Lec10. Working Capital Updated

8/13/2019 Lec10. Working Capital Updated

1/15

Work ing Cap i tal

Management


2/15

Current Assets

Inventories

Sundry Debtors

Short term Loans and

Advances given

Short term Investments Cash and Bank Balances

Raw materials andcomponents

Work in progress

Finished goods


3/15

Current Liabilities

Sundry Creditors

Trade Advances received

Short termBorrowings

Commercial Banks

Others


4/15

Working Cap i tal Concepts

Gross working capital

The firms investment in current assets

Net working capital

Current assets - current liabilities

Working capital management

The administration of the firms current assets and

the financing needed to support current assets


5/15

Sign i ficance o f Working

Cap ital Management

Current assets increase the liquidity of a firm.

Excessive levels of CA can result in asubstandard Return on Investment (ROI).

Current liabilities are the principal source ofexternal financing for small firms.

Requires continuous, day-to-day managerialsupervision.

Affects the companys risk, return, and shareprice.


6/15

Compu tat ion ofWork ing Cap i tal


7/15

Operating and Cash Cycles Illustrated

Receivables

Conversion Period

Cash

receivedInventory

sold

Inventory

period

Accounts

payable period

Cash paid

for inventory

Operating cycle

Time

Inventory

purchased

Cash cycle


8/15

The operat ing cycle

A) finding the inventory period

Annual Cost of

Goods Sold

Inventory turnover = -----------------------

Avg. inventory

365Inventory period = ---------------------------

Inventory turnover


9/15

b) Finding the accounts receivable period

Credit salesReceivables turnover = ------------------------------

Average receivables

365Receivables period = -------------------------------

Receivables turnover

Operating cycle = Inventory period + Receivables period


10/15

Cash cycle = Operating cycle - Payables period

The cash cycle

a) Finding the payables turnover

Annual Cost ofGoods Sold

Payables turnover = --------------------------

Average payables

365Payables period = ---------------------------

Payables turnover

MM


11/15

Example

Item Beginning Ending

Inventory 96 102

Accounts receivable 86 90

Accounts payable 56 60

Net Sales 800

Cost of goods sold 720


12/15


13/15

What is the length of the cash cycle?

Payables turnover= 720/(56+60)/2 =12.4137

Payables period = 365/12.4137 =29.40

Cash cycle = 90.3329.40 = 60.93 days


14/15

Trade-off between profitability and risk:the opt imal investment in cu rrent assets

Dollars

Amount ofcurrent assets (CA)

Total cost ofholding current assets

Carrying costs

Shortage costs

Minimum point

CA*The optimalamount of current assets.This point minimizes costs.


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Factors influencing Working

Capital Requirements

Nature of Business

Cash/credit sale,

Trading, manufacturing,

service Production Cycle

Time involved in

manufacture of goods

Production Policy

Seasonal, annual

Market & Supply Conditions

Competition

Predictable,

unpredictableCredit Policy

Growth and expansion

Operating Efficiency

Documents

Lec10. Working Capital Updated