Working Capital Management and Control

8/4/2019 Working Capital Management and Control

1/99

WORKING CAPITAL

MANAGEMENT AND CONTROL

Dr. Monika Goel

[email protected]


2/99

Working Capital Management

Working capital

= current assets current liabilities

Working capital management refers to

choosing the levels and mix of:

cash, marketable securities, receivables and

inventories.

different types of short-term financing


3/99

Classification of Working Capital

Gross and net working capital

Permanent and temporary working capital


4/99

Three Broad Decisions

the level of current asset

the structure/composition of current assets

the financing of current asset.


5/99

Determinants of Working Capital

Nature of Business

Degree of Seasonality

Production Policies

Growth

Position of the Business Cycle

Competitive Conditions

Production Collection Time Period

Dividend policy and sales policy


6/99

The Balance-Sheet Model of the Firm

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Shareholders

Equity

Current

Liabilities

Long-Term

Debt

What long-

terminvestmentsshould thefirm engagein?

The Capital Budgeting Decision


7/99


How can the firm

raise the money

for the required

investments?

The Capital Structure Decision

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Shareholders

Equity

Current

Liabilities

Long-Term

Debt


8/99


How much short-

term cash flowdoes a companyneed to pay itsbills?

The Net Working Capital Investment Decision

Net

WorkingCapital

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Shareholders

Equity

Current

Liabilities

Long-Term

Debt


9/99

The Operating Cycle and the Cash Cycle

TimeAccounts payable period

Cash cycle

Operating cycle

Cash

received

Accounts receivable periodInventory period

Finished goods sold

Firm receives invoice Cash paid for materials

Order

Placed

Stock

Arrives

Raw materialpurchased


10/99

The Operating Cycle and the Cash Cycle

In practice, the inventory period, the

accounts receivable period, and the accounts

payable period are measured by days in

inventory, days in receivables and days inpayables.

Cash cycle = Operating cycle Accountspayable

period


11/99

Review questionSilver Coin Ltd. is a manufacturing company. It has received an export order of 1,80,000 units.

The finance manager of the company is estimating working capital requirements for theproduction to meet export order. Following information is given for the year 2009-10 :

(i) Production in 2008-09 was 1,80,000 units and it is estimated that in 2009-10 the level will

be maintained.

(ii) Each unit will remain in process for one month. Raw material being channelised into the

pipelines immediately and the labour and overhead costs accruing evenly during the

month.

(iii) Final production will be stored in warehouse awaiting despatch for 3 months.

(iv) Credit allowed by creditors is 1.5 months from the date of delivery of raw materials.

(v) Credit permitted to debtors is 2.5 months from the date of despatch.

(vi) Selling price per unit is Rs.15.

(vii) The expected ratios of cost to the selling price are raw material 50%, direct wages 15% and

overheads 20%.(viii) Raw materials are expected to remain in store for an average of 1.5 months before issue to

production.

(ix) There is regular production and sales cycle.

(x) The company maintains Rs.60,000 as cash in hand.

(xi) Wages and overheads are paid on the first of each month for the previous month.

You are required to submit the working capital requirement to the finance manager of Silver

Coin Ltd.


12/99

Review Question

The management of Laxmi Ltd. has called for a statement showing the working capital needed tofinance a level of activity of 6,00,000 units of output for the year 2009. The cost structure for thecompanys product for the abovementioned level is given as under :

Cost Per Unit

(Rs.)

Raw materials 20

Direct labour 5

Overheads 15

Total costs 40

Profit 10

Selling price 50

Past trends indicate that raw materials are in stock on an average for three months.

Work-in-progress will approximate to half a months production.

Finished goods remain in warehouse on an average for two months.

Suppliers of materials extend one months credit.

Two months credit is normally allowed to debtors.

A minimum cash balance of Rs.1,00,000 is expected to be maintained.

The production pattern is assumed to be even during the year.

