2. WORKING CAPITAL MANAGEMENT PREPARED BY: HASSAN NOOR
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3. SCHEME OF PRESENTATION Working CapitalConcepts Working
capital Significance of working capital management Kinds of working
capital Working Capital Issues 3/29/2015 3
4. WORKING CAPITAL CONCEPTS NetWorking Capital: Net working
capital refers to the difference between current assets and current
liabilities.Current liabilities are those claims of outsider, which
are expected to mature For payment within an accounting year &
include creditors, bills payable & the outstanding expenses. In
other words you can say that this is the excess of current assets
over current liabilities. Current Assets Current Liabilities Gross
Working Capital: It refers to the firms investment in current
assets. Current assets are the assets, which can be converted into
cash within an accounting year or within an operating cycle
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5. CONT.. Cash, short-term securities, debtors (accounts
receivable & book debts), bills receivable and stock. Working
capital turnover: Working capital turnover= sales/working capital
Working Capital Management: The administration of the firms current
assets and the financing needed to support current assets.
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6. 3/29/2015 6
7. WORKING CAPITAL MANAGEMENT DEFINITION: Working capital
management involves the relationship between a firm's short-term
assets and its short-term liabilities. The basic goal of working
capital management is to ensure that a firm is able to continue its
operations and that it has sufficient ability to satisfy both
maturing short-term debt and upcoming operational expenses.
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8. 3/29/2015 8
9. SINGNIFICANCE OF WORKING CAPITAL MANAGEMENT In a typical
manufacturing firm, current assets exceed one-half of total assets.
Excessive levels can result in a substandard Return on Investment
(ROI). Current liabilities are the principal source of external
financing for small firms. Requires continuous, day-to-day
managerial supervision. Working capital management affects the
companys risk, return, and share price. 3/29/2015 9
10. CURRENT ASSETS Inventories: Inventories represent raw
materials and components, work-in-progress and finished goods.
Trade Debtors: Trade Debtors comprise credit sales to customers.
Prepaid Expenses: These are those expenses, which have been paid
for goods and services whose benefits have yet to be received.
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11. CONT.. Loan and Advances: They represent loans and advances
given by the firm to other firms for a short period of time.
Investment: These assets comprise short-term surplus funds invested
in government securities, shares and short-terms bonds. Cash and
Bank Balance: These assets represent cash in hand and at bank,
which are used for meeting operational requirements. One thing you
can see here is that this current asset is purely liquid but
non-productive. 3/29/2015 11
12. CURRENT LIABILITY Sundry Creditors: These liabilities stem
out of purchase of raw materials on credit terms usually for a
period of one to two months. Bank Overdrafts: These include
withdrawals in excess of credit balance standing in the firms
current accounts with banks Short-term Loans: Short-terms
borrowings by the firm from banks and others form part of current
liabilities as short-term loans. Provisions: These include
provisions for taxation, proposed dividends and contingencies.
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13. WORKING CAPITAL FORMAT CURRENT ASSETS Cash Accounts
receivable Notes receivable Marketable securities Inventory Prepaid
expenses Total current assets CURRENT LIABILITIES Accounts payable
Notes payable Accrued expenses Taxes payable Total current
liabilities 3/29/2015 13
14. KINDS OF WORKING CAPITAL 1. Permanent working capital:
Permanent working capital is the minimum amount of current assets,
which is needed to conduct a business even during the dullest
season of the year. The minimum level of current assets is called
permanent or fixed working capital as this part is permanently
blocked in current assets. Characteristics of Permanent working
capital It is classified on the basis of the time period It
constantly changes from one asset to another and continues to
remain in the business process. Its size increase with the growth
of business operations. 3/29/2015 14
15. PERMANENT CURRENT ASSETS Permanent Current Assets represent
the base level of inventory cash and accounts receivable , which
tends to be maintained. 3/29/2015 15
16. KINDS OF WORKING CAPITAL 2.Temporary working capital:
Temporary working capital represents a certain amount of
fluctuations in the total current assets during a short period.
Variable working capital is the amount of additional current asset
that are required to meet the seasonal needs of a firm, so is also
called as the seasonal working capital. Characteristics ofTemporary
working capital It is not always gainfully employed, though it may
change from one asset to another asset, as permanent working
capital does. It is particularly suited to business of a seasonal
or cyclical nature. 3/29/2015 16
17. TEMPORARY CURRENT ASSETS Temporary Current Assets represent
the level of inventory, cash, and account receivable that fluctuate
seasonally. 3/29/2015 17
18. WORKING CAPITAL ISSUES Assumptions 50,000 maximum units of
production Continuous production Three different policies current
asset levels are possible 3/29/2015 18
19. IMPACT ON LIQUIDITY Liquidity Analysis Policy Liquidity A
High B Average C Low Greater current asset levels generate more
liquidity; all other factors held constant. 3/29/2015 19
20. IMPACT ON EXPECTED PROFITABILITY Return on Investment = Net
profit/TotalAssets Let, CurrentAssets = (Cash+Rec.+Inv.) Return on
Investment =(Net Profit/Current +FixedAssets) 3/29/2015 20
21. IMPACT ON EXPECTED PROFITABILITY Profitability Analysis
Policy Profitability A Low B Average C High As current asset levels
decline, total assets will decline and the ROI will rise. 3/29/2015
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22. IMPACT ON RISK Decreasing Cash reduces the firms ability to
meet its financial obligations. More risk! Stricter credit policies
reduce receivables and possibly lose sales and customers. More
risk! Lower inventory levels increase stock outs and lost sales.
