Working Capital Management

CA CHANDNI BHAGAT
 What is working capital ?

Working capital is the operational liquidity of

business.
Its management is concerned with short term
financial decisions.
WC can be defined as the excess of CA over CL.
All the elements of working capital are quick moving
in nature and hence require constant monitoring for
proper management. This is WCM.
 Basic Ratios

1. Working Capital = CA – CL
2. Current ratio = CA/CL
3. Gross working Capital – the term gross refers to the
company’s investment in current assets.
4. Net working capital – when CL is deducted from Gross WC
it is called Net WC.
Current Assets are the assets that are converted into cash
within 1 year eg, Cash, Accounts receievable, Inventory, etc
Current liability are the short term liabilities that are payable
within an year. Eg, Cash credit, overdraft, creditors,
outstanding etc.
 If CA > CL
• Company can meet its
If CL > CA
short term liabilities
Company cant meet its
• If CR is 1.2 – 2 , means the
short term liabilities
Operating company is efficiently
inefficiencies. utilising its working
Low employee morale capital.
May have to raise • CR > 3
additional finance Company is comfortable to
High liquidity Risk meet its STL but; funds are
Risk of Insolvency either kept idle, or locked
in stocks/recevables.
 Ratios calculated to assess working capital efficiency

Current Ratio
Liquid ratio
Current assets to total assets
Inventory turnover ratio
Debtors turnover ratio
Current assets turnover ratio
Working capital turnover ratio
 Estimation of Working Capital

Raw material inventory –

Production(units) x Cost of raw material per unit x Avg inventory
holding period
12 months/365 days/ 52 weeks
WIP Inventory-
Production(units) x Cost of WIP per unit x Avg span of WIP in
Inventory
12 months/365 days /52 weeks
Finished goods Inventory
Production(units) x Cost of goods produced x Finished goods
holding period
12 months/365 days /52 weeks
Debtors –
Credit sales x SPx Avg debt collection period
12 months/365 days /52 weeks
Cash – Depends on organisation to organisation
Creditors –
Credit purchase or production x Raw material cost pu x credit
period allowed by creditors
12 months/365 days /52 weeks
Labour & Overheads –
Production (units) x Labour or OH cost pu x Avg time lag in
payment
12 months/365 days /52 weeks
 Extras

Factory cost/ cost of production = Mat + Lab + O/H

COGS = Factory cost + Selling & Distribution exp
Sales – COGS = Profit
How to calculate WC required by a firm (in
exams)
WC = CA - CL
Current Assets(CA) Current Liability(CL)
Stock – RM, WIP, FG (calc) Creditors
Debtors – (Calc) O/S exp – labour Cash – take if
given Overheads,S&D
Question 1. Estimate the working capital requirement for MM Ltd.
Particulars Amt.
Raw material 80
Estimated cost of production --- Direct labour 30
Overhead 60
Cost of production pu. 170
Add. Info – SP 200 Rs pu
Level of activity – 1,04,000 units of production
Raw material in stock – avg 4 weeks
WIP - avg 2 weeks(50% complete)
FG – avg 4 weeks
Credit allowed by suppliers – avg 4 weeks
Credit allowed to debtors – avg 8 weeks
Lag in payment of wages – avg 1.5 weeks
No lag in payment of O/H
Cash at bank expected to be 25,000
 Working capital Estimation
  Current Asset        
1 Stock RM 104000x80x4   640000   
    52        
  WIP 104000x170x2 x50% 340000   
    52        
  FG 104000x170x4   1360000 2340000 
    52        
2 Debtors   104000x170x8     2720000 
    52        
3 Cash given       25000 5085000
               
  Current Liability        
4 Creditors   104000x80x4     640000 
    52        
5 OS Labour 104000x30x1.5     90000 
  Expenses   52        
  O/H No lag     -- 730000
             
Working Capital
            4355000
 Question 2. ABC ltd furnishes the following estimates:
Calculate the working capital for the company(exam question)
Elements of cost - Material 40%
• - LABOUR 20%

• - O/H 20%

Following particulars are available –

a) Level of activity – 2,00,000 units
b) SP Rs 12 pu
c) RM to be in store for avg 1 month
d) Materials to be in process for an avg half a month
e) Finished good will be in stock for avg one month
f) Credit allowed to debtors is 2 months
g) Credit allowed by suppliers is 1 month
 Working capital Estimation
  Current Assets
1 Stock RM 200000x4.8x1 80000   
    12      
  WIP 200000x9.6x0.5 80000   
    12      
  FG 200000x9.6x1 160000 320000 
    12      
2 Debtors   200000x9.6x2   166400 
    12      
3 Cash given     -- 486400
             
