Working Capital Management

By:Prof. Saptarshi Mukherjee

Financial Management

Long Term Financing-Capital Budgeting -Dividend Policy-Capital Structure

Short Term Financing-Current Assets-Current Liabilities

Current Assets:

- Inventories (Raw Material/Work In Process/Finished Goods)

- Cash & Bank Balance - a/c Receivables (Trade Debtors)

- Loans & Advances Current Liabilities:

- Short term borrowings from banks

- a/c Payables (Sundry Creditors) -Trade Advances -Outstanding expenses

Gross Working Capital = Sum of all current Assets

Net Working Capital =Current Assets – Current Liabilities

Net working capital can be either + or -

Importance of management of WC

How much to invest in CA (more or less)

&

How should one finance CA (Sources & Liquidity)

Characteristics/Nature of CA- Short life Span- Swift transformation in to other assets forms

Raw Materials

WIP

Finished Goods

a/c Receivables

Cash

Wages/Salaries/OH

PURCHASE COLLECTIONCr.SALE

Inventory Conversion Period (ICP)

(RMCP+WIPCP+FGCP)

Receivable Conversion Period (RCP)

Gross Operating Cycle

Creditor Deferral Period (CDP)

Net Operating Cycle (NOC)

Operating Cycle:

Factors/determinants of Working Capital Requirements

-Nature of business

-Market & Demand conditions

-Technology & manufacturing policy

-Credit Policy for Debtors

-Availability of credit from supplier

1. From the following data, compute the duration of the operating cycle for each year & comment on the increase/decrease

Particulars Year 1 Year 2Stocks Raw Materials 20,000 27,000 WIP 14,000 18,000 FG 21,000 24,000Purchase of RM 96,000 1,35,000Cost of goods sold 1,40,000 1,80,000Sales 1,60,000 2,00,000Debtors 32,000 50,000Creditors 16,000 18,000

BANK FINANCING FOR WC:

1.Overdrafts (OD)/Cash Credit

2.Letter of credit

3.Loans

1.OVERDRAFTS (OD)

-Borrower is allowed to withdraw funds in excess of the balance in his current a/c up to certain limit specified by bank

- Amount is repaid partially or fully as when he desires.

- Interest is charged only on running balance or not on limit

sanctioned.

2. LETTER OF CREDIT

- It is an indirect form of financing compared to previous ones

- Risk is owed by the bank. It honors the obligation made by its customer, if he fails do so.

- Bank opens a LOC in favor of its customer for some specific purchase.

3.LOANS- They are fixed amounts given against security - Interest is charged on entire amount irrespective of how

much he borrows - Loans are payable in periodic installments or on

demand.

Sources of WC financing:- Commercial Banks- Accruals - Trade Credit- Public deposits - Inter corporate deposits- Factoring- Commercial Papers- Rights debentures for WC- Short term loans from financial institutions

Accruals:-Wages are paid on a monthly, fortnightly or monthly basis& tax is payable quarterly, half yearly or annually -Accruals are those which firm owes to its employees & to govt.

Trade Credit:-It is important source of WC finance, presenting 25%-50% of short-term financing - It is credit extended by the supplier of goods/services.

Accruals & Trade Credit are termed as spontaneous sources of finance.

Public deposits - They are unsecured deposits from public-No security is offered against public deposits

Inter corporate Deposits- Deposits made by one company with another company, normally for 6 months

Short term loans from financial institutions-Loans are given for a period of 1 year & can be renewed for 2 consecutive years, provided the original eligibility criteria are satisfied.- LIC,GICI & UTI give to manufacturing firms. -Totally unsecured

Commercial Papers- Generally large firms with considerable financial strength are able to issue CP.-CP is either placed with investor or sold through dealers-Maturity period- 15 to 365 days-Sold at a discount from its face value & redeemed at its face value.

Rights debentures for WC-Public limited companies can issue “rights” debenture to their shareholders- It follows certain guidelines

Factoring

Client

(Seller)

Client

(Factor)

Client

(Buyer)

PO

Pays balance amount

Repays up to 80%

Sends invoice copy

Fixes customer limit

Follow up

Pays

Deliver goods & invoice with notice to

pay the factor