Description
Describing what is working capital and how working capital requirements are met.
Definition
Interaction between Current Assets and Current Liabilities. ? The Goal of Working Capital Management is to manage the firm’s Current Assets and Current Liabilities in such a way that a satisfactory level of Net Working Capital is maintained, so as to prevent its insolvency or bankruptcy.
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Working Capital
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1.
2.
Two Concepts:
Gross Working Capital Net Working Capital
Gross refers to total current assets ? Net Working Capital refers to difference between Current assets and Current liabilities.
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Need for Working Capital
To deal with the problem arising out of the lack of immediate realization of cash against goods sold. ? For a sustained Sales activity.
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Operating Cycle
?
1.
Refers to the length of time necessary to complete the following cycle of events:
Conversion of into inventory. 2. Conversion of inventory into receivables 3. Conversion of receivables into cash
Permanent and Temporary Working Capital
Requirements that has to be met regularly as with other fixed assets are Permanent Working Capital. ? Any amount over and above the Permanent level of Working Capital is Temporary in nature.
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?
In the case of expanding firm, the permanent working capital line may not be horizontal due to the increasing (decreasing) demand of current assets to support a rising level of activity.
?
Nature Of Business
Normally, manufacturing industries and trading organizations need more working capital than in the service business organizations. A service sector does not require any amount of stock of goods. In service enterprises, there are less credit transactions. But in the manufacturing or trading firm, credit sales and advance related transactions are in large amount. So, they need more working capital.
Credit Period Credit period allowed to customers is also one of the major factors which influence the requirement of working capital. Longer credit period requires more investment in debtors and hence more working capital is needed. But, the firm which allows less credit period to customers needs less working capital.
?
Potential Growth Or Expansion Of Business If the business is to be extended in future, more working capital is required. More amount of working capital is required to meet the expansion need of business.
?
Changes In Price Level Change in price level also affects the working capital requirements. Generally, the rise in price will require the firm to maintain large amount of working capital as more funds will be required to maintain the sale level of current assets.
Access To Money Market If a firm has good access to capital market, it can raise loan from bank and financial institutions. It results in minimization of need of working capital. ? Working Capital Cycle When the working capital cycle of a firm is long, it will require larger amount of working capital. But, if working capital cycle is short, it will need less working capital.
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?
Size Of Business Working capital requirement of a firm is directly influenced by the size of its business operation. Big business organizations require more working capital than the small business organization. Therefore, the size of organization is one of the major determinants of working capital.
?
Seasonal Requirement In certain business, raw material is not available throughout the year. Such business organizations have to buy raw material in bulk during the season to ensure an uninterrupted flow and process them during the entire year. Thus, a huge amount is blocked in the form of raw material inventories which gives rise to more working capital requirements.
?
Dividend Policy The dividend policy of the firm is an important determinant of working capital. The need for working capital can be met with the retained earning. If a firm retains more profit and distributes lower amount of dividend, it needs less working capital.
?
Operating Efficiency The operating efficiency of a firm also affects the firm's need of working capital. The operating efficiency of the firm results in optimum utilization of assets. The optimum utilization of assets in turn results in more fund release for working capital.
?
Storage Time Or Processing Period Time needed for keeping the stock in store is called storage period. The amount of working capital is influenced by the storage period. If storage period is high, a firm should keep more quantity of goods in store and hence requires more working capital. Similarly, if the processing time is more, then more stock of goods must be held in store as work-in-progress.
Trade Credit
Credit extended by supplier of goods and services in the normal course of transaction. ? It is a source of finance for credit purchases. ? No formal/specific negotiation ? No legal instruments/acknowledgements of debt ? Appears in the records of buyer of goods as sundry creditors/accounts payable ? An variant is bills/notes payable
?
ADVANTAGES Easily and automatically available Flexible and spontaneous source of finance Magnitude of trade credit is related to size of operations in sales/purchases ? COST ? Not involve any explicit interest charge but Implicit cost of trade credit depends on terms offered by supplier of goods. ? The smaller the difference between the payment day and the end of the discount period, the larger is the annual interest/cost of trade credit.
