working capital management short term and long term financing mix

2. FINANCIAL MANAGEMENT
WORKING CAPITAL MANAGEMENT

3. OVERVIEW OF WORKING
CAPTITAL MANAGEMENT
Working capital
 Significance of WC Management
 Kinds of working capital
Working Capital Issues
 Financing Current Assets
Combine structure of CA & CL
 Motives for holding cash
 Speeding up CR & slowing down CP

4. WORKING CAPITAL
 working capital management involves the
relationship between a firm's short-term assets and
its short-term liabilities.
 The basic goal of working capital management is to
ensure that a firm is able to continue its operations
and that it has sufficient ability to satisfy both
maturing short-term debt and upcoming
operational expenses.

5. WORKING CAPITAL
MANAGEMENT
 In a typical manufacturing firm, current assets
exceed one-half of total assets.
 Excessive levels can result in a substandard Return
on Investment (ROI).
 Current liabilities are the principal source of external
financing for small firms.
Requires continuous, day-to-day managerial
supervision.
 Working capital management affects the company’s
risk, return, and share price.

6. WORKING CAPITAL CONCEPTS
Net Working Capital:
 net working capital refers to the difference between current assets and current liabilities. Current liabilities are those
claims of outsider, which are expected to mature
 for payment within an accounting year & include creditors, bills payable & the outstanding expenses. In other words
you can say that this is the excess of current assets over current liabilities.
Current Assets – Current Liabilities
Gross Working Capital:
• It refers to the firm’s investment in current assets.
• Current assets are the assets, which can be converted into cash within an accounting year or within an operating
cycle
• cash, short-term securities, debtors (accounts receivable & book debts), bills receivable and stock.
Working capital turnover:
Working capital turnover= sales/working capital
Working Capital Management:
The administration of the firm’s current assets and the financing needed to support current assets.

7. CLASSIFICATION OF WORKING CAPITAL
CONCE
PT
BASIS
TIME
BASI
S
NWC
Perm
anent
WC
Temp
orary
WC
Regu
lar
WC
Rese
rve
WC
Seas
onal
WC
Spec
ial
WC
GWC

8. CURRENT ASSETS
 Inventories: Inventories represent raw materials and components,
work-in-progress and finished goods.
 Trade Debtors: Trade Debtors comprise credit sales to customers.
 Prepaid Expenses: These are those expenses, which have been paid
for goods and services whose benefits have yet to be received.
 Loan and Advances: They represent loans and advances given by the
firm to other firms for a short period of time.
 Investment: These assets comprise short-term surplus funds invested
in government securities, shares and short-terms bonds.
 Cash and Bank Balance: These assets represent cash in hand and at
bank, which are used for meeting operational requirements. One thing
you can see here is that this current asset is purely liquid but non-productive.

9. CURRENT LIABILITY
 Sundry Creditors: These liabilities stem out of purchase
of raw materials on credit terms usually for a period of
one to two months.
 Bank Overdrafts: These include withdrawals in excess of
credit balance standing in the firm’s current accounts with
banks
 Short-term Loans: Short-terms borrowings by the firm
from banks and others form part of current liabilities as
short-term loans.
 Provisions: These include provisions for taxation,
proposed dividends and contingencies.

10. WORKING CAPITAL FORMAT
CURRENT ASSETS
CURRENT
LIABILITIES
 Cash
 Accounts receivable
 Notes receivable
 Marketable securities
 Inventory
 Prepaid expenses
Total current assets
 Accounts payable
 Notes payable
 Accrued expenses
 Taxes payable
Total current liabilities

11. DETERMINANTS OF WORKING
CAPITAL
• Nature of business
• Terms of sales and purchases
• Manufacturing cycle
• Business cycle
• Changes in technology
• Seasonal variation
• Market conditions
• Seasonality of operation
• Dividend policy
• Working capital cycle

12. WORKING CAPITAL ISSUES
Assumptions
 50,000 maximum units
of production
Continuous production
 Three different policies
current asset levels are
possible

13. IMPACT ON LIQUIDITY
Liquidity Analysis
Policy Liquidity
A High
B Average
C Low
 Greater current asset
levels generate more
liquidity; all other factors
held constant.

14. IMPACT ON EXPECTED
PROFITABILITY
Return on Investment
=Net profit/Total Assets
Let,
Current Assets
=(Cash+Rec.+Inv.)
Return on Investment
=(Net Profit/Current +Fixed
Assets)

15. IMPACT ON EXPECTED
PROFITABILITY
Profitability Analysis
Policy Profitability
A Low
B Average
C High
 As current asset levels
decline, total assets will
decline and the ROI will
rise.