You are required to prepare the statement of working capital determination.


13/99

Review Question

Mona Machines Ltd. has provided you the following information :

Production for the year ... 69,000 units

Finished goods in store ... Average 3 months

Raw materials in store ... Average 2 months consumption

Work-in-progress (assume 50% completion stage with full material consumption) ...Average 1 month

Credit allowed by creditors ... Average 2 months

Credit given to debtors (assume at selling price) ... Average 3 months

Selling price per unit ... Rs. 50

Raw material cost ... 50% of selling price

Direct wages ... 10% of selling price

Overheads ... 20% of selling price

Company keeps Rs. 1,00,000 in cash. There is regular production and sale cycle,and wages and overheads accrue evenly. Wages are paid in the next month ofaccrual. Material is introduced in the beginning of production cycle.

You are required to calculate working capital requirement of Mona Machines Ltd.


14/99

Some Aspects of Short-Term FinancialPolicy

There are two elements of the policy that a firmadopts for short-term finance. The Size of the Firms Investment in Current Assets

Usually measured relative to the firms level of total

operating revenues. Flexible

Restrictive

Alternative Financing Policies for Current Assets

Usually measured as the proportion of short-termdebt to long-term debt. Flexible

Restrictive


15/99

Carrying Costs and Shortage Costs

Carrying costs increase with the level ofinvestment in current assets. They include thecosts of maintaining economic value and

opportunity costs (Eg., Interest, warehousingcosts)

Shortage costs decrease with increases in thelevel of investment in current assets. They include

trading costs and the costs related to being shortof the current asset (for example, sales lost as aresult of a shortage of finished goods inventory).


16/99

Carrying Costs and Shortage Costs

$

Investment in

Current Assets ($)

Shortage costs

Carrying costs

Total costs of holding current

assets.

CA*

Minimum

point


17/99

The Size of the Investment in Current Assets

Determined by its short-term financial policies.

These financial policies can be flexible or restrictive

Flexible policy actions include:

Keeping large cash and securities balances Keeping large amounts of inventory

Granting liberal credit terms

Restrictive policy actions include:

Keeping low cash and securities balances Keeping small amounts of inventory

Allowing few or no credit sales


18/99

Appropriate Flexible Policy

$

Investment in

Current Assets ($)

Shortage costs

Carrying costs

Total costs of holding current

assets.

CA*

Minimum

point

A flexible policy is most appropriate when carrying costs are low

relative to shortage costs.


19/99

When a Restrictive Policy is Appropriate

$

Investment in

Current Assets ($)

Shortage

costs

Carrying costs

Total costs of holding current assets.

CA*

Minimumpoint

A restrictive policy is most appropriate when carrying costs are high

relative to shortage costs.


20/99

Alternative Financing Policies forCurrent Assets

In an ideal world, short-term assets are always

financed with short-term debt and long-term

assets are always financed with long-term

debt. In this world, net working capital is always

zero.


21/99

Alternative Asset Financing Policies

Flexible Policy = conservative

Flexible Policy always implies a short-term cash surplus and a large

investment in cash and marketable securities.


22/99

Alternative Asset Financing Policies

Restricitve Policy = aggressive

Restrictive Policy uses long-term financing for permanent asset

requirements only and short-term borrowing for seasonal variations.


23/99

A Compromise Financing Policy

With a compromise policy, the firm keeps a reserve of liquidity

which it uses to initially finance seasonal variations in current

asset needs. Short-term borrowing is used when the reserve is

exhausted.


24/99

Which Financing Policy is Best?

Cash Reserves+ Low chance of Financial Distress

+ Less Time in searching ST financing

- Do not earn any interest

Maturity Hedging+ Use LT financing for LT assets and ST financing for ST assets

- ST interest rates are more volatile: so avoid using STfinancing for LT assets

Relative Interest Rates If LT interest rates are lower, finance core part of ST needs

from LT funds

If ST interest rates are lower, better to use ST financing


25/99

Maturity Matching Approach

Hedge risk by matching the maturities of

assets and liabilities.