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23. IMPACT ON RISK RISK ANALYSIS Policy Risk A Low B Average C
High Risk increases as the level of current assets are reduced.
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24. SUMMARY OFTHE OPTIMAL AMOUNT OF CURRENT ASSETS SUMMARYOF
OPTIMAL CURRENTASSETANALYSIS Policy Liquidity Profitability Risk A
High Low Low B Average Average Average C Low High High 1.
Profitability varies inversely with liquidity. 2. Profitability
moves together with risk. (risk and return go hand in hand!)
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25. WORKING CAPITAL FANANCING APPROACHES There are basically
three different working capital financing approaches, which
different companies adopt to finance there assets.These approaches
are: 3/29/2015 25 WORKING CAPITAL FANANCING APPROACHES Aggressive
Approach Conservative Approach Moderate Approach
26. AGGRESSIVE APPROACH Short-Term Financing Benefits:
Financing long-term needs with a lower interest cost than short-
term debt Borrowing only what is necessary Short-Term Financing
Risks: Refinancing short-term obligations in the future Uncertain
future interest costs Result: Manager accepts greater expected
profits in exchange for taking greater risk. 3/29/2015 26
27. AGGRESSIVE APPROACH Temporary Current Asset LongTerm
Liability & Equity Current Liability Fixed Asset Permanent
Current Asset NetWorking Capital Assets Liabilities & Equity
WorkingCapital 3/29/2015 27
28. RISKSVS. COSTSTRADE-OFF (AGGRESSIVE APPROACH) Firm
increases risks associated with short-term borrowing by using a
larger proportion of short-term financing. 3/29/2015 28
29. (CONSERVATIVE APPROACH) Long-term Financing Benefits: Less
worry in refinancing short-term obligations Less uncertainty
regarding future interest costs Short-term Financing Risks:
Borrowing more than what is necessary Borrowing at a higher overall
cost(usually) Result: Manager accepts less expected profits in
exchange for taking less risk. 3/29/2015 29
30. CONSERVATIVE APPROACH Temporary Current Asset LongTerm
Liability & Equity Current Liability Fixed Asset Permanent
Current Asset NetWorking Capital Assets WorkingCapital Liabilities
& Equity 3/29/2015 30
31. RISKSVS. COSTSTRADE-OFF (CONSERVATIVE APPROACH) Firm can
reduce risks associated with short-term borrowing by using a larger
proportion of long-term financing. 3/29/2015 31
32. THE MODERATE APPROACH Fixed assets and the non-seasonal
portion of current assets are financed with long-term debt and
equity(long-term profitability of assets to cover the long-term
financing costs of the firm). Seasonal needs are financed with
short-term loans (under normal operations sufficient cash flow is
expected to cover the short-term financing cost). Also known as
Matching PrincipleApproach. 3/29/2015 32
33. THE MODERATE APPROACH Temporary Current Asset LongTerm
Liability & Equity Current Liability Fixed Asset Permanent
Current Asset NetWorking Capital Assets WorkingCapital Liabilities
& Equity 3/29/2015 33
34. MODERATE ( OR MATCHING PRINCIPLE) APPROACH A method of
financing where each asset would be offset with a financing
instrument of the same approximate maturity.. 3/29/2015 34
35. SELF-LIQUIDATING NATURE OF SHORT-TERM LOANS Seasonal orders
require the purchase of inventory beyond current levels. Increased
inventory is used to meet the increased demand for the final
product. Sales become receivables. Receivables are collected and
become cash. The resulting cash funds can be used to pay off the
seasonal short- term loan and cover associated long-term financing
costs. 3/29/2015 35
36. COMBINING LIABILITY STRUCTURE AND CURRENT ASSET DECISIONS
The level of current assets and the method of financing those
assets are interdependent. A conservative policy of high levels of
current assets allows a more aggressive method of financing current
assets. A conservative method of financing (all-equity) allows an
aggressive policy of low levels of current assets. 3/29/2015
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37. ANY QUESTION??? WE ENCOURAGEYOUTO ASK 3/29/2015 37