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MANAGEMENT
Working capital
It refers to the funds, which a company must
operating expenses.
A. Concept :
1. Gross Working Capital (Quantitative concept)
2. Net working capital (Qualitative Concept)
B. Time base:
NWC focuses on
1. Liquidity position of the firm
NWC indicates or measures the liquidity position of the firm
To maintain liquidity position, current assets should be
sufficiently in excess of current liabilities (As buffer)
1. Judicious mix of short-term and long-term financing
NWC is the portion of current assets that should be financed by
long-term funds
This concept helps to decide the extent of long-term funds
required in finance current assets
Current Assets
Current assets are the assets which can be converted
Current Liabilities
Current
Temporary
Working Capital
Permanent
Working Capital
Time
Temporary WC
Permanent WC
Time
assets.
Investment
Criticality
o Significant for all firm but Critical for small firms
Growth
o Investment in current assets and the level of current liabilities
have to be geared quickly to change in sales.
Operating Cycle
Operating cycle is the time that elapses between the
purchase of raw materials and the collection of cash for
sales
Operating cycle is the time duration required to
Operating Cycle
The operating cycle of a manufacturing
Manufacture
of
the
product
which
includes
Operating Cycle
RAW
MATERIALS
WORK-INPROCESS
CASH
CASH SALE
DEBTORS
CREDIT
SALES
FINISHED
GOODS
Stock
arrives
Cash
Goods sold
Accounts received
Inventory
receivable
Conversion
(Debtors
Period (ICP)
Conversion period
(DCP))
Accounts
payable period
Firm receives invoice Cash paid for materials
Operating Cycle
Cash Cycle
(Cash Conversion Cycle)
(CCC)
Operating Cycle
The length of the operating cycle of a manufacturing
Is
Accounts
Receivable
period/
Debtors
Operating Cycle
Operating cycle
Inventory Conversion Period Debtors conversion Period
Average inventory
Inventory Conversion Period (ICP)
Average COGS/365
Average Accounts Receivable
Debtors Conversion Period (DCP)
Average Annual Credit sales/365
Typically, it includes:
Cash Cycle
Cash cycle is the difference between operating cycle
OF
LEVEL
OF
CURRENT
ASSETS
Consequences:
BUT
Reduces return/profitability
Consequences:
BUT
Higher return/profitability
LIQUIDITY
Conservative policy
LOW
RISK OF
INSOLVENCY Conservative policy
LOW
RETURN/
PROFITABILITY
Conservative policy
LOW
Aggressive policy
HIGH
Aggressive policy
HIGH
Aggressive policy
WC Qs.doc
Cost trade-off
Determination of optimal level of current assets involves a
Loss of sales
Cost Trade-off
Minimum
cost
C
o
s
t
Total cost
Carrying
cost
Shortage cost
2. Short-term
3. Spontaneous
Examples:
3. Spontaneous Financing
It is finance obtained in normal course of business,
Short-term funds
less costly (less return)
more flexible
more risky.
financing
There are three Working Capital Financing policies
1. Conservative Policy
2. Aggressive Policy
3. Matching/Hedging Policy
1. Conservative Policy
This policy places more emphasis on the use of long-
Level of Assets
Short Term
Financing
Long Term
Financing
Fixed Assets
Time
2. Aggressive Policy
This policy involves using more Short-term
sources of funds to finance assets.
Level of Assets
Short Term
Financing
Long Term
Financing
Fixed Assets
Time
3. Matching Policy
This policy involves matching the life of the assets with
the maturity period of the source of finance i.e.
Fixed assets are financed by long term sources of finance
Current assets are financed by short term sources of finance.
Level of Assets
Short Term
Financing
Long Term
Financing
Fixed Assets
Time