Working capital Management

Working capital Management – What it means To manage funds for day to day requirement of production such as RM /SIP/FG & Recv. & expenses Money required to be invested in current assets Sum of current assets is WC – it is also called gross working capital Net working capital = CA – CL NWC represents owners'

Working capital management W.C. Need - Requirement of current assets Funding of current assets Funding out of - Own/ market /bank borrowings Level of WC funds vis a- vis operating cycle

What is operating cycle The time required to complete the process I.e. right from purchase of raw materials for cash to realization of sales in cash. It is calculated by adding number of days involved in each stages of production to sales after adjusting period of credit given by suppliers

OPERATING CYCLE CASH RM RECV WIP FG

Factors influencing OPC Nature of business- Mfg./Trading/service Seasonality- agro based Capacity utilization- high or low Business cycle- inflation/depression Product- engg./chemical/textiles/ TV etc RM- imported /local-location manufacture cycle Terms of purchase/sale

Importance of WC Payment to creditors Cash discount Dividend distribution Creation of good will Exploitation of business opportunities To take care of contingencies Operational effiency

Working capital Finance Nature of advance short term –up to 1 yr Purpose – Working capital requirement I.e to finance stock and receivables + expenses Target group – Business community- traders/Manufacturers/service providers Types of facilities- Cash credit (stock financing) & Bills facility ( financing of receivables) Quantum – 75 % of requirement

Working capital Finance Security – Primary – Charge on Stock/Receivables. Collateral –Charge on land,building,machinery & personal guarantee of promoters/directors Margin- (owned funds) – 20 to 25% Interest - Floating – PLR linked vis-a-vis credit rating

Working capital assessment Methods of assessment Turnover method MPBF – I & II Cash budget

Turn over method Based on projected turnover Gross current assets 25% 5% as margin money (NWC) on the projected turnover 20% as bank loan Mainly meant for SMEs – as per RBI directives

Turn over method Projected turnover p.a Rs 100 Gross 25 % 25 5% * 5 Permissible bank finance 20 (20% on turnover)

Maximum permissible Bank finance method(MPBF) Projected level of CA/CL on the basis of sales Projected level – past trend or expected growth Operating cycle is taken into account – two methods – I & II More scientific method Mainly meant for bigger units Superior over TOM

M.P.B.F. Method I st Method CA Rs 100 CL(excl.BB) 20 WC Gap 80 25% 20 ( on WC gap) PBF 60 II nd Method CA Rs 100 CL (excl.BB) 20 WC gap 80 25% 25 ( on CA) PBF 55

Cash budget method Yearly/Hly cash/Qly. Cash budget E.g.. Qly.estimated receipts Rs cr Qly. Estimated payments Rs Cash gap Rs 5.00 Less 25% Rs 1.25 Eligible finance Rs 3.75

Working capital assessment Documents to be submitted Application P&L/B.S./Cash Flow statement IT /sales tax returns Projection for the future period

Working capital assessment- Appraisal Achievement index – sales,cost & profit Sale – growth in sales quantity,price etc Projections- growth rate viz industry Market conditions – economic cycle - recession/inflation etc Financial analysis – ratios Inspection

Key working capital ratios Current ratio – CA/CL Receivables - debtors/sales*12 m payables - creditors/purchases * 12 m Stock turnover – Avg.stock/Cost of goods* 12 m Int.coverage – PBDIT/INT

Sources of working capital Public deposits – cannot exceed 25% of capital and free reserves. Simple to raise, No restrictive covenants and with out any collateral. Quantum restrictions and limited period. Inter Corporate deposits. No regulatory pressure & secrecy Commercial paper Factoring – financing of receivables Long term funding from debentures/equity/retained earnings/term loans.

ABC Sales15,00,000 PBIT1,50,000 Cur.assets5,00,0004,00,0003,00,000 Fixed.asst5,00,000 Toal assets10,00,0009,00,0008,00,000 Ret.on ass15%16.67%18.75% Risk vs. return