Introduction of Working Capital Management
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Transcript of Introduction of Working Capital Management
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Introduction of Working capital management
Working capital refers to that part of the rms capital which isrequired for nancing short- term or current assets such as cash,marketable securities, debtors & inventories.
Funds, thus, invested in current assts keep revolving fast and arebeing constantl converted in to cash and this cash !ows outagain in e"change for other current assets. #ence, it is alsoknown as revolving or circulating capital or short term capital.
Working capital management is concerned with the problemsarise in attempting to manage the current assets, the currentliabilities and the inter relationship that e"ist between them.
$he term current assets refers to those assets which in ordinarcourse of business can be, or, will be, turned in to cash within oneear without undergoing a diminution in value and withoutdisrupting the operation of the rm.
$he ma%or current assets are cash, marketable securities, account
receivable and inventor.
urrent liabilities ware those liabilities which intended at thereinception to be paid in ordinar course of business, within a ear,out of the current assets or earnings of the concern.
$he basic current liabilities are account paable, bill paable,bank over-draft, and outstanding e"penses.
$he goal of working capital management is to manage the rmscurrent assets and current liabilities in such wa that thesatisfactor level of working capital is mentioned.
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Meaning of Working Capital
apital required for a business can be classied under two main
categories via,
'( Fi"ed apital
)( Working apital
*ver business needs funds for two purposes for its establishment
and to carr out its da- to-da operations.
+ong terms funds are required to create production facilities
through purchase of "ed assets such as p&m, land, building,
furniture, etc.
nvestments in these assets represent that part of rms capital
which is blocked on permanent or "ed basis and is called "ed
capital.
Funds are also needed for short-term purposes for the purchase of
raw material, pament of wages and other da to- da e"penses
etc.
$hese funds are known as working capital. n simple words,
working capital refers to that part of the rms capital which is
required for nancing short- term or current assets such as cash,
marketable securities, debtors & inventories.
Funds, thus, invested in current assts keep revolving fast and are
being constantl converted in to cash and this cash !ows out
again in e"change for other current assets. #ence, it is also
known as revolving or circulating capital or short term capital.
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Concept of working capital
$here are two concepts of working capital
'. /ross working capital
). 0et working capital
$he gross working capital is the capital invested in the total
current assets of the enterprises current assets are those
1ssets which can convert in to cash within a short period
normall one accounting ear.
CONSTITUENTS OF CURRENT ASSETS
'( ash in hand and cash at bank
)( 2ills receivables
3( 4undr debtors
5( 4hort term loans and advances.
6( nventories of stock as
a. 7aw material
b. Work in process
c. 4tores and spares
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d. Finished goods
8( $emporar investment of surplus funds.
9( :repaid e"penses
;( 1ccrued incomes.
ividends paable.
5. 2ank overdraft.
6. :rovision for ta"ation , if it does not amt. to app. ?f prot.
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8. 2ills paable.
9. 4undr creditors.
$he gross working capital concept is nancial or going concernconcept whereas net working capital is an accounting concept of
working capital. 2oth the concepts have their own merits.
T'e gro(( concept i( (ometime( preferred to t'e conceptof working capital for t'e following rea(on()
'. t enables the enterprise to provide correct amount of
working capital at correct time.
). *ver management is more interested in total current assets
with which it has to operate then the source from where it is
made available.
3. t take into consideration of the fact ever increase in the
funds of the enterprise would increase its working capital.
5. $his concept is also useful in determining the rate of return
on investments in working capital. $he net working capital
concept, however, is also important for following rea(on(
t is qualitative concept, which indicates the rmsabilit to meet to its operating e"penses and short-term
liabilities.
$ indicates the margin of protection available to the
short term creditors.
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t is an indicator of the nancial soundness of
enterprises.
t suggests the need of nancing a part of workingcapital requirement out of the permanent sources of
funds.
Cla((i*cation of working capital
Working capital ma be classied in to was
?n the basis of concept.
?n the basis of time.
?n the basis of concept working capital can be classied as gross
working capital and net working capital.
?n the basis of time, working capital ma be classied as
:ermanent or "ed working capital.
$emporar or variable working capital
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"ermanent or *+ed working capital
:ermanent or "ed working capital is minimum amount which is
required to ensure e@ective utiliAation of "ed facilities and for
maintaining the circulation of current assets.
