Professional Documents
Culture Documents
What is working capital? What are its components? What factors influence working capital? How is working capital projected? What are the strategies as regards its financing? What is aggressive/moderate and conservative policy as regards working capital? Double edge characteristic. What is operating cycle? How it is calculated? Why is working capital important? Working capital financing in India-various committees. Receivables management-credit period decision evaluation-reports-control-credit policy. Creditors management-report-payment terms-prompt payment discount evaluation. Inventory management (EOQs, ABC analysis, slow moving-non moving, slump sale etc) Cash /liquid resources management ( transactive /precautionary/speculative motive) Different ways of financing working capital Some practical hints classification of current assets.
Accounts receivables
cash
Suppliers
What factors influence working capital? Nature of business. ( services-manufacturing) Seasonality of operations. (ceiling fans?) Production policy. (ceiling fans?) Market conditions. (competitors) Conditions of supply. (smooth supply/erratic supply)
10-20
20-30 30-40
80-90
70-80 60-70
Hotels/Restaurants
Electricity generation Aluminium/shipping
40-50
50-60 60-70 70-80 80-90
50-60
40-50 30-40 20-30 10-20
Steel/chemicals
Tea plantation Cotton textile/sugar Edible oils/tobacco Trading/construction
Optimal Policy. ( trade off between carrying costs and shortages costs
Carrying cost
Shortage cost
CA
Capital requirement
time
Duration of operating cycle is equal to the sum of the durations of each of these stages less the credit period allowed by
the suppliers. O=R+W+F+D-C
R=average stock of raw materials & stores/average daily consumption W=average WIP/average daily cost of production F=average FG stock/average daily cost of sales D=average receivables/average daily sales C=average creditors/average daily credit purchases.
Investment in current assets involves substantial portion of total investment. Investments in current assets and the level of current liabilities have to be geared quickly to changes in sales. Although fixed asset investments and long term financing are also responsive to variation in sales however the relationship is not as close and direct as it is in the case of working capital components.
1000
E
F G H
200
(25% of gap)
250
(25% of A)
550
A1+(25%(A-A1))
Current Ratio
Academic significance
Current ratio gradually improves. Margin money / net working capital improves by way of long term portion. Although RBI has now given freedom to banks in assessing and financing working capital, these norms and methodology is still followed by many banks.
Reporting system
Chore Committee(1979) Reference: improvements in
cash credit system for better management. Improving inter relationship between credit and production. Committees recommendation of applying 2nd method of Tandon committee for all borrowers having credit limits of more than 10 lakhs not accepted by RBI and instead applied to borrowers having limits of more than Rs 50 lakhs. Shortfall in working capital can be given as WC term loan repayable in 5 years carrying 2% extra interest. Extra interest suggestion not accepted by RBI. Separate limits for peak level and normal requirements. Introduced QIS Form 1 quarterly projection of sales/production etc, Form 2 actual and projection comparison, form 3 half yearly P7L and fund flow.
Overview-WC management
Working capital is synonymous with current assets. Gross WC is current assets net working capital is current assets less current liabilities. WC management concerns administration of firms current assets along with financing (especially current liabilities) needed to support current assets. In determining optimum level of current assets management has to consider trade off between profitability and risk. Higher level will lead to liquidity but will lead to the risk of lower profitability. Profitability varies inversely with liquidity but moves together with risk. WC has different components but it can be also classified by time permanent or temporary. Permanent WC is the amount of current assets required to meet a firms long term minimum need. Temporary on the other hand is the amount that varies with seasonal needs. When we adopt hedging approach to financing, each asset would be offset with financing instrument of approx same maturity. Short term seasonal variations would be financed with short term debts whereas permanent portion with long term debt or equity. Longer the composite maturity schedule of financing, less risky is the financing but longer the maturity schedule financing is likely to be costly and hence less profitable. The two key facets of WC management are-what level to maintain and how to finance them. These both facets are interdependent.
Inventory Management
Object: to maintain quantities of stocks at a level which optimises some predetermined management criteria which could bea) minimising costs incurred as whole, as the result of holding stocks. b) maximising profit. c) maintain certain level of customer service. d) guard against likely abnormal situations, if any.
High storage & holding costs-chances of deterioration. Loss due to capital tied up. Locking of capital may result in to losing its alternative better uses. Losses due to market price fluctuations on lower side.
Credit management
Always remember, as creditors provide you the source of working capital your credit to customers is also partially funding his working capital.
Credit evaluation. Credit granting decision. Review of credit. Customer weightages. Control of accounts receivables. Latest trends in credit management (outsourcing).
Payment terms
Cash. Open credit. (max outstanding at any point of time) Line of credit ( upper ceiling) Revolving credit. Open / revolving credit with prompt payment discount. Documentary credit.-demand bills - usance bills Letter of credit
Credit evaluation
Willingness of customer to honour obligation. ( character) Ability to meet obligation based on operating cash flow. ( capacity) Financial reserves ( capital) Security offered ( collaterals) General economic condition ( condition) Sources to get above-bank references, financial statements, experience, stock prices , DGs& D registration etc
strong
character
capacity weak strong capital strong strong weak weak
weak
weak
capital
Fair risk
Doubtful
Danger risk
Control of receivables
Periodic reports Review & follow up. Ageing of receivables-flags Collection matrix-to study trend. Expert agencies ( credit rating) Collection agents? Pit falls Incentives. Clear cut responsibility fixing.
Payables management
It is the source of capital for business. Should be given equal importance as receivables. Involves: Negotiations Volumes Price revisions Escalations Annual review. Prompt payment discounts. Deferred credit
Cash management
Cash budgeting Long term cash forecasting Reports for control Cash collections & disbursements Optimal cash balance Investment of surplus cash Cash management models
Cash budgeting
Estimating cash requirements Planning short term financing Scheduling capex Developing credit policies Checking accuracy of long term forecast
Investment portfolio
Segments: ready cash controllable cashfree cash. Criteria: safety-liquidity-yield-maturity. Options: term deposits with banks-treasury bills-mutual funds-commercial paper-ICD
collections
disbursements
cash
Funds flow
Control by reporting
Information flow
With timely information reporting it is possible to generate significant Income by properly managing collections, disbursements & investments.
Collection float
Receipt of check
Check deposit
Actual credit
Mail float
Processing float
Clearing float
Total float
Bank overdraft Cash credit. Bill discounting Letters of credit Factoring Packing credit Commercial paper Advance against book debts.
Credit Rating system & Credit Risk Assessment. Earlier banks were scoring only two financial parameters depicting operating efficiency / strength of borrowing unit and few subjective aspects of the functioning of the unit. The total score used to be graded against scale and the pricing was decided on that basis. CRS has now been replaced by CRA
CRA models
Depending upon market segment and exposure proposed every bank has different models. For example ABank has following: Regular Model: (based on all risk parameters) applicable for WC limits of Rs 5 cr and above in C&I, SSI and Agriculture segments, Rs 2 cr and above in trade segment. Simplified (regular)model: ( based on only financial risk parameters) applicable for WC limits below Rs 5 cr in C&I, WC limits in the range of 2-5 cr for SSI & Agri and limits below 2 cr for trade. Simplified liberal model (taking simplified model and again liberalizing it further) applicable to WC limits of Rs 25 lakhs and above and up to Rs 2 cr in SSI & Agri for this model NFB is excluded to compute the limits Some delegations and powers given to CGMs for interpretation
Models-applications
situations ( Rs lakhs) FBWC NFBWC Total I 180 50 230 II 210 20 230 III 400 70 470 IV 400 120 520