WORKING CAPITAL MANAGEMENT
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Transcript WORKING CAPITAL MANAGEMENT
WORKING CAPITAL
MANAGEMENT
Vanaja M.Varghese
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What is Working capital?
Liquidity available to a business
Gross working capital refers to the current
assets
Net working capital = current assets – current
liabilities
Working capital – component of the operating
capital of the business along with plant and
machinery.
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What are the components?
Current assets
Cash
Accounts receivables
Inventory
Marketable securities
Current liabilities
Accounts payable
Accrued expenses.
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Cash conversion cycle
Illustration
Inventory conversion period
= inventory/sales per day
Payables deferral period
= payables/cost of goods sold
Receivables collection period
=DSO=
receivables/sales.
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Cash conversion cycle (contd.)
Cash Conversion Cycle
= Inventory conversion period + Receivables
collection period – payables deferral period
It indicates the gap between when the firm
has spend the money to purchase the
production materials and when the firm is
able to get that money back.
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Cash conversion cycle (contd.)
The objective of a firm should be to reduce
the cash conversion cycle
Faster they recover the money- so need
lesser working capital – free cash flow
Increase the time to pay its suppliers
Collect the receivables faster
Reduce the inventory conversion period.
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Why do firms hold cash?
John Keynes
Firms hold cash for three main reasons
Speculation ( trade discounts)
Precaution ( inflows uncertainty)
Transaction ( payments)
Compensating balances - deposits that must
be maintained in the banks for the services
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Cash Budget
Projected cash inflows and outflows for a
specific period of time.
Example of a cash budget
Target cash balance can be determined with
the help of several models like the Baumol
model, Miller and Orrs model etc.
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Cash Management techniques
Cash flow synchronization
Timing the receipts of bills – in time for the
payments-maintain cash balances to the
minimum.
Using float
Float is the difference between a firm’s book
balance and the balance indicated in the banks
books
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Cash Management techniques
Float can be of two types
Disbursement float
The firm pays and thus it is deducted from the firm’s
books but not from the banks books.
Collection float
When the customer writes the cheque it is recorded
as received in the firms books but it is still
unavailable for use unless the bank clears the
cheque.
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Collection process
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Managing the float
Lock boxes
Concentration Banking
Mailed to the lock boxes
Payments made at the local sales offices, cleared
in the local banks and net amount is transferred to
the main bank
Wire transfers
This is direct transfer of funds from the account of
one entity to another entity.
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Inventory management
The twin goals of inventory management are
To ensure that inventory is available to sustain operations
To keep the ordering and holding costs to the minimum.
Decisions
Lead time
Uncertainty in demand
Cost of holding inventory
Cost of losing inventory
Projected sales and availability of raw materials
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Receivables management
Selling on credit essential to cope with the
competition.
A credit policy
Credit period ( 2/10 , net 30 )
Discounts ( discount for early payments )
Credit standards
Collection policy ( toughness/laxity)
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Receivables management
Days of sales outstanding
time the customers take to pay the bills.
Also indicates the average that the company takes to pay
their creditors.
DOS = Receivables/Sales per day
Aging schedules
It breaks down the firms receivables by the age of the
account.
It is developed from the accounts receivable ledger.
Aging schedule
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Receivables management
A firm should see to it that the DSO and the
aging schedules are working well in
comparison with the industry.
These need to be reviewed from time to time
and kept in control.
The credit policy needs to be revised.
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Accrued expenses
It includes the expenses like the wages that
needs to be paid to the workers
The taxes
Cannot be controlled by the firm
It expands with the expansion of the firms
operations.
External forces may it obligatory.
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Accounts payables
40% of the current liabilities is constituted by
accounts payables.
Trade credit
Smaller companies will have higher trade
credit.
Trade credit can be divided into two
Free trade credit
Costly trade credit
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Short term financing
Marketable securities
Working capital loans
Promissory note – amount borrowed, rate of interest , the
repayment schedule, collateral that may be required, terms
and conditions.
Line of credit – informal agreement between a bank
and borrower.
Revolving credit agreement – formal line of credit
Commercial paper
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REFERENCES
CORPORATE FINANCE by Michael&Eugene
CORPORATE FINANCE by Ross Westerfield
CORPORATE FINANCE by Meyers
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THANK YOU
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