Permanent current assets are financed with

long-term financing, while temporary current

assets are financed with short-term financing.

There are no excess funds.


26/99

Maturity Matching Approach


27/99

Review Questions

Comment on the following

Most businesses need cash funds to meet

contingencies.

Playing with float is a risky proposition.

Failure of a firm is technical if it is unable to meet

its current obligations.


28/99

Inventory Management

Two basic questions in inventory management

are (1) how much to order (or produce), and

(2) when to order (or produce).


29/99

29

ABC Analysis

Class A items are those on which the annual dollar volume ishigh.

They represent 70-80% of total inventory costs, but theyaccount for only 15% of total inventory items.

Class B items are those on which annual dollar volume ismedium.

They represent 15-25% of total dollar value, and they accountfor 30% of total inventory items on the average.

Class C items are low dollar volume items.

They represent only the 5% of total dollar volume, but theyinclude as many as 50-60% of total inventory items.


30/99

30

ABC Analysis

Percent

of

Annual

Dollar

Volume

Percent ofInventory Items

80

Class

A

Items

20

20

50 100

Class

C Items


31/99

31

ABC Analysis

Some of the Inventory Management Policies

that may be based on ABC analysis include:

a) Class A items should have tighter inventory

control.

b) Class A items may be stored in a more secure

area.c) Forecasting Class A items may warrant more care.


32/99

32

Just-in-Time Inventory

Just in Time Inventory is the minimum inventory that isnecessary to keep a system perfectly running.

With just in time (JIT) inventory, The exact amount of itemsarrive at the moment they are needed, Not a minute beforeOR not a minute after.

To achieve JIT inventory, Managers should Reduce theVariabilityCaused by some Internal and External Factors. (Goldratts boys scout example Apply the pace of the slowest

boy).

A production line cannot work faster than the slowest

workstation Existence of Inventory hides the variability.

What causes variability?


33/99

33

Rocks located along the way

Others Waiting

Time

Move

Time

Queue

Time

Set-up

Time

Run

Time

Input Output

Lead Time

Cycle Time

The section called Others are the Rocks on the river.

Those rocks include Quality Variability, In-transit Delays, Machine Breakdowns,

Large Lot-sizes, Inaccurate drawings, Employee attendance variability.


34/99

34

Just-In-Time Production

JIT production means

(1) Elimination of Waste,

(2) Synchronized Manufacturing, and

(3) Little Inventory.

Reducing the order batch size can be a major help in reducing

inventory.

Average Inventory = (Maximum Inventory + Minimum

Inventory) / 2

Average Inventory drops as the inventory re-order quantity

drops because the maximum inventory level drops.


35/99

35

Inventory Related Costs:

Holding, Ordering and Set-up Costs

Holding Costs are the costs associated with holding or

carrying inventory over time.

It includes costs related to storage; such as insurance, extra

staffing, interest, and so on.

Some example holding costs are:

building rent or depreciation,

building operating cost,

taxes on building, insurance on building,

material handling equipment leasing or depreciation,

equipment operating cost, handling manpower cost,

taxes on inventory, insurance, etc.


36/99

36

Inventory Related Costs:

Ordering and Set-up Costs

Ordering Costs include, cost of supplies, order processing,clerical cost, etc.

The ordering cost is valid if the products are purchased NOTproduced internally.

Set-up costis the cost to prepare a machine formanufacturing an order.

Set-up cost is highly correlated with set-up time.

Machines that traditionally have taken long hours to set up AreNow being set up in less than a minute by employing FMSs or

CIM systems. Reducing set up times is an excellent way to Reduce Inventory.


37/99

37

Inventory Models

Demand for an item is either dependent on the demand for

other items or it is independent.

