Professional Documents
Culture Documents
Working Capital Management
Working Capital Management
• Involve cash flows within one year or one operating cycle of the firm.
Inventories
a. Raw Materials
b. WIP Current Assets Loans &
Advances
c. Finished goods
d. Others
Cash and
Bank
Balances
Borrowings
(Short term)
Trade Advances
Commercial Banks
Others
Current
Liabilities
Current Asset Cycle
Cash
Raw
Debtors
Materials
Finished Work-In-
Goods Progress
Concepts of Working Capital
Working Capital
• Nature of Business
• Seasonality of operations
• Production policy
• Market conditions
• Conditions of supply
Nature of Business
a. Carrying Costs –
b. Shortage Costs –
Current Assets
Permanent Current
Temporary Current Assets
Assets
Strategies of Current Asset Financing
Strategies
Raw
Cash
materials
received
arrive
Finished
Accounts
goods
sold Inventory
Receivable Period
Period
Operating Cycle
Accounts 56 60
Payable
1. Inventory Period = Average Inventory / (Annual COGS/365)
Sales 80 Inventory 9 12
COGS 56 Accounts 12 16
Receivable
Accounts 7 10
Payable
= (7 + 10) / 2 = 55.4
(56/365)
Operating Cycle = Inventory Period + Accounts Receivable Period
= 68.4 + 63.9
= 132.3 days
1. Estimate the cash cost of various current assets required by the firm. The
cash cost of a current assets is:
2. Deduct the spontaneous current liabilities from the cash cost of current
assets
(Portion of current asset supported by trade credit and accruals of wages
and expenses are referred to as spontaneous current liabilities)
Working Capital Financing
Sources of Finance that are used to support Current Assets are as under:
1. Accruals
2. Trade Credit
3. Working Capital Advance by Commercial Banks
4. Regulation of Bank Finance
5. Public Deposits
6. Inter-Corporate Deposits
7. Short-term loans from Financial Institutions
8. Rights Debentures for Working Capital
9. Commercial Paper
10. Factoring
Accruals
Accruals
Employees Government
Wages Taxes
Level of
Accruals
Activity
Cost
Trade Credit
Earnings
With discount
Track Record
Liquidity
Without
position of
discount
the firm
Record of
Payment
Cost of Trade
Credit
Discount given
Cost-Free. if paid
promptly
Net 30 i.e. cost associated beyond the discount period
30 days period
10 days 20 days
Discount Period Non-Discount Period
1. What is annual percentage interest cost associated with the following credit
terms?
a. 2/20 net 50
b. 2/15 net 40
d. 1/10 net 30
f. 2/10, net 45
h. 2/15, net45
• Margin Amount
Purchase or Discount of Seller Draws
Bills Bill on
Purchaser
On due date,
bank collects
from Purchaser
Purchase
r Accepts
Bank Pays
Seller
Seller
Presents bill
to bank
Maximum Permissible Bank Finance
MPBF
• Cost
Advantages
1. Procedure is simple
2. No Restrictive Covenants
3. No security is offered
4. Reasonable Cost
Disadvantages
Disadvantages
• Regulation
• Secrecy
• Personal Contacts
Short-Term Loans from Financial Institutions
Features
2. Given for 1Yr Period and renewed for two consecutive years later
3. After loan is repaid, company has to wait for atleast 6 months before availing
of fresh loan
• Short-term
• Unsecured
• Promisory Notes
• Issued by firms with good credit rating
• Factor is Financial Institution that manages debts arising from credit sales
• In India only 4 Public Sector Banks allowed to do factoring
– SBI (SBI Factoring and Commercial Services Limited)
– Canara Bank (Canara Bank Factoring Limited)
– PNB
– Allahabad Bank
Fixes the
credit limit in
consultation
with client
He advances to
the client – 70-
80%.
Charges interest &
Commission
Factor
assumes the
collection
responsibility
Cash and Liquidity Management
Reasons for holding Cash
●
Cash collected is not exactly same as cash
Transaction Motive disbursed
●
Cash is required as buffer
●
Uncertainty about magnitude and timing of
Precautionary Motive cash inflows and outflows.
