Working Capital

Management

Dr. Arunava Bandyopadhyay

IMI Kolkata
Balance Sheet Model of the Firm
Current
Liabilities
Current Assets
Net
Working Long-Term
Capital Debt

How much short-

Fixed Assets
term cash flow
1. Tangible does a company
Shareholders’
need to pay its
2. Intangible Equity
bills?

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No reproduction or distribution without the prior written consent of McGraw-Hill Education.
MDP| IMIK| Dr. A Bandyopadhyay 3
MDP| IMIK| Dr. A Bandyopadhyay 4
 Working Capital
• Working capital is the amount of available capital that a company can
readily use for day-to-day operations.
• Working Capital is basically an indicator of the short-term financial
position of an organization and is also a measure of its overall
efficiency.
• Gross Working capital is defined as the amount of current assets
• Net Working capital is defined as the excess of current
assets over current liabilities

MDP| IMIK| Dr. A Bandyopadhyay 5

Figure 31.1 Current Assets as a Percentage of Total Assets
• Fourth quarter
2020

6
Simple Cycle of Operations

MDP| IMIK| Dr. A Bandyopadhyay 7

 Operating Cycle and Cash
Conversion Cycle

Cash Conversion Cycle

= operating cycle – accounts payable period
MDP| IMIK| Dr. A Bandyopadhyay 8
= (Inventory TO period + Receivables TO period) – Accounts payable period
Cash Cycle Example – I

• Inventory:
• Beginning = 200,000
• Ending = 300,000
• Accounts Receivable:
• Beginning = 160,000
• Ending = 200,000
• Accounts Payable:
• Beginning = 75,000
• Ending = 100,000
• Net sales = 1,150,000
• Cost of Goods sold = 820,000
Cash Cycle Example – II
• Inventory period
• Average inventory = (200,000 + 300,000) / 2 = 250,000
• Inventory turnover = 820,000 / 250,000 = 3.28 times
• Inventory period = 365 / 3.28 = 111.3 days
• Receivables period
• Average receivables = (160,000 + 200,000) / 2 = 180,000
• Receivables turnover = 1,150,000 / 180,000 = 6.39 times
• Receivables period = 365 / 6.39 = 57.1 days
• Operating cycle = 111.3 + 57.1 = 168.4 days
Cash Cycle Example – III
• Payables Period
• Average payables = (75,000 + 100,000) / 2 = 87,500
• Payables turnover = 820,000 / 87,500 = 9.37 times
• Payables period = 365 / 9.37 = 38.9 days
• Cash Cycle = 168.4 – 38.9 = 129.5 days
• We have to finance our inventory for 129.5 days.
• If we want to reduce our financing needs, we need to
look carefully at our receivables and inventory periods
—they both may be excessive.
Page 194 Annual Report
Page 194 Annual Report
Particulars FY 24 FY 23
Inventory Turnover Ratio 12.075 11.742
Trade Receivables Turnover Ratio 6.167 7.078 Balmer Lawrie & Co.
Trade Payables Turnover Ratio 4.996 5.685

Inventory Period (in Days) 30.23 31.08

Receivables Period (in Days) 59.19 51.57
Payables Period (in Days) 73.06 64.20

Operating Cycle (in Days) 89.41 82.65 Particulars FY 24 FY 23

Cash Conversion Cycle (in Days) 16.36 18.45 Inventory Turnover Ratio 2.746244 2.73038
Trade Receivables Turnover Ratio 2.496227 2.535153
Trade Payables Turnover Ratio 25.97996 20.24205

Inventory Period (in Days) 132.91 133.68

Receivables Period (in Days) 146.22 143.98
Concor India Ltd. Payables Period (in Days) 14.05 18.03

Operating Cycle (in Days) 279.13 277.66

Cash Conversion Cycle (in Days) 265.08 259.62
MDP| IMIK| Dr. A Bandyopadhyay 14
 Cash CYCLE
BLC 3M Nava
250

200

150

100

50

0
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

-50

MDP| IMIK| Dr. A Bandyopadhyay 15

Industry Scenario
Size of Investment in Current Assets
• A flexible short-term finance policy includes
• Keeping large balances of cash and marketable securities
• Making large investments in inventory
• Granting liberal credit terms
• A restrictive short-term finance policy includes.
• Keeping low cash balances, no investment in marketable
securities
• Making small investments in inventory
• Allowing no credit sales and no accounts receivable
Carrying Costs and Shortage Costs
$
Minimum Total costs of holding current
point assets.
Carrying costs

Shortage costs
Amount of
current assets
CA* (CA)
Appropriate Flexible Policy
$

Carrying costs
Minimum
point Total cost.

