ch1.3_principles of wc mgmt_formulation of wc policy

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Principles of W C Mgmt and

Formulation of W C Policy

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Introduction

The goal of W.C. Mgmt is to manage the firms

C.A. and C. L. in such a way that a satisfactory

level of W.C. is maintained.

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Concepts of W.C.

Gross W. C.> C. A.

Net W. C. -> C. A.C.L.

Focusing on management of C.A.

How to optimise invest in C.A.?

How shd C.A. be financed?

Focusing on liability management

Indicates the liquidity position of the firm

Suggests the extent to which W.C. needs may be

financed by permanent sources of fund

Conventional rule to maintain C.A. twice the level of

C.L.

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Operating & Cash Conversion Cycle

Operating cycle is the time duration required to

convert sales, after the conversion of resources

into inventories, into cash.

Gross Operating Cycle

Inventory Conversion Period

RMCP + WIPCP + FGCP

Debtors Conversion Period

Net Operating Cycle

GOCPayable Deferral period

If Depis excluded from expenses in computation of Op

Cycle then NOC also represents Cash Conversion Cycle

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RMCP = RMI / RMC X 360

WIPCP = WIPI / COP X 360

FGCP = FGI / COGS X 360

DCP = Dr / Cr Sales x 360

CrDP = Cr / Cr Pur x 360

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Permanent & Variable W C

Permanent WC is the min level of CAs.

Variable WC is the extra WC needed to support the

changing prod & Sales activities of the firm

Amountofwo

rkingcapital(Rs.)

Time

Temporary or

fluctuating

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Balanced WC Position

Firm shd have optimum WC balance, if it is in

excess then it will adversely affect the

profitability and if it is short then it will create

liquidity problem

Dangers of excessive WC

Pitfalls of inadequate WC

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Determinants of WC

Nature of business

Market & demand conditions

Size of the firm

Seasonal fluctuations

Boom & recession

Technology & Mfging Policy

Mfging cycle

Credit Policy

Norms of industry

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Availability of credit from suppliers Suppliers bargaining power

Operating efficiency

Price level changes

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Issues in W C Mgmt

Aspects of W C Mgmt Time

Investment

Criticality

Growth

Liquidity v/s Profitability

To ensure solvency the firm shd be very liquid i.e

larger CAs holding

To have higher profitability the firm may sacrifice

solvency and maintain low level of CAs

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The cost trade-off

Cost of liquidity & cost of illiquidity

Optimum CA is when total cost is minimised

Total Cost

Costs

Cost of

illiquidity

Level of

Current Assets

Minimum

Cost

Optimum Level of

current assets

Cost of

Liquidity

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Policies for Financing C As

3 types of financing policies Long-term financing

Short-term financing

Spontaneous financing Depending on the mix of short term and long

term financing the various approaches

followed may be:

Matching approach

Conservative approach

Aggressive approach

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Matching Approach

Fixed Assets

Long-term

financing

Assets

Time

Short-termfinancing

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Conservative Approach

Fixed Assets

Long-term

financing

Assets

Time

Short-termfinancing

(a)(b)

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