Working Capital Management PPT _ BEC DOMS BAGALKOT MBA by BabasabPatil

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									Working Capital
 Management
            WORKING CAPITAL
   Current assets – Current liabilities
   It measures how much in liquid assets a company has
    available to build its business.
   A short term loan which provides money to buy earning
    assets.
   Allows to avail of unexpected opportunities.
   Positive working capital is required to ensure that a firm is
    able to continue its operations and that it has sufficient funds
    to satisfy both maturing short-term debt and upcoming
    operational expenses. The management of working capital
    involves managing inventories, accounts receivable and
    payable and cash.
            WORKING CAPITAL
   An increase in working capital indicates that the business has
    either increased current assets (that is received cash, or other
    current assets) or has decreased current liabilities, for
    example has paid off some short-term creditors.
     Working Capital Management
   Decisions relating to working capital and short term financing are
    referred to as working capital management. Short term financial
    management concerned with decisions regarding to CA and CL.
   Management of Working capital refers to management of CA as well as
    CL.
   If current assets are less than current liabilities, an entity has a working
    capital deficiency, also called a working capital deficit.
   These involve managing the relationship between a firm's short-term
    assets and its short-term liabilities.
     Working Capital Management
   The goal of working capital management is to ensure that the firm is able
    to continue its operations and that it has sufficient cash flow to satisfy
    both maturing short-term debt and upcoming operational expenses.
   Businesses face ever increasing pressure on costs and financing
    requirements as a result of intensified competition on globalised markets.
    When trying to attain greater efficiency, it is important not to focus
    exclusively on income and expense items, but to also take into account the
    capital structure, whose improvement can free up valuable financial
    resources
          WORKING CAPITAL MANAGEMENT




 Active working capital management is an extremely
  effective way to increase enterprise value.
  Optimising working capital results in a rapid release
  of liquid resources and contributes to an
  improvement in free cash flow and to a permanent
  reduction in inventory and capital costs, thereby
  increasing liquidity for strategic investment and debt
  reduction. Process optimisation then helps increase
  profitability.
        WORKING CAPITAL MANAGEMENT


 The fundamental principles of working capital
  management are reducing the capital
  employed and improving efficiency in the
  areas of receivables, inventories, and
  payables.
          Why working Capital is important?


 Investment in CA represents a substantial
  portion of total investment.
 Investment in CA and level of CL have to be
  geared quickly to changes in sales.
    Concepts of Working Capital
 Gross Working Capital
 Net working Capital
        Gross Working Capital
 Total Current assets
 Where Current assets are the assets that can
  be converted into cash within an accounting
  year & include cash , debtors etc.
 Referred as “Economics Concept” since assets
  are employed to derive a rate of return.
          Net Working Capital
 CA – CL
 Referred as ‘point of view of an Accountant’.
 It indicates liquidity position of a firm &
  suggests the extent to which working capital
  needs may be financed by permanent sources
  of funds.
CONSTITUENTS OF WORKING
        CAPITAL
 CURRENT ASSETS
   Inventory
   Sundry Debtors
   Cash and Bank Balances
   Loans and advances
 CURRENT LIABILITIES
   Sundry creditors
   Short term loans
   Provisions
              Characteristics of Current Assets


 Short Life Span
  I.e. cash balances may be held idle for a week or two
   , thus a/c may have a life span of 30-60 days etc.
 Swift Transformation into other Asset forms
 I.e.each CA is swiftly transformed into other asset
   forms like cash is used for acquiring raw materials ,
   raw materials are transformed into finished goods
   and these sold on credit are convertible into A/R &
   finlly into cash.
            Matching Principle
 If a firm finances a long term asset(like machinery)
  with a S-T Debt then it will have to be periodically
  finance the asset which will be risky as well as
  inconvenient.
 i.e. maturity of sources of financing should be
  properly matched with maturity of assets being
  financed.
 Thus Fixed Assets & permanent CA should be
  supported with L-T sources of finance & fluctuating
  CA by S-T sources.
MATCHING PRINCIPLE
       Need for Working Capital
 As profits earned depend upon magnitude of sales
  and they donot convert into cash instantly, thus there
  is a need for working capital in the form of CA so as
  to deal with the problem arising from lack of
  immediate realisation of cash against goods sold.
 This is referred to as “Operating or Cash Cycle” .
 It is defined as “The continuing flow from cash to
  suppliers, to inventory , to accounts receivable &
  back into cash “.
       Need for Working Capital
 Thus needs for working capital arises from cash or
  operating cycle of a firm.
 Which refers to length of time required to complete
  the sequence of events.
 Thus operating cycle creates the need for working
  capital & its length in terms of time span required to
  complete the cycle is the major determinant of the
  firm’s working capital needs.
        Operating or Cash Cycle
1.   Conversion of cash into inventory
2.   Conversion of inventory into Receivables
3.   Conversion of Receivables into Cash
 OPERATING CYCLE

