WORKING CAPITAL

MANAGEMENT
Vanaja M.Varghese

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What is Working capital?
 Liquidity available to a business
 Gross working capital refers to the current
assets
 Net working capital = current assets – current
liabilities
 Working capital – component of the operating
capital of the business along with plant and
machinery.

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What are the components?
 Current assets
 Cash
 Accounts receivables
 Inventory
 Marketable securities
 Current liabilities
 Accounts payable
 Accrued expenses.

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Cash conversion cycle
 Illustration
 Inventory conversion period
= inventory/sales per day
 Payables deferral period
= payables/cost of goods sold
 Receivables collection period
=DSO= receivables/sales.

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Cash conversion cycle (contd.)
 Cash Conversion Cycle
= Inventory conversion period + Receivables
collection period – payables deferral period
 It indicates the gap between when the firm
has spend the money to purchase the
production materials and when the firm is
able to get that money back.

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Cash conversion cycle (contd.)
 The objective of a firm should be to reduce
the cash conversion cycle
 Faster they recover the money- so need
lesser working capital – free cash flow
 Increase the time to pay its suppliers
 Collect the receivables faster
 Reduce the inventory conversion period.

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Why do firms hold cash?
 John Keynes
 Firms hold cash for three main reasons
 Speculation ( trade discounts)
 Precaution ( inflows uncertainty)
 Transaction ( payments)
 Compensating balances - deposits that must
be maintained in the banks for the services

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Cash Budget
 Projected cash inflows and outflows for a
specific period of time.
 Example of a cash budget
 Target cash balance can be determined with
the help of several models like the Baumol
model, Miller and Orrs model etc.

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Cash Management techniques
 Cash flow synchronization
 Timing the receipts of bills – in time for the
payments-maintain cash balances to the
minimum.
 Using float
 Float is the difference between a firm’s book
balance and the balance indicated in the banks
books

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Cash Management techniques
 Float can be of two types
 Disbursement float
The firm pays and thus it is deducted from the firm’s
books but not from the banks books.
 Collection float

When the customer writes the cheque it is recorded

as received in the firms books but it is still
unavailable for use unless the bank clears the
cheque.

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Collection process

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Managing the float
 Lock boxes
 Mailed to the lock boxes
 Concentration Banking
 Payments made at the local sales offices, cleared
in the local banks and net amount is transferred to
the main bank
 Wire transfers
 This is direct transfer of funds from the account of
one entity to another entity.

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Inventory management
 The twin goals of inventory management are
 To ensure that inventory is available to sustain operations
 To keep the ordering and holding costs to the minimum.
 Decisions
 Lead time
 Uncertainty in demand
 Cost of holding inventory
 Cost of losing inventory
 Projected sales and availability of raw materials

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Receivables management
 Selling on credit essential to cope with the
competition.
 A credit policy
 Credit period ( 2/10 , net 30 )
 Discounts ( discount for early payments )
 Credit standards
 Collection policy ( toughness/laxity)

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 Receivables management
 Days of sales outstanding
 time the customers take to pay the bills.
 Also indicates the average that the company takes to pay
their creditors.
 DOS = Receivables/Sales per day
 Aging schedules
 It breaks down the firms receivables by the age of the
account.
 It is developed from the accounts receivable ledger.
 Aging schedule

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Receivables management
 A firm should see to it that the DSO and the
aging schedules are working well in
comparison with the industry.
 These need to be reviewed from time to time
and kept in control.
 The credit policy needs to be revised.

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Accrued expenses
 It includes the expenses like the wages that
needs to be paid to the workers
 The taxes
 Cannot be controlled by the firm
 It expands with the expansion of the firms
operations.
 External forces may it obligatory.

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Accounts payables
 40% of the current liabilities is constituted by
accounts payables.
 Trade credit
 Smaller companies will have higher trade
credit.
 Trade credit can be divided into two
 Free trade credit
 Costly trade credit

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Short term financing
 Marketable securities
 Working capital loans
 Promissory note – amount borrowed, rate of interest , the
repayment schedule, collateral that may be required, terms
and conditions.
 Line of credit – informal agreement between a bank
and borrower.
 Revolving credit agreement – formal line of credit
 Commercial paper

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REFERENCES
 CORPORATE FINANCE by Michael&Eugene
 CORPORATE FINANCE by Ross Westerfield
 CORPORATE FINANCE by Meyers

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THANK YOU

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