Slide 2: Related to current assets and current liabilities. Related to interrelationship exist b/w Current Assets and Current Liabilities
Slide 6:
The term Gross Working Capital is also referred to as working capital, means the total current assets.
Slide 8:
Current assets – current liabilities
Slide 9:
That portion which is financed with long term funds. CA – CL The excess of CA-CL must be financed with long term funds. This definition is more useful for the analysis of the trade -of b/w profitability and risk.
Slide 10: The level of NWC has a bearing on profitability and risk. Profitability: Used in this context is measured by profits after expenses. Risk: it is defined as the probability that a firm will become technically insolvent so that it will not be able to meet its obligations when they become due for payment.
Slide 12:
The working capital cycle can be defined as:
› The period of time which elapses between
the point at which cash begins to be expended on the production of a product and the collection of cash from a customer.
Slide 14:
The chain starts with the firm buying raw materials on credit. • In due course this stock will be used in production, work will be carried out on the stock, and it will become part of the firm’s work in progress (WIP) • Work will continue on the WIP until it eventually emerges as the finished product • As production progresses, labor costs and overheads will need to be met • Of course at some stage trade creditors will need to be paid • When the finished goods are sold on credit, debtors are increased • They will eventually pay, so that cash will be injected into the firm Each of the areas – stocks (raw materials, work in progress and finished goods), trade debtors, cash (positive or negative) and trade creditors – can be viewed as tanks into and from which funds flow.
Slide 15:
Working capital is clearly not the only aspect of a business that affects the amount of cash: • The business will have to make payments to government for taxation • Fixed assets will be purchased and sold • Lessors of fixed assets will be paid their rent • Shareholders (existing or new) may provide new funds in the form of cash • Some shares may be redeemed for cash • Dividends may be paid • Long-term loan creditors (existing or new) may provide loan finance, loans will need to be repaid from time to time, and • Interest obligations will have to be met by the business.
Slide 16:
The working capital cycle measures the amount of time that elapses between the moment when your business begins investing money in a product or service, and the moment the business receives payment for that product or service. This doesn’t necessarily begin when you manufacture a product—businesses often invest money in products when they hire people to produce goods, or when they buy raw materials.
Slide 17: A good working capital cycle balances incoming and outgoing payments to maximize working capital. Simply put, you need to know you can afford to research, produce, and sell your product. A short working capital cycle suggests a business has good cash flow. For example, a company that pays contractors in 7 days but takes 30 days to collect payments has 23 days of working capital to fund—also known as having a working capital cycle of 23 days. Amazon.com, in contrast, collects money before it pays for goods. This means the company has a negative working capital cycle and has more capital available to fund growth. For a business to grow, it needs access to cash—and being able to free up cash from
Slide 18: Need of Working Capital: Operating cycle events:
› Conversion of cash into inventory. › Conversion of inventory into receivables. › Conversion of receivables into cash.
Slide 19: Accounts Payable
Value Addition
Raw Materials
WIP
Cash
THE WORKING CAPITAL CYCLE (OPERATING CYCLE)
Finished Goods
Accounts Receivable
SALES
Slide 20: The need of WC does not come to end after the cycle is completed. So it is important to know the difference b/w permanent and temporary working capital.
Slide 21: Amount of Working Capital
Variable Working Capital
Permanent Working Capital Time
Slide 22: Variable Working Capital Amount of Working Capital Permanent Working Capital
Time
Slide 23: Total Assets Fluctuating Current Assets
Permanent Current Assets
Fixed Assets
Time
Slide 24: Total Assets Short-term Debt Fluctuating Current Assets
Permanent Current Assets
Long-term Debt + Equity Capital
Fixed Assets
Time
Slide 27:
Factors to be considered Total costs incurred on materials, wages and overheads The length of time for which raw materials remain in stores before they are issued to production. The length of the production cycle or WIP, i.e., the time taken for conversion of RM into FG. The length of the Sales Cycle during which FG are to be kept waiting for sales. The average period of credit allowed to customers. The amount of cash required to pay day-to-day expenses of the business. The amount of cash required for advance payments if any. The average period of credit to be allowed by suppliers. Time – lag in the payment of wages and other overheads
Slide 28:
Components of working capital
› Current assets › Current liabilities
Holding period of various inventories The credit collection period and credit payment period It depends on budgeted level of activity in terms of production/ sales. WC requirements are related to the cost excluding depreciation.
Slide 29:
The steps involved in estimating the different items of CA and CL under Operating Cycle approach.
Slide 30:
Estimation of Current Assets:
› Raw Material inventory › Work-in –process inventory › Finish goods inventory › Debtors › Cash and bank balances Estimation of Current liabilities: › Trade creditors › Direct wages › Overheads (other than depreciation and
amortisation)
Slide 31:
Estimation of Current Assets:
› Raw material inventory: The investment in
raw material inventory is estimated on the basis of under mentioned equation:
Budgeted prod. × Cost of RM × Average inventory (in units) per unit holding period (months/ days) 12 months/ 365 days
Slide 32:
WIP inventory =
Budgeted prod. × Est. WIP cost × (in units) per unit (Months/ days)
Avg. time span of WIP inventory
12 months/365 days
Slide 33:
Finished goods inventory:
Budgeted production × Cost of goods produced × Finished goods holding (in units) per unit excluding dep. Period (months/ days) 12 months/ 365 days
Slide 34:
Debtors:
Budgeted credit sales × cost of sales per unit × Avg. debt collection (in units) (months/days) excluding dep. Period
12 months/365 days
Slide 35:
Cash and Bank balances:
› Motives for holding cash of the business firm › Attitude of management towards risk › The access to the borrowing sources in times
of need and past experience and so on.
Slide 36:
Trade creditors:
Budget yearly production × RM cost × Credit period allowed by (in units) per unit creditors (months/days) 12 months / 365 days
Slide 37:
Direct wages:
Budget yearly production × Direct labor cost × Avg. time lag in (in units) per unit payment of wages (M/D) 12 months/ 365 days
Note: the average credit period for the payment of wages approximated to a half a month in the case of monthly wage payment.
Slide 38:
Overheads:
Budget yearly production × Overhead cost × Avg. Time lag in payments (in units) per unit overheads (M/D) 12 months/ 365 days
Slide 39: (I)
Estimation of Current Assets
i.
a) b) c)
Amount
Inventories:
Raw Material Work -in-process Finished goods
ii. Debtors iii. Minimum desired cash and bank balances Total Current Assets
(I)
Estimation of Current Liabilities
i. Creditors ii. Wages iii. Overheads Total Current Liabilities
(I) I.
Net working Capital (I-II) Add: Margin of Contingency Net working Capital Required
Slide 40: Working Capital Policy
Moderate: Match the maturity of the assets with the
maturity of the financing. Aggressive: Use short-term financing to finance permanent assets. Conservative: Use permanent capital for permanent assets and temporary assets.
Slide 41: $
Temp. WC
}
S-T Loans L-T Fin: Stock & Bonds,
Perm WC
Fixed Assets Years
Slide 42: $ Zero S-T debt L-T Fin: Stock & Bonds
Perm WC
Fixed Assets Years
Slide 44: 1. 2. 3. 4.
Cash in hand Cheques in hand Bank balances Near cash securities: 1. Marketable securities and bank fixed deposits
Slide 45: A. Transactionary Motive: B. Precautionary Motive: C. Speculative Motive:
Slide 46: I. Credit standing of the enterprise. II. Production policy. III. Production process. IV. Terms of purchase and sale. V. Collection policy. VI. Nature of the business. VII.Availability of opportunities. VIII.Economic conditions. IX. Managerial policies.