? ? ? ?
Bank Credit
Primary institutional source of WC finance in India, esp current assets ? Forms of Credit
?
? Cash Credit/Overdrafts
? Loans
? Purchase/Discount Bills ? Letter of Credit
? Working Capital Term Loans
Mode of Security
?
Banks provide credit on the basis of modes of security
? Hypothecation ? Pledge
? Lien
? Mortgage ? Charge
Forms of Financing/Style of Credit
?
Drawbacks:
? No control over level of drawings ? No position to forsee a demand for credit ? Uncertainties
Hence modus operandi bifurcated it to loan and fluctuating/demand cash credit ? Alternative Systems/Framework of Lending
?
? Inventory and receivable norms ? Credit delivery system ? Maximum Permissible Bank Finance(MPBF)
?
Turnover Method
Commercial Papers
Short term unsecured negotiable instrument, consisting of usance promissory note with a fixed maturity. ? Issued on discount on face value basis but can be on issue of interest bearing ? Direct Paper ? Dealer Paper
?
?
Advantages:
? Simple and less documentation
? Flexible in terms of maturities tailored to
?
? ?
?
?
match cash flow of suppliers Diversify to money market at cheaper costs Get higher returns Better financial standing Unsecured and no limitations Incorporate fund flow
Factoring
Provides resources to finance receivables, also facilitates the collection of receivables ? Started as a RBI initiatives ? 2-bank sponsored org.
?
? SBI Factors and Commercial Services Ltd ? Canbank Factors Ltd.
?
Private Sectors- Foremost Factors Ltd.
Definition and Mechanism
Definition ? Functions of Factors:
?
? Financing facility/trade debts ? Maintenance/administration of sales ledger ? Collection facility of accounts recievable ? Assumption of credit risk, credit control and
credit restriction ? Provision of advisory services
?
Cost of Services
Advantages and Evaluation
? ? ? ? ? ?
? ? ? ? ? ? ? ?
Impact on balance sheet Off-balance sheet financing Reduction in Current liabilities Improvement in current ratio Higher credit standing Improved efficiency More Time for planning and production Reduction of cost and expenses Additional source Evaluation framework Cost of in-house management Cost of recourse and non-recourse factoring Benefits of recourse factoring Benefits of non-recourse factoring
Leverage is the ratio of the net rate of return of shareholder’s equity and net rate of return on total capitalisation. ? Types of leverage: 1. Operating leverage 2. Financial leverage 3. Combined leverage
?
OPERATING LEVERAGE
The firm’s ability to use fixed operating costs to magnify the effects of changes in sales on its EBIT. ? With fixed costs, the percentage change in profits accompanying a change in volume is greater than the percentage change in the volume. ? Determined by the relationship between the firm’s sales revenues and its earnings before interest and taxes. ? The earnings before interest and taxes are also generally called as operating profit.
?
DEGREE OF LEVERAGE
DOL= contribution EBIT ? DOL = % Change in EBIT % Change in sales = EBIT / EBIT Q/Q
?
FINANCIAL LEVERAGE
Financial leverage exists whenever a firm has debts other sources of funds that carry fixed charges. ? It is concerned with the operating with the effects of the changes in EBIT on the earnings available in the equity holders. ? Defined as the ability of a firm to use fixed financial charges to magnify the effects of the changes in EBIT on the earnings per share.
?
Computation of financial leverage
Where the capital structure consists of equity shares and debts : ? Financial leverage: EBIT EBIT- INT : % Change in EPS %Change in EBIT
?
Importance of financial leverage
Capital structure management. 2. Maximization of EPS and market value of shares. 3. Measurement of risk.
1.
COMBINED LEVERAGE
DCL= DOL*DFL ? The combined leverage can work in either direction . It will be favorable if sales increase and unfavorable when sales decrease because changes in sales will result in more than proportionate returns in the form of EPS.
