Dr.Rajinder S. Aurora 1

WORKING CAPITAL MANAGEMENT

DR. R.S.AURORA

PROFESSOR IN SOFT SKILLS,

CONTROL SYSTEMS AND STRATEGY

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What is Capital?

Amount invested in business for starting an enterprise or for expansion and diversification

Amount invested depends on the size and nature of the enterprise

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Classification of Capital:

Owned Capital and Borrowed Capital

Long Term and Short Term Capital

Fixed and Working Capital

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• Excess of Current Assets over Current Liabilities

Working Capital is…

• Also known as Circulating Capital, Fluctuating Capital or Revolving Capital

• Magnitude and composition keep changing continuously

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Current Assets and Current Liabilities:

Current Assets represents assets which can be converted into cash in less than a year

Include cash, short-term securities, debtors, bills receivables and stock

Current Liabilities represents claims of outsiders expected to mature for payment within a year

Include creditors, bills payable, bank overdraft and outstanding expenses

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Gross Working Capital:

• Investments in Current Assets

Concepts of Working Capital:

Net Working Capital:

• Difference between Current Assets and Current Liabilities

• Can be Positive or Negative or Zero

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Working Capital Cycle

Equity and LoansCASH

Purchase of Material

Stock of WIP

Stock of Finished Goods

Sales

S.Debtors

Bills Receivable

Credit Sales Cash Sales

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Adequacy of Working Capital:

• Avoid excessive and paucity of funds

• Excess funds results in idle capital

• Paucity impairs profitability, interrupts production and generates inefficiencies

• Adequacy implies having the right amount of working capital

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Dangers of Excessive Capital:

• Unnecessary accumulation of inventories

• Indication of defective credit policy and slack collection period• Makes management complacent

• Tendencies of accumulating inventories to make speculative profits grow

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Dangers of Inadequate Working Capital:

• Stagnates growth

• Difficult to achieve profit targets

• Operating inefficiencies creep in

• Ineffective utilization of fixed assets

• Unable to avail attractive credit opportunities• Loss of reputation

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Determinants of Working Capital:

• Nature and Size of business

• Manufacturing Cycle

• Sales Growth

• Demand Conditions

• Production Policy

Contd…

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• Operating efficiency and performance

• Price level changes

• Firms credit Policy

• Availability of credit

Contd…

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Symptoms of Poor Working Capital Management :

• Excessive inventory• Slow down in collection from debtors• Purchase of capital goods with working capital resources• Unplanned production schedules • Inefficient use of trade credit• Overtrading• Dependency on short-term funds for permanent working capital• Inefficient cash management• Inability to get working capital limits

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The time duration required to convert sales, after the conversion of resources into inventories, into cash.

Operating Cycle:

Involves four stages:

• Acquisition of Raw Materials and Stores

• Work-in-Process

• Sales of the Finished Product

• The Recovery of Receivables

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Operating Cycle:

Raw Materials Purchased

Order StockPlaced Arrives

Invoice Received

Accounts payable period

WIP Inventory Period

Finished Goods

Sold

Time

Cash Received

Accounts Receivable Period

Cash paid for Materials

Operating Cycle

Cash Cycle

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Reasons for Prolonged Operating Cycle:

• Purchase of materials in excess

• Buying inferior or defective materials

• Failure to get trade and cash discount

• Inability to purchase during seasons

• Defective Inventory policy

• Lack of production planning

• Use of outdated technology

• Defective credit policy

• Poor maintenance and upkeep

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How to reduce Operating Cycle?

• Purchase Management

• Production Management

• Sound credit and collection policies

• Proper monitoring of External Environment

• Proper personnel policy

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Gross and Net Operating Cycle:

Gross Operating Capital:

Raw Material Conversion Period + WIP Conversion Period +Finished Goods Conversion Period + Book Debts ConversionPeriod

Net Operating Period:

Gross Operating Period – Payment Deferral Period

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Components of Operating Cycle:

• Raw Material Conversion Period: (Average value of raw material stock / Average consumption of raw material) x 365

• WIP Conversion Period: (Average WIP / Average cost of goods sold) x 365 • Finished Goods Conversion Period: (Average stock of finished goods / Average cost of goods sold) x 365

• Book Debts Conversion Period: (Average value of receivables / Average value of sales) x 365

• Payment Deferral Period: (Average level of creditors / Average purchase of raw materials) x 365

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Types of Capital based on Operating Cycle:

Permanent Working Capital:

Minimum level of current assets continuously

Required for carrying on business operations Fluctuating Working Capital:

Extra capital needed to support changing Production and sales activities

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Permanent and Temporary Working Capital:

Permanent

Temporary

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ANY QUESTIONS PLEASE ???

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THANK YOU