Working Capital

Management

CONTENT
Introduction
Types of Working Capital
Components of Working Capital
Need for Working Capital
Objectives of Working Capital Management
Factors Determining Working Capital Management
Working Capital Management Strategies
Methods of Working Capital Estimation

INTRODUCTION

TYPES OF WORKING CAPITAL

WORKING CAPITAL
BASIS OF
CONCEPT
Gross
Working
Capital

Net
Working
Capital

BASIS OF
TIME
Permanent
/ Fixed
WC

Temporary
/ Variable
WC

Seasonal
WC

Special
WC

TYPES OF WORKING CAPITAL

Total
Assets

Fluctuating
Current
Assets
Permanent current assets

Fixed Assets

Time

COMPONENTS OF WORKING CAPITAL

Current Assets
a)Cash and bank balances
b)Temporary investments
c)Short term advances
d)Prepaid expenses
e)Receivables
f)Inventory of raw material
g)Inventory of work-in-progress
h)Inventory of finished goods

COMPONENTS OF WORKING CAPITAL

Current Liabilities
a)Creditors
b)Outstanding expenses
c)Short term borrowing
d)Advances received against sales
e)Taxes and dividends payable

Need for Working Capital (operating cycle)

Raw material
purchased on
credit

Raw material
into process

Raw material
holding period

WIP period

Creditors payment period

Finished
goods

Finished goods
sold on credit

Finished goods
holding period

Cash Cycle

Cash received
from debtors

Debtors collection
period

Need for Working Capital (operating cycle)

Need for Working Capital (operating cycle)

1. Conversion of cash into finished goods
2. Conversion of finished goods into receivables
3. Conversion of receivables into cash
This process is known as operating cycle.

Need for Working Capital (operating cycle)

1.
2.
3.
4.
5.

Raw Material Holding Period

Work-in-Progress Period
Finished Goods Holding Period
Receivables Collection Period
Creditors Payment Period

Need for Working Capital (operating cycle)

Need for Working Capital (operating cycle)

Need for Working Capital (operating cycle)

Average stock of raw materials
Average WIP inventory
Average finished goods inventory
Average accounts receivable
Average accounts payable
Average raw material purchased on credit and consumed
per day
Average WIP value of raw material committed per day
Average cost of goods sold per day
Average sales per day

(Rs. million)
200
300
180
300
180
10
12.5
18
20

Need for Working Capital (operating cycle)

Calculate:
a)Raw Material Holding Period
20 days
b)Work-in-Progress Period
24 days
c)Finished Goods Holding Period
10 days
a)Receivables Collection Period
15 days
Creditors Payment Period
18 days
c)Duration of operating cycle
51 days

Reason of DISQUIETED Operating cycle

a)
b)
c)
d)
e)
f)
g)
h)

Purchase of material in excess / short of requirements

Buying inferior or defective materials
Inability to purchase during seasons
Defective inventory policy
Lack of production planning, coordination and control
Mismatch between supply and demand
Inability to get credit from suppliers
Lack of proper monitoring of external environment

What impact Operating Cycle???

a) Purchase management: five Rs
right quality, right quantity, right price, right time, right place.
b) Production Management
equipments, technology
c) Marketing management
Advertising, sales promotion, distribution channel
Credit collection policies
External environment

Objectives of Working Capital Management

Factors Determining WCM

1. Nature of business
2. Manufacturing cycle
3. Business cycle
4. Seasonal variations
5. Scale of operation
6. Inventory Policy
7. Credit policy
8. Business standing
9. Market conditions
10.Environmental factors

WCM Strategies
1. Conservative Approach
Carry high levels of current assets in relation to sales.
Long term funds = Fixed assets + Total permanent C.A. + Part of temporary C.A.
Short term funds = Part of temporary C.A.

2. Aggressive Approach
Long term funds = Fixed assets + Part of permanent C.A.
Short term funds = Part of permanent C.A. + Total temporary C.A.

3. Matching or Trade-off Approach

Long term funds = Fixed assets + Total permanent C.A.
Short term funds = Total temporary C.A.

