Working Capital Mgt Ppt

8/6/2019 Working Capital Mgt Ppt

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Working Capital

Management


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Topics CoveredTopics Covered

Working Capital conceptsWorking Capital concepts

Credit ManagementCredit Management Inventory ManagementInventory Management

Cash ManagementCash Management

Marketable SecuritiesMarketable Securities

Working capital cycleWorking capital cycle Working Capital FinanceWorking Capital Finance


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Working Capital ConceptsWorking Capital ConceptsGross Working CapitalGross Working CapitalThe firms investment in current assetsThe firms investment in current assets

Net Working CapitalNet Working CapitalCurrent AssetsCurrent Assets -- Current Liabilities.Current Liabilities.

..

Working Capital ManagementWorking Capital ManagementThe administration of the firms current assets and theThe administration of the firms current assets and the

financing needed to support current assetsfinancing needed to support current assets


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Working CapitalWorking CapitalCurrent assets and liabilities for Indian manufacturing firms (31 March,

2008)Rs. Crores

Cash Rs.74651.53 Rs.26285.89 Current portion of long-term debt

Other short-term financial investments 30125.67 155962.85 Accounts payable

Accounts receivable 249097.79 29180.15 Income tax provisions

16957.65 Dividend Provisions

Inventories 173214.88 63028.27 Other current liabilities

Total current assets Rs.527089.87 Rs.291414.81 Total current liabilities

Net working capital (current assets - current liabilities) = 527089.87 - 291414.81 = Rs.235675.06 crores

Current LiabilitiesCurrent Assets


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Significance of WorkingSignificance of Working

Capital ManagementCapital Management In a typical manufacturing firm, current assetsIn a typical manufacturing firm, current assets

exceed oneexceed one--half of total assets.half of total assets.

Excessive levels can result in a substandardExcessive levels can result in a substandardReturn on Investment (ROI).Return on Investment (ROI).

Current liabilities are the principal source ofCurrent liabilities are the principal source ofexternal financing for small firms.external financing for small firms.

Requires continuous, dayRequires continuous, day--toto--day managerialday managerial

supervision.supervision. Working capital management affects theWorking capital management affects the

companys risk, return, and share price.companys risk, return, and share price.


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Working Capital IssuesWorking Capital Issues

AssumptionsAssumptions

50,000 maximum50,000 maximumunits of productionunits of production

ContinuousContinuousproductionproduction

Three differentThree differentpolicies for currentpolicies for currentasset levels areasset levels arepossiblepossible

Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets

Policy APolicy A

Policy

BPolicy B

Policy CPolicy C

Current Assets

OUTPUT (units)

ASSET

LEVEL


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Impact on LiquidityImpact on Liquidity

Liquidity AnalysisLiquidity Analysis

PolicyPolicy Liquidity Liquidity

AA HighHigh

BB AverageAverage

CC LowLow

Greater current assetGreater current assetlevels generate morelevels generate more

liquidity; all otherliquidity; all otherfactors held constantfactors held constant


Policy APolicy A

Policy BPolicy B

Policy CPolicy C

Current Assets

OUTPUT (units)

ASSET LEVEL


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Impact onImpact on

Expected ProfitabilityExpected Profitability

Return on InvestmentReturn on Investment==

Net ProfitNet ProfitTotal AssetsTotal Assets

LetLet Current AssetsCurrent Assets ==(Cash + Rec. + Inv.)(Cash + Rec. + Inv.)

Return on InvestmentReturn on Investment==

Net ProfitNet Profit(Current(Current ++ Fixed Assets)Fixed Assets)


Policy APolicy A

Policy BPolicy B

Policy CPolicy C

Current Assets

OUTPUT (units)

ASSET

LEVE

L


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Impact onImpact on

Expected ProfitabilityExpected Profitability

Profitability AnalysisProfitability Analysis

PolicyPolicy Profitability Profitability

AA LowLow

BB AverageAverage

CC HighHigh

As current asset levelsAs current asset levelsdecline, total assetsdecline, total assetswill decline and thewill decline and the

ROI will rise.ROI will rise.


Policy APolicy A

Policy BPolicy B

Policy CPolicy C

Current Assets

OUTPUT (units)

ASSET

LEVE

L


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Impact on RiskImpact on Risk

Decreasing cashDecreasing cashreduces the firms abilityreduces the firms abilityto meet its financialto meet its financialobligations.obligations. More risk!More risk!

Stricter credit policiesStricter credit policiesreduce receivablesreduce receivables andandpossibly lose sales andpossibly lose sales andcustomers.customers. More risk!More risk!

Lower inventory levelsLower inventory levelsincrease stock outs andincrease stock outs andlost sales.lost sales. More risk!More risk!


