1. WORKING CAPITAL MANAGMENT

2. 2 Working Capital Working Capital – All the items in the short term part of the balance sheet, e.g. cash, short term debt, investments, inventory, debtors (receivables), payables (creditors) etc Net Working Capital is the difference between Current Assets and Current Liabilities Cash Management, Liquidity Management Interconnected terms.

3. Types of working capital Gross Working capital Net working capital

4. Working Capital Concepts Net Working Capital Current Assets - Current Liabilities. Gross Working Capital The firm’s investment in current assets. Working Capital Management The administration of the firm’s current assets and the financing needed to support current assets.

5. Land Equipment Buildings Cash Vehicles Store Supplies Notes Receivable Accounts Receivable Resources owned or controlled by a company Assets

6. Bank overdrafts Long term debts Accounts /Notes Payable Shareholder’ s Fund Creditors’ claims on assets Liabilities

7. Classifications of Working Capital Time Time ◦Permanent ◦Temporary u Components u Cash, marketable securities, receivables, and inventory

8. PERMANENT WORKING CAPITAL There is always a minimum level of CA which is continuously required by a firm to carry on its business operations. Thus, the minimum level of investment in current assets that is required to continue the business without interruption is referred as permanent working capital.

9. Permanent Working Capital The amount of current assets required to meet a firm’s long-term minimum needs. Permanent current assets TIME AMOUNT

10. Temporary/VARIABLE WORKING CAPITAL This is the amount of investment required to take care of fluctuations in business activity or needed to meet fluctuations in demand consequent upon changes in production & sales as a result of seasonal changes.

11. Temporary Working Capital The amount of current assets that varies with seasonal requirements. Permanent current assets TIME AMOUNT Temporary current assets

12. DISTINCTION Permanent is stable over time whereas variable is fluctuating according to seasonal demands. Investment in permanent portion can be predicted with some profitability whereas investment in variable cannot be predicted easily. While permanent is minimum investment in various CA, variable is expected to take care for peak in business activity.

13. DISTINCTION While permanent component reflects the need for a certain irreducible level of current assets on a continuous and uninterrupted basis, the temporary portion is needed to meet seasonal & other temporary requirements. Also permanent capital requirements should be financed from LT sources, ST funds should be used to finance temporary working capital needs of a firm

14. Factors affecting the composition of working capital Nature of Business. Production cycle Business cycle Production policy Credit policy Nature of Raw Material. Technology. Nature of finished goods. Degree of Competition. Profit level Level of taxes Dividend policy Growth and expansion policy Price level changes Operating efficiency

15. INTERDEPENDENCE AMONG COMPONENTS OF WORKING CAPITAL Sundry Debtors Or Accounts Receivable Finished Goods Work-in Process Raw Materials Components Stores etc. Sundry Creditors Or Accounts Payable Cash Selling & Distribution Gen. Administration & Financial Costs Wages, Salaries &manufa cturing Costs

16. Objective of Working Capital Mgt To provides support for smooth functioning of normal business operations. Liquidity Vs Profitability i. Conservative approach ii. Aggressive approach Choosing the pattern of financing i. Spontaneous liabilities ii. Balance between bank borrowing and long term finances.

17. Financing Current Assets: Short- Term and Long-Term Mix Spontaneous Financing: Spontaneous Financing: Trade credit, n other payables n accruals, that arise spontaneously in the firm’s day-to-day operations. ◦Based on policies regarding payment for purchases, labor, taxes, and other expenses. ◦We are concerned with managing non- spontaneous financing of assets.

18. Hedging ( Maturity Matching ) Approach A method of financing where each asset would be offset with a financing instrument of the same approximate maturity. TIME AMOUNT Long-term financing Fixed assets Current assets* Short-term financing** * * Less amount financed spontaneously by payables and accruals. ** ** In addition to spontaneous financing (payables and accruals).

19. Financing Needs and the Hedging Approach Fixed assets and the non-seasonal portion of current assets are financed with long-term debt and equity (long-term profitability of assets to cover the long-term financing costs of the firm). Seasonal needs are financed with short-term loans (under normal operations sufficient cash flow is expected to cover the short-term financing cost).

20. Self-Liquidating Nature of Short- Term Loans Seasonal orders require the purchase of inventory beyond current levels. Increased inventory is used to meet the increased demand for the final product. Sales become receivables. Receivables are collected and become cash. The resulting cash funds can be used to pay off the seasonal short-term loan and cover associated long-term financing costs.

21. Risks vs. Costs Trade-Off (Conservative Approach) Long-Term Financing Benefits Long-Term Financing Benefits ◦Less worry in refinancing short-term obligations ◦Less uncertainty regarding future interest costs Long-Term Financing Risks Long-Term Financing Risks ◦Borrowing more than what is necessary ◦Borrowing at a higher overall cost (usually) Result Result ◦Manager accepts less expected profits in exchange for taking less risk.

22. Risks vs. Costs Trade-Off (Conservative Approach) Firm can reduce risks associated with short-term borrowing by using a larger proportion of long-term financing. TIME AMOUNT Long-term financing Fixed assets Current assets Short-term financing

23. Comparison with an Aggressive Approach Short-Term Financing Benefits Short-Term Financing Benefits ◦Financing long-term needs with a lower interest cost than short-term debt ◦Borrowing only what is necessary Short-Term Financing Risks Short-Term Financing Risks ◦Refinancing short-term obligations in the future ◦Uncertain future interest costs Result Result ◦Manager accepts greater expected profits in exchange for taking greater risk.

24. Firm increases risks associated with short-term borrowing by using a larger proportion of short-term financing. TIME AMOUNT Long-term financing Fixed assets Current assets Short-term financing Risks vs. Costs Trade-Off (Aggressive Approach)

25. Summary of Short- vs. Long-Term Financing Financing Maturity Asset Maturity SHORT-TERMLONG-TERM Low Risk-Profitability Moderate Risk-Profitability Moderate Risk-Profitability High Risk-Profitability SHORT-TERM Temporary (Temporary) LONG-TERM Permanent (Permanent)

26. CRITERIA FOR EVALUATION OF WORKING CAPITAL MANAGEMENT  Liquidity  Availability of cash  Inventory turnover  Credit extended to customers  Credit obtained from suppliers  Under-trading and over trading under-trading Overtrading

27. 27 The Various Cycles Inventory Conversion Inventory x 365 Cost of Goods Sold Payables Conversion Payables/Creditors x 365 Cost of Goods Sold Receivables Conversion Receivables/Debtors x 365 Turnover

28. 28 Balance Sheet Short Term Items Current assets Inventories 1,910 1,903 Trade and other receivables 1,713 1,625 Current tax assets 13 - Other financial assets 43 78 Cash and short term assets 733 917 4,412 4,523 Current liabilities Short term borrowings 355 555 Trade and other payables 1,690 1,735 Current tax liabilities 121 44 Other financial liabilities 119 13 Short term provisions 82 130 1,367 2,477 Turnover 9,577 Cost of goods sold 8,943

29. 29 Operating Cycle Purchase Resources Pay Sell on Credit Receive Cash Inventory Conversion 78 days Receivables Conversion 65 days Payables Period Cash Conversion Cycle 69 days 74 days Operating Cycle 143