*ver rm has to maintain a minimum level of raw material, work-
in-process, nished goods and cash balance.
$his minimum level of current assts is called permanent or "ed
working capital as this part of working is permanentl blocked in
current assets.
1s the business grow the requirements of working capital alsoincreases due to increase in current assets.
Temporar, or -aria.le working capital
$emporar or variable working capital is the amount of working
capital which is required to meet the seasonal demands and some
special e"igencies.
Bariable working capital can further be classied as seasonal
working capital and special working capital.
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$he capital required to meet the seasonal need of the enterprise
is called seasonal working capital.
4pecial working capital is that part of working capital which is
required to meet special e"igencies such as launching ofe"tensive marketing for conducting research, etc.
$emporar working capital di@ers from permanent working capital
in the sense that is required for short periods and cannot be
permanentl emploed gainfull in the business.
Importance or ad-antage of ade/uateworking capital
Sol-enc, of t'e .u(ine(()
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1 concern can face the situation during the depression.
1uick and regular return on in-e(tment()
4uCcient working capital enables a concern to pa quick andregular of dividends to its investors and gains condence of
the investors and can raise more funds in future.
2ig' morale)
1dequate working capital brings an environment of
securities, condence, high morale which results in overall
eCcienc in a business.
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E+ce(( or inade/uate working capital*ver business concern should have adequate amount of
working capital to run its business operations. t should have
neither redundant or e"cess working capital nor inadequate nor
shortages of working capital.
2oth e"cess as well as short working capital positions are bad
for an business. #owever, it is the inadequate working capital
which is more dangerous from the point of view of the rm.
3i(ad-antage( of redundant or e+ce((i-eworking capital
*"cessive working capital means ideal funds which earn no
prot for the rm and business cannot earn the required rate
of return on its investments.
7edundant working capital leads to unnecessar purchasing
and accumulation of inventories.
*"cessive working capital implies e"cessive debtors and
defective credit polic which causes higher incidence of bad
debts.
t ma reduce the overall eCcienc of the business.
f a rm is having e"cessive working capital then the
relations with banks and other nancial institution ma not
be maintained.
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>ue to lower rate of return n investments, the values of
shares ma also fall.
$he redundant working capital gives rise to speculative
transactions.
3i(ad-antage( of inade/uate working capital
*ver business needs some amounts of working capital. $he need
for working capital arises due to the time gap between production
and realiAation of cash from sales.
$here is an operating ccle involved in sales and realiAation of
cash. $here are time gaps in purchase of raw material and
productionD production and salesD and realiAation of cash.
T'u( working capital i( needed for t'e following purpo(e()
For the purpose of raw material, components and spares.
$o pa wages and salaries
$o incur da-to-da e"penses and overload costs such as
oCce e"penses.
$o meet the selling costs as packing, advertising, etc.
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$o provide credit facilities to the customer.
$o maintain the inventories of the raw material, work-in-
progress, stores and spares and nished stock.
For studing the need of working capital in a business, one has to
stud the business under varing circumstances such as a new
concern requires a lot of funds to meet its initial requirements
such as promotion and formation etc. $hese e"penses are called
preliminar e"penses and are capitaliAed.
$he amount needed for working capital depends upon the siAe of
the compan and ambitions of its promoters.
/reater the siAe of the business unit, generall larger will be the
requirements of the working capital.
$he requirement of the working capital goes on increasing with
the growth and e"pensing of the business till it gains maturit.
1t maturit the amount of working capital required is callednormal working capital.
$here are others factors also in!uence the need of working capital
in a business.
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Factor( determining t'e working capital
re/uirement(
4 Nature of .u(ine(()$he requirements of working is ver limited in public utilit
undertakings such as electricit, water suppl and railwas
because the o@er cash sale onl and suppl services not
products, and no funds are tied up in inventories and
receivables.
?n the other hand the trading and nancial rms requires
less investment in "ed assets but have to invest large amt.
of working capital along with "ed investments.
5 Si6e of t'e .u(ine(()
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/reater the siAe of the business, greater is the requirement
of working capital.
3 "roduction polic,
f the polic is to keep production stead b accumulatinginventories it will require higher working capital.