Policy APolicy A

Policy BPolicy B

Policy CPolicy C

Current Assets

OUTPUT (units)

ASSET

LEVE

L


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Impact on RiskImpact on Risk

Risk AnalysisRisk Analysis

PolicyPolicy RiskRisk

AA LowLow

BB AverageAverage

CC HighHigh

Risk increases as the levelRisk increases as the levelof current assets areof current assets are

reduced.reduced.


Policy APolicy A

Policy BPolicy B

Policy CPolicy C

Current Assets

OUTPUT (units)

ASSET

LEVE

L


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Summary of the OptimalSummary of the Optimal

Amount of Current AssetsAmount of Current AssetsSSUMMARYUMMARYOOFFOOPTIMALPTIMAL CCURRENTURRENTAASSETSSETAANALYSISNALYSIS

PolicyPolicy Liquidity Liquidity Profitability Profitability RiskRisk

AA HighHigh LowLow LowLow

BB AverageAverage AverageAverage AverageAverageCC LowLow HighHigh HighHigh

1. Profitability varies inversely with liquidity.1. Profitability varies inversely with liquidity.

2. Profitability moves together with risk.2. Profitability moves together with risk.(risk and return go hand in hand!)(risk and return go hand in hand!)


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Classifications of WorkingClassifications of Working

CapitalCapital

ComponentsComponents

Receivables, inventory , cash and

marketable securities

TimeTime

PermanentPermanent

TemporaryTemporary


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Permanent Working Capital

Permanent Working Capital

The amount of current assets required to meet a firms longThe amount of current assets required to meet a firms long--term minimumterm minimum

needsneeds..

TIME

Permanent current assetsPermanent current assets

RUPEE

AMOUNT


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Temporary Working CapitalTemporary Working CapitalThe amount of current assets that varies with seasonal requirementsThe amount of current assets that varies with seasonal requirements..

Temporary current assetsTemporary current assets

Permanent current assets

Permanent current assets

TIME

RUPEE

AMOUNT


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Credit ManagementCredit ManagementTerms ofSaleTerms ofSale -- Credit, discount, and paymentCredit, discount, and payment

terms offered on a sale.terms offered on a sale.

ExampleExample -- 5/10net 305/10net 30

55-- percent discount for early paymentpercent discount for early payment

1010 -- number of days that the discount isnumber of days that the discount isavailableavailable

net 30net 30 -- number of days before payment is duenumber of days before payment is due


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Terms of SaleTerms of Sale A firm that buys on credit is in effect borrowing from itsA firm that buys on credit is in effect borrowing from its

supplier. It saves cash today but will have to pay later.supplier. It saves cash today but will have to pay later.

This, of course, is an implicit loan from the supplier.This, of course, is an implicit loan from the supplier.

We can calculate the implicit cost of this loanWe can calculate the implicit cost of this loan

( )

Effective annual rate

1 + - 1discountdiscounted price365/ extra days credit

=


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Terms of SaleTerms of SaleExampleExample -- On a Rs.100 sale, with terms 5/10 net 60, what is theOn a Rs.100 sale, with terms 5/10 net 60, what is the

implied interest rate on the credit given?implied interest rate on the credit given?

45.4%

or.454,=

1-1

1-1

rateannualective

365/50

95

5

creditdays365/extra

pricediscounteddiscount

!

!


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Credit AgreementsCredit Agreements TerminologyTerminology

open accountopen account

promissory notepromissory note commercial draftcommercial draft

sight draftsight draft

time drafttime draft

trade acceptancetrade acceptance bankers acceptancebankers acceptance

irrevocable letter of creditirrevocable letter of credit

conditional saleconditional sale


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Credit AnalysisCredit AnalysisNumerical Credit Scoring categoriesNumerical Credit Scoring categories

The customers characterThe customers character

The customers capacity to payThe customers capacity to pay

The customers capitalThe customers capital

The collateral provided by the customerThe collateral provided by the customer

The condition of the customers businessThe condition of the customers business


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Credit AnalysisCredit AnalysisCredit AnalysisCredit Analysis -- Procedure to determine theProcedure to determine the

likelihood a customer will pay its bills.likelihood a customer will pay its bills.

Credit agencies provide reports on the creditCredit agencies provide reports on the credit

worthiness of a potential customer.worthiness of a potential customer.

Financial ratios can be calculated to helpFinancial ratios can be calculated to helpdetermine a customers ability to pay its bills.determine a customers ability to pay its bills.


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The Credit DecisionThe Credit DecisionCredit PolicyCredit Policy -- Standards set to determine the amountStandards set to determine the amount

and nature of credit to extend to customers.and nature of credit to extend to customers.

Credit ScoringCredit Scoring What your lender wont tell you.What your lender wont tell you.

Extending credit gives you the probability of making aExtending credit gives you the probability of making aprofit, not the guarantee. There is still a chance ofprofit, not the guarantee. There is still a chance ofdefault.default.

