Capital Structure Capital Budgeting

Decisions in Corporate Finance / Finance Functions

1. Capital Structure Decisions ( Financing )

2. Capital Budgeting Decisions ( Investing )
3. Working Capital Decisions
4. Dividend Decisions
Working Capital Management
 Working Capital
• Gross Working Capital is the firm’s investment in
Current Assets.

• Current Assets are those that get converted into

cash within an accounting year or operating
cycle.

• Current Assets include

a) Inventory / Stock
b) Debtors / Bills Receivable
c) Cash & Short Term Securities
 Working Capital
• Net Working Capital is the difference between
current assets and current liabilities.

• Current Liabilities include :

1) Creditors / Bills Payable
2) Outstanding Expenses

• Net Working Capital can be positive or

negative.
 Working Capital Management
• It focuses on

1) Extent of Funds to be invested in Current Assets.

2) Extent of Funds to be invested in each type of

Current Assets.

3) Proportion of long term and short term capital

to be used to finance Current Assets.

4) Type / Source of Financing to be availed.

 Working Capital Funding
• For every firm a minimum amount of net working
capital is permanent.

• So some portion of working capital should be financed

with permanent sources of funds.

• The permanent sources could be:

a) equity capital,
b) retained earnings,
c) debentures,
d) term loans etc.

• Management needs to decide on proportion of debt

and equity to be used for funding .
Working Capital Sources
 Need for Working Capital Management
• Working Capital of a firm should neither be excessive
nor inadequate.

• Excessive investment in current assets impacts the

profitability of the firm.

• Inadequate investment in current assets affects the

solvency of the firm.

• Working Capital requirement depends upon the

business activity and therefore could fluctuate.

• Imbalances in the requirement have to be frequently

corrected.
Temporary

Permanent
Temporary and Permanent Working Capital
 Need for Working Capital
• Objective of corporate finance is to enhance
the shareholder value.

• It requires efficient utilization of capital and

consistency in operations.

• A firm has to invest in current assets to ensure

consistency in sales and operations.
 Determinants of Working Capital
• Working Capital requirement of a firm
depends upon various factors :
1) Nature of Business
2) Production Cycle
3) Business Cycle
4) Production Policy
5) Growth and Expansion
6) Availability of Raw Materials
 Estimation of Working Capital
• The following are the popular methods of
estimating working capital :
1) Estimation Method
2) Percentage of Sales Method
3) Operating Cycle Method
Operating Cycle
 Operating Cycle
Operating Cycle = Inventory Conversion Period + Receivables Conversion Period

Inventory Conversion Period = Raw Material Conversion Period +

Work In Progress Conversion Period +
Finished Goods Conversion Period

Raw Material Conversion Period =

(Average Raw Material Inventory x 360)/ Raw Material Consumed

Work in Progress Conversion Period =

(Average WIP Inventory x 360)/Cost of Production

Finished Goods Conversion Period =

(Average Finished Goods Inventory x 360)/Cost of Goods Sold

Receivables Conversion Period =

(Average Book Debts x 360)/Credit Sales
Compute the Operating Cycle from the particulars given below :
Average Stock Maintained Amount in Rs Lacs
Raw Material 320 (320x360)/4400 26.18
WIP 350 (350x360)/10000 12.6
Finished Goods 260 (260x360)/10500 8.91
47.69
Raw Materials Consumed 4400
Total Cost of Production 10000
Total Cost of Sales 10500
Total Sales 16000

Average Debtors 480 (480x360)/16000 10.8

Operating Cycle ( in Days ) = 58.5

 Compute the Operating Cycle and Cash Cycle
Credit Period Allowed by Creditors 60 Days
in Crs
Average Debtors Outstanding 6
Raw Material Consumed 60
Cost of Production 145
Cost of Goods Sold 157.5
Sales 200
Average Stock of Raw Materials 5.75
Average Stock of Work in Progress 6.75
Average Stock of Finished Goods 4.8
Daily Consumption of R M 0.166667
RM Conversion Period 34.5

Daily Cost of Production 0.402778

WIP Conversion Period 16.8

Daily Cost of Sales 0.4375

FG Conversion Period 11.0

Daily Sales 0.555556

Debtors Collection Period 10.8

Gross Operating Cycle 73.0

Less : Creditors Payment Period 60
Net Operating Cycle ( Cash Cycle ) 13.0
 Practice Question

What is the Operating Cycle and Cash Cycle of the Company

Amount ( Rs. Lacs )

Op Bal Cl Bal
Raw Materials 60 80
Work in Progress 80 120
Finished Goods 120 140
Accounts Receivable 220 280
Accounts Payable 180 200

For the Year

Raw Materials Consumed 750
Manufacturing Overheads 650
Selling & Admin Overheads 450
Sales 3400
Computing Working Capital
Requirement
The Cost of Sales of Company A is Rs. 200 Crs for the Year 2018. The Net Operating Cycle
of the Company is 64 Days. The company expects to have a similar level of operations
for the year 2019. What would be the total requirement of Working Capital of the
Company assuming that the company would like to keep Rs 1 Cr as Cash Balance to
meet contingencies ?