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doc_458625410.pptx
Describing what is working capital and how working capital requirements are met.
Definition
Interaction between Current Assets and Current Liabilities. ? The Goal of Working Capital Management is to manage the firm’s Current Assets and Current Liabilities in such a way that a satisfactory level of Net Working Capital is maintained, so as to prevent its insolvency or bankruptcy.
?
Working Capital
?
1.
2.
Two Concepts:
Gross Working Capital Net Working Capital
Gross refers to total current assets ? Net Working Capital refers to difference between Current assets and Current liabilities.
?
Need for Working Capital
To deal with the problem arising out of the lack of immediate realization of cash against goods sold. ? For a sustained Sales activity.
?
Operating Cycle
?
1.
Refers to the length of time necessary to complete the following cycle of events:
Conversion of into inventory. 2. Conversion of inventory into receivables 3. Conversion of receivables into cash
Permanent and Temporary Working Capital
Requirements that has to be met regularly as with other fixed assets are Permanent Working Capital. ? Any amount over and above the Permanent level of Working Capital is Temporary in nature.
?
?
In the case of expanding firm, the permanent working capital line may not be horizontal due to the increasing (decreasing) demand of current assets to support a rising level of activity.
?
Nature Of Business
Normally, manufacturing industries and trading organizations need more working capital than in the service business organizations. A service sector does not require any amount of stock of goods. In service enterprises, there are less credit transactions. But in the manufacturing or trading firm, credit sales and advance related transactions are in large amount. So, they need more working capital.
Credit Period Credit period allowed to customers is also one of the major factors which influence the requirement of working capital. Longer credit period requires more investment in debtors and hence more working capital is needed. But, the firm which allows less credit period to customers needs less working capital.
?
Potential Growth Or Expansion Of Business If the business is to be extended in future, more working capital is required. More amount of working capital is required to meet the expansion need of business.
?
Changes In Price Level Change in price level also affects the working capital requirements. Generally, the rise in price will require the firm to maintain large amount of working capital as more funds will be required to maintain the sale level of current assets.
Access To Money Market If a firm has good access to capital market, it can raise loan from bank and financial institutions. It results in minimization of need of working capital. ? Working Capital Cycle When the working capital cycle of a firm is long, it will require larger amount of working capital. But, if working capital cycle is short, it will need less working capital.
?
?
Size Of Business Working capital requirement of a firm is directly influenced by the size of its business operation. Big business organizations require more working capital than the small business organization. Therefore, the size of organization is one of the major determinants of working capital.
?
Seasonal Requirement In certain business, raw material is not available throughout the year. Such business organizations have to buy raw material in bulk during the season to ensure an uninterrupted flow and process them during the entire year. Thus, a huge amount is blocked in the form of raw material inventories which gives rise to more working capital requirements.
?
Dividend Policy The dividend policy of the firm is an important determinant of working capital. The need for working capital can be met with the retained earning. If a firm retains more profit and distributes lower amount of dividend, it needs less working capital.
?
Operating Efficiency The operating efficiency of a firm also affects the firm's need of working capital. The operating efficiency of the firm results in optimum utilization of assets. The optimum utilization of assets in turn results in more fund release for working capital.
?
Storage Time Or Processing Period Time needed for keeping the stock in store is called storage period. The amount of working capital is influenced by the storage period. If storage period is high, a firm should keep more quantity of goods in store and hence requires more working capital. Similarly, if the processing time is more, then more stock of goods must be held in store as work-in-progress.
Trade Credit
Credit extended by supplier of goods and services in the normal course of transaction. ? It is a source of finance for credit purchases. ? No formal/specific negotiation ? No legal instruments/acknowledgements of debt ? Appears in the records of buyer of goods as sundry creditors/accounts payable ? An variant is bills/notes payable
?
ADVANTAGES Easily and automatically available Flexible and spontaneous source of finance Magnitude of trade credit is related to size of operations in sales/purchases ? COST ? Not involve any explicit interest charge but Implicit cost of trade credit depends on terms offered by supplier of goods. ? The smaller the difference between the payment day and the end of the discount period, the larger is the annual interest/cost of trade credit.
