Presented By:Rahul Dhanik(RP14068)NICMAR, Pune

IMPACT OF WORKING CAPITAL

ON FIRM’S PROFITABILITY

(A case study of Real Estate

company)

THESIS OBJECTIVE:

• To investigate the relationship among working capital and organisation profitability.

• To verify the connection among working capital management and profit of real estate firms over 10 years, 2004-14.

RELATIONSHIP:• Relationship between working capital management measures and profitability of firms.

MEANING OF WORKING CAPITAL(WC):

• Funds required for short term purposes or day to day expenses are working capital.

• Working capital typically means the firm’s holding of current or short-term assets such as cash, receivables, inventory and marketable securities.

• It is also known as revolving or short term capital or circulating capital.

WORKING CAPITAL MANAGEMENT:

• Its goal is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both short-term debt and upcoming operational expenses.

• It is the ability to control effectively and efficiently the current assets and current liabilities in a manner that provides the firm with maximum return on its assets and minimizes payments for its liabilities.

COMPONENT OF WORKING CAPITAL:The working capital cycle is made up of four core components:• Cash & Cash equivalent.• Creditors/accounts payable.• Inventory/stock in hand.• Debtors/accounts receivables.

IMPORTANCE OF WORKING CAPITAL:• If the working capital is too:

• High - Business has surplus funds which are not earning a return.• Low - May indicate that your business is facing financial difficulties.

• To Forecast the optimum working capital requirement the following formula may be used:• (Estimated cost of good sold x Operating cycle) + Desired cash balance.• Operating Cycle, O = R + W + F + D – C• Where, O = Duration of operating cycle.

R = Raw Material storage period.W= Work-in-process period.F = Finished Good Storage period.D = Debtors collection period.C = Creditors payment period.

TYPES OF WORKING CAPITAL:WORKING CAPITAL

BASIS OF

CONCEPT

BASIS OF

TIME

Gross

Working

Capital

Net

Working

Capital

Permanent

/ Fixed

WC

Temporary

/ Variable

WC

Regular

WC

Reserve

WC

Special

WC

Seasonal

WC

CONCEPT OF WORKING CAPITAL:Two possible interpretations :

- Balance sheet concept- Operating cycle concept

Balance sheet concept• There are two interpretations of working capital under the balance

sheet concept.- Excess of current assets over current liabilities (Net working capital).- Gross or total current assets.

• The definition is meaningful only as an indication of the firm’s current solvency in repaying its creditors.

• When firms speak of shortage of working capital they in fact possibly imply scarcity of cash resources

CONCEPT OF WORKING CAPITAL: (CNTD)

Operating cycle concept:• A company’s operating cycle typically consists of three primary

activities:i. Purchasing resources.

• The firm has to maintain cash balance to pay the bills as they come due

ii. Producing the product.• In addition, the company must invest in inventories to fill

customer orders promptlyiii. Distributing (selling) the product.

• And finally, the company invests in accounts receivable to extend credit to customers

• Operating cycle is equal to the length of inventory and receivable conversion periods.

OPERATING CYCLE OF A TYPICAL COMPANY:

Payable

Deferral period

Inventory

conversion

period

Cash conversion

cycle

Operating

cycle

Pay for

Resources

purchases

Receive

CashPurchase

resources

Sell

Product

On credit

Receivable

Conversion period

FORMULAE:• Inventory conversion period

Avg. inventory= ------------------

Cost of sales/365

• Receivable conversion periodAccounts receivable

= -----------------------Annual credit sales/365

• Payables deferral periodAccounts payable + Salaries, etc

= ----------------------------------------------------(Cost of sales + selling, general and admn. Expenses)/365

• Cash conversion cycle = operating cycle – payables deferral period.

ANALYSIS OF WORKING CAPITAL:

Analysis

Ratio Analysis Fund flow analysisWorking capital

budget

RATIO ANALYSIS:• It is a simple arithmetical expression of one number to another. The

technique of ratio analysis can be employed for measuring working capital position of the firm.

• The following ratio may be calculated for this process:• Current ratio• Acid test ratio.• Absolute liquid ratio.• Inventory turnover ratio.• Receivables turnover ratio.• Payables turnover ratio.• Working capital turnover ratio.• Working capital leverage.• Ratio of current liabilities to tangible net worth.

FUND FLOW ANALYSIS:

• It is a technical device designated to study the sources from which additional funds were derived and the use to which these sources were put.

• It is an effective management tool to study changes in the financial position(WC) of a business enterprise between beginning and ending financial statements.

• It consist of:I. Preparing schedules of change in working capital.II. Statement of sources and application of funds.

WORKING CAPITAL BUDGET:• Budget is a financial or quantitative expression of business

plans and policies to be pursued in the future period of time.• Working capital budget as a part of total budgeting process

of a business is prepared estimating future long term and short term WC needs and sources to finance them and then comparing the budgeted figures with the actual performance for calculating variances.

• The successful implementation of WC budget involves the preparing of separate budgets for various elements of WC such as cash inventories and receivables etc.

• The objective of a WC budget is to ensure availability of funds as and when needed and to ensure effective utilization of those resources.

REFERENCES:S.NO TITLE SOURCE

1. Working capital management Chapter 18. Working capital management

Kaiser Wilhelm II.

2. Relationship Between Working Capital

Management and Firm Profitability

Manufacturing Sector of Pakistan

Muhammad Safdar Sial

Lecturer ,Department of Management Sciences, COMSATS Institute of

Information

Technology

3. Determining working capital solvency level and

its effect on profitability in selected indian

manufacturing firms.

ICBI 2010 - University of Kelaniya, Sri Lanka

4. Working Capital Management And Profitability

– Case Of Pakistani Firms

International Review of Business Research Papers

Vol.3 No.1. March 2007, Pp.279 - 300

5. The Relationship between Working Capital

Management Efficiency and ebit

Azhagaiah Ramachandran

Muralidharan Janakiraman

6. Management of working capital. Agarwal, N. K. 1977. Management of working capital. phd diss., Delhi

School of Economics.

7. Liquidity-profitability trade off: An empirical

investigation in a emerging market.

Eljelly, A. M. A. 2004. International Journal of Commerce and

Management 14 (2)

8.

Financing of working capital in the food

processing industry in India

Gupta, S., and P. Sharma. 2003.

Business Analyst 24 (2)