●
Cash required to protect against uncertainties
●
Fluctuations in commodity prices, security
Speculative Motive
prices, interest rates and forex rates
• Establish reliable forecasting and reporting systems
• Cash Budgeting
• Short-term Financing
• Needs information
o Estimated Sales
o Production Plan
o Purchasing Plan
o Financing Plan
o Capital Expenditure budget
Sl.No. Items of Cash Receipts Basis of Estimation
and Payments
1. Cash Sales Estimated Sales and its division between Cash
and Credit Sales
2. Collection of Accounts Estimated Sales, its division between Cash and
Receivable Credit Sales and Collection pattern
3. Interest and Dividend Firm’s Portfolio of Securities and Return expected
Receipts from the portfolio
4. Increase in Financing Plan
Loans/Deposits and
Issue of Securities
5. Sale of Assets Proposed disposal of Assets
6. Cash Purchases Estimated Purchases and its division between
Cash and Credit Purchases
7. Payment of Purchases Estimated Purchases, its division between Cash
and Credit Purchases and Terms of Credit
Purchase
Sl.No. Items of Cash Receipts & Basis of Estimation
Payments
8. Wages & Salaries Manpower employed and wages and
salaries structure
9. Manufacturing expenses Production Plan
10. General, Administration and Administration and Sales Personnel and
Selling Expenses Proposed Sales Promotion and
distribution expenditure
11. Capital Equipment Purchases Capital expenditure budget and payment
pattern associated with Capital
Equipment Purchases
12. Repayment of Loans and Financing Plan
Retirement of Securities
Deviations from Expected Cash Flows
• Deviation from the actual cash flows and the expected cash flows.
Advantages
1. Complete Picture
2. Appropriate tool for day-to-day predictions
Disadvantages
Float
Difference between the Cash Balance and the Bank Balance of Cash
Collecting bank collects cheques directly and deposits in local bank account of customer
Reduces
Processing
Time
• Customers in a particular area send cheques to the local bank office and not
the Corporate Office.
• On a daily basis, funds from this account are transferred to the Principal
Bank Account.
• Concentration banking when combined with Lock Box will give further better
results.
Delaying Payments
• Payments to be done only when they fall due and not before that
• Centralize Disbursements
• Seller sends electronic bill to buyer and latter authorises his bank to make
payment and the bank transfers funds electronically.
Trans
action
Cost
Total Cost
Oppo
rtunity
Cost
Investment of Surplus Funds
• Safety
• Liquidity
• Yield
• Maturity
Investment Options
Advantages
7. Ready Forwards
8. Bill Discounting
Cash Management Models
Cash Budget
Surplus
Deficit
Marketable Securities Cash Holdings
Baumol Model
• Proposed by William J.Baumol
• Applies Economic Order Quantity (EOQ) concept to determine cash conversion size
which in turn influences
C = √(2 bT /I)
TC = I (C/2) + b (T/C)
Interest Income Conversion
Foregone Costs
Eg:
1. Zeta requires Rs. 1.5 Mn cash for meeting its transaction needs over the
next 3months
2. To meet the projected cash needs, Zeta can sell its marketable securities in
any of the five lot sizes: 100000/-, 200000/-, 300000/-, 400000/- and
500000/-.
3. Zeta can earn 16% annual yield on its marketable securities i.e. for 3
months, interest is 4%.
5. Cash payments are made evenly over the 3months planning period.
C = √ (2 bT/I)
= 193649/-
This means that if the marketable securities are sold in lots of Rs. 200000/-, it
would minimise the Total Cost.
Miller & Orr Model
• On the other hand, once the balance touches ‘Lower Control Limit’, enough
Marketable Securities are disposed to restore the cash balance to its
‘Return Point’
UL = 3 RP – 2LL
RP = Return Point
B = Fixed Cost Per Order for converting Marketable securities into cash
I = Daily interest rate earned on Marketable Securities
σ² = Variance of daily changes in the expected cash balance
LL = Lower Control Limit
UL = Upper control Limit