Working Capital Management: Presented by

WORKING CAPITAL MANAGEMENT
Presented by:
Nishant Gupta
Pranshu Agrawal
WHAT IS WORKING CAPITAL?
 Working capital can be defined in two ways:
o Gross Working Capital
o Net Working Capital
 Gross Working Capital can be defined as the investment made in

current assets.
 Net Working Capital can be defined as the difference between current

assets and current liabilities.
 It measures how much in liquid assets a company has available to build its
business.
CONCEPT OF WORKING CAPITAL
TOTAL
GROSS WORKING CAPITAL(GWC) CURRENT
ASSETS
(CA)
NET WORKING CAPITAL(NWC)

CURRENT ASSETS(CA)
-
CURRENT LIABILITIES(CL)
POSITIVE NWC NEGATIVE NWC

CA>CL CA<CL
Purchases Payment Credit sale
Collection
RMCP+WIPCP+FGC
P
Inventory conversion period Receivables conversion period
Gross operating Cycle
Payable Net operating cycle
Operating Cycle of a Manufacturing

Firm
WORKING CAPITAL MANAGEMENT
 working capital management is concerned with decisions regarding to
current assets & current liabilities.
 Three important points to be considered:

1: Time is very imp. Factor consequently discounting and compounding
techniques,
2: A risk return trade off is involved in holding excess current assets,
3: Levels of fixed as well as current assets depend upon expected sales, but
it is only current assets which can be adjusted with sales fluctuations in
the short run
CIRCULAR FLOW OF CAPITAL
INVENTORIES
ION SA
T LE
ODU S
PR
OPERATIONS RECEIVABLES
OP
EX ERA O NS
PE T I
NS NG TI
ES L EC
L
CO
CASH
Inventory management
Nature of Inventories
Inventories are stock of the product a company is manufacturing for sale and
components that make up the product.
Inventories constitute the most significant part of assets.
The forms of Inventories are :

1) Raw Material
2) Work in Process
3) Finished Goods
Inventory Management
 The inventory management is to ensure availability of materials in

sufficient quantity as and when required and also to minimize
investment in inventories.
 On an average, inventories are approximately 60% of current

assets in Public Ltd. Companies in India.
 Its imperative to manage inventories effectively and efficiently in

order to avoid unnecessary investment.
NEED TO HOLD INVENTORIES
 Transactions motive:- to facilitate smooth production and sales
operations.
 Precautionary motive:-to guard against the risk of unpredictable

changes in demand and supply forces and other factors.
 Speculative motive:-to take advantage of price fluctuations.

OBJECTIVES OF INVENTORY MANAGEMENT
 To maintain an efficient and smooth production of finished goods for
uninterrupted sales operations.
 To maintain a minimum investment in inventories to maximize profitability.
 Ensure a continuous supply of raw materials to facilitate uninterrupted

production.
 Maintain sufficient stocks of raw materials in periods of short supply and

anticipate price changes.
Receivables
Management
 Receivables is defined as the debt owed to the firm by customers
arising from sale of goods and services in the ordinary course of
business.
 When a firm makes an ordinary sale of goods and services and

does not receive payments the firm grants trade credits and creates
accounts receivable which could be collected in future.
 Receivables management is also called trade credit management

OBJECTIVES
 Achieving growth in sales and profits
 Meeting competition
 Establish and communicate the credit policies
 Evaluation of customers and setting credit limits
 Ensure prompt and accurate billing

Cash management
Managing an entity’s Resources
The Manager
Resource Decisions Cash Management

Inventory Management
Working Capital Management
Investment Decisions Investment in Human Capital
Long-term Assets
Accounts Receivable
Operating
Decisions
Recruitment, Selection
Cash Inflows
Human Resources Training, Productivity
Performance Appraisal
Decisions
Compensation
Unions & Labor Relations Value
Creation
Economics of Information
Information Database Management
Decisions Data Modeling Discount Rate
IS Planning & Development
Cost of Financial
Financing Decisions Debt vs. Tax Financing
Capital Markets
MEANING
 The corporate process of collecting, managing and (short-term)
investing cash. A key component of ensuring a company's
financial stability and solvency.
 Successful cash management involves not only avoiding

insolvency, but also reducing days in account receivables (AR),
increasing collection rates.
The Cash Flow Cycle
Deliver
Goods
Order Receive Pay Sell Send Customer
Goods Goods Invoice Goods* Invoice Pays
Day 1 15 40 218 221 230 280
14 25 178 3 9 50
Cash Flow Cycle = 280 days

