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.