       Phase 3
                 Receivables

                       Phase 2
Cash
                 Inventory
       Phase 1
TYPES OF WORKING CAPITAL
 PERMANENT WORKING CAPITAL
 VARIABLE WORKING CAPITAL
          PERMANENT WORKING CAPITAL



 THERE IS ALWAYS A MINIMUM LEVEL OF
  CA WHICH IS CONTINOUSLY REQUIRED BY
  A FIRM TO CARRY ON ITS BUSINESS
  OPERATIONS.
 THUS , THE MINIMUM LEVEL OF
  INVESTMENT IN CURRENT ASSETS THAT IS
  REQUIRED TO CONTINUE THE BUSINESS
  WITHOUT INTERRUPTION IS REFERRED AS
  PERMANENT WORKING CAPITAL.
             VARIABLE WORKING CAPITAL


   THIS IS THE AMOUNT OF INVESTMENT REQUIRED
    TO TAKE CARE OF FLUCTUATIONS IN BUSINESS
    ACTIVITY OR NEEDED TO MEET FLUCTUATIONS IN
    DEMAND CONSEQUENT UPON CHANGES IN
    PRODUCTION & SALES AS A RESULT OF SEASONAL
    CHANGES.
             DISTINCTION
   PERMANENT IS STABLE OVER TIME WHEREAS
    VARIABLE IS FLUCTUATING ACCORDING TO
    SEASONAL DEMANDS.
   INVESTMENT IN PERMANENT PORTION CAN BE
    PREDICTED WITH SOME PROFITABILITY WHEREAS
    INVESTMENT IN VARIABLE CANNOT BE PREDICTED
    EASILY.
   WHILE PERMANENT IS MINIMUM INVESTMENT IN
    VARIOUS CA , VARIABLE IS EXPECTED TO TAKE
    CARE FOR PEAK IN BUSINESS ACTIVITY.
             DISTINCTION
   WHILE PERMANENT COMPONENT REFLECTS THE
    NEED FOR A CERTAIN IRREDUCIBLE LEVEL OF
    CURRENT ASSETS ON A CONTINOUS AND
    UNINTERRUPTED BASIS , THE TEMPORARY
    PORTION IS NEEDED TO MEET SEASONAL & OTHER
    TEMPORARY REQUIREMENTS.
   ALSO PERMANENT CAPITAL REQUIREMENTS
    SHOULD BE FINANCED FROM L-T SOURCES , S-
    TFUNDS SHOULD BE USED TO FINANCE
    TEMPORARY WORKING CAPITAL NEEDS OF A FIRM,
  OPERATING
ENVIRONMENT OF
WORKING CAPITAL
  CHAPTER 2
      Monetary and Credit Policies
   Monetary policy is the process by which the govt.,central bank, or
    monetary authority of a country controls (i) the supply of money, (ii)
    availability of money, and (iii) cost of money or rate of interest, in order
    to attain a set of objectives oriented towards the growth and stability of the
    economy.
   Monetary policy is the process by which the government, central bank, or
    monetary authority of a country controls (i) the supply of money, (ii)
    availability of money, and (iii) cost of money or rate of interest, in order
    to attain a set of objectives oriented towards the growth and stability of the
    economy.Monetary theory provides insight into how to craft optimal
    monetary policy.
   Monetary policy involves variations in money supply , interest rates ,
    lending by commercial banks etc.
                         Credit Policy
   Credit gives the customer the opportunity to buy goods and services, and
    pay for them at a later date.
 Clear, written guidelines that set
 (1) the terms and conditions for supplying goods on credit ,
 (2) customer qualification criteria
 (3) procedure for making collections , and
 (4) steps to be taken in case of customer delinquency . Also called collection
    policy.
 Where delinquency means Failure to repay an obligation when due or as
    agreed. Thus in consumer installment loans, missing two successive
    payments will normally make the account delinquent
       Advantages of credit trade