For example, demand for refrigerator is independent of the

demand for cars.

But, demand for auto tires is certainly dependent on the

demand of cars.

We will deal with the Independent Demand Situation.

In the dependent demand situation we use Material

Requirement Planning (MRP) systems.


38/99

38

What to answer?

In the independent demand situation, we

should be interested in answering:

a) When to place an order for an item, and

b) How much of an item to order.


39/99

39

Independent Demand Inventory Models

There are Four Basic Independent Demand

Inventory Models:1) Economic Order Quantity (EOP) Model (the most

known model).2) Production Order Quantity Model.

3) Back order inventory model.

4) Quantity discount model.


40/99

40

Economic Order Quantity (EOQ) Model

EOQ model makes a number of assumptions:

1-) Demand is known and constant.

2-) Lead time (the time between placement of order and receipt ofthe order) is constant and known.

3-) Orders arrive in one batch at a time, and they arrive in onepoint in time.

4-) Quantity discounts are not possible.

5-) The costs include only setup cost (or ordering cost whenbuying) and holding cost.

6-) Orders are always placed at the right times. Therefore, stockouts (or shortages) can be completely avoided.


41/99

41

With these assumptions in EOQ Model, the graphic of

inventory usage over time is as follows:

Inventory

Level

Time

Q

Average

Inventory

Level

Usage

Rate

0

Q = order quantity

(That is also equal to the

Maximum Inventory)

Minimum Inventory = 0

When inventory level reaches 0, a new order is

placed and received.


42/99

42

Objective: Minimize total cost

The objective of inventory models is to

minimize total cost.

If we minimize the setup and holding costs,

we will be able to minimize total cost.

As the quantity ordered (Q) increases, holding

cost increases, and setup cost decreases.


43/99

43

Where the total cost is minimum?

Annual

Cost

Order Quantity

(Q)

Annual

Holding

Cost

Setup Cost

(Ordering

Cost)

Total

Cost

MinimumTotal

Cost

Optimal Order

Quantity (Q*)

Optimal order quantity (Q*) occurs at a point where setup cost is

equalto the total (annual) holding cost.


44/99

44

Finding the optimum

Optimal order quantity (Q*) occurs at a point where setup cost isequalto the total (annual) holding cost.

By using this fact, we can write an equation for Q* as follows:

D: Annual Demand in units for the inventory item.

S: Setup cost (or the ordering cost) for each order.Notice: (Setup cost for production, order cost for buying).

H: Annual Holding cost of inventory per unit.


45/99

45

Finding the optimum

There will be (D/Q) times of ordering in a

whole year.

Therefore, Annual Setup Cost = (D/Q) . S

Average Annual Holding Cost =(Average Inventory) . H

= (Q/2) . H


46/99

46

Finding the optimum

We get optimum point by setting:

Annual Setup Cost = Annual Holding Cost

(D/Q) . S = (Q/2) . H

Therefore,

Q2 = 2DS / H

Q* = [2DS / H]1/2

Q* value is also called as the EOQ.


47/99

47

Example

An Inventory model has the followingcharacteristics:

Annual Demand (D) = 1000 unitsOrdering (Setup) cost (S)= $10 per order;

Holding cost per unit per year (H) = $.50

Assume that there are 270 working days in a year(excluding holidays and weekends).


48/99

48

Example

Questions:

a) Find the Economic Order Quantity (Q*) for this

inventory model.

b) How many orders should be placed during oneyear?

c) What is the expected time between two

consecutive orders?d) What is the total annual cost of this inventory

model?


49/99

49

Example

Answers:

a) EOQ= Q* = [2(1000)10 / .50]1/2 = 200 units

b) Expected number of orders placed during the year (N) = D /

Q* = 1000 / 200 = 5 times.

c) Expected time between orders (T) = (Working days in a year) /

N = 270 / 5 = 54 days.

d) Total Annual Cost = Annual Setup Cost + Annual Holding Cost

= DS / Q* + (Q*) H / 2

= 1000 (10) / 200 + (200) (.50) / 2

= $100


50/99

50

Considering the Reorder Point

So far, we only decided how much to order(That is Q*).

