fm working capital management for mba

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PART – 1

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WORKING CAPITAL
MANAGEMENT
Part –1: WORKING CAPITAL
 Definition of WC
 Why WC ....???
 Objectives and Aspects of WC
 Purpose and Need of WC
 Components of WC
 Concepts of WC
 WC in case of Stable firm &
Growing firm

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INTRODUCTION:
• Working Capital plays the
crucial role in the business as
the role of heart in the human
body.

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DEFINITION:
 Working capital refers to funds required
to be invested in the business for a short
period usually upto one year.
 It is also known Short-term capital or
Circulating capital
 “Working capital is the amount of funds
necessary to cover the cost of operating the
enterprise.”
--- Acc.. to Shubin

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WHY WC...??
 The firm has to maintain cash balance to pay
bills as they come due.
 In addition, the company must invest in
inventories to fill customer orders promptly.
 And finally, company invests in accounts
receivable to extend credit to customers.

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OBJECTIVES OF WC:
→ To optimize investments in current assets.
→ To see that company meets its current
liabilities obligation.
→ Manage current assets to see that the return
on current assets is more than cost of capital.
→ Proper balance between current assets &
current liabilities.

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Example:

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ASPECTS OF WC:
There are many aspects of WCM which makes
it important function of financial
management.
 Time
 Investment
 Credibility
 Growth

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PURPOSE OF WC:
 To hold the stock of raw materials for such a
period
 To hold the stock of work in progress for
process period
 To hold the stock of finished goods for such
a period
 To grant credit to customers
 To hold cash balances to meet the expenses

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NEED FOR WC:
֍ Operating Cycle.
֍ Operating cycle in a Trading firm is the
length of time required.
Cash
Inventory
of FG
Receivable
s

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֍ Operating cycle in a Manufacturing firm is
the length of time required
֍ Distinct Phases in Operating Cycle
Cash
Inventory
of FG
Inventory
of WIP
Inventory
of RM
Receivable
s

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Components of Operating Cycle:
 Gross Operating Cycle:
R W F D GOC
RM storage
period
WIP holding
period
FG storage
period
Debtors Collection
Period
Gross
Operating
Cycle

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 Net Operating Cycle:
R W F D C NOC
Creditors
Collection Period
Net
Operating
Cycle
RMSP WIPHP FGSP DCP

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How to Calculate Components of OC:
Average RM Storage Period
(in days)
Average stock of RM
Average Cost of RM Consumption per day
Average WIP Holding Period
( in days)
Average stock of WIP
Average Cost of WIP per day
Average FG Storage Period
(in days )
Average stock of FG
Average Cost of Goods Produced per day
Average Debtors Collection
Period ( in days)
Average Trade Debtors
Average Cost of Credit Sales per day
Average Creditors Payment
Period (in days)
Average Trade Creditors
Average Credit Purchases per day
Average Time-Lag in
Payment of exp’s (in days)
Average Creditors for Expenses
Average Expenses per day

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How to Calculate Number of Operating
Cycles in a year:-
The no. Of Operating Cycles in a year may be
calculated as follows:
No.of days in a year
No. of Operating Cycles in a year =
Net Operating Cycle(in days)

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Illustration-1:
1. RM Inventory Consumed during the year 60,00,000
2. Average stock of RM 10,00,000
3. Factory Cost of Goods Produced 1,05,00,000
4. Average stock of WIP 4,37,500
5. Office Cost of Goods Produced 1,14,00,000
6. Average stock of FG 9,50,000
7. Average trade debtors 11,25,000
8. Cost of Credit Sales 90,00,000
9. Average trade creditors 5,00,000
10. Expenses for the year 30,00,000
11. Average creditors for Expense 5,00,000
12. No.of working days in a year (assume 360days)

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 From the above following information of
Company , Calculate ---
1. Gross Operating Cycle
2. Net Operating Cycle
3. No.of Operating Cycles in a
year

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Concepts Of WC:
WC
On the
basis of
Concept
Gross working
capital
Net working
capital
On the
basis of
Time
Permanent
working capital
Temporary
working
capital

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On the basis of Concept/Value:
Gross W/C: It refers to the firm’s investment in
current assets.
CA includes – stock of rawmaterial, WIP, FG’s, etc.
In the form of Equation , Gross W/C can be shown
below:- CASH
Inventories
i. Raw-materials
ii. Work-in-progress
iii. Finished Goods
Short term Marketable
securities and other current
assets
Gross
Working
Capital

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 Net W/C: It refers to diff b/w current assets
and current liabilities.
CL includes – trade creditors , bills payable,
o/s exp’s, etc.
Net Working Capital is a Qualitative Concept,
which indicates:
i. Liquidity position of the firm
ii. Part of current assets which should be financed
with long-term funds

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 In the form of an equation , Net Working
Capital has been shown below:
 Example: A company buys stocks of raw material
for cash. It implies that company is financing raw
material stock from its internal sources. Suppose,
the company gets a two months credit for the same
purchase. It implies the stock is financed by
creditors.
Gross Working Capital (or)
current Assets
Current Liabilities
LESS
Net Working
Capital

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Difference b/w Gross WC & Net WC :
Gross working capital Net working capital
1. Quantitative in nature 1. Qualitative in nature
2. It indicates total sum
of current assets
2. It expressed as
current assets minus
current liabilities
3. It is suitable for
companies
3. It is suitable for sole
trading & partnership
4. It is a concept very
popular in financial
management
4. It is a concept very
popular in accounting
system
5. It cannot reveal the
true financial position of
company
5. It is very useful to find
out true financial position
of the company

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On the basis of Time:
Time
Permanent /
fixed WC
Regular wc
Reserve wc
Temporary WC
Seasonal wc
Special wc

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Permanent Working Capital:
It refers to a certain
minimum level of current assets, which
is essential for firm to carry on its
business irrespective of the level of
operations.

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Characteristics of PWC:
 Classified on the basis of Time factor
 Always remain in process
 Size increases according to the Growth of
enterprise
 suitable for business, which is the same
for all the year long
 Constantly changes from one asset to
another

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Temporary Working Capital:
It refers to the amount of
working capital over and above the
fixed minimum amount of WC,
which is required to meet seasonal
and other temporary requirements.

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Working Capital in case of a Stable firm
 In case of a Stable firm , the
Permanent working capital is
stable over time and takes the
shape of a Horizontal line.
while temporary working
capital is fluctuating –
sometimes increasing and
sometimes decreasing.

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Amountofworkingcapital
Level of temporary working capital
Level of permanent working capital
Time
Y
X
Temporary
working capital
line
Permanent
working capital
line
Working capital in case of Stable Firm Diagram

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 In case of a Growing firm , the Permanent
working capital may also keep on
increasing over time to support a rising
level of activity and hence PWC line may
not always be Horizontal. while
Temporary working capital is fluctuating –
sometimes increasing and sometimes
decreasing.
Working Capital in case of a
Growing firm

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Working capital in case of a Growing Firm Diagram
Amountofworkingcapital
Time
Y
X
Temporary
working capital
line
Permanent
working capital
line

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Prepared by ...
Sravan Kumar . D

fm working capital management for mba

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