Working Capital Management Presented By: Neelam kashyap Nidhi Patel Ritu tiwari Chandni khariya Manish Sen Nakul Jain Working Capital Management M.B.A 2nd Semester

Agenda Meaning of Working Capital Concept of Working Capital Management Types of Working Capital Importance of Working Capital Principles of Working capital Management Methods of Estimating Working Capital Requirement Working Capital Cycle Illustration

Meaning 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 as cash, marketable securities, debtors, inventories.” It is also know as revolving or circulating capital or short-term capital.

Definition In the words of Genestenberg: “Circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another, as for example, from cash to inventories, inventories to receivables, receivables, receivables into cash”

Concept Of Working Capital Management The process of controlling flow of working capital in the organization is know as working capital management. Working capital can be defined as Gross working capital or Net working capital. Gross working capital refers to the current assets of the organization and the difference between the current assets and liabilities is know as Net working capital. Gross Working Capital Net Working Capital

Types Of Working Capital Temporary working capital Permanent working capital Seasonal working capital Special working capital

Temporary working capital It refers to the working capital that is required to produce extra units of products in case of excess demand. The temporary working capital is also know as fluctuating working capital. Permanent working capital It refers to the working capital that is needed for the smooth functioning of the business. If the organization fail to maintain permanent working capital, it will cease to exist in the long run.

Seasonal working capital It refers to the working capital that is required to produce extra units of products in case of excess demand. The temporary working capital is also know as fluctuating working capital. Special working capital It refers to the working capital that is needed for the smooth functioning of the business. If the organization fail to maintain permanent working capital, it will cease to exist in the long run.

Importance Solvency of the business Goodwill Easy loans Cash discounts Regular supply of raw material Regular payment of salaries, wages, and day to day functions Ability to face crisis.

Factors Determining Working Capital Requirements Characteristics of business Labour requirements Cost of raw material Credit policy Seasonal variation Sales turnover

Characteristics of business:- It refers to the type of business in which an organization is engaged. If the organization is in the public utility business then it requires more working capital as most of the transactions are carried on the cash basis. However manufacturing organization would require less working capital. Labor requirement:- It refers to the amount of labor required in the mode of operation adopted by an organization. There are two modes of production, such as labor intensive or capital intensive. If an organization adopts labor intensive mode of production then it require more working capital for wage payment. However , if an organization adopts capital intensive mode of production less working is required.

Cost of raw material:- Credit policy:- It the organization requires expensive raw material then more working capital is needed to carry out produciton.On the other hand, if an organization need low priced raw material then it requires less working capital. Credit policy:- It refers to an agreement between an organization and its suppliers for the purchase of raw material. An organization would require less working capital if the supplier agree to provide raw material on credit base and vice versa.

Seasonal variation:- Sales turonver:- It refers to the demand of a product in a particular seasons. The working capital requirements of the organization producing seasonal products is more than in the peak session and less in other session. Sales turonver:- It refers to an amount of sales achieved by an organization in a financial year. If the sale turnover is high then high working capital is required or vice versa. Therefore we can see that working capital requirement and sales turnovers are inversely proportional to each other.

Principles Of Working Capital Management Principle of Risk Variation Principle of Cost of Capital Principles of Equity Position Principle of Maturity Payment

Principle of Risk Variation:- It help in determining the relationship between risk and profitability associated with working capital management. In the present context, risk refers to the ability of an organization to write-off its current liabilities If the working capital increases by raising short term loans then the risk for the organization may increase and profitability may decrease. The organization can increase its profitability by paying short term loans. Therefore it can be stated that there is an inverse relationship between the risk and profitability of an organization.

Principle of Cost of Capital It help in determining the relationship between the cost of capital and degree of risk. According to this principle, there is an inverse relationship between the two. For example, if debt capital increases , the cost of capital goes down, but the risk of paying return at the time of loss increases and vice versa. This happen because organization does not need to pay dividends on equity at the time of loss.

