Working Capital

Management
Harsha Vardhan
harsha@acmegrade.in
 Working Capital
• Gross Working Capital
• Amount of money invested in Current Assets of the Firm
• Net Working Capital
• Difference between Current Assets and Current Liabilities of the Firm.
• Current Asset Management
• Avoid excessive investment in Current Assets.
• Avoid inadequate investment in Current Assets.
• Liquidity Management
• Current Assets > Current Liabilities.
Operating and Cash Conversion Cycle

Cash

Accounts Purchase Raw

Receivable Material

Manufacturing
Sales
/ Value Add

Finished
Goods /
Inventory
 Working Capital
• Permanent Working Capital
• Fluctuating / Variable Working Capital
• Dangers of Excessive Working Capital
• Unnecessary inventory accumulation
• Slack in collection / bad credit policy
• General Managerial inefficiency
• Speculative Tendencies
• Dangers of inadequate Working Capital
• Stagnant Growth due to lack of capacity
• Difficulty in meeting planned targets
• Difficulty in meeting day to day commitments
• Underutilization of fixed assets
• Inability to use leverage in business
• Bad credit terms from suppliers / credit squeeze.
 Determinants of Working Capital
• Nature of Business
• Market and Demand Conditions
• Technology
• Manufacturing Policy
• Level Production
• Variable Production
• Credit Policy
• Supplier’s Credit
• Operating Efficiency
• Price Level Changes
 Issues in Working Capital Management
• Current Assets to Fixed Assets Ratio
• Varies on business purpose.
• Manufacturing firms tend to have higher fixed assets
• Liquidity vs Profitability – Risk – Return Tradeoff
• Profitability – Return on working capital
• Solvency – Having enough current assets to pay current liabilities
• The Cost Trade-off
• Cost of liquidity
• Cost of illiquidity
 Estimating Working Capital
• Current Assets holding period
• Ratio of sales
• Regression formulae – Y=a + bX + e
• Y = Working Capital
• X = Sales
• e = Error term
• Ratio of fixed investment
 Financing Current Assets
• Long Term Financing
• Short Term Financing
• Factoring Bills
• Short – term loans (less than 12 months)
• Spontaneous Financing
• Suppliers Credit
• Overdraft facility
 Credit Policy
• Credit Standards & Analysis
• Credit Standards – Criteria in selecting customers for the purpose of credit extension.
• Credit Analysis
• Quality of customers
• Time taken to repay credit obligation
• Average Collection period
• Default risk
• Character
• Capacity
• Condition
• Good Account
• Bad Account
• Marginal Account

• Credit terms
• Credit Period
• Cash Discount
• Rate of Cash Discount
• Cash Discount Period
• Collection Policy and Procedures
• PDC’s
• Penal Interest
• Bill Discounting
• Credit Limit
 Factoring
• A Contract between supplier of goods / services and a Factor
• The supplier is in business of sale of goods / services to its customers
(debtors).
• The factor performs at least 2 of the 4 services
• Finance supplier – including loans / advance
• Maintain accounts wrt receivables
• Collection of accounts receivables
• Protection against default in payment by debtors
• Notice of assignment of receivables is to be given to debtors.
• Factoring Vs Bill Discounting