Now, we should find what time to order.

We assumed that firm will wait until itsinventory reaches to zero before placing anorder.

And, we also assumed that the Orders will

receive immediately. However, there is a time between placement

and receipt of an order.


51/99

51

Considering the Reorder Point

This is called LEAD TIME or delivery time.

Here, we will use the term Reorder Point

(ROP) for when to order.

ROP (in units) = (Demand Per Day) x (Lead

time for a new order in days)

ROP = d x L


52/99

52

Reorder Point

Inventory

Time

(Days)

Q* Slope = d (units/day)

ROP(units)

L = Lead Time

ROP = d . L

When the inventory level reaches the ROP, a new order is required.

It will take a time that is equal to the Lead Time (L) to receive the

new order.


53/99

53

Reorder Point

Here, Demand per day (d) is found by thefollowing equation:

d = D / Number of working days in a year

This ROP equation assumes that demand isuniform and constant.

If this is not the case, an extra (safety) stock isadded (because of uncertainty).


54/99

54

Example

Annual demand for an item is D = 8000/year.

This year there will be 200 working days in a

year.

Delivery of an order for this item takes 3working days (L = 3 days).


55/99

55

Example

Questions:

a) Find the demand per day for this item.

b) What is the ROP for this item?


56/99

56

Example

Answers:

a) Demand per day for this item (d) = 8000 / 200 =

40 units / day.

b) ROP = d . L = 40 . 3 = 120 units.

When inventory level becomes 120 units, an Order

should be placed.


57/99

57

Production Order Quantity Model

In EOQ Model, We assumed that the entire

order was received at one time.

However, Some Business Firms may receive

their orders over a period of time.

Such cases require a different inventory

model.

Here, we take into account the daily

production rate and daily demand rate.


58/99

58

Production Order Quantity Model..

Inventory

Time

Maximum

Inventory

t

Production

occurs at a

rate of p Demand

occursat a rate

of d


59/99

59


Since this model is especially suitable forproduction environments, It is called ProductionOrder Quantity Model.

Here, we use the same approach as we used in EOQ

model.Lets define the following:

p: Daily Production rate (units / day)

d: Daily demand rate (units / day)

t: Length of the production in days.

H: Annual holding cost per unit


60/99


61/99

61


If we replace the values of t in the Max.

Inventory formula:

Max. Inventory = p (Q/p) - d (Q/p)

= Q - dQ/p

= Q (1 d/p)

Annual Holding Cost = (Max. Inventory / 2) . H

= Q/2 (1 d/p) . H

Annual Setup Cost = (D/Q) . S


62/99

62


Now we will set:

Annual Holding Cost = Annual Setup Cost

Q/2 (1 d/p) . H = (D/Q) . S

p

dH

DSQ

1

22

p

dH

DSQ

1

2*

This formula gives us the optimum production quantity for the

Production Order Quantity Model.

It is used when inventory is consumed as it is produced.


63/99

Banking

Norms and

Macro Aspect

of WorkingCapital

Management


64/99

Regulation of bank finance

Implemented by RBI in mid 1960s in order to

Measure of discipline among industrial borrowers.

Redirect credit to the priority sector of the economy

RBI has been issuing guidelines and directivesto the banking sector toward this end.


65/99

Committees

To control the tendency of over-financing and the

diversion of the banks funds.

Tandon committee. Daheija committee.

Chore committee.

Marathe committee.


66/99

Tandon committee

Reserve Bank of India setup a committee under thechairmanship of Shri P.L. Tandon in July 1974.

The practices of most of the banks are still influenced bytandon committee recommendations though financialliberalization occurred in 1990s.