16. IMPACT ON RISK
 Decreasing Cash reduces
the firm’s ability to meet its
financial obligations. “More
risk!”
 Stricter credit policies
reduce receivables and
possibly lose sales and
customers. “More risk!”
 Lower inventory levels
increase stock outs and lost
sales.

17. IMPACT ON RISK
Risk Analysis
Policy Risk
A Low
B Average
C High
 Risk increases as the
level of current assets are
reduced.

18. AMOUNT OF CURRENT
ASSETS
SUMMARY OF OPTIMAL CURRENT ASSET ANALYSIS
Policy Liquidity Profitability Risk
A High Low Low
B Average Average Average
C Low High High
1. Profitability varies inversely with liquidity.
2. Profitability moves together with risk. (risk and return go
hand in hand!)

19. SHORT-TERM AND LONG-TERM
MIX
Spontaneous Financing:
 It refers to the automatic source of short term funds
arising in the normal course of business
 Example: trade credit &outstanding expenses.
No explicit cost is requried and firm expect to use it
to full extent.
We are concerned with managing non-spontaneous
financing of assets.

20. HEDGING(or MATURITY
MATCHING) APPROACH
 A method of financing
where each asset would
be offset with a
financing instrument of
the same approximate
maturity..

21. HEDGING(or MATURITY
MATCHING) APPROACH
 Less amount financed
spontaneously by
payables and accruals.
 In addition to
spontaneous financing
(payables and
accruals).

22. FINANCING NEEDS AND THE
HEDGING APPROACH
 Fixed assets and the non-seasonal portion of current
assets are financed with long-term debt and
equity(long-term profitability of assets to cover the
long-term financing costs of the firm).
 Seasonal needs are financed with short-term loans
(under normal operations sufficient cash flow is
expected to cover the short-term financing cost).

23. SELF-LIQUIDATING NATURE
OF SHORT-TERM LOANS
 Seasonal orders require the purchase of inventory
beyond current levels.
 Increased inventory is used to meet the increased
demand for the final product.
 Sales become receivables.
Receivables are collected and become cash.
 The resulting cash funds can be used to pay off the
seasonal short-term loan and cover associated long-term
financing costs.

24. RISKS VS. COSTS TRADE-OFF
(CONSERVATIVE APPROACH)
Long-term Financing Benefits:
 Less worry in refinancing short-term obligations
 Less uncertainty regarding future interest costs
Short-term Financing Risks:
 Borrowing more than what is necessary
 Borrowing at a higher overall cost(usually)
Result:
 Manager accepts less expected profits in exchange
for taking less risk.

25. RISKS VS. COSTS TRADE-OFF
(CONSERVATIVE APPROACH)
 Firm can reduce risks
associated with short-term
borrowing by using
a larger proportion of
long-term financing.

26. COMPARISON WITH AN
AGGRESSIVE APPROACH
Short-Term Financing Benefits:
 Financing long-term needs with a lower interest cost than
short-term debt
 Borrowing only what is necessary
Short-Term Financing Risks:
 Refinancing short-term obligations in the future
 Uncertain future interest costs
Result:
 Manager accepts greater expected profits in exchange
for taking greater risk.

27. RISKS VS. COSTS TRADE-OFF
(AGGRESSIVE APPROACH)
 Firm increases risks
associated with short-term
borrowing by using
a larger proportion of
short-term financing.

28. SUMMARY OF SHORT- VS.
LONG-TERM FINANCING

29. STRUCTURE AND CURRENT
ASSET DECISIONS
 The level of current assets and the method of
financing those assets are interdependent.
 A conservative policy of “high” levels of current
assets allows a more aggressive method of financing
current assets.
A conservative method of financing (all-equity)
allows an aggressive policy of “low” levels of current
assets.

30. MOTIVES FOR HOLDING CASH:
TRANSACTION MOTIVE
SPECULATIVE MOTIVE
PRECAUTIONARY MOTIVE

31. SPEEDING UP CASH PECEIPTS &SLOWING
DOWN CASH PAYOUTS

32. CUSTOMER
MAILS
CHECK
FIRMS
RECEIVES
CHECK
FIRM
DEPOSITS
CHECK
FIRM’s
BANK A/C
credit
COLLECTION FLOAT &ITS COMPONENTS
Availability
float
Mail float Processing float
Deposit float

33. SPEEDING UP CASH RECEIPTS:
EARLIER BILING
LOCKBOX SYSTEM
ARC
CHECK 21 AND BEYOND
CONCERATION SERVICE FOR TRANSFERRING
FUNDS:
• DTC
• ACHET
• WT

34. SLOWING DOWN CASH PAYMENTS:
PAYABLE THROUGH DRAFT
PAYROLL AND DIVIDEND PAYMENT
REMOTE DISBURSEMENT
CONTROLLED DISBURSEMENT