Definition of Working capital-.ppt
- 1. Definition of Working capital- “Working Capital is the amount of funds necessary to cover the cost of operating the enterprise.” Working capital is required for the routine and day to day operations of the enterprise. Working capital= Current assets – Current Liabilities. Current assets- Current assets are those assets which can be converted into cash with in one year. Example- Cash in hand, bank balance, Bills Receivables, Debtors, short term loan and advances, stock etc.
- 2. Current liabilities • Current liabilities are those which can be payable in cash with in one year. • Examples- Bills payable, creditors, short term loan , dividends payable, Bank overdraft.
- 3. Objectives of Working Capital • Cash doesn’t earn a return • Want to maintain liquidity – Take cash discounts – Maintain firm’s credit rating – Minimize interest costs – Avoid insolvency • Good cash management implies maintaining adequate liquidity with minimum cash in bank – Can place portion of cash balance into marketable securities (AKA: near cash or cash equivalents)
- 4. Factors affecting working capital requirements- • 1.Nature of the Business- certain concerns as public utility services like electricity, railways etc. provide services and not products they work on cash basis only. They require less working capital . But private business concerns make sale on credit and hence require more working capital.
- 5. 2.Length of production cycle- • The longer the time taken by raw material get converted into finished products, larger are the funds required as working capital. This is because longer time span would increase costs like labour and overheads etc.
- 6. 3.Length of working capital cycle. • It refers to the time taken by raw material to get converted into cash again. Longer the time larger is the need for working capital.
- 7. 4.Seasonal business- • Those businesses which are seasonal require more working capital during a particular season only and not during the whole year. Demand for working capital is less in off seasons.
- 8. 5.Size of the business- • Big business with large scale operations require more working capital as compared to a small business with limited scale of operations.
- 9. 6.Earning Capacity- • Firms with high earning capacity are able to generate cash profits and hence can fulfill their working capital requirements. But firms with low earning capacity require more generation of working capital.
- 10. Policies of Working Capital- • Aggressive Policy • High risk, and often high return, the aggressive working capital policy sees the company keep a really low amount of current assets. The idea here is very simple. Collect payments on time, leaving no debtors and invest that amount in the business. And pay the creditors as late as possible. This means that the business uses very little of its own cash, paying the creditors as late as it possibly can.
- 11. • It is a high risk arrangement though, because, should your creditor come asking for money, and for some reason, you don't have enough money to pay them off, you might end up having to sell a costly asset to pay off your debt to them.
- 12. aggressive policies may involve holding low levels of cash and stocks, with the risk of potential cash shortages and stock-outs conservative policies may be more flexible with higher levels of cash and stock, giving lower risk at the expense of reduced profitability Working Capital Policy (2)
- 13. Conservative Policy- • In this policy, you not only match the current assets and the current liabilities, but you also keep a little safety net just in case of any uncertainty. Undoubtedly, this is the policy with the lowest risk, but it reduces the money used in increasing the production. So this was all about which policy you can choose for your working capital. As you can see, it really depends on your business and risk appetite. So choose wisely!
- 14. Static Vs Dynamic View of working Capital- • Static View of Working Capital- • Gross Working Capital and net Working capital. • (a). Gross Working capital is equal to the total of all current assets(including loans and advances) of a company. • (b). Net working capital is defined as the difference between Gross working capital and current Liability (including provisions).
- 15. Dynamic view Of Working capital- • Working capital can be viewed as the amount of capital required for the smooth and uninterrupted functioning of the normal business operation of a company ranging from the procurement of raw materials, converting the same into finished products for sale and realizing cash along with profit from the accounts receivable that arise from the sale of finished goods on credit.
- 16. OPERATING CYCLE Stages: 1) Raw materials 2) Work-in-process 3) Finished Goods 4) Receivables (Debtors/Credit sales) Less: Creditors (creditors/Credit purchases) …...begins with acquisition of raw materials and ends with collection of receivables.
- 17. THE WORKING CAPITAL CYCLE (OPERATING CYCLE) Accounts Payable Cash Raw Materials W I P Finished Goods Value Addition Accounts Receivable SALES