67/99

67

Backorder Inventory Model

In this model, we assume that stock outs (and backordering) areallowed.

In addition to previous assumptions, we assume that sales will

not be lost due to a stock out.

Because, we will back order any demand that can not befulfilled.

B: Backordering cost per unit per year

b: The amount backordered at the time the next order arrives

Q b: Remaining units after the backorder is satisfied


68/99

68


Inventory

Time

(Q - b)

b

T1 T2

b

Q

0


69/99

69


Total Annual Cost = Annual Setup Cost + Annual Holding Cost +Annual Backordering Cost

Annual Setup (Ordering) Cost = (D/Q) . S

Annual Holding Cost = (Average Inventory Level) . H

Average Average inventory Proportion of time

Inventory = level during there is inventory

Level in stock period in stock

= (Q b) / 2 . T1 / T


70/99

70


By using the graphical ratios, we know that:T1 / T = (Q b) / Q

Therefore, if we replace T1/T in the above equation

we getAverage Inventory Level = (Q b)2 / 2Q

(Q b)2

Annual Holding Cost = ---------- . H

2Q


71/99

71


Annual Backordering Cost = (Average Backordering) . B

Average Backordering = (Average number of stock outs during out of stockperiod) x (Proportion of time inventory is on backorder)

Average Backordering = b / 2 . T2 / T

By using the graphical ratios, we know that:

T2 / T = b / Q Therefore, if we replace T2/T in the above equation we get:

Average Backordering = b2 / 2Q and

b2

Annual Backordering Cost = ---------- . B

2Q


72/99

72


DS (Q b)2 b2Total Cost (TC) = ------- + ---------- . H + --------- . B

Q 2Q 2Q

We find optimum order quantity (Q*) and optimum

backordering quantity (b*) by taking the derivatives ofdTC/dQ = 0 and dTC / db = 0 and then putting the valuesin their places.

We find that:

B

BH

H

DSQ

2*

HB

HQb

*

*


73/99

73

Quantity Discount Model

A quantity discount is simply a reduced price (P) for an item whenit is purchased in LARGER quantities.

A typical quantity discount schedule is as follows:

Alternative Quantity Discount (%) Discount (unit) Price1 0-999 0 $5.002 1000-1999 4 $4.803 2000- 5 $4.75


74/99

74


Since the unit cost for the Third discount is thelowest, We might be tempted to order 2000 ormore units.

However, this quantity might not be the onethat minimizes the Total Cost.

Remember that, As the quantity goes up, theholding cost increases.

Here, there is a trade off between reducedproduct price (P) and increased holding cost(H).


75/99

75


Total Cost = Setup Cost + Holding Cost + Product Price (Cost)

Total Cost = DS / Q + QH / 2 + PD

where P is the price per unit

To determine the minimum Total Cost, we perform the following

process which includes 4 steps:

Step 1: Assume that

I: is a percentage value, and

I . P represents the holding cost as a percentage of price per unit(P).


76/99

76


For each discount alternative, calculate avalue of Q* = [2DS / IP]1/2

Here, instead of using a value of H, the holding

cost is equal to I . P That is, If the item is expensive (such as a Class

A Item), Its holding cost will be higher.

Since the price of item (P) is a factor in AnnualHolding Cost, we can no longer assume thatthe holding cost is constant (such as H) whenprice changes.


77/99

77


Step 2: For any discount alternative,

If the calculated optimum order quantity (Q*) is too low to

qualify for the discount range,

Then, Adjust the order quantity upward to the lowest quantity

that will qualify for the particular discount alternative.

Step 3: Using the total cost (TC) equation above, compute a

total cost for every order quantity (Q). Use the adjusted Q

values.

Step 4: Select the discount alternative which has theminimum Total Cost (TC).


78/99

78

Example

Consider the quantity discount schedule givenin the beginning (above).

Assume that the Ordering (Setup) Cost (S) is

$49 per each order.

