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Working Capital Management

This document discusses working capital management and provides definitions and concepts related to working capital. It defines working capital as the capital required to finance short-term assets such as cash, inventory, and receivables. It also discusses the operating cycle of businesses and how working capital requirements vary based on factors like industry, size, and credit terms. Additionally, it covers estimating working capital needs, managing cash flows, sources of working capital like bank loans, and the criteria banks typically evaluate for working capital lending.

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Abhishek Mishra
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693 views21 pages

Working Capital Management

This document discusses working capital management and provides definitions and concepts related to working capital. It defines working capital as the capital required to finance short-term assets such as cash, inventory, and receivables. It also discusses the operating cycle of businesses and how working capital requirements vary based on factors like industry, size, and credit terms. Additionally, it covers estimating working capital needs, managing cash flows, sources of working capital like bank loans, and the criteria banks typically evaluate for working capital lending.

Uploaded by

Abhishek Mishra
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Working Capital Management

A perspective
Some basics

• Business requires money to generate more money


• Tasks of Entrepreneur to –
- envisage the process
- accumulate resources
- take risks
- enjoy the return
• Resources and their funding is primarily of two
types:
BUSINESS

Long-term Assets Short-term Assets

Long-term Funds Short-term Assets


Working Capital

• Centuries old concept


• Necessity of every business
• Needed for various purposes
• Requirement varies according to industry, size,
technology, creditability, etc.
• Available from numerous sources
Working Capital

• Working capital typically means the firm’s holding


of current or short-term assets such as cash,
receivables, inventory and marketable securities.
• These items are also referred to as circulating
capital
• Corporate executives devote a considerable
amount of attention to the management of working
capital.
Definition of Working Capital

• Working Capital refers to that part of the firm’s


capital, which is required for financing short-term or
current assets such a cash marketable securities,
debtors and inventories. Funds thus, invested in
current assets keep revolving fast and are
constantly converted into cash and this cash flow
out again in exchange for other current assets.
Working Capital is also known as revolving or
circulating capital or short-term capital.
• Part of long term finance is locked in and used for
supporting current activities
Concept of working capital …1

• Two possible interpretations :


- Balance sheet concept
- Operating cycle concept
• Balance sheet concept
- There are two interpretations of working capital
under the balance sheet concept.
o Excess of current assets over current liabilities (Net
working capital)
o Gross or total current assets.
- The definition is meaningful only as an indication
of the firm’s current solvency in repaying its
creditors.
- When firms speak of shortage of working capital
they in fact possibly imply scarcity of cash
Concept of working capital …2

•Operating cycle concept


- A company’s operating cycle typically consists of
three primary activities:
o Purchasing resources,
- The firm has to maintain cash balance to pay the bills as they come
due
o Producing the product and
- In addition, the company must invest in inventories to fill customer
orders promptly
o Distributing (selling) the product.
- And finally, the company invests in accounts receivable to
extend credit to customers
- Operating cycle is equal to the length of inventory
and receivable conversion periods.
TYPES OF WORKING CAPITAL

WORKING CAPITAL

BASIS OF BASIS OF TIME


CONCEPT

Gross Net Working Permanent / Temporary /


Working Capital Fixed WC Variable WC
Capital
Operating cycle of a typical company

Receive
Sell
Purchase Cash
Product
resources
On credit
Pay for
Resources
purchases

Receivable
Inventory
Conversion
conversion
period
period
Cash conversion
Payable
cycle
Deferral
period

Operating
cycle

Importance of working capital


• Risk and uncertainty involved in managing the cash flows
• Uncertainty in demand and supply of goods, escalation in cost both
operating and financing costs.
THE WORKING CAPITAL
CYCLE
Accounts Payable (OPERATING CYCLE)

Raw WIP
Materials

Cash Finished
Goods

Accounts SALES
Receivable
Matching approach to asset financing

Total Assets
Short-term
Debt
Rs
Fluctuating Current Assets

Long-term
Permanent Current Assets Debt +
Equity
Capital

Fixed Assets

Time
MANAGEMENT OF WORKING CAPITAL

• How to manage the current assets, the current


liabilities and the inter-relationship that exists
between them.
• Working Capital Management Policies of a firm
have a great effect on its profitability, liquidity and
structural health of the organization.
Nature of Working Capital Management

Dimension I
Profitability,
Risk, & Liquidity

II D
sio n el Com imensi
n ev posi o
im e
D tion & L tion n III
p osi A of C & Leve
Com of C L l
Estimation of working capital requirements

• Factors to be considered
- Total costs incurred on materials, wages and overheads
- The length of time for which raw materials remain in stores before
they are issued to production.
- The length of the production cycle or WIP, i.e., the time taken for
conversion of RM into FG.
- The length of the Sales Cycle during which FG are to be kept
waiting for sales.
- The average period of credit allowed to customers.
- The amount of cash required to pay day-to-day expenses of the
business.
- The amount of cash required for advance payments if any.
- The average period of credit to be allowed by suppliers.
- Time – lag in the payment of wages and other overheads
Management of cash

1. Importance of Cash
When planning the short or long-term funding
requirements of a business, it is more important to
forecast the likely cash requirements than to
project profitability etc.

More businesses fail for lack of cash than for want


of profit.
Calculating Cash Flows

•Cash flow planning entails forecasting and


tabulating all significant cash inflows
relating to sales, new loans, interest
received etc., and then analyzing in detail
the timing of expected payments relating
to suppliers, wages, other expenses, capital
expenditure, loan repayments, dividends,
tax, interest payments etc.
MANAGING CASH FLOWS

• Cash Management will be successful only if cash collections are accelerated


and cash payments, as far as possible, are delayed
• Methods of ACCELERATING CASH INFLOWS
- Prompt payment from customers (Debtors)
- Quick conversion of payment into cash
- Decentralized collections
- Lock Box System (collecting centers at different locations)
• Methods of DECELERATING CASH OUTFLOWS
- Paying on the last date
- Payment through Cheques and Drafts
- Adjusting Payroll Funds (Reducing frequency of payments)
- Centralization of Payments
- Inter-bank transfers
- Making use of Float
Sources of Working Capital

• Cash Credit / Overdraft


• Cash Management
• Working Capital Demand Loan
• Bill Discounting / Receivable Discounting
• Export Finance / Bill Negotiation
• Term Loans
• Letter of Credit
• Bank Guarantee
• Foreign Currency Loans
Bank criteria for typical WC lending

• Age of Business > 2 years


• Turnover > Rs. 2 cr.
• Tangible Net Worth > Rs.1 cr.
• EBITDA margin > 5%
• PAT margin : profitable operations for the last 2
years
• Receivables beyond 6 months < 5% of annual
revenues
Usual Qualitative Assessment by Banks

Factor Parameter

Borrower/ Experience in Industry; commitment to timely order execution;


Promoter consistency in quality

Large scale servicing capability for different clients; location of base in


Scale
areas of good quality labour, rentals & power

Wide range of services; USP in the services offered; value added/


Capabilities
premium services

Company
Long term buyers; clients well distributed
Profile

Key management must be technically qualified; relevant domain


Partners
knowledge pool; reputation of promoters
THANK YOU

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