Working Capital Management

OF
Navana Furniture Limited


COURSE NAME : WORKING CAPITAL MANAGEMENT
COURSE CODE : F-405

SUBMITTED TO
M. Shahjahan Mina
Professor
Department of Finance
University of Dhaka


SUBMITTED BY:
Group Members

SL NO NAME CLASS ROLL
01. A.S.M Kamran 16- 040
02. Sharmin Akter 16- 048
03. Tamanna Tanvir Haque 16- 088
04. Alusli akter 16- 162
05. Belal Hossain 16- 264



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2
Letter of Transmittal:

July 13, 2013
M. Shahjahan Mina
Professor
Department of Finance
University of Dhaka

Sir,
We submit here with the report of the group assignment on Working Capital Management of
Navana Furniture Limited selected through the unanimous opinions of the group members
fixing the date of submission on 13/07/2013.

We think the topic that we have selected is really an important & interesting fact for the
finance students with the textual studies acquiring practical orientation of how the
manufacturing company is dealing with the issues related to working capital management to
run the company for maintaining profitability.

We thank you for giving us the opportunity to work on this topic.

Sincerely yours

Sharmin Akter
On behalf of all the members of our group.

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Acknowledgement:

We would like to pay our gratitude to all of the related books, authors, and related web site
that helped us a lot for the completion of this report before, during and after the working
period. At first we would like to acknowledge the Almighty, who helped us every time gave
us moral support and strength every moment.

We are especially grateful to our honourable course teacher M. Shahjahan Mina for giving us
valuable suggestions and guidelines so that we can prepare this report successfully. Without
his support it was almost impossible for us to complete this report.

Then we would like to thank the people who have provide us the valuable information about
Navana Furniture Limited to work on working capital management issues.










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Executive Summary:

The report on Working Capital Management is a very good experience for us. Every
manufacturing company faces the problem of Working Capital Management in their day-to-
day processes. An organization can reduce cost and the increase profits only if it is able to
manage its Working Capital efficiently. At the same time, the company can provide customer
satisfaction and hence can improve their overall productivity and profitability.

This report is a sincere effort to study and analyze the Working Capital Management
of Navana Furniture Limited. We have focused on the crucial managerial decisions about
making a financial overview of the company by conducting a Working Capital analysis of
NFL.

The report is a bridge between the institute and the organization. This made me employ my
theoretical knowledge about the myriad and fascinating facets of finance. Moreover, in the
process I could contribute substantially to the organizations growth. The experience that I
gathered over the past two months has certainly provided the orientation, which I believe will
help me in shouldering any responsibility in future.






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Table of Contents:

SL NO. TOPIC NAME PAGE
NO.
01.
10
02.
10
03.
11
04.
14
06.
17
07.
18
08.
21
09.
22
10.
24
11.
26
12.
30
11.
34




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01.I ntroduction To The Report :

1.1 Origin of the report:
The report has been prepared as a practical requirement for the Working Capital
Management course. M. Shahjahan Mina, our honourable course instructor, assigned the
students of BBA 16
th
batch to do a report on working capital management of a manufacturing
company (Bangladesh perspective).

1.2 Background of the Report:
Manufacturing companies play a very important role to improve the economic condition of a
country. In the following report we have tried to explore the managerial issues related to the
working capital and some certain activities according to those issues of a manufacturing
company named Navana Furniture Limited. We have also shown some mathematical
illustration of their working capital performance.

1.3 Objective of the study:
Our main objective of the study is to fulfil the requirement of our course on Working Capital
Management. Other objectives behind conducting this study are as follows:
To learn about how a manufacturing company manages its working capital and what are
the principles and procedures it follows in this case.
To learn about what are limitations a manufacturing company has in managing working
capital activities.
To gather practical knowledge about those.

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1.4 Source of information:

The report is prepared using both primary and secondary information.
The primary information is collected mainly from our course related book written by I.M.
Panda and from the employees of that manufacturing company.
The secondary information used in the report has been extracted mainly from online source.
We have also explored the related website.


