Working capital management

Chapter 19

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Working capital
 Gross working capital:
Total investment in current assets

 Net Working capital

current assets – current liability

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CURRENT ASSETS
 CASH AND BANK BALANCE
 MARKETABLE SECURITIES
 A/C RECEIVABLE
 INVENTORY

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CURRENT LIABILITIES
 A/C PAYABLE
 ACCRUED EXPENSES
 BANK OVERDRAFT

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activity
 Cash Rs.5000
 A/c Receivable 12000
 Closing stock 8000

 A/c payable Rs.2000

 Accrued expense 1500
 Bank overdraft 4000

 What is net working capital?????

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 Activity-solution
 Current assets – current liabilities = NWC
 25000 - 7500 = 17500

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 If you ....... Then ......

You release cash

Collect receivables (debtors) faster from the cycle

Your receivables
Collect receivables (debtors) slower soak up cash

You increase your

Get better credit (in terms of duration cash resources
or amount) from suppliers

Shift inventory (stocks) faster You free up cash

You consume more

Move inventory (stocks) slower cash
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ACTIVITY
 Compute working capital from following data.
 Cash Rs.600
 Accrued expense Rs.250
 Bank overdraft Rs.50
 Marketable securities Rs.25
 Other current liabilities Rs.25
 A/c Receivable Rs.400
 Short term loan Rs.100

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Activity-solution
 Current assets
 Cash 600
 Marketable securities 25
 A/c receivable 400
1025
Less: Current liabilities
Accrued expense 250
bank overdraft 50
short term loan 100
other current liabilities 25 425
net working capital 600
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 CASH CONVERSION CYCLE

CASH

MATERIAL

FINISHED GOODS A/C RECEIVABLE

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 CASH CONVERSION CYCLE

CASH
Purchase on credit
Of 30 days

Collection
period
Payable period
Collection time
MATERIAL 60 days

Processing time
Processing period 45 days

FINISHED GOODS A/C RECEIVABLE

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 CASH CONVERSIO CYCLE

INVENTORY PERIOD + RECEIVABLE PERIOD

--
PAYBLE PERIOD

60 + 45 - 30 = 75 days

A/c payable reduce net working capital period 12

 INVENTORY PERIOD

AVERAGE INVENTORY X 365

COST OF GOODS SOLD

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 RECEIVABLE PERIOD

AVERAGE A/C RECEIVBALE X 365

ANNUAL SALES

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 A/C PAYALE PERIOD

AVERAGE A/C PAYABLE X 365

COST OF GOODS SOLD

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ACTIVITY
 Inventory-op Rs. 120
 Inventory-ending 75
 Purchases 400
 Credit sales 2000
 A/c receivable-op 300
 A/c receivable-ending 200
 A/c payable-op 150
 a/c payable-ending 50

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SOLUTION
 Receivable days = 46 days

 Inventory days = 80 days

 A/c payable days = 82 days

CASH CONVERSION CYCLE

46 + 80 - 82 = 44 DAYS
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TRY PAGE NO.529 Q NO.6

ACTIVITY
 A company generally pays its suppliers six
weeks after receiving an invoice, while its
debtors usually pay within four weeks of
invoicing. Raw materials socks are held for a
week before processing, and processing
takes three weeks. Finished goods stay in
stock for an average of two weeks.

 How long is the company’s operating cycle?

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Activity solution
 Cash operating cycle=

 4 + 1 + 3 + 2 -6 = 4 weeks

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 activity

Sales Rs.250,000
Cost of goods sold 210,000
Purchases 140,000
A/c Receivable 31250
A/c payable 21000
Inventory 92500

Calculate the length of the cash operating cycle

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 activity

A company’s annual sales are Rs.8 million

with a mark up on cost of 60%. It normally
pays creditors two months after purchases
are made, holding one month's worth of
demand in stock.
It allows debtors one and half months
credit and its cash balance currently stands
at Rs.1250,000. what are it current and
quick ratio
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 Sales 160%

Cost of sales 100% Gross profit 60%

A/c payable = 2/12 x cost = 2/12 x 5 million = 0.833 million

A/c Receivable = 1.5/12 x annual sales = 1.5/12 x 8 million

1 million
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Inventory = 1/12 x cost = 1/12 x 5 million = 0.417 million

CURRENT RATIO

0.417 + 1 + 1.25 = 3.2

0.833

QUICK RATIO

1 + 1.25 / 0.833 = 2.7

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Factors affecting Working Capital
 Nature of Business
 Size of the Business
 Production Policy
 Seasonal Variation
 Credit Policy
 Business Cycle
 Operating Efficiency

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