WORKING CAPITAL MANAGEMENTPRESENTED BY:AHAD FAROOQIMARIUM QURESHIOMER USMAN PEERJINOAM KHANSABA SALMAN

Introduction

Working capital typically means the firm’s holding of current or short-term assets such as cash, receivables, inventory and marketable securities.

These items are also referred to as circulating capital

Corporate executives devote a considerable amount of attention to the management of working capital.

DefinitionWorking Capital refers to that part of the firm’s

capital, which is required for financing short-term or current assets such a cash marketable securities, debtors and inventories. Funds thus, invested in current assets keep revolving fast and are constantly converted into cash and this cash flow out again in exchange for other current assets. Working Capital is also known as revolving or circulating capital or short-term capital.

Nature Of Working CapitalWorking capital management is concerned with the

problems that arise in attempting to manage the current assets, the current liabilities and the interrelations that exist between them.

Current assets refer to those assets which in the ordinary course of business can be, or will be, converted into cash within one year without undergoing a diminution in value and without disrupting the operations of the firm.

Examples- cash, marketable securities, accounts receivable and inventory.

Current liabilities are those liabilities which are intended, at their inception, to be paid in the ordinary course of business, within a year, out of the current assets or the earnings of the concern.

Examples- accounts payable, bills payable, bank overdraft and outstanding expenses.

Concept of working capital

There are two possible interpretations of working capital concept:

1.Balance sheet concept

2.Operating cycle concept

Balance Sheet ConceptBalance sheet conceptThere are two interpretations of working capital under the balance sheet concept.

a. Excess of current assets over current liabilities

b. gross or total current assets.

Excess of current assets over current liabilities are called the net working capital or net current assets.

Working capital is really what a part of long term finance is locked in and used for supporting current activities.

The balance sheet definition of working capital is meaningful only as an indication of the firm’s current solvency in repaying its creditors.

When firms speak of shortage of working capital they in fact possibly imply scarcity of cash resources.

In fund flow analysis an increase in working capital, as conventionally defined, represents employment or application of funds.

Operating Cycle ConceptOperating cycle conceptA company’s operating cycle typically consists

of three primary activities:◦ Purchasing resources,◦ Producing the product and◦ Distributing (selling) the product.

These activities create funds flows that are both unsynchronized and uncertain.Unsynchronized because cash disbursements (for example, payments for resource purchases) usually take place before cash receipts (for example collection of receivables).

They are uncertain because future sales and costs, which generate the respective receipts and disbursements, cannot be forecasted with complete accuracy.

Manage and Measuring Liquidity Liquidity:The degree to which an asset or security can be bought or sold in the market without affecting the asset's price. Liquidity is characterized by a high level of trading activity. Assets that can be easily bought or sold.

OR The ability to convert an asset to cash quickly. Also known as "marketability.“Liquidity Management:Liquidity management is the ability of the

firm to generate enough cash required to meet the firm’s needs.

Drags are delay and slowing in cash inflows While pulls are accelerating cash outflows.

Sources of LiquidityThe primary sources of liquidity include the

sources that a firm uses for its regular daily operations. This includes:

Cash◦ Cash received from sales◦ Collection of receivables◦ Short-term investment, and others

Short-term Funding◦ Trade credit from suppliers◦ Working capital loans from banks

Cash flow management◦ The firm can also generate working capital by

effectively managing its cash.

Secondary Sources of LiquidityThese are the sources of liquidity that are

not normally a part of the regular operations. However, in times of need, the firm may use these sources. These include:

Renegotiating existing debt contractsLiquidating short-term and/or long-term

assetsFiling for bankruptcyUtilizing the secondary sources of funding

can impact the company’s financial structure and may even affect its operations. This also indicates that the firm’s financial condition is deteriorating.

Measure Of Liquidity

Cash Conversion CycleA metric that expresses the length of time, in

days, that it takes for a company to convert resource inputs into cash flows. The cash conversion cycle attempts to measure the amount of time each net input dollar is tied up in the production and sales process before it is converted into cash through sales to customers. This metric looks at the amount of time needed to sell inventory, the amount of time needed to collect receivables and the length of time the company is afforded to pay its bills without incurring penalties.

Also known as "cash cycle."

Operating CycleExpressed as an indicator (days) of

management performance efficiency, the operating cycle is a "twin" of the cash conversion cycle. While the parts are the same - receivables, inventory and payables - in the operating cycle, they are analyzed from the perspective of how well the company is managing these critical operational capital assets, as opposed to their impact on cash.Formula:

DIFFERENCESOPERATING CYCLE CASH CONVERSION CYCLE

An operating cycle is the average time period between the acquisition of inventory and the receipt of cash from the inventory's sale. A short operating cycle means a more prompt return on investment for the firm's inventory. During an economic downtown, an operating cycle typically lasts longer than in periods of economic growth.

The cash conversion cycle is the number of days required for a company to convert resources to cash flows. This measure calculates the time period during which each input dollar is committed to production and sales processes before it is converted to cash through the accounts receivable process. The cash conversion process gives insight into the financial stability of a company because it reflects the time period during which assets are committed to business processes and therefore are not available to invest to achieve even greater returns. As a result, the shorter the cash conversion cycle, the better.

CALCULATIONOPERATING CYCLE CASH CONVERSION CYCLE

To calculate the operating cycle, determine the duration of each element of the operating cycle including raw materials, work-in-process, finished goods and bills receivable. Next, calculate the aggregate duration of the cycle by adding together each of these elements. The greater the operating cycle, the greater the business requirement for working capital. The greater the working-capital requirement, the higher the inventory-carrying cost, including interest payments, and the greater the opportunity cost due to the inability to invest funds in a higher use. In addition, the lower the operating cycle, the greater the number of completed cycles per year, and the greater the annual gross and net profits.

The cash conversion cycle calculation uses elements of the operating cycle equation, including raw materials, work-in-process, finished goods and bills receivable, in addition to the days' payables outstanding. The days' payables outstanding is the average time required by the company to pay its vendors. First, calculate the accounts payable turnover by dividing the cost of goods sold by accounts payable. Next, divide 365 days by the accounts payable turnover to determine the days' payables outstanding. To determine the cash conversion cycle, first add the days' sales outstanding and the days' sales in inventory, and then subtract the days' payables outstanding. The resulting cash conversion cycle measures the time period between the cash outflow for materials required for the production of a product or service and the cash inflow from sales. A decrease in the cash conversion cycle can lead to an increase in the operating profit margin.

Managing Cash PositionThe amount of cash that a company,

investment fund or bank has on its books at a specific point in time. The cash position is a sign of financial strength and liquidity. In addition to cash itself, it will often take into consideration highly liquid assets such as certificates of deposit, short-term government debt and other cash equivalents.

Short Term Investment FundsA type of fund that invests in short-

term investments of high quality and low risk. The goal of this type of fund is to protect capital with low-risk investments while achieving a return that beats a relevant benchmark such as a Treasury bill index.

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