1.5 Limitations:

Firstly, we have not enough experience to make a qualified business report.
Secondly, we have not got enough time, which hampered the related processes to some
extent. The time was not enough to prepare a formal and long business report.
Thirdly, financial bindings were another drawback in preparing the report.
Fourthly, there were some technological problems.

We think the report could be organized more extensively if there was sufficient time and
proper response of the reference groups to cover all particulars regarding report format,
structure, investigation etc.





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Working Capital Management
Navana Furniture Limited.....

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Concepts of working capital:
Working capital (abbreviated WC ) is a financial metric which represents operating liquidity
available to a business, organization or other entity considered a part of operating capital.
There are two concepts of working capital management gross and net.
Gross working capital refers b to the firms investment in current assets. Current assets are
the assets which can be converted into cash within an accounting and include cash, short-term
securities, debtors, bills receivables and stock. The consideration of the level of investment in
current assets should avoid two danger points. Excessive investment in current assets should
be avoided because it impairs the firms profitability, as idle investment earns nothing. On the
other hand, inadequate amount of working capital can threaten solvency of the firm because
its inability to meet its current obligations.
Net working capital refers to the difference between current assets and current liabilities.
Current liabilities are those claims of outsiders which are expected to mature for payment
within an accounting year and include creditors, bills payables, and outstanding expenses.
Net working capital is a qualitative concept. It indicates the liquidity position of the firm and
suggests the extent to which working capital needs may be financed by permanent sources of
funds.

Operating and cash conversion cycle:
Operating cycle is the time duration required to convert sales, after the conversion of
resources into inventories, into cash. The operating cycle of a manufacturing company
involves three phases:
Acquisition of resources such as raw material, labour, power and fuel etc.
Manufacture of the product which includes conversion of raw material into work-in-
process into finished goods.
Sale of the product either for cash or on credit. Credits sales create account receivable
for collection.

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The length of the gross operating cycle of a manufacturing firm is the sum of:
1. Inventory conversion period (ICP).
2. Debtors conversion period (DCP)
Inventory conversion period (ICP):
The inventory conversion period is the sum of raw material conversion period (RMCP) work-
in-process conversion period (WIPCP) finished goods conversion period (FGCP).
ICP = RMCP + WIPCP + FGCP
Raw material conversion period (RMCP): The raw material conversion period (RMCP) is
the average time period taken to convert material into work in process. It depends on; a) raw
material consumption and (b) raw material inventory. The following formula is used in
calculation of RMCP.
RMCP = ( 360 days/RMC )* RMI
Work-in-process conversion period (WIPCP): The work-in-process conversion period
(WIPCP) is the average time period taken to convert work in process into finished goods. The
following formula is used in calculation of WIPCP.
WIPCP = ( 360 days/COP ) * WIPI
Finished goods conversion period (FGCP): The finished goods conversion period (FGCP)
is the average time period taken to sell the finished goods. The following formula is used in
calculation of FGCP.
FGCP = ( 360 days/COGS) * FGI
Debtor conversion period (DCP):
The debtor conversion period (DCP) ) is the average time period taken to convert debtors into
cash. DCP represents the average collection period. It is calculated as follows:
DCP (collection period) = ( 360 days / cost of sales or credit sales)*Debtors


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Net operating cycle:
Net operating cycle (NOC) is the difference between gross operating cycle and payables
deferred period (PDP).
NOC = GOC PDP
BASIC ELEMENTS OF CREDIT POLICY :
The term credit policy is used to refer to the combination of three decision variables. These
variables are discussed below :-
CREDIT STANDARD :
Credit standards are criteria to decide the types of customers to whom goods
could be sold on credit. If a firm has more slow-paying customers , its
investment in accounts receivable will increase. The firm will also be exposed to
higher risk of default.

CREDIT TERMS :
Credit terms specify duration of credit and terms of payment by customers.
Investment in accounts receivable will be high if customers are allowed
extended time period for making payments.

COLLECTION EFFORTS :
Collection efforts determine the actual collection period. The lower the
collection period, the lower the investment in accounts receivable and vice
versa.


THE REASONS FOR GRANTING CREDIT :
Companies in practice feel the necessity of granting credit for several reasons :
COMPETION :
Generally the higher the degree of competition, the more the credit granted by a
firm.

