Post on 21-Jan-2015
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WORKING CAPITAL MANAGEMENT
Presented By
Erum Altaf
PBA02123014
Lahore Business School
University of Lahore, Lahore
WORKING CAPITAL
The capital of a business which is used in its day-
to-day trading operations.
FORMULA TO CALCULATE WC
WC= Current Assets-Current Liabilities
This ratio indicates whether a company has enough
short term assets to cover its short term debt. Anything
below 1 indicates negative W/C (working capital). While
anything over 2 means that the company is not
investing excess assets.
WORKING CAPITAL MANAGEMENT
WCM involves managing the firm’s current assets
and current liabilities and optimally financing its net
working capital needs,
WCM is very important because it directly affect the
liquidity and profitability of the firm.(Smith, 1980)
PROFITABILITY
Measure of Amount by which company’s revenue
exceeds its relevant expenses.
Rate of return of firms investment. An unwarranted
high investment in current assets would reduce this
rate. (Vishani, 2007).
LIQUIDITY
Having enough money in form of cash or near
cash to meet financial obligations.
Principal of risk and return.
WCM
WCM have been approached in numerous ways.
Researcher studied on
1. The impact of Optimum inventory management.
2. Management of account receivables.
IMPACT OF OPTIMUM INVENTORY
Large inventory + Trade credit High
Sales
(Rehman A Nasir, 2007)
(Long MS, Malitz IB 1993)
TRADE CREDIT POLICY
An agreement where a customer can purchase goods on
account (without paying cash), paying the supplier at a later
date. Usually when the goods are delivered, a trade credit is
given for a specific amount of days - 30, 60 or 90. Jewelry
businesses sometimes extend credit to 180 days or longer.
Basically, this is a credit a company gives to another for the
purchase of goods and services.
MANAGEMENT OF ACCOUNT
RECEIVABLE
Lesser the time a firm needs to realize cash from
its customers relative to the time it require to
pay off its creditors the better it is for its liquidity
position and reduce the risk of dependency on
external and more expensive sources of capital.
CASH CONVERSION CYCLE AND PROFITABILITY
The gap in the midest of the disbursement made
for the procurement of raw material and the
assortment of sales of finished goods.. (Deloof,
2003)
ESTIMATION OF CCC
CCC=Inventory conversion period+ Average collection
period-Average payment period
IMPORTANCE OF CASH POSITION FOR
SUSTAINABLITY25 years ago, Largay and Srickney in 1980 has reported the importance of cash position for
sustainability of the firm.
analysis of the W. T. Grant Company’s bankruptcy and subsequent liquidation helped give rise to
a general recognition among financial analysts of the need for inclusion of the statement of cash
flows in corporate financial reporting. While standard ratio analysis of profitability, turnover,
liquidity, and solvency as applied to W. T. Grant’s balance sheet and income statements though
the mid-1970’s gave investors confidence in the continuing viability of that firm, these ratios
belied an anemic multi-year trend in the company’s operating cash flows that continued until its
bankruptcy in 1975. Largay and Stickney demonstrate that disparate signals can - and in the case
of W. T. Grant most certainly did - arise between standard ratio analysis involving the balance
sheet and income statement on the one hand, and measurements of cash flow on the other.
IMPORTANCE OF WCM
In 1980, Smith discussed about importance of
WCM, he said WCM is important because of its
effect on the firm’s profitability and Risk &
consiquently its value.
EFFICIENT WORKING CAPITAL
MANAGEMENT
Efficient WCM involves planning and controlling of current assets
and current liabilities.
Current assets are short lived investment that are continually
being converted into other assets type. (Rao, 1989)
And for this purpose, manager spend considerable time on day-to-
day problems that involve working capital decisions. (Eljelly, 2004)
TRADE CREDIT, QUALITY GUARANTEES, AND
PRODUCT MARKETABILITY.Long, malitz and Ravid(1993), developed model of trade credit in
which asymmetric information leads good firms to extend trade
credit so that buyers can verify product quality before payment.
