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Working Capital Management
By:Prof. Saptarshi Mukherjee
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Financial Management
Long Term Financing-Capital Budgeting -Dividend Policy-Capital Structure
Short Term Financing-Current Assets-Current Liabilities
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Current Assets:
- Inventories (Raw Material/Work In Process/Finished Goods)
- Cash & Bank Balance - a/c Receivables (Trade Debtors)
- Loans & Advances Current Liabilities:
- Short term borrowings from banks
- a/c Payables (Sundry Creditors) -Trade Advances -Outstanding expenses
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Gross Working Capital = Sum of all current Assets
Net Working Capital =Current Assets – Current Liabilities
Net working capital can be either + or -
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Importance of management of WC
How much to invest in CA (more or less)
&
How should one finance CA (Sources & Liquidity)
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Characteristics/Nature of CA- Short life Span- Swift transformation in to other assets forms
Raw Materials
WIP
Finished Goods
a/c Receivables
Cash
Wages/Salaries/OH
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PURCHASE COLLECTIONCr.SALE
Inventory Conversion Period (ICP)
(RMCP+WIPCP+FGCP)
Receivable Conversion Period (RCP)
Gross Operating Cycle
Creditor Deferral Period (CDP)
Net Operating Cycle (NOC)
Operating Cycle:
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Factors/determinants of Working Capital Requirements
-Nature of business
-Market & Demand conditions
-Technology & manufacturing policy
-Credit Policy for Debtors
-Availability of credit from supplier
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1. From the following data, compute the duration of the operating cycle for each year & comment on the increase/decrease
Particulars Year 1 Year 2Stocks Raw Materials 20,000 27,000 WIP 14,000 18,000 FG 21,000 24,000Purchase of RM 96,000 1,35,000Cost of goods sold 1,40,000 1,80,000Sales 1,60,000 2,00,000Debtors 32,000 50,000Creditors 16,000 18,000
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BANK FINANCING FOR WC:
1.Overdrafts (OD)/Cash Credit
2.Letter of credit
3.Loans
1.OVERDRAFTS (OD)
-Borrower is allowed to withdraw funds in excess of the balance in his current a/c up to certain limit specified by bank
- Amount is repaid partially or fully as when he desires.
- Interest is charged only on running balance or not on limit
sanctioned.
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2. LETTER OF CREDIT
- It is an indirect form of financing compared to previous ones
- Risk is owed by the bank. It honors the obligation made by its customer, if he fails do so.
- Bank opens a LOC in favor of its customer for some specific purchase.
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3.LOANS- They are fixed amounts given against security - Interest is charged on entire amount irrespective of how
much he borrows - Loans are payable in periodic installments or on
demand.
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Sources of WC financing:- Commercial Banks- Accruals - Trade Credit- Public deposits - Inter corporate deposits- Factoring- Commercial Papers- Rights debentures for WC- Short term loans from financial institutions
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Accruals:-Wages are paid on a monthly, fortnightly or monthly basis& tax is payable quarterly, half yearly or annually -Accruals are those which firm owes to its employees & to govt.
Trade Credit:-It is important source of WC finance, presenting 25%-50% of short-term financing - It is credit extended by the supplier of goods/services.
Accruals & Trade Credit are termed as spontaneous sources of finance.
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Public deposits - They are unsecured deposits from public-No security is offered against public deposits
Inter corporate Deposits- Deposits made by one company with another company, normally for 6 months
Short term loans from financial institutions-Loans are given for a period of 1 year & can be renewed for 2 consecutive years, provided the original eligibility criteria are satisfied.- LIC,GICI & UTI give to manufacturing firms. -Totally unsecured
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Commercial Papers- Generally large firms with considerable financial strength are able to issue CP.-CP is either placed with investor or sold through dealers-Maturity period- 15 to 365 days-Sold at a discount from its face value & redeemed at its face value.
Rights debentures for WC-Public limited companies can issue “rights” debenture to their shareholders- It follows certain guidelines
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Factoring
Client
(Seller)
Client
(Factor)
Client
(Buyer)
PO
Pays balance amount
Repays up to 80%
Sends invoice copy
Fixes customer limit
Follow up
Pays
Deliver goods & invoice with notice to
pay the factor
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