COMPANYS BARGAINING POWER:
If a company has a higher bargaining power vis--vis its buyers, it may grant no
or less credit. The company will have a strong bargaining power if it has a strong
product, monopoly power, brand image, large size or strong financial position.

BUYERS REQUIREMENTS :
In a number of business sectors buyers or dealers are not able to operate
without extended credit. This is particularly so in the case of industrial products.
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BUYERS STATUS :
Large buyers demand easy credit terms because of bulk purchases and higher
bargaining power. Some companies follow a policy of not giving much credit to
small retailers since it is quite difficult to collect dues from them.

RELATIONSHIP WITH DEALERS :
Companies sometimes extend credit to dealers to build long-term relationships
with them or to reward them for their loyalty.

MARKETING TOOL :
Credit is used as a marketing tool, particularly when a new product is launched
or when a company wants to push its weak product.

INDUSTRY PRACTICE :
Small companies have been found guided by industry practice and norm more
than the large companies. Sometimes companies continue giving credit because
of past practice rather than industry practice.

TRANSIT DELAYS :
This is a forced reason for extended credit in the case of a number of companies.
Most companies have evolved systems to minimize the impact of such delays.
Some of them take the help of banks to control cash flows in such situation.



FACETS OF CASH MANAGEMENT :
Cash management is concerned with the managing of :
1. Cash flows into and out of the firm.
2. Cash flows within the firm.
3. Cash balances held by the firm at a point of time by financing deficit or investing
surplus cash.
It can be represented by a cash management cycle as shown in the following figure. Sales
generate cash which has to be disbursed out. The surplus cash has to be invested while
deficit has to be borrowed. Cash management seeks to accomplish this cycle at a minimum
cost. At the same time it also seeks to achieve liquidity and control. Cash management
assumes more importance than other current assets because cash is the most significant
and the least productive assets that a firm holds. It is significant because it is used to pay the
firms obligations. However cash is unproductive. Unlike fixed assets or inventories, it does
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not produce goods for sale. Therefore, the aim of cash management is to maintain adequate
control over cash position to keep the firm sufficiently liquid and to use excess cash in some
profitable way.














Figure : Cash management cycle.
MOTIVES FOR HOLDING CASH :
The firms need to hold cash may be attributed to the following three motives :
The transaction motive
The precautionary motive
The speculative motive


TRANSACTION MOTIVE :
The transaction motive requires a firm to hold cash to conduct its business in the ordinary
course. The firm needs cash primarily to make payments for purchase, wages and salaries,
other operating expenses, taxes, dividends etc. The need to hold cash would not arise if
Information
and control
Business
operation
Cash
collection
Cash
payments
Deficit
Surplus
Borrow
Invest
Working capital Management


14
there were perfect synchronisation between cash receipts and cash payments, i.e., enough
cash is received when the payment has to be made. But cash receipts and payments are not
perfectly synchronized. The transactions motive mainly refers to holding cash to meet
anticipated payments whose timing is not perfectly matched with cash receipts.

PRECAUSIONARY MOTIVE :
The precautionary motive is the need to hold cash to meet contingencies in the future. It
provides a cushion or buffer to withstand some unexpected emergency. The precautionary
amount of cash depends upon the predictability of cash flows. If cash flows can be predicted
with accuracy, less cash will be maintained for an emergency. The amount of precautionary
cash is also influenced by the firms ability to borrow at short notice when the need arises.
Precautionary balance should be held more in marketable securities and relatively less in
cash.

SPECULATIVE MOTIVE :
The speculative motive relates to the holding of cash for investing in profit-making
opportunities as and when they arise. The opportunity to make profit may arise when the
security prices change. The firm will hold cash, when it is expected that interest rates will
rise and security prices will fall. The firms also speculate on materials prices. If it is expected
that materials prices will fall, the firm can postpone materials purchasing and make
purchases in future when price actually falls.

TYPES OF SHORT TERM INVESTMENT OPPORTUNITIES :
The following short term investment opportunities are available to companies to invest
their temporary cash surplus :


TREASURY BILLS :
Treasury bills are short-term government securities. The usual practice is to sell treasury
bills at a discount and redeem them at par on maturity. They can be bought and sold any
time; thus, they have liquidity. Also, they do not have the default risk.

