UNIT 5 WORKING CAPITAL MANAGEMENT

ASSIGNMENT

1.Do you think that an adequate working capital enables a

firm to exploit of favorable market conditions? Support
your answer with proper reasons.
Answer:-

Adequate working capital means an amount of working capital

sufficient to meet day to day operation activities of the business concern
under normal situations.
No business can run successfully without an adequate amount of
working capital. If an enterprise has an adequate working capital, it is
able to carry on its affairs without any financial stringency and
economically.
It will also be ready to face losses and unforeseen emergencies without
inviting any disaster.
Efficient working capital management helps maintain smooth
operations and can also help to improve the company's earnings and
profitability.
Management of working capital includes inventory management and
management of accounts receivables and accounts payables.
The main objectives of working capital management include
maintaining the working capital operating cycle and ensuring its ordered
operation, minimizing the cost of capital spent on the working capital,
and maximizing the return on current asset investments.

These are few ways to improve working capital:

1. Earning additional profits
2. Issuing common stock or preferred stock for cash
3. Borrowing money on a long-term basis
 4. Replacing short-term debt with long-term debt
5. Selling long-term assets for cash

An adequate working capital enables a firm to exploit of favorable

market conditions in following ways:-

• Adequate working capital helps in maintaining solvency of the

business by providing uninterrupted flow of production.
• It enables a business concern to make prompt payments and hence
helps in creating and maintaining goodwill.
• A concern having adequate working capital, high solvency and good
credit standing can arrange loans from banks and other on easy and
favorable terms.
• It enables a concern to avail cash discounts on the purchases and hence
it reduces costs. • It ensures regular supply of raw materials and
continuous production.
• A company which has ample working capital can make regular
payment of salaries, wages, etc.
• Concern with adequate working capital can exploit favorable market
conditions.
• It enables a concern to face business crisis.
• It creates an environment of security, confidence, and high morale and
creates overall efficiency in a business
 2. As a financial manager, what factors would you consider
while estimating working capital requirements of a firm?

Answer:-

As a financial manager we would consider factors affecting working

capital requirements of a firm:-

1.Nature of Business – The requirement of working capital also varies

among the enterprises depending upon the nature of the business. For
instance, trading companies require more working capital than
manufacturing companies. For service / trading firm lower to modest
working capital is required; while for manufacturing concern,
substantial WC is required.

2.Seasonality of operations – Firms which have marked seasonality in

their operations usually have high fluctuations in working capital
requirement. Some raw materials are available only in season. But, the
need of raw material is throughout the year. Hence, the company is
forced to buy the raw materials in bulk and store them for one year. If
so, more amount of working capital is required.
3.Production policy – Adequate production policy may reduce the sharp
fluctuations in WC requirement, even in seasonal firms. If the
production is carried on the basis of order, less amount of working
capital is enough. Sometimes, the production is carried on in
anticipation of demand in future. If so, more amount of working capital
is required.

4.Market conditions – Degree of competition in market place has a

strong influence on WC requirement. If competition is strong, higher
amount of WC required, otherwise if competition is weak low level of
WC will suffice.

5.Supply conditions – If supply of raw materials, spares, other goods, is

prompt, adequate and predictable, the firm can manage with small
inventory (or working capital).
 3. What methods do you suggest for estimating working capital
needs?

Answer:-

Methods of estimating working capital needs:-

1.Cash Forecasting Method: Total cash receipts and cash disbursement

for a particular period are taken into consideration under cash
forecasting method. Cash flow forecasting is important because if a
business runs out of cash and is not able to obtain new finance, it will
become insolvent. Cash flow is the life-blood of all businesses,
particularly start-ups and small enterprises. Direct cash forecasting is a
method of forecasting cash flows and balances used for short term
liquidity management purposes. Direct cash forecasting, sometimes
called the receipts and disbursements method of forecasting, aims to
show cash movements and positions at specific future points in time. An
indirect cash forecast is one that is derived from a various projected
income statements and balance sheets, generally done as part of the
planning and budgeting processes.

2.Balance Sheet Method: Closing cash and bank balances are arrived to
find the working capital. The balance sheet method (also known as the
percentage of accounts receivable method) estimates bad debt expenses
based on the balance in accounts receivable. The method looks at the
balance of accounts receivable at the end of the period and assumes that
a certain amount will not be collected.