   Usually results in more customers than cash trade.
   Can charge more for goods to cover the risk of bad debt.
   Gain goodwill and loyalty of customers.
   People can buy goods and pay for them at a later date.
   Farmers can buy seeds and implements, and pay for them only
    after the harvest.
   Stimulates agricultural and industrial production and commerce.
   Can be used as a promotional tool.
   Increase the sales.
    Disadvantages of credit trade

   Risk of bad debt.
   High administration expenses.
   People can buy more than they can afford.
   More working capital needed.
   Risk of Bankruptcy.
Instruments of Monetary Policy in
              India
   Money Supply
   Bank Rate
   Reserve Ratios
   Interest Rates
   Selective Credit Controls
   Flow of Credit
                    Money Supply
   This is the sum total of money public funds and can be used
    for settling transactions to buy and sell things and make other
    payments constitutes the money supply of a nation.
   Money supply = Notes and coins with public + Demand
    deposits with Commercial papers
                           Bank Rate
   Standard rate at which bank is prepared to buy or rediscount bills of
    exchange or other commercial papers eligible for purchase under Reserve
    bank of India Act,1934.
   The rate of interest charged by central bank on their loans to commercial
    banks is called bank rate(Discount rate).
   An increase in bank rate makes it more expensive for commercial banks to
    borrow . This exerts pressure to bring about the rise in interest rates
    (lending rates) charged by commercial banks on their lending to public.
    This leads to a general tightening in economy.
   Whereas decrease in bank rate has the opposite effect and leads to general
    easing of credit in the economy.
    RESERVE REQUIREMENTS
   The reserve requirement (or required reserve ratio) is a bank
    regulation that sets the minimum reserves each bank must hold to
    customer deposits and notes. These reserves are designed to satisfy
    withdrawal demands, and would normally be in the form of fiat
    currency stored in a bank vault(vault cash), or with a central bank.
   The reserve ratio is sometimes used as a tool in the monetary policy,
    influencing the country's economy, borrowing, and interest rates
    .Western central banks rarely alter the reserve requirements because it
    would cause immediate liquidity problems for banks with low excess
    reserves; they prefer to use open market operations to implement their
    monetary policy
   RESERVE REQUIREMENTS
 Thus central bank makes it legally obligatory
   for commercial banks to keep a certain
   minimum percentage of deposits in reserve.
 These are of 2 types:-
1. Cash reserves

2. Liquidity reserves
                     CRR
 CASH RESERVE RATIO
 THIS IS DEFINED AS A cash reserve ratio
  (or CRR) is the percentage of bank reserves to
  deposits and notes. The cash reserve ratio is
  also known as the cash asset ratio or liquidity
  ratio.
      STATUTORY LIQUIDITY
            RATIO
 Statutory Liquidity Ratio (SLR) is a term used in
  the regulation of banking in India. It is the amount
  which a bank has to maintain in the form:
 Cash
 Gold valued at a price not exceeding the current
  market price,
 Unencumbered approved securities (G Secs or Gilts
  come under this) valued at a price as specified by the
  RBI from time to time.
                 STATUTORY LIQUIDITY RATIO