They found evidence consistent with the model. The find suggest
that producer may increase the implicit cost of extending trade
credit by financing their receivables through payable and short-
term borrowing.
TRADE CREDIT AND WCM
Previous studies have analyzed the high cost of trade
credit,
Firms finance themselves with seller credit when they
do not have other more economic sources of finance
available. (Petersen and Rajan, 1994 & 1997)
WORKING CAPITAL AND BUDGETING
WC consist of large portion of firm’s total investment
in assets, 40% in manufacturing and 50%-60% in
retailing and wholesale industries respectively.
Moyer, Mcguigan and Kretlow (1995).
WCM AND LIQUIDITY, PROFITABILITY
Smith and begemann, 1997 emphasized that those who
promoted WC theory shared that profitability and liquidity
comprised the salient goals of working capital theory.
Results indicates that there were no significant differences
amongst the years with respect to the independent variables.
WCM AND PROFITABILITY
Standard measure of WC is CCC
Shin and Soenen (1998) found a strong negative relationship
between the length of the firms net trade cycle and its profitability,
They also suggest that one possible way to create shareholder
value is to reduce firm’s NTC.
SOURCE OF FINANCING
In 1999 Smith and Smith said that Trade policy
is a spontanous source of financing that reduce
the amount required to finance the sums tied
up in inventory and customer account.
WCM AND CORPORATE
PROFITABILITY
Deloof (2003), used a sample of 1008 large Belgian non-financial firms.
Test Correlation and regression.
Found significant negative relationship between gross operating
income and CCC.
Suggests that manager can increase corporate profitability by
reducing the number of days A/R and inventory
WCM AND INDIAN CEMENT COMPANIES
In 2003, Ghosh and Maji examine the efficiency of indian cement company
Calculated 3 indexes, Performance index, Utilization Index, and Overall
effficiency index.
Run regression analysis
Results found that some of the firms successfully improved efficiency
during these years.(1992-1993), (2001-2002).
RELATIONSHIP BETWEEN PROFITABILITY AND
LIQUIDITY
Profitability and liquidity measured by current ratio and cash
gap on sample of 929 joint stock companies in Saudi Arabia.
Using correlation and regression analysis,
Results found a negative relationship between the firms
profitability and liquidity.(Eljelly, 2004)
WCM AND PROFITABILITY
Lazaridis and tryfonidis (2006), conducted cross sectional anaylysis
Sample of 131 listed firms on Athens Stock Exchange for period of
2001-2004.
Using correlation and regression analysis.
Suggest that manager can create profit for their companies by
collecting handeling CCC and by keeping CCC at optimal level.
EFFECT OF WCM
Raheman and Naser in 2007, Sample of 94 Pakistani
listed companies.
Used Correlation and regression analysis.
Found negative relationship between variables of WCM
and profitability of the firm.
WCM AND SMES
In 2007, Garcia-Teruel and Martinez-Solano conducted
Panel data analysis on 8872 SMEs from Spain covering
period of 1996-2002.
Demonstrate that managers could create value by
reducing their inventory and the number of days for
which their accounts are outstanding.
Shorten CCC and increase profitability.
NON-FINANCIAL FIRMS AND WCM
In 2009, Falope and Ajilore used sample of nigarian non-
financial sector.
Panel data analysis
Negative relationship
VARIABLES IN ALL RESEARCHES
CCC Retren on Investment
Debt to total assets Return on Assets.
Debt to equity ratio Net Operating Profit.
Age of inventory Account Recievable.
Age of debtor Sales Growth.
Age of creditor GDP
Ratios
SUMMARY/RESULTS
The research indicates that working capital management impacts on
the profitability of the firm but there still is ambiguity regarding the
appropriate variables that might serve s proxies for WCM.
Slow collection of A/R is correlated with low profitability.
Manager can improve profitability by reducing the credit period
granted to their customers.