Professional Documents
Culture Documents
Capital Requirements
Involve cash flows within one year or one operating cycle of the firm.
Inventories
a. Raw Materials
b. WIP Current Assets Loans &
Advances
c. Finished goods
d. Others
Cash and
Bank
Balances
Borrowings
(Short term)
Trade Advances
Commercial Banks
Others
Current
Liabilities
Current Asset Cycle
Cash
Raw
Debtors
Materials
Finished Work-In-
Goods Progress
Concepts of Working Capital
Working Capital
Nature of Business
Seasonality of operations
Production policy
Market conditions
Conditions of supply
Nature of Business
a. Carrying Costs
b. Shortage Costs
Current Assets
Strategies
Raw
Cash
materials
received
arrive
Finished
Accounts
goods
sold Inventory
Receivable Period
Period
Operating Cycle
Accounts 56 60
Payable
1. Inventory Period = Average Inventory / (Annual COGS/365)
Sales 80 Inventory 9 12
COGS 56 Accounts 12 16
Receivable
Accounts 7 10
Payable
= (7 + 10) / 2 = 55.4
(56/365)
Operating Cycle = Inventory Period + Accounts Receivable Period
= 68.4 + 63.9
= 132.3 days
1. Estimate the cash cost of various current assets required by the firm. The
cash cost of a current assets is:
2. Deduct the spontaneous current liabilities from the cash cost of current
assets
(Portion of current asset supported by trade credit and accruals of wages
and expenses are referred to as spontaneous current liabilities)
Working Capital Financing
Sources of Finance that are used to support Current Assets are as under:
1. Accruals
2. Trade Credit
3. Working Capital Advance by Commercial Banks
4. Regulation of Bank Finance
5. Public Deposits
6. Inter-Corporate Deposits
7. Short-term loans from Financial Institutions
8. Rights Debentures for Working Capital
9. Commercial Paper
10. Factoring
Accruals
Accruals
Employees Government
Wages Taxes
Level of
Accruals
Activity
Cost
Trade Credit
Earnings
With discount
Track Record
Liquidity
Without
position of the
discount
firm
Record of
Payment
Cost of Trade
Credit
Discount given
Cost-Free.
if paid promptly
Net 30 i.e. cost associated beyond the discount period
30 days period
10 days 20 days
Discount Period Non-Discount Period
1. What is annual percentage interest cost associated with the following credit
terms?
a. 2/20 net 50
b. 2/15 net 40
d. 1/10 net 30
f. 2/10, net 45
h. 2/15, net45
Margin Amount
Purchase or Discount of
Bills Seller Draws
Bill on
Purchaser
On due date,
bank collects Purchaser
from Accepts
Purchaser
Seller
Bank Pays
Presents bill
Seller
to bank
Maximum Permissible Bank Finance
MPBF
Cost
Advantages
1. Procedure is simple
2. No Restrictive Covenants
3. No security is offered
4. Reasonable Cost
Disadvantages
Disadvantages
Regulation
Secrecy
Personal Contacts
Short-Term Loans from Financial Institutions
Features
2. Given for 1Yr Period and renewed for two consecutive years later
3. After loan is repaid, company has to wait for atleast 6 months before availing
of fresh loan
Short-term
Unsecured
Promisory Notes
Issued by firms with good credit rating
Factor is Financial Institution that manages debts arising from credit sales
In India only 4 Public Sector Banks allowed to do factoring
SBI (SBI Factoring and Commercial Services Limited)
Canara Bank (Canara Bank Factoring Limited)
PNB
Allahabad Bank
He advances
to the client Factor
70-80%. assumes the
Charges collection
interest & responsibility
Commission
Cash and Liquidity Management
Reasons for holding Cash
Cash Budgeting
Short-term Financing
Needs information
o Estimated Sales
o Production Plan
o Purchasing Plan
o Financing Plan
o Capital Expenditure budget
Sl.No. Items of Cash Receipts Basis of Estimation
and Payments
1. Cash Sales Estimated Sales and its division between Cash
and Credit Sales
2. Collection of Accounts Estimated Sales, its division between Cash and
Receivable Credit Sales and Collection pattern
3. Interest and Dividend Firms Portfolio of Securities and Return expected
Receipts from the portfolio
4. Increase in Financing Plan
Loans/Deposits and
Issue of Securities
5. Sale of Assets Proposed disposal of Assets
6. Cash Purchases Estimated Purchases and its division between
Cash and Credit Purchases
7. Payment of Purchases Estimated Purchases, its division between Cash
and Credit Purchases and Terms of Credit
Purchase
Sl.No. Items of Cash Receipts & Basis of Estimation
Payments
8. Wages & Salaries Manpower employed and wages and
salaries structure
9. Manufacturing expenses Production Plan
10. General, Administration and Administration and Sales Personnel and
Selling Expenses Proposed Sales Promotion and
distribution expenditure
11. Capital Equipment Purchases Capital expenditure budget and payment
pattern associated with Capital
Equipment Purchases
12. Repayment of Loans and Financing Plan
Retirement of Securities
Deviations from Expected Cash Flows
Deviation from the actual cash flows and the expected cash flows.
Advantages
1. Complete Picture
2. Appropriate tool for day-to-day predictions
Disadvantages
Float
Difference between the Cash Balance and the Bank Balance of Cash
Customers in a particular area send cheques to the local bank office and
not the Corporate Office.
On a daily basis, funds from this account are transferred to the Principal
Bank Account.
Concentration banking when combined with Lock Box will give further better
results.
Delaying Payments
Payments to be done only when they fall due and not before that
Centralize Disbursements
Seller sends electronic bill to buyer and latter authorises his bank to make
payment and the bank transfers funds electronically.
Transaction
Cost
Total Cost
Opportunity
Cost
Investment of Surplus Funds
Investment
Portfolio
Taxes, dividend,
interest
High liquidity Earning Interest
payments,
repayments
Criteria for Evaluating Investment Instruments
Safety
Liquidity
Yield
Maturity
Investment Options
Advantages
7. Ready Forwards
8. Bill Discounting
Cash Management Models
Cash Budget
Surplus Deficit
Marketable
Cash Holdings
Securities
Baumol Model
Proposed by William J.Baumol
Applies Economic Order Quantity (EOQ) concept to determine cash conversion size
which in turn influences
C = (2 bT /I)
TC = I (C/2) + b (T/C)
Interest Income Conversion
Foregone Costs
Eg:
1. Zeta requires Rs. 1.5 Mn cash for meeting its transaction needs over the
next 3months
2. To meet the projected cash needs, Zeta can sell its marketable securities in
any of the five lot sizes: 100000/-, 200000/-, 300000/-, 400000/- and
500000/-.
3. Zeta can earn 16% annual yield on its marketable securities i.e. for 3
months, interest is 4%.
5. Cash payments are made evenly over the 3months planning period.
C = (2 bT/I)
= 193649/-
This means that if the marketable securities are sold in lots of Rs. 200000/-, it
would minimise the Total Cost.
Miller & Orr Model
On the other hand, once the balance touches Lower Control Limit, enough
Marketable Securities are disposed to restore the cash balance to its
Return Point
UL = 3 RP 2LL
RP = Return Point
B = Fixed Cost Per Order for converting Marketable securities into cash
I = Daily interest rate earned on Marketable Securities
= Variance of daily changes in the expected cash balance
LL = Lower Control Limit
UL = Upper control Limit