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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)
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