Working Capital Management
CONCEPT
Any firm will have both Assets and Liabilities. These are classified on their duration, as short-term or Current Assets and long-term or Fixed Assets Working Capital Management is Management of short-term assets and liabilities The Aim of Working Capital Management is to manage the firms Current Assets and Current Liabilities in such a way that the level of working capital is kept at optimal levels and the operations of the Company are not disrupted The Net Working Capital (Current Assets Current Liabilities) will determine the firms Profitability and Risk By Risk we mean the probability of firm becoming Technically insolvent whereby it will be unable to meet its obligation when they are due
Working Capital Management
CONCEPT
Appropriate Finance Mix which limits the risk and increases profits 1. Aggressive Approach High Risk and High Profit Mix LT Funds for Core/Fixed portion of current assets Temp/seasonal needs financed by ST Funds 2. Conservative Approach Low-Risk and Low-Profit Mix LT Funds for Total Current Assets ST Funds resorted to for Emergencies only
A Good Finance Manager has to trade off between the two
Working Capital Management
CONCEPT
If you have insufficient working capital and try to increase sales, you can easily over-stretch the financial resources of the business. This is called Over Trading. Early warning signs include : Pressure on existing cash Exceptional cash generating activities e.g. offering high discounts for early cash payment
Bank overdraft exceeds authorized limit
Seeking greater overdrafts or lines of credit Part-paying suppliers or other creditors Paying bills in cash to secure additional supplies
Management pre-occupation with surviving rather than managing
Frequent short-term emergency requests to the bank (to help pay wages, pending receipt of a cheque
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Working Capital Management
Balance Sheet
Share capital
Reserves & surplus Loans (long term) Current liabilities
Fixed assets
Current assets Misc exp & losses
Working Capital Management
COMPONENTS
CURRENT ASSETS
Inventories
Debtors Cash & Bank Balances
CURRENT LIABILITIES
Creditors
Short Term Liabilities Provisions
Net Working Capital = Current Assets Current Liabilities
Working Capital Management
OPERATING CYCLE
The Length of time required for conversion of non-cash assets into cash. The chain is cash into raw materials, raw materials into wip, wip into FG, FG into receivables and receivables into cash.
Working Capital Management
Bad Debts, LD and other deductions Payments for Raw Materials & Services
Total Costs plus Margin
Conversion Costs
Working Capital Management
OPERATING CYCLE
Long Operating Cycle
Lengthy Production Process Liberal Credit Policy Submissive Warranties causing excessive Inventory Holding
Highly Competitive Market necessitating high FG
Technological handicap causing hick-ups in First Time Jobs Lack of structured Vendor Database resulting in high lead time
Supplies from a few vendors
More businesses fail for lack of cash than for want of Profit
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Working Capital Management
OPERATING CYCLE
Length of Operating Cycle a Raw Material Storage
= Avg Stock of RM & Stores / Avg daily consumption b W I P Period
= Avg WIP Inventory / Avg cost of prodn per day c FG Storage period
= Avg FG Inventory / Avg cost of goods sold per day d Debtors Collection Period
= Avg book debts / Avg credit sales per day Length of Operating Cycle = a + b + c + d
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Working Capital Management
COMPONENTS
Receivables (Debtors) Cash Inflow can be significantly enhanced if the amounts owing to business are collected faster. Every business needs to know who owes money how much how long for what reason held up
Adhere to Corp Credit Policies
Invoice promptly and clearly as per terms of contract Sort out disputes prior to invoicing to enable speedy clearance Monitor debts with ageing schedules & fix responsibilities for collection with time bound liquidation plan
Late Payments erode profits and can lead to Bad Debts
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Working Capital Management
COMPONENTS
Receivables (Debtors) Track and pursue late payers Dont feel guilty asking for money you are entitled to it ! In case of disputes take what you can for the resolved part now and agree for terms for the remainder. It eases your cash flow When asking for money, be hard on issue but soft on person Ensure to get TDS certificates promptly as it is as good as Cash Objective is to get money not to score points on verification
Get external help if your own efforts fail
A customer who does not pay is not a customer
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Working Capital Management
COMPONENTS
Inventory Management Managing Inventory is a Balancing Act
While excessive stocks are a burden on Cash Resources insufficient stocks can result in lost sales, opportunities and delayed supplies
Constant commercial coordination for identifying paying customers willing to take deliveries Avoid holding stocks against unwilling and non liquid customers. Be forceful in effecting deliveries as per terms and demand payments which are due. Insist on compensation for delayed payments Stock sitting on shelves for long period destroys wealth
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Working Capital Management
COMPONENTS
Inventory Management Apply tight controls on significant few and simplify controls for trivial many Develop a strong system for vendor base to minimise lead time and avoid procedural delays for ensuring optimum level of stock
Periodic review and disposal of obsolete / non moving stock releases cash to system
Constantly review the BOM for established product lines which may have continued to include same contingency percentage despite achieving lower wastages due to improved process Attempt to divest non movers by re-allocation of resources Strong system of Vendor Rating enables lower Inventory
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Working Capital Management
COMPONENTS
Managing Payables (Creditors) They are vital part of effective cash management and should be managed carefully to enhance the Cash position. Purchasing initiates cash out flows and an over-zealous purchasing function can create liquidity problems. Some important checks are very necessary to safeguard against avoidable commitments Are purchase quantities backed by existing firm orders from customers ? If not with what authority are the purchases being made ? Are the deliveries matching our delivery schedule with customers ? Any provision for imposing penalty for delayed supply from vendor ?
