2. DEFINING WORKING CAPITAL
Holding of the firm in current assets.
Part of firm’s capital that is required for financing
short term current assets.
It is never exhausted.
Revolves in the operating cycle.
3. CURRENT ASSETS
That can be converted into cash within one
accounting year.
Includes :
cash
receivables
Inventory
Marketable securities
4. TYPES OF WORKING CAPITAL
CONCEPT TIME
Gross
working temporary
capital
Net
working permanent
capital
5. NET WORKING CAPITAL
GROSS WORKING CAPITAL
FOCUSSES ON :- FOCUSSES ON :
Liquidity position of the Financing of current
firm assets
Judicious mix of short
term and long term Optimization of
financing. investments in current
assets.
6. TYPES OF WORKING CAPITAL
ON THE BASIS OF CONCEPT
NET WORKING GROSS WORKING
CAPITAL CAPITAL
CA-CL
Investment in CA
+ive CA>CL
-ive CA < CL
8. OPERATING CYCLE
Time required to convert sales into cash
Three major phases are :
PURCHASING
THE RESOURCES
PRODUCING THE
PRODUCT
SELLING THE
PRODUCT
12. RAW MATERIAL CONVERSION PERIOD
(RMCP)
Average time taken to convert material into work in
process.
It depends upon – ( i ) raw material
consumption per day
( ii ) raw material inventory
RMCP = RM inventory*360
RM consumed
13. WORK IN PROCESS CONVERSION
PERIOD (WIPCP )
Average time taken to complete the semi finished
work
WIPCP=(WIPinventory*360)
COP
18. CREDITORS DEFERRAL PERIOD (CDP)
Average time taken by the firm in paying its debts.
CDP= creditors*360
credit purchases
19. PERMANENT AND TEMPORARY
WORKING CAPITAL
PERMANENT WC – minimum level of required
current assets.
TEMPORARY WC – extra WC needed to support
the changing production and sales activities of the
firm.
21. DETERMINANTS OF WORKING CAPITAL
Nature of business
Market and demand conditions
Technology and manufacturing policy
Credit policy
Availability of credit from suppliers
Operating efficiency
Price level changes
22. ISSUES IN WORKING CAPITAL
MANAGEMENT
Current assets to fixed assets ratio
Liquidity Vs profitability – RISK RETURN
TRADE OFF
THE COST TRADE--OFF
23. (1.) CURRENT ASSETS TO FIXED
ASSETS RATIO
Alternative current asset policies
24. CURRENT ASSETS TO FIXED ASSETS
RATIO
Optimum level of current assets so that the wealth
of the shareholders is maximized.
APPROACHES TO DETERMINE OPTIMUM
LEVEL OF CA/FA RATIO
- conservative
- aggressive
- moderate
27. THE COST TRADE OFF
cost of liquidity :
If a firm’s level of CA is very high it has excessive
liquidity.
Its return on assets is very low because funds are
tied up in idle stocks which earns nothing.
Cost of illiquidity:
Cost of holding insufficient current assets.
28. OPTIMUM LEVEL OF CURRENT ASSETS
With the level of CA the cost of liquidity increases
while the cost of illiquidity decreases.
The firm should maintain current assets at that level
where the sum of these two cost is minimized.
29. ESTIMATING WORKING CAPITAL
NEEDS
BEST METHOD – OPERATING CYCLE
THREE APPROACHES ARE :-
i. Current assets holding period
ii. Ratio of sales
iii. Ratio of fixed investments.
ROR = PBIT / NET FIXED INVEST. + WC
30. POLICIES FOR FINANCING CURRENT
ASSETS ( TYPES )
LONG TERM FINANCING – sources are ordinary
share capital , preference share capital ,
debentures , long term borrowings.
SHORT TERM FINANCING : banks, public deposit,
factoring of receivables etc.
SPONTANEOUS FINANCING – automatic sources
of short term funds arising from normal course of a
business.
31. THREE APPROACHES FOR MIX OF
SHORT TERM AND LONG FINANCNG
Matching approach
Conservative approach
Aggressive approach
32. MATCHING PLAN ( HEDGING
APPROACH )
Financing under matching plan
33. MATCHING APPROACH
Firm can adopt a financial plan that matches the
expected life of assets.
Long term financing – fixed assets
Short term financing – variable current assets.
35. CONSERVATIVE APPROACH
Financing policy depends more on long term funds.
The firm finances its permanent current assets and
also a part of temporary current assets with long
term financing.
37. AGGRESSIVE APPROACH
When a firm relies more on short term financing.
Permanent fixed assets are also financed with short
term funds.
38. (3.) RISK RETURN TRADE OFF
If firm wants to use short term financing it must
determine it its portion in total financing.
Short term financing is preferred because:
cost advantage
flexibility
39. RISK RETURN TRADE OFF
Short term financing Long term financing
Less expensive Less expensive
Greater risk Lower risk
High returns Lower return