Upload
avinpapriwal5516
View
101
Download
3
Embed Size (px)
Citation preview
Chapter 26
WORKING CAPITAL MANAGEMENT
OUTLINE
• Characteristics of Current Assets
• Factors Influencing Working Capital Requirements
• Level of Current Assets
• Current Assets Financing Policy
• Profit Criterion for Current Assets
• Operating Cycle Analysis
• Cash Requirement for Working Capital
CHARACTERISTICS OF CURRENT ASSETS
• Short life span• Swift transformation into other asset forms
Current Assets Cycle
Accounts receivable
Finished goods
Wages, salaries, factory overheads
Work-in- process
Raw materials
Cash Suppliers
FACTORS INFLUENCING WORKING
CAPITAL REQUIREMENTS
• Nature of Business
• Seasonality of Operations
• Production Policy
• Market Conditions
• Conditions of Supply
WORKING CAPITAL POLICY
Two important issues in working capital policy are:
• What should be the level of investment in current
assets?
• What mix of long-term and short-term financing should
the firm employ to support current assets?
LEVEL OF CURRENT ASSETS
Flexible Restrictive (Conservative) (Aggressive)
Policy Policy Liquidity High Low Inventories Large Small Debtors High Low
A flexible policy results in fewer production stoppages, ensures quicker deliveries to customers, and stimulates sales .. but
HIGHER INVESTMENT IN CURRENT ASSETS
A restrictive policy leads to more production stoppages, delayed deliveries to customers, and lost sales … but
LOWER INVESTMENT IN CURRENT ASSETS
CAPITAL REQUIREMENTS
AND THEIR FINANCING
Capitalrequirements
Fluctuating current asset requirement
Permanent current asset-requirement
Fixed asset requirement
Time
A
B
C
CURRENT ASSETS FINANCING
POLICY
According to the maturity principle, fixed assets and
permanent current assets should be supported by long-
term sources of finance whereas fluctuating current assets
must be supported by short-term sources of finance.
PROFIT CRITERION FOR
WORKING CAPITAL
• Investment in current assets is easily reversible.
• For reversible investments, the criterion of net profit per
period (which here means residual income) is equivalent
to the criterion of net present value
OPERATING CYCLE AND CASH CYCLE
Order placed Stock arrives Goods sold Cash received
Inventory period Accounts receivable period
Accounts payable period
Firm receives Cash paid for invoice materials
Operating cycle
Cash cycle
Average inventoryInventory period =
Average COGS / 365 Average accounts receivable
Accounts receivable period = Annual sales / 365 Average accounts payable
Average payable period = Average COGS / 365
ILLUSTRATION
Financial Information for Horizon Limited
Balance Sheet Data
Profit and Loss Beginning of End of
Account Data 20X0 20X0
Sales 800 Inventory 96 102
Cost of goods 720 Account receivable 86 90
Sold Accounts payable 56 60
(96 + 102) / 2
Inventory period = = 50.1 days
720 / 365
(86 + 90) / 2Accounts receivable period = = 40.2 days
800 / 365
(56 + 60) / 2Accounts payable period = = 29.4 days
720 / 365 Operating cycle = 50.1 + 40.2 = 90.3 days
Inventory Accounts period receivable
period
Cash cycle = 90.3 - 29.4 = 60.9 days Operating Accounts
cycle payable period
CASH REQUIREMENT FOR
WORKING CAPITAL
Step 1 : Estimate the cash cost of various current assets
required by the firm.
Step 2 : Deduct the spontaneous current liabilities from
the cash cost of current assets
SUMMING UP
• Current assets have a short life span and are swiftly transformed into other asset forms.
• The working capital needs of a firm are influenced by numerous factors : nature of business, seasonality of operations, production policy, market conditions, and supply conditions.
• Determining the optimal level of current assets involves a tradeoff between carrying costs and shortage costs.
• According to the matching, the maturity of the sources of finance should match the maturity of assets being financed.
• The operating cycle of a firm begins with the acquisition of raw materials and ends with the collection of receivables.
• The cash requirement of working capital is calculated by estimating the cash cost of various current assets required by the firm and deducting the spontaneous current liabilities from the cash cost of current assets.