WORKING CAPITAL
MANAGEMENT
Vanaja M.Varghese
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What is Working capital?
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Liquidity available to a business
Gross working capital refers to the current
assets
Net working capital = current assets – current
liabilities
Working capital – component of the operating
capital of the business along with plant and
machinery.
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What are the components?
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Current assets
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Cash
Accounts receivables
Inventory
Marketable securities
Current liabilities
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Accounts payable
Accrued expenses.
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Cash conversion cycle
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Illustration
Inventory conversion period
= inventory/sales per day
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Payables deferral period
= payables/cost of goods sold
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Receivables collection period
=DSO=
receivables/sales.
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Cash conversion cycle (contd.)
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Cash Conversion Cycle
= Inventory conversion period + Receivables
collection period – payables deferral period
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It indicates the gap between when the firm
has spend the money to purchase the
production materials and when the firm is
able to get that money back.
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Cash conversion cycle (contd.)
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The objective of a firm should be to reduce
the cash conversion cycle
Faster they recover the money- so need
lesser working capital – free cash flow
Increase the time to pay its suppliers
Collect the receivables faster
Reduce the inventory conversion period.
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Why do firms hold cash?
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John Keynes
Firms hold cash for three main reasons
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Speculation ( trade discounts)
Precaution ( inflows uncertainty)
Transaction ( payments)
Compensating balances - deposits that must
be maintained in the banks for the services
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Cash Budget
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Projected cash inflows and outflows for a
specific period of time.
Example of a cash budget
Target cash balance can be determined with
the help of several models like the Baumol
model, Miller and Orrs model etc.
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Cash Management techniques
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Cash flow synchronization
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Timing the receipts of bills – in time for the
payments-maintain cash balances to the
minimum.
Using float
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Float is the difference between a firm’s book
balance and the balance indicated in the banks
books
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Cash Management techniques
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Float can be of two types
Disbursement float
The firm pays and thus it is deducted from the firm’s
books but not from the banks books.
 Collection float
When the customer writes the cheque it is recorded
as received in the firms books but it is still
unavailable for use unless the bank clears the
cheque.
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Collection process
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Managing the float
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Lock boxes
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Concentration Banking
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Mailed to the lock boxes
Payments made at the local sales offices, cleared
in the local banks and net amount is transferred to
the main bank
Wire transfers
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This is direct transfer of funds from the account of
one entity to another entity.
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Inventory management
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The twin goals of inventory management are
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To ensure that inventory is available to sustain operations
To keep the ordering and holding costs to the minimum.
Decisions
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Lead time
Uncertainty in demand
Cost of holding inventory
Cost of losing inventory
Projected sales and availability of raw materials
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Receivables management
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Selling on credit essential to cope with the
competition.
A credit policy
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Credit period ( 2/10 , net 30 )
Discounts ( discount for early payments )
Credit standards
Collection policy ( toughness/laxity)
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Receivables management
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Days of sales outstanding
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time the customers take to pay the bills.
Also indicates the average that the company takes to pay
their creditors.
DOS = Receivables/Sales per day
Aging schedules
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It breaks down the firms receivables by the age of the
account.
It is developed from the accounts receivable ledger.
Aging schedule
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Receivables management
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A firm should see to it that the DSO and the
aging schedules are working well in
comparison with the industry.
These need to be reviewed from time to time
and kept in control.
The credit policy needs to be revised.
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Accrued expenses
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It includes the expenses like the wages that
needs to be paid to the workers
The taxes
Cannot be controlled by the firm
It expands with the expansion of the firms
operations.
External forces may it obligatory.
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Accounts payables
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40% of the current liabilities is constituted by
accounts payables.
Trade credit
Smaller companies will have higher trade
credit.
Trade credit can be divided into two
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Free trade credit
Costly trade credit
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Short term financing
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Marketable securities
Working capital loans
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Promissory note – amount borrowed, rate of interest , the
repayment schedule, collateral that may be required, terms
and conditions.
Line of credit – informal agreement between a bank
and borrower.
Revolving credit agreement – formal line of credit
Commercial paper
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REFERENCES
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CORPORATE FINANCE by Michael&Eugene
CORPORATE FINANCE by Ross Westerfield
CORPORATE FINANCE by Meyers
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THANK YOU
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