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    Chapte R: Principles of Working Capital Management

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    The large holding of current assets, reduces the overall profitability. Concepts of Working Capital refer to the firm's total investment in current assets. Operating Cycle is the time duration required to convert sales, after the conversion of resources into inventories, into cash.

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    Chapte R: Principles of Working Capital Management

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    mylyf12
    89 views24 pages
    The large holding of current assets, reduces the overall profitability. Concepts of Working Capital refer to the firm's total investment in current assets. Operating Cycle is the time duration required to convert sales, after the conversion of resources into inventories, into cash.

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    The large holding of current assets, reduces the overall profitability. Concepts of Working Capital refer to the firm's total investment in current assets. Operating Cycle is the time duration required to convert sales, after the conversion of resources into inventories, into cash.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    89 views24 pages

    Chapte R: Principles of Working Capital Management

    Uploaded by

    mylyf12
    The large holding of current assets, reduces the overall profitability. Concepts of Working Capital refer to the firm's total investment in current assets. Operating Cycle is the time duration required to convert sales, after the conversion of resources into inventories, into cash.

    Copyright:

    Attribution Non-Commercial (BY-NC)
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    You are on page 1of 24

    CHAPTE R 27

    PRINCIPLES OF WORKING CAPITAL MANAGEMENT

    LEARNING OBJECTIVES
    2

    Underline

    the need for investing in current assets, and elaborate the concept of operating cycle Highlight the necessity of managing current assets and current liabilities Explain current asset investment and financing Focus on the proper mix of short-term and long-term financing for current assets

    Difference in the management of fixed assets and current assets


    First,

    in managing fixed assets, time is a very important factor; consequently, discounting and compounding techniques play a significant role in capital budgeting and a minor one in the management of current assets. Second, the large holding of current assets, reduces the overall profitability. Thus, a risk-return trade-off is involved in holding current assets. Third, levels of fixed as well as current assets depend upon expected sales, but it is only the current assets which can be adjusted with sales fluctuations in the short run. Thus, the firm has a greater degree of flexibility in managing current assets.

    Concepts of Working Capital


    4

    Gross

    working capital (GWC) GWC refers to the firms total investment in current assets. Current assets are the assets which can be converted into cash within an accounting year (or operating cycle) and include cash, short-term securities, debtors, (accounts receivable or book debts) bills receivable and stock (inventory).

    Concepts of Working Capital


    5

    Net working capital (NWC) NWC refers to the difference between current assets and current liabilities. Current liabilities (CL) are those claims of outsiders which are expected to mature for payment within an accounting year and include creditors (accounts payable), bills payable, and outstanding expenses. NWC can be positive or negative.

    Positive NWC = CA > CL Negative NWC = CA < CL

    Concepts of Working Capital


    6

    GWC

    focuses on

    Optimisation of investment in current


    Financing of current assets

    NWC

    focuses on

    Liquidity position of the firm Judicious mix of short-term and long-tern financing

    Operating Cycle
    7

    Operating

    cycle is the time duration required to convert sales, after the conversion of resources into inventories, into cash. The operating cycle of a manufacturing company involves three phases:

    Acquisition of resources such as raw material, labour, power and fuel etc. Manufacture of the product which includes conversion of raw material into work-in-progress into finished goods. Sale of the product either for cash or on credit. Credit sales create account receivable for collection.

    Cont
    8

    The

    length of the operating cycle of a manufacturing firm is the sum of:


    Inventory conversion period (ICP). Debtors (receivable) conversion period (DCP).

    Operating cycle of a manufacturing firm

    Gross Operating Cycle (GOC)


    9

    The

    firms gross operating cycle (GOC) can be determined as inventory conversion period (ICP) plus debtors conversion period (DCP). Thus, GOC is given as follows:

    Inventory conversion period


    10

    Inventory

    conversion period is the total time needed for producing and selling the product. Typically, it includes:

    raw material conversion period (RMCP) work-in-process conversion period (WIPCP) finished goods conversion period (FGCP)

    11

    Debtors (receivables) conversion period (DCP)


    Debtors

    conversion period (DCP) is the average time taken to convert debtors into cash. DCP represents the average collection period. It is calculated as follows:

    12

    Creditors (payables) deferral period (CDP)


    Creditors(payables)

    deferral period (CDP) is the average time taken by the firm in paying its suppliers (creditors). CDP is given as follows:

    13

    Cash Conversion or Net Operating Cycle


    Net

    operating cycle (NOC) is the difference between gross operating cycle and payables deferral period.

    Net

    operating cycle is also referred to as cash conversion cycle.

    PERMANENT AND VARIABLE WORKING CAPITAL


    14

    Permanent

    or fixed working capital A minimum level of current assets, which is continuously required by a firm to carry on its business operations, is referred to as permanent or fixed working capital. Fluctuating or variable working capital The extra working capital needed to support the changing production and sales activities of the firm is referred to as fluctuating or variable working capital.

    15

    Permanent and temporary working capital

    16

    Determinants of Working Capital


    1.
    2. 3. 4. 5. 6. 7.

    Nature of business Market and demand Technology and manufacturing policy Credit policy Supplies credit Operating efficiency Inflation

    17

    Issues in Working Capital Management


    Current Assets

    to Fixed Assets Ratio Liquidity vs. Profitability: RiskReturn Trade-off The Cost Trade-off

    Alternative current asset policies

    Cost Trade-off

    Estimating Working capital


    18

    Current assets holding period To estimate working capital requirements on the basis of average holding period of current assets and relating them to costs based on the companys experience in the previous years. This method is essentially based on the operating cycle concept. Ratio of sales To estimate working capital requirements as a ratio of sales on the assumption that current assets change with sales.

    Ratio of fixed investment To estimate working capital requirements as a percentage of fixed investment.

    19

    Working Capital Finance Policies

    Long-term Short-term Spontaneous

    20

    Working Capital Finance Policies


    Matching

    Conservative
    Aggressive

    Matching Approach
    21

    Financing under matching plan

    Conservative Approach
    22

    Conservative financing

    Aggressive Approach
    23

    Aggressive financing

    24

    Short-term vs. Long-term Financing: A Risk-Return Trade-off


    Cost

    Flexibility
    Risk Risk-return trade-off

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