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Working capital managememt
Working capital management involves maintaining a balance between short-term assets and liabilities to ensure business continuity and ability to meet obligations. Key aspects include: 1) Determining optimal levels of current assets like inventory and receivables by balancing liquidity, profitability and risk. Higher current assets increase liquidity but reduce profits, while lower assets increase risk. 2) Financing current asset levels through a combination of short and long-term financing. A conservative approach uses more long-term financing for less risk, while an aggressive approach uses more short-term financing for higher potential profits but more risk. 3) Current asset and financing decisions are interdependent - higher current asset levels allow more short-term financing
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Working capital managememt
- 1. FINANCIAL MANAGEMENTWORKING CAPITALMANAGEMENT
- 2. OVERVIEW OF WORKINGCAPTITAL MANAGEMENTWorking capital
- 3. Significance of workingcapital management
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- 5. Kinds of workingcapital
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- 7. Financing Current Assets: Short-Term and Long-Term MixCombining Liability Structure and Current Asset Decisions
- 8. WORKING CAPITALworking capitalmanagement involves the relationship between a firm's short-term assets and its short-term liabilities. The basic goal of working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability to satisfy both maturing short-term debt and upcoming operational expenses.
- 9. SINGNIFICANCE OF WORKINGCAPITAL MANAGEMENTIn a typical manufacturing firm, current assets exceed one-half of total assets.
- 10. Excessive levels canresult in a substandard Return on Investment (ROI).
- 11. Current liabilities arethe principal source of external financing for small firms.
- 12. Requires continuous, day-to-daymanagerial supervision.
- 13. Working capital managementaffects the company’s risk, return, and share price.WORKING CAPITAL CONCEPTS Net Working Capital:net working capital refers to the difference between current assets and current liabilities. Current liabilities are those claims of outsider, which are expected to mature for payment within an accounting year & include creditors, bills payable & the outstanding expenses. In other words you can say that this is the excess of current assets over current liabilities. Current Assets – Current LiabilitiesGross Working Capital:It refers to the firm’s investment in current assets.
- 14. Current assets arethe assets, which can be converted into cash within an accounting year or within an operating cycle
- 15. cash, short-term securities,debtors (accounts receivable & book debts), bills receivable and stock. Working capital turnover: Working capital turnover= sales/working capitalWorking Capital Management: The administration of the firm’s current assets and the financing needed to support current assets.
- 16. CURRENT ASSETSInventories: Inventoriesrepresent raw materials and components, work-in-progress and finished goods. Trade Debtors: Trade Debtors comprise credit sales to customers. Prepaid Expenses: These are those expenses, which have been paid for goods and services whose benefits have yet to be received. Loan and Advances: They represent loans and advances given by the firm to other firms for a short period of time. Investment: These assets comprise short-term surplus funds invested in government securities, shares and short-terms bonds. Cash and Bank Balance: These assets represent cash in hand and at bank, which are used for meeting operational requirements. One thing you can see here is that this current asset is purely liquid but non-productive.
- 17. CURRENT LIABILITYSundry Creditors:These liabilities stem out of purchase of raw materials on credit terms usually for a period of one to two months. Bank Overdrafts: These include withdrawals in excess of credit balance standing in the firm’s current accounts with banks Short-term Loans: Short-terms borrowings by the firm from banks and others form part of current liabilities as short-term loans. Provisions: These include provisions for taxation, proposed dividends and contingencies.
- 18. WORKING CAPITAL FORMATCURRENTASSETS CURRENT LIABILITIESCash Accounts receivableNotes receivableMarketable securitiesInventoryPrepaid expenses Total current assetsAccounts payableNotes payableAccrued expensesTaxes payableTotal current liabilities
- 19. POINTS KEPT INMIND WHILE PLANNING1. Excessive investment (Profitability) It results in unnecessary accumulation of inventories. Thus, chances of inventory mishandling, waste, theft & losses increase. b. It is an indication of defective credit policy & slack collection period. c. Excessive WC makes management complacent, which degenerates into managerial inefficiency. d. Tendencies of accumulating inventories tend to make speculative profits grow.
- 20. CONT…2. Inadequate investment(Liquidity) It stagnates growth. It become difficult to implement operating plans and achieve the firm’s operating profit target. Operating inefficiencies creep in when it becomes difficult even to meet day-to-day commitments. Fixed assets are not efficiently utilized for the lack of working capital funds. Thus, the firm’s profitability would deteriorate. Paucity of WC funds render the firm unable to avail attractive credit opportunities. The firm loses its reputation when it is not in a position to honour its short-term obligations.
- 21. KINDS OF WORKINGCAPITAL1.Permanent working capital:Permanent working capital is the minimum amount of current assets, which is needed to conduct a business even during the dullest season of the year. The minimum level of current assets is called permanent or fixed working capital as this part is permanently blocked in current assets. Characteristics of Permanent working capital It is classified on the basis of the time period It constantly changes from one asset to another and continues to remain in the business process. Its size increase with the growth of business operations.