MANAGING CASH COLLECTIONS AND DISBURSEMENTS
 Accelerating cash collections
 Decentralized collections
 Lock-box system
MODELS FOR DETERMINATION OF OPTIMUM CASH BALANCE
 Baumol Model
 The Miller-Orr model

BAUMOL’S MODEL
 It provides a formal approach for determining a firm’s optimum cash balance
under certainty. Its assumptions are as follows:
 The firm is able to forecast its cash needs with certainty
 The firm cash payments occur uniformly over period of time
 The opportunity cost of holding cash is known and it does not change over time
 The firm will incur the same transactions cost whenever it converts securities to
cash
Optimal Cash Balance via Baumol Model
50000000 1002 504 339.3333333 258 210
Cost ($)
C*=  2cT/K
Total Costs
K(C/2)+c(T/C)
Holding Costs:
k(C/2)
Transaction Costs: c(T/C)
C*
Cash Balance
 Where,
k is opportunity cost
C is cash balance
c is cost per transaction
T is total fund requirement
EXAMPLE
Total cash requirement (T)Rs. 2

Opportunity cost of funds(k) 15%p.a
Transaction cost(c) Rs. 150 per transaction
Find out the Optimum cash balance?
Determine the total cost
SOLUTION
Optimum cash balance i.e. C*= 2cT/K

C*= 2(150)(20,000,000)/0.15
= Rs. 200,000
 Total
Cost=150(20,000,000/200,000)+0.15(200,000/2)
 =150(100)+0.15(100,000)=15,000+15,000
 = Rs. 30,000
Problems with the Baumol Model
• Cash flows may not be very predictable, much less

constant
• Treasurers may want a ‘safety stock’ of cash

THE MILLER - ORR MODEL
 The Miller-Orr Model provides a formula for

determining the optimum cash balance (Z), the
point at which to sell securities to raise cash
(lower limit L) and when to invest excess cash by
buying securities and lowering cash holdings
(upper limit H).
 Depends on:
 transaction costs of buying or selling securities
 variability of daily cash (incorporates uncertainty)
 return on short-term investments
THE MILLER - ORR MODEL
Dollars in the Cash Account
Upper Limit Buy Securities

H
L
Lower Limit Sell Securities
Days of the Month

THE MILLER-ORR MODEL
- TARGET CASH BALANCE (Z)
3
3 x TC x V
Z= +L
4xr
where: TC = transaction cost of buying
or selling securities
V = variance of daily cash flows
r = daily return on short-term
investments
L = minimum cash requirement
THE MILLER-ORR MODEL
- TARGET CASH BALANCE (Z)
 Example: Suppose that short-term securities yield
5% per year and it costs the organization $50 each
time it buys or sells securities (TC). The daily
variance of cash flows is $1000 (V) and your bank
requires $1,000 minimum checking account
balance (L).*
3
3 x 50 x 1000
Z= 4 x .05/360 + $1,000
= $3,000 + $1,000 = $4,000

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WORKING CAPITAL MANAGEMENT

 Gross Working Capital can be defined as the investment made in

 Net Working Capital can be defined as the difference between current

NET WORKING CAPITAL(NWC)

POSITIVE NWC NEGATIVE NWC

Gross operating Cycle

Payable Net operating cycle

Operating Cycle of a Manufacturing

 Three important points to be considered:

2: A risk return trade off is involved in holding excess current assets,

Inventories constitute the most significant part of assets.

The forms of Inventories are :

 The inventory management is to ensure availability of materials in

 On an average, inventories are approximately 60% of current

 Its imperative to manage inventories effectively and efficiently in

 Precautionary motive:-to guard against the risk of unpredictable

 Speculative motive:-to take advantage of price fluctuations.

 To maintain a minimum investment in inventories to maximize profitability.

 Ensure a continuous supply of raw materials to facilitate uninterrupted

 Maintain sufficient stocks of raw materials in periods of short supply and

 When a firm makes an ordinary sale of goods and services and

 Receivables management is also called trade credit management

 Establish and communicate the credit policies

 Evaluation of customers and setting credit limits

 Ensure prompt and accurate billing

Resource Decisions Cash Management

 Successful cash management involves not only avoiding

Day 1 15 40 218 221 230 280

Cash Flow Cycle = 280 days

 Accelerating cash collections

 The Miller-Orr model

 The firm is able to forecast its cash needs with certainty

 The firm cash payments occur uniformly over period of time

Transaction Costs: c(T/C)

Total cash requirement (T)Rs. 2

Optimum cash balance i.e. C*= 2cT/K

• Cash flows may not be very predictable, much less

• Treasurers may want a ‘safety stock’ of cash

 The Miller-Orr Model provides a formula for

Upper Limit Buy Securities

Days of the Month

= $3,000 + $1,000 = $4,000

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