Denying credit guarantees neither profit or lossDenying credit guarantees neither profit or loss


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The Credit DecisionThe Credit DecisionThe credit decision and its probable payoffsThe credit decision and its probable payoffs

Customer pays = p

Customer de aults = 1-p

Payo = 0

Payo = Rev - Cost

Payo = - Cost

Offer credit

Refuse credit


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The Credit DecisionThe Credit Decision Based on the probability of payoffs, the expected profit can beBased on the probability of payoffs, the expected profit can be

expressed as:expressed as:

p x PV(Rev - Cost) - (1 - p) x (PV(cost)

The break even probability of collection is:

p = PV(Cost)PV(Rev)


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Collection PolicyCollection PolicyCollection PolicyCollection Policy -- Procedures to collectProcedures to collect

and monitor receivables.and monitor receivables.

Ageing ScheduleAgeing Schedule -- Classification ofClassification of

accounts receivable by timeaccounts receivable by time

outstanding.outstanding.


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Collection PolicyCollection Policy Sample ageing schedule for accounts receivableSample ageing schedule for accounts receivable

Customer's Less than More than1-2 months 2-3 months Total Owed

Name 1 month 3 months

A 10,000 0 0 0 10,000

B 8,000 3,000 0 0 11,000

* * * * * *

* * * * * *

* * * * * *Z 5,000 4,000 6,000 15,000 30,000

Total s.200,000 s.40,000 s.15,000 s.43,000 s.298,000


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Inventory ManagementInventory Management Components of InventoryComponents of Inventory

Raw materialsRaw materials

Work in processWork in process

Finished goodsFinished goods

Goal = Minimize amount of cash tied up in inventoryGoal = Minimize amount of cash tied up in inventory

Tools used to minimize inventoryTools used to minimize inventory JustJust--inin--timetime

Lean manufacturingLean manufacturing


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Cash ManagementCash ManagementCash does not pay interestCash does not pay interest

Move money from cash accounts intoMove money from cash accounts intoshort term securitiesshort term securities

Sweep programsSweep programs

MMDAsMMDAs

Concentration bankingConcentration banking

LockLock--box systembox system


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Money Market InvestmentsMoney Market Investments

(India)(India)Investment

Borrower

Maturities

When Issued Marketability

Basis for

Calculating Interest Comments

Treasury Bills Government of India

14-days, 91-

days, 182-days,

or 364 days

Good

Secondary

Market

Discount

14-day and 91-day T-Bills are auctioned

weekly. The 182-days and 364-days T-Bills

are auctioned fortnightly.

Certificates of

DepositBanks

14 days to 1

year

Fair

secondary

market

Discount The CDs are negotiable instruments

Commercial Papers

Industrial firms,

financial institutions

apart from primary

dealers and satellite

dealers

15 days to 1

year

Fair

secondary

market

Discount

Only companies with a CRISIL rating of P2

and above or equivalent rating can issue

CPs

Repurchase

agreements (repos)

Banks and primarydealers, and all entities

having SGL and current

account with RBI

1 day (2 to 3days if issued

on Fridays or

holidays)

ExcellentSecondary

market

Repurchase price

set higher than

selling price;difference quoted

as repo interest

rate (adjusted for

coupon)

Since June 2000, RBI is conducting Repotransactions every day under the Liquidity

Adjustment Scheme


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WORKING

CAPITAL CYCLEWORKING

CAPITAL CYCLEReceivable AR

converted to Cash

Goods orServices

converted to

Accounts

Receivable AR

Collect ARCollect AR CashCash

Produce goodsProduce goodsor Servicesor Services

Cash converted toCash converted to

prepaid expensesprepaid expenses

DeliverGoodsDeliverGoods

or servicesor servicesSalesSales

OrderOrder


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WORKING CAPITAL FINANCINGWORKING CAPITAL FINANCING

Working Capital is financed by following sources:

OWNED FUNDS

A portion of long term funds, equity share capital and reserves& surplus is utilized to fund working capital BANK BORROWINGS

Various bank products like cash credit, packing credit, billsdiscounting etc.

CREDITORS

Raw Materials W-I-P Finished Goods Debtors

Trade Payables Long Term Funds + Bank Borrowings

Funding the Cash Operating Cycle


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WORKING CAPITAL FINANCINGWORKING CAPITAL FINANCING

WorkingWorkingCapitalCapital

ProductsProducts

FundFund

BasedBased

NonNonFundFund

BasedBased

StructuredStructured

ProductsProducts

DomesticDomestic ExportExport

Letter ofLetter of

CreditCredit

BankBank

GauranteeGaurantee

Buyer &Buyer &

SuppliersSupplierscreditcredit

CommercialCommercial

PaperPaper

CorporateCorporate

LoansLoansS

ecuritizationS

ecuritization FactoringFactoring ForfeitingForfeiting

PrePre--shipmentshipment

PostPostshipmentshipment

CashCashCreditCredit

OverdraftOverdraft

BillBillFinanceFinance

DocumentaryDocumentary

CleanClean


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Working Capital Mgt Ppt