   The quantum is specified as some percentage of the total demand and time
    liabilities ( i.e. the liabilities of the bank which are payable on demand anytime,
    and those liabilities which are accruing in one months time due to maturity) of a
    bank. This percentage is fixed by the Reserve Bank of India. The maximum and
    minimum limits for the SLR are 40% and 25% respectively.
   Following the amendment of the Banking regulation Act(1949) in January 2007,
    the floor rate of 25% for SLR was removed. Presently the SLR is 24% with effect
    from 8 November, 2008.
   The objectives of SLR are:
   To restrict the expansion of bank credit.
   To augment the investment of the banks in Government securities.
   To ensure solvency of banks. A reduction of SLR rates looks eminent to support
    the credit growth in India.
              INTEREST RATES
   This is generally done by stipulating min. rates of interest for
    extending credit against commodities covetred under
    selective credit control.
   Also, concessive or ceiling rates of interest are made
    applicable to advances for certain purposes ao to certain
    sectors to reduce the interest burden and thus facilitate their
    development.
   Further obj. behind fixing rates on deposits are to avoid
    unhealthy competition amongst the banks for deposits and
    keep the level of deposit rates in alignment with lending rates
    of banks for deposits.
       Selective Credit Controls
 These are Qualitative instruments which are
  aimed at affecting changes in the availability
  of credit with respect to particular sectors of
  the economy.
 Thus selective controls are called selective
  because they are aimed at movement of credit
  towards selective sectors of the economy.
        Selective Credit Controls
 The general instruments such as Reserve ratios,
  Bank rate and open market operations.
 They are called so because they influence the
  nation’s money supply and general availability of
  credit.
 Quantitative instruments are called quantitative
  because they affect the total volume(quantity) of
  money supply and credit in the country.
        Selective Credit Controls
 The most widely used qualitative techniques are
  selective control and moral suasion.
 While the general credit controls operate on the cost
  and total volume of credit , selective credit controls
  relate to tools available with the monetary authority
  for regulating the distrubution or direction of bank
  resources to particular sectors of economyin
  accordance with broad national priorities considered
  necessary for achieving the set.
       MORAL SUASION
 IT IMPLIES THE CENTRAL BANK
  EXERTING PRESSURE ON BANKS BY
  USING ORAL AND WRITTEN APPEALS
  TO EXPAND OR RESTRICT CREDIT IN
  LINE WITH ITS CREDIT POLICY.
  DETERMINATION OF
WORKING CAPITAL NEEDS

     CHAPTER 3
 Different approaches in determination of
             working capital
 Industry norm approach
 Economic modeling approach
 Strategic choice approach
INDUSTRY NORM APPROACH
 THIS APPROACH IS BASED ON THE
  PREMISE THAT EVERY COMPANY IS
  GUIDED BY THE INDUSTRY PRACTICE.
 LIKE IF MAJORITY OF FIRMS HAVE
  BEEN GRANTING 3 MONTHS CREDIT
  TO A CUSTOMER THEN OTHERS WILL
  HAVE TO ALSO FOLLOW THE
  MAJORITY DUE TO FEAR OF LOSING
  CUSTOMERS.
   ECONOMIC MODELLING
        APPROACH
 TO ESTIMATE OPTIMUM INVENTORY
  IS DECIDED WITH THE HELP OF EOQ
  MODEL.
     STRATEGIC CHOICE
        APPROACH
 THIS APPROACH RECOGNISES THE
  VARIATIONS IN BUSINESS PRACTICE
  AND ADVOCATES USE OF
  STRATEGYIN TAKING WORKING
  CAPITAL DECISIONS.
 THE PURPOSE BEHIND THIS
  APPROACH IS TO PREPARE THE UNIT
  TO FACE CHALLENGES OF
  COMPETITION & TAKE A STRATEGIC
  POSITION IN THE MARKET PLACE.
     STRATEGIC CHOICE
        APPROACH
 THE EMPHASIS IS ON STRATEGIC
  BEHAVIOUR OF BUSINESS UNIT.THUS
  THE FIRM IS INDEPENDENT IN
  CHOOSING ITS OWN COURSE OF
  ACTION WHICH IS NOT GUIDED BY
  THE RULES OF INDUSTRY,
    Determinants of working capital
   General nature of business
   Production cycle
   Business cycle
   Credit policy
   Production policy
   Growth and expansion
   Profit level
   Operating efficiency

								
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