Annual Demand (D) is 5000 units, and

Inventory carrying charge is a percentage

(I=0.20) of product cost (P).

Question: What order quantity will minimize

the total inventory cost.

l


79/99

79

Example

Answer:

Step 1: Compute Q* for every discount range.

orderunitsIPDSQ /700

)5)(2(.)49)(5000(22*1

orderunitsIP

DSQ /714

)8.4)(2(.

)49)(5000(22*2

orderunitsIP

DSQ /718

)75.4)(2(.

)49)(5000(22*3

l


80/99

80

Example

Step 2: Adjust values of Q* that are below allowable discountranges.

- For Q1, allowable range is 0-999. Since Q1* = 700 is between 0

and 999, It does not have to be adjusted.

- For Q2, allowable range is 1000-1999. Since Q2* = 714 is not inthe allowed range, we adjust it to the lowest allowable value,

That is Q2* = 1000.

- For Q3, allowable range is 2000-. Since Q3* = 718 is not in the

allowed range, we adjust it to the lowest allowable value, Thatis Q3* = 2000.

l


81/99

81

Example

Step 3: Compute total cost for each of theorder quantities (Q*):

5000 x Unit price$49 x (5000 / 700) (Average Inventory x Holding Cost) =

(Q / 2) x (I x P) =

(700 / 2) x (5 x 0,20)

E l


82/99

82

Example

Step 4: An Order quantity of 1000 units willminimize the total cost.

However, if the third discount cost is lowered to

$4.65, selecting this discount alternative (2000

units) would be the optimum solution.

Tandon committee


83/99

The terms of reference of the Committee were:

1. To suggest guidelines for commercial banksto follow upand supervise credit from the point of view of ensuringproper end use of funds and keeping a watch on the safetyof advances;

2. To suggest the type of operational dataand otherInformation that may be obtained by banks periodically from theborrowers and by the Reserve Bank of India from the leading banks;

3. To make suggestions for prescribing inventory normsfor

the different industries, both in the private and public sectors andindicate the broad criteria for deviating from these norms ;

Tandon committee


84/99

Tandon committee

4. To make recommendations regarding resources forfinancingthe minimum working capital requirements ;

5. To suggest criteria regarding satisfactory capital

structure and sound financial basisin relation toborrowings ;

6. To make recommendations as to whether the existingpattern of financingworking capital requirements by cash

credit/overdraft system etc., requires to be modified, ifso, to suggest suitable modifications

Tandon committee


85/99

Tandon committee

Recommendations

Norms of current asset.

Maximum permissible bank finance.

Emphasis on loan systems.

Periodic information and reporting system.

Tandon committee


86/99

Tandon committee

Norms for current assets.

They defined the norms(15 industries) for

Raw materials

Stock in progress

Finished goods

Receivables

Tandon committee


87/99

Tandon committee

Maximum permissible bank finance (MPBF)

Three methods for determining MPBF

Method 1: MPBF=0.75(CA-CL)

Method 2: MPBF=0.75(CA)-CL

Method 3: MPBF=0.75(CA-CCA)-CL

CA- current asset, CL- current liabilities,

CCA- core current assets (permanent component ofworking capital).

Tandon committee


88/99

Current Assets Rs.(in millions)

Raw material 18Work in process 5Finished goods 10Receivables(including billsDiscounted) 15Other current assets 2

50

Current Liabilities

Trade Creditors - 12Other current liabilities - 3Bank borrowings (including Bills discounted)- 25

40

MPBF for Mercury Company Limited as per above methods are:

Method 1: 075(CA-CL) = 075(50-15) = Rs.26.25 millionMethod 2: 0.75(CA)-CL = 0.75(50)-15 = Rs.22.5 millionMethod 3: 0.75(CA-CCA)-CL = 0.75(50-20)-15 = Rs.7.5 million

Method 2 is adopted.