5 #engt' of production c,cle)$he longer the manufacturing time the raw material and
other supplies have to be carried for a longer in the process
with progressive increment of labor and service costs before
the nal product is obtained.
4o working capital is directl proportional to the length of the
manufacturing process.
6 Sea(onal -ariation()/enerall, during the bus season, a rm requires larger
working capital than in slack season.
8 Working capital c,cle)$he speed with which the working ccle completes one ccle
determines the requirements of working capital. +onger the
ccle larger is the requirement of working capital.
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ash
7aw=aterial
Work inprogress
Finished/oods
>ebtors& 2ills
7eceivables
7 Rate of (tock turno-er)$here is an inverse co-relationship between the question of
working capital and the velocit or speed with which the
sales are a@ected. 1 rm having a high rate of stock
turnover will needs lower amt. of working capital ascompared to a rm having a low rate of turnover.
8 Credit polic,)1 concern that purchases its requirements on credit and
sales its product E services on cash requires lesser amt. of
working capital and vice-versa.
9 &u(ine(( c,cle)
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n period of boom, when the business is prosperous, there is
need for larger amt. of working capital due to rise in sales,
rise in prices, optimistic e"pansion of business, etc. ?n the
contrar in time of depression, the business contracts, sales
decline, diCculties are faced in collection from debtor andthe rm ma have a large amt. of working capital.
4: Rate of growt' of .u(ine(()n faster growing concern, we shall require large amt. of
working capital.
44 Earning capacit, and di-idend polic,)
4ome rms have more earning capacit than other due toqualit of their products, monopol conditions, etc. 4uch
rms ma generate cash prots from operations and
contribute to their working capital. $he dividend polic also
a@ects the requirement of working capital.
1 rm maintaining a stead high rate of cash dividend
irrespective of its prots needs working capital than the rm
that retains larger part of its prots and does not pa so high
rate of cash dividend.
45 "rice le-el c'ange()hanges in the price level also a@ect the working capital
requirements. /enerall rise in prices leads to increase in
working capital.
Ot'er Factor( are)
?perating eCcienc. =anagement abilit.
rregularities of suppl.
mport polic.
1sset structure.
mportance of labor.
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2anking facilities, etc.
Management of working capital
=anagement of working capital is concerned with the
problem that arises in attempting to manage the current
assets, current liabilities.
$he basic goal of working capital management is to manage
the current assets and current liabilities of a rm in such a
wa that a satisfactor level of working capital is maintained,
i.e. it is neither adequate nor e"cessive as both the
situations are bad for an rm.
$here should be no shortage of funds and also no working
capital should be ideal.
W?70/ 1:$1+ =101/*=*0$ :?+*4 of a rm has a
great on its probabilit, liquidit and structural health of the
organiAation.
4o working capital management is three dimensional in
nature as
' t concerned with the formulation of policies with regard to
protabilit, liquidit and risk.
) t is concerned with the decision about the composition
and level of current assets.
3 t is concerned with the decision about the composition
and level of current liabilities.
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Working capital anal,(i(
1s we know working capital is the life blood and the centre ofa business.
1dequate amount of working capital is ver much essential
for the smooth running of the business.
1nd the most important part is the eCcient management of
working capital in right time.
$he liquidit position of the rm is totall e@ected b themanagement of working capital.
4o, a stud of changes in the uses and sources of working
capital is necessar to evaluate the eCcienc with which the
working capital is emploed in a business.
$his involves the need of working capital analsis.
$he analsis of working capital can be conducted through anumber of devices, such as 7atio analsis, Fund !ow
analsis, 2udgeting etc
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4 RATIO ANA#;SIS
1 ratio is a simple arithmetical e"pression one number to
another. $he technique of ratio analsis can be emploed for
measuring short-term liquidit or working capital position of
a rm.
$he following ratios can be calculated for these purposes
'. urrent ratio.
). Guick ratio
3. 1bsolute liquid ratio
5. nventor turnover.
6. 7eceivables turnover.
8. :aable turnover ratio.
9. Working capital turnover ratio.
;. Working capital leverage
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$he ob%ective working capital budget is to ensure availabilit
of funds as and needed, and to ensure e@ective utiliAation of
these resources.
$he successful implementation of working capital budgetinvolves the preparing of separate budget for each element
of working capital, such as, cash, inventories and receivables
etc.