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COMMERCIAL PAPERS :
Commercial papers are short-term, unsecured securities issued by highly creditworthy large
companies. They are issued with a maturity of three months to one year. It is marketable
securities and so liquidity is not a problem.

CERTIFICATES OF DEPOSITES :
Certificates of deposit are papers issued by banks acknowledging fixed deposits for a
specified period of time. CPs are negotiable instruments that make them marketable
securities.

BANK DEPOSITS :
A firm can deposit its temporary cash in a bank for a fixed period of time. The interest rate
depends on the maturity period. The default risk of the bank deposits is quite low.

INTER-CORPORATE DEPOSITS :
Inter-corporate lending/borrowing or deposits is a popular short-term investment
alternative for companies. Generally a cash surplus company will deposit (lend) its fund in a
sister or associate companies or with outside companies with high credit standing. The risk
of default is high, but returns are quite attractive.

MONEY MARKET MUTUAL FUNDS :
Money market mutual funds focus on short term marketable securities. They have a
minimum lock-in period of 30 days and after this period , an investor can withdraw the
money any time at a short notice . They offer attractive yields; yields are usually 2 percent
above than on bank deposits of same maturity.
QUESTION :
A companys current credit sale is tk 1 crore and has some unutilized capacity. Now
company is planning to increase the sales volume by extending the credit period from 45
days to 60 days with 2.5/20 net 60 terms of sales. It is expected that sales will increase by
20% but bad debt loss is expected to be 1% on all sales. Moreover, additional collection cost
would be tk 10,000 per month. Selling price and variable cost tk 100 and tk 70
respectively(per unit). It is expected that 50% of the accounts receivable will be collected
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within discount period. Opportunity cost of fund is 20% and corporate tax rate should be
25%. Should the company revise the credit policy?


Navana Furniture Limited
Statement of comprehensive income, 2012.

Particulars BD Taka BD Taka
Sales 426,319,150
Less: COGS
Raw material purchases 267,646,532
Add: opening stock 44,933,921
Less: closing stock 35,626,103
Raw material consumed 276,954,350
Add: opening WIP 63,010,670
Less: closing WIP 82,579,283
Less: factory over head 42,180,097
Cost of production 299,565,834
Add: opening FG 72,255,618
Less: closing FG 86,774,972
Cost of goods sold 285,046,480
Gross profit 141,272,670
Operating expenses 123,905,918
Net profit before tax 17,366,752
Income tax expenses 3,060,442
Net profit 14,306,310

Cost of sales ( COGS + Operating expenses) 408,952,398
Trade debtors 157,070,959
creditors 79,612,659


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Calculation of operating cycle of NFL:
No. Particulars 2012
A. Inventory conversion period: (1+2+3) 255.15 days
1. RMCP = ( 360 days/RMC )* RMI
= (360 days/276,954,350)* 35,626,103
46.31 days
2. WIPCP = ( 360 days/COP ) * WIPI
= (360 days/299,565,834)* 82,579,283
99.24 days
3. FGCP = ( 360 days/COGS) * FGI
= (360 days/285,046,480)* 86,774,972
109.60 days
B. DCP ( collection period) = ( 360 days/ cost of sales or credit
sales)*Debtors
= (360 days/408,952,398)* 157,070,959
138.27 days
C. Gross operating cycle (A+B) 393.42 days
D. Payable deferred period = (360 days/credit purchases)*creditors
= (360 days/267,646,532)* 79,612,659
107.08 days
E. Net operating cycle (C D) 286.34 days




Flow of working capital over the last 5 years:
Particulars 2008 2009 2010 2011 2012
Total Current Liabilities 109,876,935 108,419,846 212,358,117 362,936,070 491,451,302
Total Current assets 171,931,094 174,166,912 270,292,818 414,193,734 539,802,808
Net working capital 62,054,159 65,747,066 57,934,701 51,257,664 48,351,506

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-
100,000,000
200,000,000
300,000,000
400,000,000
500,000,000
600,000,000
2008 2009 2010 2011 2012
Years
Working capital trend
Total Current Liabilities
Total Current assets
Net working capital