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Working Capital Management
COMPONENTS
Managing Payables (Creditors) Have we got the best competitive terms of payment and price by involving adequate participation of the other vendors ? Is the price agreed is within our supply price to our customer ? In case of Proprietary or single source item whether the purchase is done as per the extant policy guideline thereon etc., ? Whether the P.O provides for receipt and inspection of items prior to release of payment ? If not why?
When purchases are made from customers choice of vendors, whether there is a clause for Joint inspection with customer for ensuring suitability to avoid future disputes.
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Working Capital Management
Pitfalls . . . . . . .
Ambiguous Commercial clauses
Excessive Commitments on Warranties
Un Authorized Terms of Payment Subsequent Commercial deviations not known to Units
Ignorance of extant legislation (Excise / Sales Tax Etc.,)
Irregular Purchase Commitments not backed by Orders
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Working Capital Management
IMPACT
Higher (Excess) Working Capital Puts strain on Cash Resources, especially for large companies faced with stiff competition Cost of Higher Working Capital makes product pricing less competitive resulting in reduced turnover/profitability
Excess Inventory, Large Collectible debts and poor cash management may expose the organization to loss due to disposal of surplus stock later, laxity of customers to honour their dues may lead to litigations besides inhibiting the company from going into much needed areas of expansions needing cash resources.
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Working Capital Management
IMPACT
Lower (In-adequate) Working Capital Inhibits an organization from accepting profitable orders at competitive terms on delivery period, challenging prices, exacting quality standards etc., for fear of failure !
Orders lost due to lack of capacity may have a telling effect on future tenders where customers insist on prior experience. Under utilization of shop capacity will lead to lower profitability in the long run threatening the viability of the organization.
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Working Capital Management
MEASUREMENT
Result =X days Ratio Stock Turnover (in days) Formulae Avg Stock*365/ Cost of Goods Sold Interpretation On average you turn over the value of entire stock every x days. For effective analysis break this down into product groups. Obsolete,slow moving stocks will increase this while faster production, just in time ordering will decrease this.
Receivables Ratio (in days)
Debtors * 365 / Sales
=X days
It takes on avg x days to collect monies due to you. If your official credit terms are 45 days and it takes 65 days say..Why? On average you pay your suppliers every x days. If you get better credit terms this will increase and if you pay earlier to avail discounts it will decrease. 19
Payables Ratio (in days)
Creditors* 365 / Cost of Sales(or purchases)
=X days
Working Capital Management
MEASUREMENT
Ratio Current Ratio Formulae Current Assets / Current Liabilities Result =X times Interpretation For eg., 1.5 times would mean that you should be able to lay your hands on Rs.1.5 for every Rs.1.0 you owe. Less than 1 means you could have liquidity problems to meet your current demands.
Quick Ratio
(Current Assets Inventory) / Current Liabilities
=X times
Similar to current ratio but it recognizes that it may take time to convert Inventory into Cash !
Working Capital Ratio
Inventory + Receivables Payables) / Sales
As % of A higher percentage means that Sales working capital needs are high relative to your Sales
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Working Capital Management
CONCLUSION
Remember, a good supplier is someone who will work with you to enhance the future viability and profitability of your company The best executive has the sense enough to pick good men, and the self-restraint enough to keep from meddling. (Theodore Roosevelt) An overburdened, overstretched executive is the best executive, because he or she doesn't have the time to meddle, to deal in trivia, to bother people (Jack Welch) Never tell people how to do things. Tell them what to do and they will surprise you with their ingenuity. (General George S Patton Jr) The person who figures out how to harness the collective genius of his or her organization is going to blow the competition away. (Walter Wriston)
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Working Capital Management
CONCLUSION
Individual commitment to a group effort -- that is what makes a team work, a company work, a society work, a civilization work. (Vince Lombardi)
Management by objective works - if you know the objectives. Ninety percent of the time you don't. (Peter Drucker)
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