 2499990
Finished Goods Gross Working Capital Required 6499974
Conversion
period 3 months Less
Debtors Creditors for RM - Payment
Conversion period 4 months
period 3 months Value of Creditors Payment Rs 4 per units x 83333 x 4 months 1333328
Creditors
payment
period 4 months Credit period for wages and
Lag in payment overheads 0.5 months
of wages and Values of wages and overheads (Rs 2 wages per unit x Rs 2 OH per unit)x 83333 x 50% 166666
overheads 1/2 month
Net Working Capital Required 4999980
Add:
Cash Balance Required 150000
Working Capital Forecast for a Production of 10 Lac units 5149980
The Cost of Sales of Company A is Rs. 200 Crs for the Year 2019. The Net Operating Cycle
of the Company is 64 Days. The company expects to have a similar level of operations
for the year 2020. What would be the total requirement of Working Capital of the
Company assuming that the company would like to keep additional Rs 1 Cr as Cash
Balance to meet contingencies ?

Cost of Sales per day = ?

= 200/365 = 0.548 Crs
Per Day Requirement of Working Capital = Rs 54.8 Lacs

Net Operating Cycle = 64 Days

Working Capital = 64 x .548 =35.07 Crs
Total Working Capital Required = 35.07 +1 = 36.07 Crs
Working Capital Approaches
 Working Capital

Permanent Working Capital Fluctuating Working Capital

The minimum amount investment that

The amount of investment in Current
is required to be in Current Assets
Assets that varies through the year
through out the year
Consider the Working Capital Projection of
M/s Atul School Garments Working Capital requirement of this
Month Amount Rs. Lacs
business ranges from Rs 25 Lacs to Rs 70 lacs
April 60
May 70
June 50
July 50 Permanent
August 40
Working
September 30 Balance is
October 25
Capital
called
November 25
December 30
Fluctuating
January 40 Working Capital
February 40
March 40
 Working Capital Sources

Term
Loans

Cash
Credit CP
Working Capital Financing Approaches
• There are three approaches to financing
working capital:
1) Matching / Hedging Approach
2) Conservative Approach
3) Aggressive Approach
 Matching / Hedging Approach

Working Capital Requirement of

M/s Atul Garments
70
60
50
Rs 35 Lacs –
40
30 60 60 65 60 55
Long Term
20 40 50 50 50 45 40
10
35 Source
0

Only Permanent Current Assets are financed through Long Term Sources and entire
Fluctuating Current Assets are financed through Short Term Sources.
 Conservative Approach

Working Capital Requirement of

M/s Atul Garments
70
60 Rs 50 Lacs
50
40 Long Term
30 60 60 65 60 55
20 40 50 50 50 45 40 Source
10
35
0

Entire Permanent Current Assets and a part of Fluctuating Current Assets are financed
through Long Term Sources of Working Capital.
• The company has to make a trade off between risk, return and liquidity while deciding on the
finance mix.
 Aggressive Approach

Working Capital Requirement of

M/s Atul Garments
70
60
50
40
30 60 60 65 60 55
20 40 50 50 50 45 40 35
10 Rs 25 Lacs
0
Long Term
Source

Only a part of the permanent Current Assets are financed through Long Term Sources
and the balance is financed through Short Term Sources.
 Working Capital Funding
• For every firm a minimum amount of net working
capital is permanent.

• So some portion of working capital should be financed

with permanent sources of funds.

• The permanent sources could be:

a) equity capital,
b) retained earnings,
c) debentures / bonds,
d) term loans etc.

• Management also needs to decide on proportion of

debt and equity to be used for funding .