  Current Liability
4 Creditors   200000x4.8x1   80000 
    12      
OS
5 Expenses Labour No lag   --  
           
  O/H No lag   -- 80000
           
  Working Capital     406400
 Question 3

X ltd has a total sales of Rs 60,00,000. The expected

profit is 10% on turnover. And material/ lab/ o/h are
expected to be 30%,20%, 30% respectively of the total cost
of goods sold.
At the end of each year, raw material stock would amount
to 2 months consumption, WIP to one month of factory
cost, and finished goods to half a month of total cost.
There is a 2 month credit period allowed to customers and
reced by suppliers.
The company has a policy of carrying cash equal to one
month requirement of labour , o/h and selling/distb exp.
Calculate the working capital requirement.
 Solution

Estimated Sales 600,000

- profit (10%) 60000
COGS 5,40,000
Material (30%) 162000
Labour (20%) 108000
O/heads( 30%) 162000
Factory Cost = Mat + Lab + O/h = 432000
COGS = Factory cost + Selling and distrb
Selling and Distrb = 540000- 432000 = 108000
Estimation of Working Capital
Current Assets
RM = 27000
WIP= 36000
Finished stock = 22500
Debtors= 100000
Cash = 31500 217000
Current liability
Creditors 30000 -30000
WC = 187000
 Question 4 (exam question)

Prepare the working capital requirement from te following

info:
Avg collection period - 60 days
Avg payment period – 75 days
Inventory holding period – 90 days
(Calculated with reference to COGS)
Cash & Bank Balance – 2.5% of Sales
Sales Rs. 1,20,00,000 Gross profit -25%
Credit Purchase = 1/3rd of the COGS
The co expects 50% sales increment during the next year.
Assume 1 year = 360days
 Question 5 (exam question)

From the information taken from the budget of RK ltd. Prepare a statement
showing avg amount of working capital required by the company.Using
operating cycle method, estimated annual sales is Rs 2,00,000 units @10 Rs
p.u.
Production & sales qty coincide and will be carried out evenly during the year.
Estimated cost of production is as under:
Material – Rs 5 p.u.
Labour – Rs. 2 p.u.
O/Hs - Rs. 1.75 p.u
60 days credit is allowed to customers & 50 days credit is available from
supplier. 40 days supply of raw material and 15 day supply ofd finished goods
are kept in the stores. Production cycle is of 20 days.
A cash balance equal to 1/3rd of avg of other Working capital is kept for
contingencies.
 Operating Cycle
We will hardly find a firm which doesnt require WC for its day to day
operations.
However management of WC is mostly critical in manufacturing
business. The need of WCM is critical because of the time gap that
arises between production of goods and their actual realisation after
sales.
This time gap is technically called as operating cycle or working
capital cycle.
If depriciation is excluded from expenses in the operating cycle it is
called cash operating cycle.
The WC requirement can be estimated with the duration of
operating cycle. The longer the OC, the larger the WC
requirement.
The reduction in operating cycle will improve the cash
conversion cycle and ultimately improves the profitabilty of the
firm.
 Calculation of Operating cycle

The operating cycle of a company consist of time

period between the procurement of inventory and
the collection of cash from recievables.
Operating cycle period Duration
(days)
Raw material holding period xxx
+ Work in progress period xxx
+ Finished goods holding period xxx
+ Receivables collection period xxx
(-) Creditors payment period xxx
Net operating cycle xxx
How to calculate working capital using operating cycle

The longer the operating cycle, the higher the

requirement of working capital and vice versa.
WC =
(estimated COGS x operating cycle) + Desired cash
365 or 52 or 12
 Question 6

Manchester Ltd. expects its cost of goods sold for

2017 to be 136 crores. The operating cycle for the
year is 54 days. What is the expected WC. if the co.
wants to maintain a cash balance of 1.5 crores.
Sol:
360 day ---- 136 crore
54 days ---- 136/360
WC = 136 x 54 = 20.4 crores + 1.5 crores = 21.9 cr
360
 Calculation of holding period

Raw material = Avg RM stock x 365

holding period Annual Purchases/consumption
WIP period = Avg WIP x 365
Annual COGS/Annual cost of production
Finished goods = Avg finished goods stock x 365
holding period Annual COGS
Receivable collection period = Avg Receivable x 365
Annual Credit Sales
Creditors payment period = Avg Creditors x 365
Annual Credit purchases
Annual consumption(RM) = Op RM + RM purchase -
Cl RM
Annual Cost of production = Annual consumption
(RM)+ Direct Labour + Factory O/H + (op WIP – cl
WIP)
COGS(Cost of goods sold) = Cost of Production +
Selling & Distribution
Sales = COGS + Profit
 Question 7.

