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TOPIC YOU MAY KNOW

WHAT IS WORKING CAPITAL
TYPES OF WORKING CAPITAL FACTORS AFFECTING WORKING CAPITAL

ESTIMATION THROUGH VARIOUS

APPROACHES PROJECTION OF WORKING CAPITAL VARIOUS METHODS OF PROJECTION

some concepts of W.C.

1. Gross working capital = net current assets
2.Net working capital = net current assets-net current liabilities 3. A routine expenditure financed through fixed assets and long term funds.

Some questions to answer regarding working capital:

QUES: It is just the finance to pay day to day expenses or more than that? QUES: What should be the level of working capital? QUES: How it affect liquidity and profitability of any firm or business?

Factors affecting working capital

Nature of organisation
Seasonal variations Avalibility of raw material & credit

Synchronisation of cash flows

Dividend polices Degree of competition Growth and expansion strategies

ESTIMATION OF WORKING CAPITAL

Working capital can be estimated by determining financing mix which can be determined by following approaches: Matching approach Conservative approach Aggressive approach

HEDGING APPROACH (MATCHING APPROACH)

Hedging approach refers to a process of matching

maturities of debt with maturities of financial needs. In this approach maturity of source of funds should match the nature of assets should be financed. This approach is also known as matching approach. The hedging approach suggests that the permanent working capital should be financed with long term sources while temporary working capital should be financed with short term funds.

MATCHING APPROACH
fluctuating current assets total assets
short term debt

Assets

permanent current assets

long term debt +equity capital

fixed assets
Time
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Aggressive approach suggest that the entire estimated investment in current assets should be financed with short term funds and even a part of fixed asset investment should be financed with short term sources.

AGGRESSIVE APPROACH
fluctuating current assets total assets
short term debt

Assets

permanent current assets long term debt +equity capital fixed assets
Time
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This

approach suggested that the entire estimated investment in current assets should be financed from long term sources and short should be used only for emergency requirement. Distinct features of this approach: Liquidity is greater Risk is minimized The cost of financing is relatively more as interest has to be paid even on seasonal requirement for the entire period.
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CONSERVATIVE APPROACH
fluctuating current assets total assets
short term debt

Assets

permanent current assets

long term debt +equity capital

fixed assets
Time
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The aggressive approach implies low cost, high profit and high risk while the conservative approach leads to high cost, low profit, low risk. Both the approaches are the two extremes and neither of them serves the purpose of efficient working capital management. A trade off between the two will then be an acceptable approach, one way of determining trade off is by finding the average of maximum and minimum requirement of current asset and working capital.

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It means the determination of future cash requirements of a firm so that the liquidity of financial resources may be maintained.

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Percentage of Sales method Regression Analysis method Operating Cycle method Projected Balance sheet method

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Under this method, The working capital is determined on the basis of past experience. This is possible when the relationship between sales and working capital over the years is found to be stable, then this relationship may be taken as a base for determining the working capital for the future.

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Merit: Easy to use Easy to understand Used for projecting relatively short term changes in working capital Demerit: This method can not be universally applied because of assumption of linear relationship between sales and working capital.

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Regression analysis is a statistical technique applied for forecasting working capital requirements. It works only after establishing the average relationship between sale and working capital and its various components in the past year. This is expressed by the following equation: Y = a + bX where, X = Sales Y = Working capital level a = Intercept of the least square time with vertical axis b = Slope of the time

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Operating cycle refers to the time that elapses between the purchase of raw material and payment of suppliers of those materials. Operating cycle usually consist of 5 steps:
o Purchase of raw material on credit o Conversion of those material into finished goods o The sale of finished goods on credit o The collection of account receivables o The payment of account payables

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OPERATING CYCLE

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The length of the operating cycle of a manufacturing firm is the sum of:

inventory conversion period (ICP). Debtors (receivable) conversion period (DCP). Creditors or payables deferral period (CDP)

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Inventory conversion period is the total time needed for producing and selling the product. Typically, it includes:

raw material conversion period (RMCP) Average Raw Materials = ------------------Raw material consumed

x 365

work-in-process conversion period (WIPCP) Average work in process = ------------------x 365 Total cost of production finished goods conversion period (FGCP) Average stock (FG) = ------------------Total cost of goods sold

x 365

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The debtors conversion period is the time required to collect the outstanding amount from the customers. Average debtors = ------------------- x 365 Total credit sales

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Creditors or payables deferral period (CDP) is the length of time the firm is able to defer payments on various resource purchases. Average Creditors = ------------------x 365 Total credit Purchases

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STATEMENT OF WORKING CAPITAL REQUIREMENTS

Current Assets: (i) Cash (ii) Debtors or Receivables(for ..months sales) (iii) Stock (formonths sales) (iv) Advance payment, if any (v) Others Total Current Assets Less: Current Liabilities (i) Creditors (for..months Purchases) (ii) Lag in payment of expenses(o/s expenses, if any) Total Current Liabilities Working capital(C.A. C.L. ) Add: Provision / Margin For Contingencies Net Working Capital Required

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Prepare an estimate of working capital requirement from the following information of a trading concern (a) Project annual sales 100000 units (b) Selling price Rs. 8 per unit (c) Net profit on sales 25% (d) Average credit period allowed to customers 8 weeks (e) Average credit period allowed by suppliers 4 weeks (f) Average stock holding in terms of sales requirement 12 weeks (g) Allow 10% for contingencies

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PROJECTED BALANCE SHEET

Here estimates of different assets and liabilities are made and a balance sheet is prepared based on these forecasted assets and liabilities, that is called projected balance sheet. The difference between assets and liabilities of this balance sheet is treated as shortage and surplus of cash for that period.

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THANK YOU

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