Working Capital Management

Working Capital Concepts

Gross Working Capital
The firm’s investment in current assets.

Net Working Capital

Current Assets - Current Liabilities.
Working Capital Management
The administration of the firm’s current assets
and the financing needed to support current
assets.
Tracing Cash and Net Working
Capital
 Current Assets are cash and other assets that
are expected to be converted to cash within
the year.
 Cash
 Marketable securities
 Accounts receivable
 Inventory
 Current Liabilities are obligations that are
expected to require cash payment within the
year.
 Accounts payable
 Accrued wages
Balance Sheet Model of the Firm

Net Current
Current Assets
Working Liabilities
Capital
Long-Term
How much short- Debt
Fixed Assets
term cash flow
1. Tangible does a company Shareholders’
need to pay its Equity
2. Intangible
bills?
The Operating Cycle and the Cash Cycle
Raw material
Cash
purchased Finished goods sold
received
Order Stock
Placed Arrives

Inventory period Accounts receivable period

Time
Accounts payable period

Firm receives invoice Cash paid for materials

Operating cycle

Cash cycle
The Operating Cycle and the Cash Cycle

Accounts
Cash cycle = Operating cycle – payable
period

 In practice, the inventory period, the

accounts receivable period, and the
accounts payable period are measured by
days in inventory, days in receivables, and
days in payables.
The Operating Cycle and the Cash
Conversion Cycle
Inventory conversion period
plus: Receivable collection period
equals: Operating cycle
minus: Payables deferral period
equals: Cash conversion cycle

 Shortening cash conversion cycle frees up cash

to reinvest in business or to reduce debt and
interest
A Look at Operating and Cash Cycles
Receivab Inventor Operatin Payable Cash
le Period y Period g Cycle Period Cycle
(Days) (Days) (Days) (Days) (Days)
Textile 85 110 195 58 137
FMCG 23 69 92 118 -26
Auto 31 40 71 69 2
Electronic 133 152 285 110 175
s
Metals 34 102 136 76 60

Maruti 8 14 22 49 -27
HUL 14 23 37 90 -53
Working Capital Needs of Different Firms
Permanent and Temporary Working Capital

 Working capital is permanent to the extent

that it supports constant or minimum level of
sales

 Temporary working capital supports seasonal

peaks in business
Working Capital Policy

 Firm must set policy on following issues:

 How much working capital is used
 Extent to which working capital is supported by
short- vs. long-term financing
 How each component of working capital is
managed
 The nature/source of any short-term financing
used
Cash Management
Key Concepts and Skills
 Understand the reasons for holding cash
balances, as well as potential methods for
determining the target cash balance
 Understand the concept of float, as well as
tools for managing disbursement and
collections float
Reasons for Holding Cash
 Transactions motive
 Ability to cover normal activities of the firm
 Precautionary Motive
 Cash as a safety margin to act as a financial
reserve
 Speculative Motive
 Ability to exploit some profitable opportunities,
which are out of the normal course of business
Float
 The difference between bank cash and book
cash is called float.
 The delay in time between the disbursement
of a check to its clearing through the bank
system.
 Float management involves controlling the
collection and disbursement of cash.
Accelerating Collections
Customer Company Company
Cash
mails receives deposits
received
payment payment payment

time
Mail Processing Clearing
delay delay delay

Mail Processing Clearing

float float float

Collection float
Overview of Lockbox
Processing
Corporate Corporate Corporate Corporate
Customers Customers Customers Customers

Post Office Post Office

Box 1 Local Bank Box 2
Collects funds
from PO Boxes

Envelopes opened;
separation of
checks and receipts

Details of receivables Deposit of checks

go to firm into bank accounts

Firm processes Bank clears checks

receivables
Delaying Disbursements

Firm prepares
check to supplier
1. Write check on a distant
bank.
Post Office 2. Hold payment for several
processing
days after postmarked in
Delivery of check office.
to supplier
3. Call supplier firm to verify
statement accuracy for
Deposit goes to
supplier’s bank large amounts.
4. Mail from distant post
Bank collects funds office.
5. Mail from post office that
requires a great deal of
Investing Idle Cash
 A firm with surplus cash can park it in the
money market.
 Some large firms and many small ones use money
market mutual funds.
 Firms have surplus cash for three reasons:
 Seasonal or Cyclical Activities
 Planned Expenditures
 Different Types of Money Market Securities
Credit Management
Terms of the Sale
 The terms of sale are composed of
 Credit Period
 Cash Discounts
Credit Period
 Credit periods vary across industries.
 Generally a firm must consider three factors in
setting a credit period:
 The probability that the customer will not pay
 The size of the account
 The extent to which goods are perishable
 Lengthening the credit period generally
increases sales
Cash Discounts
 Often part of the terms of sale
 There is a tradeoff between the size of the
discount and the increased speed and rate of
collection of receivables.
 An example would be “3/10, net 30”
 The customer can take a 3% discount if s/he pays
within 10 days.
 In any event, s/he must pay within 30 days.
Credit Analysis
 Credit Information
 FinancialStatements
 Credit Reports on Customer’s
Payment History with Other Firms
 Banks
 Customer’s Payment History with
the Firm
Collection Effort
 Most firms follow a protocol for customers
that are past due:
1. Send a delinquency letter
2. Make a telephone call to the customer
3. Employ a collection agency
4. Take legal action against the customer
Collection Effort
 There is a potential for a conflict of interest
between the collections department and the
sales department.
 You need to strike a balance between
antagonizing a customer and being taken
advantage of by a deadbeat.
Factoring
 The sale of a firm’s accounts receivable to a
financial institution (known as a factor)
 The firm and the factor agree on the basic
credit terms for each customer.

The factor pays an agreed-

upon percentage of the
accounts receivable to the
Customers send firm. The factor bears the
payment to the risk of nonpaying
Factor
factor. customers.

Customer Firm
Goods
Remember

Cash is king

Balance is key
FM S02 Conclusion
Course Objectives
 To give you the big picture of FM II so that you can
understand how things fit together
 You can forget the details, but don’t miss
the story.

 To give you the capacity to understand the modern

finance theories and apply, in real world situations, the
techniques that have been developed in Financial
Management
Larger Picture
 Shareholder’s wealth maximization
Bigger Picture

Capital structure
Companies /Financing Investors
decision

Capital budgeting
/Investments
decision

Projects
Dividend decision
Lessons Learnt

 Leverage
 Operating Leverage
 Financial Leverage
 Basics of Capital Structure
 Dividend Controversy
 Working capital management
 Financing of Firms (short term and long
term)
I hope you found the sessions informative
and engaging.

I look forward to seeing you in Behavioural

Finance & Value Investment

Keep learning and growing!

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