From the following data, compute the duration of

operating cycle for ABC enterprises. (fig’s in 000’s)
Assume 360 days for computational purpose:
Particulars `Amount
Stocks
- Raw material 20
-WIP 14
-FG 21
Purchases 96
COGS 140
Sales 160
Debtors 32
Creditors 16
Operating cycle period
Duration (days)
Raw material holding period (purchases/credit purchase)
96000 – 360
20000 – x 360/9600075 days
+ Work in progress period( Factory cost/ COGS)
140000 – 360
14000- x 360/140000 36 days
+ Finished goods holding period ( Factory cost/ COGS)
140000- 360
21000 x 360/140000 54 days
+ Receivables collection period (Sales/ credit sales)
160000- 360
32000 x 360/160000 72 days
(-) Creditors payment period (purchases/credit purchase)
96000-360
16000 x 360/96000 (60 days)
(-) O/s expenses holding period -----------------------------------------
Net operating cycle 177 days
 Components of WCM

Inventory Management
Receivables management
Cash Management
 Inventory Management

In a manufacturing unit 20 t0 30% of the total assets are

usually in inventory and any effort in stock control will
bring major benefits for the enterprise.
An efficient management of inventory is an essential
requirement for the success of enterprise.
The production manager and the finance manager of the
company should know the items of inventory,
classification of inventory and related costs before
taking any steps for inventory management.
The efficiency shown in inventory will have a direct
impact on profitability.
 Features of Ideal Inventory policy

Proper Accounting And Physical Controls

Proper Storage to avoid spoilage, breakage, Wastage
etc
Fixation of Inventory Levels like Reorder level,
Minimum Level, Maximum Level, Economic Order
Quantity
Regular monitoring of inventory movements
Reducing investment in slow moving stock
Disposal of non moving stock and scrap
 Techniques

Inventory turnover ratio – higher the better

EOQ(Economic order Qty) – efficient ordering and
storage cost = 20000 UNITS
Inventory level – reorder level, minimum and
maximum stock levels, danger level
JIT ( Just in time ) Inventory Management
ABC Analysis/ Class of Items % of Items % of value

Pareto analysis A 15 80
B 35 15
C 50 5
100 100
 Receivables Management

A typical manufacturing company has a receivable around 20-

25%.This represents a considerable investment of funds and so
the management of these assets can have significant effect on the
profit performance of the company
Receivable balance as shown in the Balance Sheet of the
company relates to sales made on credit for which the payment
has not yet been received.
A retail trade will do his business mostly on cash basis whereas a
manufacturing concern will have a heavy balance in receivables
The management of receivables broadly covers the study of credit
policy, credit analysis, credit control, management of
investments and increase in efficiency of short term funds.
 Credit Policy

Points to be kept in mind for setting up credit policy

 Credit period for general customers
 Credit period for special customers
 Cash Discount policy on purchases
 Establishment Management Information System of Debtor
ageing
 Collection policy of debtors balance
 Credit Insurance for risk of Bad Debts
 Steps for recovery for bad and doubtful debts
 Techniques

Cash Discount
Debtor turnover ratio
Ageing Analysis
ABC Analysis
Credit Control / policy
 Cash Management

There is an inverse relation in liquidity and profitability. Higher the

liquidity, less will be the profitability.

The basic objectives of CM are :

 To ensure availability of cash as per payment schedule.
 To minimise the amount of idle cash.

Effective cash management requires:

 Improving forecast of Cash flows
 Accelerating collections
 Using floats
 Controlling disbursements
 Getting available funds to where they are needed.
 Motives for holding cash

Transaction motive
Precautionary motive
Speculative motive
Future requirements
 Methods of Improving Liquidity

Good Inventory Management

Rapid Stock Turnover
Disposal of Unnecessary Assets
Sale of Loss Making Divisions and Brands
Conversion of Debt into Shares
Taking Customer Deposit
Account Receivable Management