Tandon committee


89/99

Tandon committee

Style of credit

Only a portion of MPBF must be cash credit componentand the balance must be in the form of working capitaldemand loan.

Information system:.

quarterly information system-form I

Estimate production and sale for current and ensuring quarter.

The estimate of current asset and liabilities for the ensuing

quarter.

Q t l i f ti t f II


90/99

Quarterly information system-form II

Production and sales during current year and for thelatest completed year.

Asset and liabilities for the latest completed year.

Half yearly operating statements- form III

Actual and estimated operating performance for thehalf year ended.

Half yearly operating statements- form IIIB

Actual and estimated sources and uses of funds for

the half year ended.

Chore Committee(1979)


91/99

Chore Committee(1979)

This committee was formed by RBI to review the cash creditsystem of banks.

The important recommendations of the Committee are asfollows:

1. The banks should obtain quarterly statements in theprescribed formatfrom all borrowers having working capitalcredit limits of Rs. 50 lacs and above.

2. The banks should undertake a periodical reviewof limits ofRs. 10 lacs and above.

Chore Committee


92/99

Chore Committee

3. The banks should not bifurcate cash credit accountsintodemand loan and cash credit components.

5. Banks should discourage sanction of temporary limits bychargingadditional one per cent interest over the normal rate

on these limits.

6. The banks should fix separate credit limitsfor peak level andnon-peak level, wherever possible.

7. Banks should take steps to convert cash credit limits into billlimits for financing sales.

Marathe committee


93/99

Marathe committee

A committee set up to review the licensing policy for new urban co-operative banks. Headed by S. S. Marathe of the Reserve Bank ofIndia (RBI) Board, the committees prescriptions submitted in May1992, favour a liberal entry policy and include :

Establishment of new urban co-operative banks on the basis of needand potential, and achievementof revised viability norms. The one-bank-per-district approach is to be discarded.

Achieving prescribed viability norms in terms of share capital, initialmembershipand other parameters within a specified time.

Introduction of a monitoring system to generate early warningsignals and for the timely detection of sickness.

Dahejia committee(1968)


94/99

j ( )

Existing deficiencies.

It is the borrower who decides how much would borrow, thebanker does not decide how much he would lend and is,

therefore not in a position to do credit sales.

The bank credit is treated is considered as first source offinance.

Amount of credit extended is based on the amount of securitiesavailable and not the level of operations of the borrower.

Present practice


95/99

Assessment of working capital requirement.

Projected balance sheet method.

Cash budget method

Turnover method

Current ratio norm.

1.33 is considered only as benchmark and banks do

accept a lower currentratio.

Present practice


96/99

Present practice

Emphasis on loan system Bulk of the working capital limit is in the form of working

capital demand loan and only a small portion in cashcredit component.

Financial follow up results

FFR I- simplified form of form II used under tandon. Hasto be submitted on quarterly basis.

FFR II- simplified form of form III. Has to be submitted inhalf yearly basis.

Cash Budgeting


97/99

Cash Budgeting A cash budget is a primary tool of short-tun

financial planning. The idea is simple: Record the estimates of

cash receipts and disbursements.

Cash Receipts Arise from sales, but we need to estimate when

we actually collect.

Cash Outflow

Payments of Accounts Payable Wages, Taxes, and other Expenses

Capital Expenditures

Long-Term Financial Planning

Cash Budgeting


98/99

Cash Budgeting

The cash balance tells the manager whatborrowing is required or what lending will bepossible in the short run.

The Short-Term Financial Plan


99/99

The Short-Term Financial Plan

The most common way to finance a temporarycash deficit to arrange a short-term loan. Unsecured Loans

Line of credit down at the bank

Secured Loans Accounts receivable financing can e either assignedor

factored.

Inventory loans use inventory as collateral.

Other Sources Bankers acceptances Commercial paper.

Working Capital Management and Control

Documents

Transcript of Working Capital Management and Control