3. Adjusted Profit and Loss Method: Working capital is forecasted on

the basis of opening cash and bank balances. Some of the items are
added and some of the items are deducted to arrive closing cash and
bank balances i.e. working capital. It gives more details of incomes and
expenses in connection with long term planning.
4. Percent of Sales Method: The relationship between sales and working
capital and its various components may be expressed as number of days
of sales; as turnover and as percentage of sales. The percent of sales
method is a financial forecasting model in which all of a business's
accounts — financial line items like costs of goods sold, inventory, and
cash — are calculated as a percentage of sales. Those percentages are
then applied to future sales estimates to project each line item's future
value.

5. Operating Cycle Method: The operating cycle refers to the period

required to convert the cash back into cash. Operating cycle method for
estimating working capital is based on the duration of the operating
cycle. Longer the period of the cycle, bigger will be the working capital
requirements.

6. Regression Analysis Method: An average relationship between sales

and working capital (current assets) and its various components has
been established for the past years. Regression analysis is a statistical
technique for quantifying the relationship between variables. In simple
regression analysis, there is one dependent variable (e.g. sales) to be
forecast and one independent variable.
 4. What recommendations would you make to improve the operating cycle of
a company?

Answer:-
Adequate working capital means an amount of working capital sufficient to meet day to
day operation activities of the business concern under normal situations. No business can
run successfully without an adequate amount of working capital. If an enterprise has an
adequate working capital, it is able to carry on its affairs without any financial stringency
and economically. It will also be ready to face losses and unforeseen emergencies
without inviting any disaster. Efficient working capital management helps maintain
smooth operations and can also help to improve the company's earnings and profitability.
Management of working capital includes inventory management and management of
accounts receivables and accounts payables. The main objectives of working capital
management include maintaining the working capital operating cycle and ensuring its
ordered operation, minimizing the cost of capital spent on the working capital, and
maximizing the return on current asset investments.

These are few ways to improve working capital:

1. Borrowing money on a long-term basis or Replacing short-term debt with
longterm debt: Borrowing money on long term basis gives you the flexibility of
repaying it in smaller amounts along with using some money for the growth of
your company.
2. Improve your inventory management: High liquidity of your current assets could
reflect insufficiency in product demand. On the other hand, large inventory may
decrease your business’s current assets due to unnecessary expenses and waste
such as increase in warehousing costs.
3. Manage expenses better to improve cash flow: With this, your working capital is
 highly affected when assets are tied up in things like inventory or unpaid invoices.
4. Automate processes for your business financing: Automate your accounts to
eliminate expensive labor costs and errors. While manual management can add
cause to delays in getting paid, automation saves money in the long run and
reflects up-to-date business financing processes in your business.
5. Work with vendors who offer good deals and discounts: Establishing a good
working relationship with your vendors will not only help you get special deals
discounts but will also help you earn your vendor’s trust.
6. Track your business performance: Looking for business financing opportunities
would be much easier for you if you have enough data to back up your claims and
promises to potential investors or loan providers.
 5. Company A is having operating cycle of 15 days, B is having an
operating cycle of 10 days which company is having better
position and why?
Answer:-

A company’s operating cycle typically consists of three primary

activities:-
1.purchasing resources
2 producing the product, and
3 distributing (selling) the product.
These activities create funds flows that are both unsynchronized
because cash disbursements usually take place before cash receipts.
 The operating cycle of a company consists of time period between the
procurement of inventory and the collection of cash from receivables.
The operating cycle is the length of time between the company’s
outlay on raw materials, wages and other expenses and inflow of cash
from sale of goods.
The duration of the operating cycle depends on the nature of industry
and the efficiency in working capital management. Quicker the
operating cycle less amount of investment in working capital is needed
and it improves the profitability. The longer the operating cycle the
greater the level of resources 'tied up' in working capital.
So according to question company B which is having operating cycle
of 10 days is in better position, because less amount of investment in
working capital is needed and it improves the profitability . On the
other hand company A having 15 days operating cycle has greater level
of resources 'tied up' in working capital.