? ? ? ?
Bank Credit
Primary institutional source of WC finance in India, esp current assets ? Forms of Credit
?
? Cash Credit/Overdrafts
? Loans
? Purchase/Discount Bills ? Letter of Credit
? Working Capital Term Loans
Mode of Security
?
Banks provide credit on the basis of modes of security
? Hypothecation ? Pledge
? Lien
? Mortgage ? Charge
Forms of Financing/Style of Credit
?
Drawbacks:
? No control over level of drawings ? No position to forsee a demand for credit ? Uncertainties
Hence modus operandi bifurcated it to loan and fluctuating/demand cash credit ? Alternative Systems/Framework of Lending
?
? Inventory and receivable norms ? Credit delivery system ? Maximum Permissible Bank Finance(MPBF)
?
Turnover Method
Commercial Papers
Short term unsecured negotiable instrument, consisting of usance promissory note with a fixed maturity. ? Issued on discount on face value basis but can be on issue of interest bearing ? Direct Paper ? Dealer Paper
?
?
Advantages:
? Simple and less documentation
? Flexible in terms of maturities tailored to
?
? ?
?
?
match cash flow of suppliers Diversify to money market at cheaper costs Get higher returns Better financial standing Unsecured and no limitations Incorporate fund flow
Factoring
Provides resources to finance receivables, also facilitates the collection of receivables ? Started as a RBI initiatives ? 2-bank sponsored org.
?
? SBI Factors and Commercial Services Ltd ? Canbank Factors Ltd.
?
Private Sectors- Foremost Factors Ltd.
Definition and Mechanism
Definition ? Functions of Factors:
?
? Financing facility/trade debts ? Maintenance/administration of sales ledger ? Collection facility of accounts recievable ? Assumption of credit risk, credit control and
credit restriction ? Provision of advisory services
?
Cost of Services
Advantages and Evaluation
? ? ? ? ? ?
? ? ? ? ? ? ? ?
Impact on balance sheet Off-balance sheet financing Reduction in Current liabilities Improvement in current ratio Higher credit standing Improved efficiency More Time for planning and production Reduction of cost and expenses Additional source Evaluation framework Cost of in-house management Cost of recourse and non-recourse factoring Benefits of recourse factoring Benefits of non-recourse factoring
Leverage is the ratio of the net rate of return of shareholder’s equity and net rate of return on total capitalisation. ? Types of leverage: 1. Operating leverage 2. Financial leverage 3. Combined leverage
?
OPERATING LEVERAGE
The firm’s ability to use fixed operating costs to magnify the effects of changes in sales on its EBIT. ? With fixed costs, the percentage change in profits accompanying a change in volume is greater than the percentage change in the volume. ? Determined by the relationship between the firm’s sales revenues and its earnings before interest and taxes. ? The earnings before interest and taxes are also generally called as operating profit.
?
DEGREE OF LEVERAGE
DOL= contribution EBIT ? DOL = % Change in EBIT % Change in sales = EBIT / EBIT Q/Q
?
FINANCIAL LEVERAGE
Financial leverage exists whenever a firm has debts other sources of funds that carry fixed charges. ? It is concerned with the operating with the effects of the changes in EBIT on the earnings available in the equity holders. ? Defined as the ability of a firm to use fixed financial charges to magnify the effects of the changes in EBIT on the earnings per share.
?
Computation of financial leverage
Where the capital structure consists of equity shares and debts : ? Financial leverage: EBIT EBIT- INT : % Change in EPS %Change in EBIT
?
Importance of financial leverage
Capital structure management. 2. Maximization of EPS and market value of shares. 3. Measurement of risk.
1.
COMBINED LEVERAGE
DCL= DOL*DFL ? The combined leverage can work in either direction . It will be favorable if sales increase and unfavorable when sales decrease because changes in sales will result in more than proportionate returns in the form of EPS.
?
doc_458625410.pptx