Shortage costs
Amount of
current assets
CA* (CA)
Appropriate Restrictive Policy
$
Minimum Total cost
point

Carrying costs

Shortage
costs
Amount of
CA* current assets
(CA)
Alternative Financing Policies
• A flexible short-term finance policy means a low
proportion of short-term debt relative to long-term
financing.
• A restrictive short-term finance policy means a high
proportion of short-term debt relative to long-term
financing.
• In an ideal world, short-term assets are always
financed with short-term debt, and long-term assets
are always financed with long-term debt.
• In this world, net working capital is zero.
Cash Budgeting

• A cash budget is a primary tool of short-term

financial planning.
• The idea is simple: Record the estimates of cash
receipts and disbursements.
• Cash Receipts
• Arise from sales, but we need to estimate when we
actually collect
• Cash Outflow
• Payments of accounts payable
• Wages, taxes, and other expenses
• Capital expenditures
• Long-term financing
Cash Budgeting Example – I
• Pet Treats Inc. specializes in gourmet pet treats and receives all income from
sales
• Sales estimates (in millions)
• Q1 = 500; Q2 = 600; Q3 = 650; Q4 = 800; Q1 next year = 550
• Accounts receivable
• Beginning receivables = $250
• Average collection period = 30 days
• Accounts payable
• Purchases = 50% of next quarter’s sales
• Beginning payables = 125
• Accounts payable period is 45 days
• Other expenses
• Wages, taxes, and other expense are 30% of sales
• Interest and dividend payments are $50
• A major capital expenditure of $200 is expected in the second quarter
• The initial cash balance is $80 and the company maintains a minimum
balance of $50
Cash Budgeting Example – II
• ACP = 30 days; this implies that 2/3 of sales are collected in
the quarter made, and the remaining 1/3 are collected the
following quarter.
• Beginning receivables of $250 will be collected in the first
quarter.

Q1 Q2 Q3 Q4
Beginning Receivables 250 167 200 217
Sales 500 600 650 800
Cash Collections 583 567 633 750
Ending Receivables 167 200 217 267
Cash Budgeting Example – III
• Payables period is 45 days, so half of the purchases will be paid for each
quarter, and the remaining will be paid the following quarter.
• Beginning payables = $125

Q1 Q2 Q3 Q4
Payment of accounts 275 313 362 338
Wages, taxes, and other expenses 150 180 195 240
Capital expenditures 200
Interest and dividend payments 50 50 50 50
Total cash disbursements 475 743 607 628
Cash Budgeting Example – IV

Q1 Q2 Q3 Q4
Total cash receipts 583 567 633 750
Total cash disbursements 475 743 607 628
Net cash inflow 108 –176 26 122
Beginning cash balance 80 188 12 38
Net cash inflow 108 –176 26 122
Ending cash balance 188 12 38 160
Minimum cash balance –50 –50 –50 –50
Cumulative surplus (deficit) 138 –39 –12 110
The Short-Term Financial Plan
• The most common way to finance a temporary cash
deficit is to arrange a short-term loan.
• Unsecured Loans
• Line of credit (at the bank)
• Secured Loans
• Accounts receivable can be either assigned or factored.
• Inventory loans use inventory as collateral.
• Other Sources
• Banker’s acceptance
• Commercial paper
Reasons for Holding Cash
• Speculative motive: hold cash to take advantage of
unexpected opportunities
• Precautionary motive: hold cash in case of
emergencies
• Transaction motive: hold cash to pay the day-to-day
bills
• Trade-off between opportunity cost of holding cash
relative to the transaction cost of converting
marketable securities to cash for transactions
27.2 Understanding Float

• Float: difference between cash balance recorded in the cash account

and the cash balance recorded at the bank
• Disbursement float
• Generated when a firm writes checks
• Available balance at bank – book balance > 0
• Collection float
• Checks received increase book balance before the bank credits the account
• Available balance at bank – book balance < 0
• Net float = disbursement float + collection float
Example: Types of Float
• You have $3,000 in your checking account. You just
deposited $2,000 and wrote a check for $2,500.
• What is the disbursement float?
• What is the collection float?
• What is the net float?
• What is your book balance?
• What is your available balance?
Cash Collection and Concentration

One of the goals of float management is to try to reduce the

collection delay. There are several techniques that can reduce
various parts of the delay.

32
Example: Measuring Float
• Size of float depends on the dollar amount and the time delay
• Delay = mailing time + processing delay + availability delay
• Suppose you mail a check each month for $1,000 and it takes 3
days to reach its destination, 1 day to process, and 1 day before
the bank makes the cash available
• What is the average daily float (assuming 30-day months)?
• Method 1: (3+1+1)(1,000) / 30 = 166.67
• Method 2: (5/30)(1,000) + (25/30)(0) = 166.67

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No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Example: Cost of Float
• Cost of float: opportunity cost of not being able to use
the money
• Suppose the average daily float is $3 million with a
weighted average delay of 5 days.
• What is the total amount unavailable to earn interest?
• 5*3 million = $15 million
• What is the NPV of a project that could reduce the delay by
3 days if the cost is $8 million?
• Immediate cash inflow = 3*3 million = $9 million
• NPV = 9 – 8 = $1 million

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No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Example: Accelerating Collections – I
• Your company does business nationally, and currently, all
checks are sent to the headquarters in Tampa, FL. You are
considering a lockbox system that will have checks processed in
Phoenix, St. Louis, and Philadelphia. The Tampa office will
continue to process the checks it receives in-house.
• Collection time will be reduced by 2 days on average
• Daily interest rate on T-bills = .01%
• Average number of daily payments to each lockbox is 5,000
• Average size of payment is $500
• The processing fee is $.10 per check plus $10 to wire funds to a
centralized bank at the end of each day.
Example: Accelerating Collections – II
• Benefits
• Average daily collections = 3(5,000)(500) = $7,500,000
• Increased bank balance = 2(7,500,000) = $15,000,000
• Costs
• Daily cost = .1(15,000) + 3*10 = $1,530
• Present value of daily cost = 1,530/.0001 = $15,300,000
• NPV = 15,000,000 – 15,300,000 = –$300,000
• The company should not accept this lockbox
proposal