Working Capital Required = (200/360)x64 = 35.55 Crs + 1 Cr = 36.55 Crs

Find the Working Capital Requirement for a Annual Activity Level of 156000 Units
based on the following information :
Cost Break Up Rs
Raw Material 90
Direct Labour 40
Overheads 75
Total Costs 205
Profit 60
Selling Price 265

Raw Material Storage Period 1 Month

Work in Progress Period 1/2 Month
Finished Goods Storage Period 1 Month
Credit Allowed by Suppliers 1 Month
Debtors Collection Period 2 Months

Lag in Payment of Wages 1/2 Month

Lag in Payment of Overheads 1 Month

20% of Output is sold for Cash

Cash to be kept for Contingencies Rs 100000

Assume WIP consists of 50% of costs

 Per Month Units Period Per Unit Cost Amount
Raw Materials 13000 1 90 1170000

WIP 13000 0.5

RM 45 292500
Labour 20 130000
Overheads 37.5 243750
666250

Finished Goods 13000 1 205 2665000

Debtors (26000x.8) 20800 205 4264000

Creditors 13000 1 90 1170000

Wages 13000 0.5 40 260000

Overheads 13000 1 75 975000

 Statement of Working Capital Required Rs
Current Assets
Cash 100000
Stock
Raw Materials 1170000
WIP 666250
Finished Goods 2665000 4501250
Sundry Debtors 4264000
Gross Working Capital Required 8865250
Current Liabilities
Sundry Creditors 1170000
Wages Payable 260000
Overheads 975000 2405000
Net Working Capital Required 6460250
 Prepare a Working Capital Budget for a Year based on the Annual Budget
Sales expected Rs 46.80 Lacs 78000 Units
25% of Sales in Cash

Raw Materials 60% of Sales Value

Labour Rs 6 Per Unit
Variable Overheads Rs 1 Per Unit
Fixed Overheads including Depreciation of Rs 110000 500000

Stock Levels
Raw Materials 3 Weeks
WIP ( RM = 100%, Labor & Overheads = 50% ) 1 Week
Finished Goods 2 Weeks

Debtors Credit 4 Weeks

Creditors Payment 4 weeks
Lag in Wages 1/2 Week
Lag in Overheads 2 Weeks

Cash Required Rs 50000

Statement of Working Capital Rs
Cost Break Up
Current Assets Unit Price 60
RM 36
Cash 50000 Labour
Variable Costs
6
1
Fixed 5
Stock Profit 12

Raw Materials 162000

WIP 63000
Finished Goods 144000 369000
Sundry Debtors 230400
649400
Current Liabilities
Sundry Creditors 216000
Wages Payable 18000
Overheads 18000 252000
Net Working Capital 397400
 Weekly RM WIP Finsihed Goods Debtors
Holding ( Weeks Holding ( Weeks Holding ( Weeks Collecti
) Amount ) Amount ) Amount on Amount

Sales ( Units ) 1500

Amount

RM 54000

Labour 9000

Variable 1500

Fixed 7500

72000 3 162000 1 63000 2 144000 4 230400

 Find the Working Capital Requirement for Year 2019

Crs
Sales Year 2018 85

Expected Sales for 2019 110

Financial Position at the end of 2018 Crs

Land & Building 4
P&M 5
Inventory 11
Receivables 7
Cash 3
30
Equity Capital 10
Reserves 4
Loans 8
Creditors 6
Provision for Tax 2
30
Working Capital Approaches
 Working Capital Financing Approches
• There are three approaches to financing
working capital:
- Matching / Hedging Approach
- Conservative Approach
- Aggressive Approach
 Matching / Hedging Approach

Permanent Current Assets are fully financed through Long Term Sources and
Fluctuating Current Assets are finance through Short Term Sources.
 Conservative Approach

Entire Permanent Current Assets and also a part of Fluctuating Current Assets are
financed through Long Term Sources.

• The company has to make a trade off between risk,

return and liquidity while deciding on the finance mix.
 Aggressive Approach

Only a part of the permanent Current Assets are financed through Long Term Sources
and the balance is financed through Short Term Sources.