Working Capital Management
Working Capital Management
Working Capital Management
Introduction
A business venture requires two types of funds, i.e. long term
daily basis.
Working capital is mainly concerned with current assets and
current liabilities:
Current assets include cash, marketable securities, sundry debtors
assets.
Net working capital is defined as current assets minus current
liabilities.
There is need to finance every aspect of operations therefore we
the cash from sales has not come and therefore we require
working capital.
Working capital of a firm has direct bearing on profitability and
cycle.
We can write
GOC =
ICP =
Therefore
GOC =
(GOC):
Gross Operating Cycle
Inventory Conversion period
Debtors conversion period
Raw material conversion period
Work in progress conversion period
Finished goods conversion period
ICP + DCP
RMCP + WIPCP + FGCP
RMCP + WIPCP + FGCP + DCP
period
NOC = GOC CDP
finance.
Temporary or variable working capital also consists of current
assets
Temporary working capital can be financed from sources which
determined carefully.
Excessive
will require larger working capital to sustain supplies while revenues will take time to
flow in.
Availing Credit from Suppliers: Suppliers credit reduces the cash conversion cycle
its operations is obvious. However, what is not obvious is that the working capital
increase is required much before the actual growth takes place.
Inflation: On the whole it has been observed that the requirement of working capital
turn depends upon the demand for the product. Many firms experience cyclic and seasonal
demand for their products and services. These variations affect the temporary working
capital.
When demand goes up due to better general economic conditions, sales will increase and
for newer and better technologies which would shorten the manufacturing cycle and hence
working capital requirement.
Operating Efficiency: Good operating efficiency will reduce the requirement of
working capital.
Lean Manufacturing: There is a Japanese word muda which means waste and lean is
antidote to muda.
With implementation of lean concept the manufacturing cycle time shortens,
transportation costs are reduced and required inventory levels go down. All these result in
would manage with minimum level of current assets at all production levels.
approach.
period.
If the current assets are too high it implies that the firm is holding
of high liquidity and the cost of holding too little current assets as
the cost of low liquidity and plot these against the increasing
levels of current assets the curves are as shown in figure given
below
main methods.
1.
The relevant factors are the holding periods of the various types of
inventories, debtors collection period, creditors payment period,
budgeted yearly production/sales, cost of goods produced, cost of
sales, average time-lag in payment of wages and other overheads,
minimum cash balances and so on.
Average inventory
holding period
(months/days)
12 months/365 days
Work-in-Process (WIP) Inventory The relevant costs to determine work-in-process
inventory are the proportionate share of cost of raw materials and conversion costs
(labor and manufacturing overhead costs).
In case, full unit of raw material is required in the beginning, the unit cost of WIP
would be higher, that is, cost of full unit + 50 per cent of conversion cost, compared to
the raw material requirement throughout the production cycle; WIP is normally
equivalent to 50 per cent of total cost of production. Symbolically,
Budgeted production
(in units)
Finished goods
holding period
(months/days)
12 months/365 days
Debtors
12 months/365 days
Average debt
collection period
(months/days)
The important current liabilities (CL) are, trade-creditors, wages and overheads:
Trade Creditors
Budgeted yearly
production
(in units)
Raw material
cost
per unit
Credit period
allowed by creditors
(months/days)
12 months/365 days
Direct labor
cost per unit
12 months/365 days
Average time-lag in
payment of wages
(months/days)
The average credit period for the payment of wages approximates to a half-amonth in the case of monthly wage payment.
Overheads (Other Than Depreciation and Amortization)
Budgeted yearly
production
(in units)
Overhead cost
per unit
Average time-lag in
payment of overheads
(months/days)
12 months/365 days
Amount
Rs per unit
Raw Material
200
Manufacturing expenses
50
40
Selling Price
350
given below:
Stage
Raw material
1.5
1.0
Finished goods
0.5
Debtors
1.0
Amount (Rs)
Amount (Rs)
9,00,000
WIP:
Raw material (3,000 * 200)
6,00,000
Manufacturing expense @
30% of (3,000 * 50)
45,000
6,45,000
Finished goods:
Raw material (3,000 * 0.5 * 200)
3,00,000
75,000
3,75,000
8,70,000
Total
27,90,000
3,10,000
31,00,000
While preparing a project report on behalf of a client you have collected the following facts.
Estimate the net working capital required for that project. Add 10 per cent to your computed
figure to allow contingencies:
Particulars
Raw material
Direct labor
Overheads (exclusive of depreciation, Rs 10 per unit)
Total cash cost
Rs 80
30
60
170
Additional information:
Selling price, Rs 200 per unit
Level of activity, 1,04,000 units of production per annum
Raw materials in stock, average 4 weeks
Work in progress (assume 50 per cent completion stage in respect of conversion
costs and 100 per cent completion in respect of materials), average 2 weeks
Finished goods in stock, average 4 weeks
Solution
Net working capital estimate of a project
(A) Current assets:
(i) Raw materials in stock, (1,04,000 Rs 80 4/52)
(ii) Work-in-progress
(a) Raw material (1,04,000 Rs 80 2/52)
(b) Direct Labor (1,04,000 Rs 15 2/52)
(c) Overheads (1,04,000 Rs 30 2/52)
(iii) Finished goods stock: (1,04,000 Rs 170 4/52)
(iv) Debtors: (1,04,000 Rs 170 8/52)
(v) Cash at bank
Total investment in current assets
(B) Current liabilities:
(i) Creditors, average 4 weeks: (1,04,000 Rs 80 4/52)
(ii) Lag in payment of wages (1,04,000 Rs 30 1.5/52)
Total current liabilities
Net working capital: Current assets Current liabilities
Add: 10 per cent contingencies
Net working capital required
(C)
Rs 6,40,000
3,20,000
60,000
1,20,000
13,60,000
27,20,000
25,000
52,45,000
6,40,000
90,000
7,30,000
45,15,000
4,51,500
49,66,500
Note:
A full unit of raw material is required at the beginning of the
If the average working capital was 20 % of the annual sales, the same
ratio is taken to estimate the working capital requirement of the current
year.
adopted are:
Long-term Financing
Generally, long-term requirements are financed by long-term sources
there will be periods when we do not require funds but debt cannot
be returned since it is long-term.
Spontaneous Financing
This means, automatic generation of short-term funds during the
In order to decide the use of method for financing current assets, a firm may adopt
any of the three approaches.
short-term financing.
fluctuating requirements.
However, it is more risky to use short-term sources of finance, as
capital.
Thank You