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- 23. CONT…2.Temporary working capital:Temporaryworking capital represents a certain amount of fluctuations in the total current assets during a short period. Variable working capital is the amount of additional current asset that are required to meet the seasonal needs of a firm, so is also called as the seasonal working capital. Characteristics of Temporary working capital It is not always gainfully employed, though it may change from one asset to another asset, as permanent working capital does. • It is particularly suited to business of a seasonal or cyclical nature.
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- 25. DETERMINANTS OF WORKINGCAPITALNature of business
- 26. Terms of salesand purchases
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- 35. Working capital cycleWORKINGCAPITAL ISSUESAssumptions50,000 maximum units of production
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- 37. Three different policiescurrent asset levels are possibleIMPACT ON LIQUIDITYLiquidity AnalysisPolicyLiquidityA HighB AverageC LowGreater current asset levels generate more liquidity; all other factors held constant.IMPACT ON EXPECTED PROFITABILITYReturn on Investment =Net profit/Total AssetsLet,Current Assets=(Cash+Rec.+Inv.)Return on Investment=(Net Profit/Current +Fixed Assets)
- 38. IMPACT ON EXPECTEDPROFITABILITYProfitability AnalysisPolicyProfitabilityA LowB AverageC HighAs current asset levels decline, total assets will decline and the ROI will rise.IMPACT ON RISKDecreasing Cash reduces the firm’s ability to meet its financial obligations. “More risk!”
- 39. Stricter credit policiesreduce receivables and possibly lose sales and customers. “More risk!”
- 40. Lower inventory levelsincrease stock outs and lost sales.IMPACT ON RISKRisk AnalysisPolicyRiskA LowB AverageC HighRisk increases as the level of current assets are reduced.SUMMARY OF THE OPTIMAL AMOUNT OF CURRENT ASSETSSUMMARY OF OPTIMAL CURRENT ASSET ANALYSISPolicy Liquidity Profitability Risk A High Low Low B Average Average Average C Low High HighProfitability varies inversely with liquidity.Profitability moves together with risk. (risk and return go hand in hand!)
- 41. FINANCING CURRENT ASSETS:SHORT-TERMAND LONG-TERM MIXSpontaneous Financing:Trade credit, and other payables and accruals, that arise spontaneously in the firm’s day-to-day operations.Based on policies regarding payment for purchases, labor, taxes, and other expenses.
- 42. We are concernedwith managing non-spontaneous financing of assets.HEDGING(or MATURITY MATCHING) APPROACHA method of financing where each asset would be offset with a financing instrument of the same approximate maturity..
- 43. HEDGING(or MATURITY MATCHING)APPROACHLess amount financed spontaneously by payables and accruals.In addition to spontaneous financing (payables and accruals).
- 44. FINANCING NEEDS ANDTHE HEDGING APPROACHFixed assets and the non-seasonal portion of current assets are financed with long-term debt and equity(long-term profitability of assets to cover the long-term financing costs of the firm).
- 45. Seasonal needs arefinanced with short-term loans (under normal operations sufficient cash flow is expected to cover the short-term financing cost).SELF-LIQUIDATING NATURE OF SHORT-TERM LOANSSeasonal orders require the purchase of inventory beyond current levels.
- 46. Increased inventory isused to meet the increased demand for the final product.
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- 48. Receivables are collectedand become cash.
- 49. The resulting cashfunds can be used to pay off the seasonal short-term loan and cover associated long-term financing costs.RISKS VS. COSTS TRADE-OFF (CONSERVATIVE APPROACH)Long-term Financing Benefits:Less worry in refinancing short-term obligations
- 50. Less uncertainty regardingfuture interest costsShort-term Financing Risks:Borrowing more than what is necessary
- 51. Borrowing at ahigher overall cost(usually)Result:Manager accepts less expected profits in exchange for taking less risk.RISKS VS. COSTS TRADE-OFF (CONSERVATIVE APPROACH)Firm can reduce risks associated with short-term borrowing by using a larger proportion of long-term financing.
- 52. COMPARISON WITH ANAGGRESSIVE APPROACHShort-Term Financing Benefits:Financing long-term needs with a lower interest cost than short-term debt
- 53. Borrowing only whatis necessaryShort-Term Financing Risks:Refinancing short-term obligations in the future
- 54. Uncertain future interestcostsResult:Manager accepts greater expected profits in exchange for taking greater risk.RISKS VS. COSTS TRADE-OFF (AGGRESSIVE APPROACH)Firm increases risks associated with short-term borrowing by using a larger proportion of short-term financing.
- 55. SUMMARY OF SHORT-VS. LONG-TERM FINANCING
- 56. COMBINING LIABILITY STRUCTUREAND CURRENT ASSET DECISIONSThe level of current assets and the method of financing those assets are interdependent.
- 57. A conservative policyof “high” levels of current assets allows a more aggressive method of financing current assets.
- 58. A conservative methodof financing (all-equity) allows an aggressive policy of “low” levels of current assets.