Principles of Equity Position It helps in deciding whether to invest in current assets or not. The investment in current assets would decrease the working capital of the organization. According to this principle the amount of working capital employed in current assets should positively influence the return on equity and value of an organization. The optimum amount which should be invested in current assets to raise the equity position of the organization, is calculated with the help of following formula:- Level of Current Assets = Current Assets Percentage of Total assets

Principle of Maturity Payment It states that an organization should frame its policies in such a way so that its cash inflow would be sufficient to meets it cash outflow. This facilitates the timely payments of short-term debts, which in turn enhance the goodwill and creditworthiness of an organization.

Sources For Financing Working Capital Requirement Bank Credit Loans from financial institution Public deposit

Methods Of Estimating Working Capital Requirements Percentage Of Sales Method Regression Analysis Cash Forecasting Method Operating Cycle Method Projected Balance Sheet Method

Working Capital Cycle / Operating Cycle “The working capital cycle measures the time between paying for goods supplied to you and the final receipt of cash to you from their sale. It is desirable to keep the cycle as short as possible as it increases the effectiveness of working capital”

The working capital cycle is made up of three core components:- Debtors Management Inventory Management Cash Management

Cash received from debtors Raw material introduced into process Finished goods produced Sales of finished goods Working Capital Cycle

Computation of Working Capital by Operating Cycle method Under this method working capital is calculated in three steps :- First, we calculate operating cycle period Second, number of operating cycle in the year Third, calculation of working capital

Calculation of Operating cycle period Operating Cycle period = Gross Operating Cycle period – Payable Deferral Period Gross operating cycle period: It includes Raw material Conversion Period Work In Process Conversion Period Finished Goods Conversion Period Receivables Conversion Period

Formulas used: Raw material Conversion Period = Average Stock of Raw Material Raw Material Consumption Per Day Work in Process Conversion Period= Average Stock of Work in Process Total Cost Of Production Per Day Finished Goods Conversion Period = Average Stock of Finished Goods Total Cost of Goods Sold Per Day

Receivable Conversion Period = Average Accounts Receivable Net Credit Sales Per Day Payable Deferral Period = Average Payables Net Credit Purchases Per Day

Calculation of number of operating cycle during the year Number of Operating Cycle = Number of Days Operating cycle period

Calculation of Working Capital Working Capital = Total Operating Expenses Number of Operating Cycles

Calculation of Operating Cycle Period Operating Cycle Period Particulars No. of Days Raw Material conversion period Work in progress conversion period Finished good conversion period Receivable conversion period Expenses in advance Total (-)Payable Deferral Period (-) Outstanding Wages (-)Outstanding Overheads and other Expenses Operating Cycle Period

Calculation of Operating Expenses of the Year Particulars Amount Total Cost of Material Total Cost of Labor Total Cost of Overheads Total Operating Expenses of the year

Illustration:- Ques:- Find out working capital by operating cycle method taking 360 days in a year . Sales is 9000 units @ Rs.100 each Material cost = Rs.50 per unit Labor cost =Rs.25 per unit Overheads =Rs. 15 per unit Customers are given 45 days credit and 50 days credit is allowed by suppliers Raw material is for 30 days and finished goods is for 15 days are kept in stock. Production cycle period is 25 days

Calculation of Operating Cycle Period Operating Cycle Period Particulars No. of Days Raw Material conversion period 30 Work in progress conversion period 25 Finished good conversion period 15 Receivable conversion period 45 Total 115 (-)Payable Deferral Period (-)50 Operating Cycle Period 65

Calculation of Operating Expenses of the Year Particulars Amount Total Cost of Material (9000x50) 450000 Total Cost of Labor (9000x25) 225000 Total Cost of Overheads (9000x15) 135000 Total Operating Expenses of the year 81000

Calculation of Operating Expenses of the Year Particulars Amount Total Cost of Material (9000x50) 450000 Total Cost of Labor (9000x25) 225000 Total Cost of Overheads (9000x15) 135000 Total Operating Expenses of the year 81000

Number of Operating Cycle = Number of Days Operating cycle period Number of Operating Cycle = 360 65 Number of Operating Cycle = 5.538 Working Capital = Total Operating Expenses Number of Operating Cycles Working Capital = 810000 5.538 Working Capital = 146262.18

Conclusion “Just as a circulation of blood is essential in the human body for maintaining life, working capital is very essential to maintain the smooth running of a business. No business can run successfully without an adequate amount of working capital.”

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