WCM Strategies (Conservative Approach)

Total
Assets

Short-term financing

Fluctuating
Current
Assets
Permanent current assets
Long-term
financing
Fixed Assets

Time

WCM Strategies (Aggressive Approach)

Total
Assets

Fluctuating
Current
Assets

Short-term financing

Permanent current assets

Long-term
financing
Fixed Assets

Time

WCM Strategies (Matching Approach)

Total
Assets

Short-term financing

Fluctuating
Current
Assets
Permanent current assets
Long-term financing

Fixed Assets

Time

Level of current assets to get desired level of sales

Conservative approach

Current Assets
($)

Moderate approach
Aggressive
approach

Sales ($)

Level of current assets to get desired level of sales

Particulars
Fixed Assets
Current Assets
Total Assets
Share capital
Debenture (@ 12%)
C.L. (Short term loan @ 8%)
Financing
Net W.C.
Current Assets financed by:
Short term sources
Long term sources
Current Ratio

Conservative
40
40
80
40
30
10
80
30
10
30
40
4

Moderate Aggressive
40
40
35
30
75
70
35
30
25
20
15
20
75
70
20
10
15
20
35
2.33

20
10
30
1.5

Level of current assets to get desired level of sales

Sales
EBIT (15% on sales)
Less: Interest
Interest on debentures (@12%)
Interest on short term loan
(@8%)
EBT
Less: Tax @40%
EAT
Return on investment (in %)

Conservative
180
27

Moderate
180
27

Aggressive
180
27

3.6
0.8

3
1.2

2.4
1.6

22.6
9.04
13.56
16.95

22.8
9.12
13.68
18.24

23
9.2
13.8
19.71429

METHODS OF W. C. ESTIMATION
1. Percentage of Sales Method
2. Regression Analysis Method
3. Operating Cycle Method

METHODS OF W. C. ESTIMATION
(Percentage of Sales Method)
Question: XYZ Ltd. Achieved a turnover of Rs. 85 crores for the accounting
year 2007-08. It is anticipated that the turnover of the company will reach Rs.
110 crores for the year 2008-09. Financial position the company is as follows:
Estimate the W.C. requirement for the year 2008-09.
Liabilities
Rs. (Crores)
Equity Share Capital
10
Reserves and surplus
4
Secures loans
5
Unsecured Loans
3
Sundry creditors
6
Provision for taxation
2
30

Assets
Rs. (Crores)
Land and building
4
Plant and machinery
5
Inventories
11
Receivables
7
Cash and Bank
3
30

METHODS OF W. C. ESTIMATION
(Percentage of Sales Method)
Solution:
First identify C.A. and C.L.
Current Assets
Receivables = 0.0823*110
Cash and Bank = 0.035*110
Inventory = 0.129*110
W.C. = C.A. C.L.
= 16.808

Current Liability
Sundry creditors = 0.07*110
Provision for taxation = 0.0235*110

METHODS OF W. C. ESTIMATION
(Regression Analysis Method)
Relationship between sales and W.C.; y = a + bx
y = na + b x
xy = a x + b x2
Where,
y = working capital
x = sales
a = intercept
b = rate of change of working capital with one unit change in revenue

METHODS OF W. C. ESTIMATION
(Regression Analysis Method)
Year
2004-05
2005-06
2006-07
2007-08
2008-09

Sales W.C.
128
66
176
81
208
95
228 130
276 135

507 = 5*a + 1016*b

109364 = 1016*a + 218784*b
b = 0.5142
a = -3.086
y = -3.086 + 0.5142*x

METHODS OF W. C. ESTIMATION
(Operating Cycle Method)

Practice Numerical
From the following details you are required to make an assessment of the
average monthly W.C. requirement.
Particulars
Purchase of material
Wages
Rent
Salaries
Other Overheads
Credit sales
Average amount of stocks and WIP
Average amount of undrawn profit

Average period of credit

6 months
1.5 months
6 months
1 month
2 months
2 months

Estimate
2600000
1950000
100000
800000
750000
6000000
400000
300000

Practice Numerical
Current Assets:
Stocks and WIP400000
Debtors(6000000*1/2) 3000000
Total C.A.
3400000
Current Liabilities:
Purchases
(2600000/6)
433333
Wages (1950000/1.5) 1300000
Rent (100000*1/6) 16666
Salaries800000
Other overhead (750000*1/2) 375000
Total C.L.
2924999
Total W.C.
475001
Less: Average amount of undrawn profit
Net W.C.
175001

300000