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KDFEF
WORKING CAPITAL
Unit : I – V
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Unit I –Syllabus
Working Capital Policy
Importance of Working Capital Management
Concept of Working Capital
Risk and Return Trade off Financing Capital Requirements
Issues in working capital policy
Size of Working Capital
Forecasting & Management of Working capital.
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Two types of capital is required by every business firm to run its
business operations.
(i) Fixed capital
(ii) working capital
Meaning Of Working Capital Working capital refers to the capital that is required for day-to-day
working in a business firm such as purchasing raw materials, for meeting
day-to-day expenditures on salaries, wages, rents,etc.
DEFINITION
ICAI – working capital means the funds available for day-to-day
operations of an enterprise.
Working capital management –
An Overview
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Higher Return On Capital
Improved Credit Profile And Solvency
Higher Profitability
Higher Liquidity
Increased Business Value
Favorable Financing Conditions
Uninterrupted Production
Ability To Face Shocks And Peak Demand
Competitive Advantage
CONCEPT OF WORKING CAPITAL
The funds invested in current assets are termed as working capital. It is the fund
that is needed to run the day-to-day operations. There are two concepts in
respect of working capital:
Gross Working Capital = Total current assets
Net Working Capital = Current Assets - Current liabilities
Importance Of Working Capital
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MEANING OF WORKING CAPITAL MANAGEMENT
Working capital management refers to a company's managerial
accounting strategy designed to monitor and utilize the two
components of working capital, current assets and current liabilities,
to ensure the most financially efficient operation of the company.
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The risk-return tradeoff is the principle that potential return rises with an
increase in risk. Low levels of uncertainty or risk are associated with low
potential returns, whereas high levels of uncertainty or risk are associated
with high potential returns. According to the risk-return tradeoff, invested
money can render higher profits only if the investor is willing to accept the
possibility of losses.
https://www.youtube.com/watch?v=ejpc9JS1GAw
Risk and Trade off
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Determinants of working capital
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Issues In Working Capital Policy
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https://www.youtube.com/watch?v=38iYNkW28lw
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Unit II–Syllabus
Cash Management
Factors influencing Cash Balance determining minimum cash balance
Cash Budgeting
Cash Control
Cash Management Models.
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Cash management is a broad term that refers to the collection,
concentration and disbursement of cash. It encompasses a firm‟s
level of liquidity, its management of cash balance and its short-term
investment strategies.
Meaning
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To make payment according to payment schedule
To minimise cash balance
Nature of cash management
The nature of cash management would depend upon the organizational structure of a firm. In a highly centralised organization, the central/head office controls the inflow and outflows of cash on a routine basis.In a decentralised organization, it may not be possible for central office to exercise control over cash flows.
https://www.slideshare.net/tamana2223/14685550-cashmanagementpresentation
Objectives Of Cash Management
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Profitability of business concept signifies the operational efficiency of the business organisation by value addition through the utilisation of resources i.e men, materials, money and machines.The liquidity refers to the ability of the organisation to realise value in money and its ability to pay in cash the obligations that one due for payment.There is an inverse relationship between profitability and liquidity.
Factors Determining Cash NeedsSynchronisation of cash flows.Consideration of short costs.Position of accounts receivableNature of product/business.Availability of other sources of fundsManagement‟s attitude regarding procurement.Operating and cash cycleMarket conditions in relation to assets.Control of cash disbursements
Profitability And Liquidity
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Help to increase efficiency of operations and higher productivity.
Ensures higher liquidity and enhances the rate of earnings
Ample cash helps to avail cash discounts and trade discount from
the suppliers.
It helps in maintaining the goodwill of the concern.Ensures credit worthiness and financial soundness of a concern, regular flow of raw materials to the process of production. Facilitates new investments and in expanding its future market. Creates good confidence among the investors, creditors, customers, employees and general public. Ensures steady supply of inventories to meet the needs of customers. Helps to overcome the short-term crises caused by depression. It facilitates to enjoy new business opportunities
Advantages Of Maintaining Optimum Or
Adequate Cash
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1. Controlling inflow of cash or sources of cash.
(a) Accelerating collection
(b) Concentration banking
(c) Lock-box system
(d) Efficient inventory production management
2. Control over cash outflows or application of cash
Functions of cash management
a) Billing float
b) Mail float
c) Cheque processing float
d) Bank processing float
3. Optimum investment of surplus cash
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4. Controlling level of cash
a) Preparing cash budget
b) Providing unpredictable discrepancies
c) Consideration of short cost
d) Exploring other sources of finance.
Cash management planning
The first step in cash management is to estimate the requirement of
cash in the firm. For this purpose, cash budget is to be prepared.
Cash Budget:
Cash budget shows the cash inflows and outflows expected in a
budget period and net effect of these flows on cash balances.
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Cash management controlThe finance manager has to control the levels of cash balance at various units of the firm. He should devise a system whereby each division of a firm retains enough cash to meet its day-to-day requirements without having surplus balance on hand. For this, methods have to be employed to(a) speed up the mailing time of payment from
customers(b) reduce the time during which payments
received by the firm remain uncollected and speed up the movement of funds to disbursement banks.
Cash management models https://www.slideshare.net/godfreouseph/cash-management-model
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Unit III –Syllabus
Inventory Management
Need for inventories & importance
Techniques for Managing Inventory
Materials & valuation of stock
Monitoring & control of inventories.
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Inventory refers to the stock pile of the product a firm is offering for sale
and the components that make up the product. In other words,
inventory is composed of assets that will be sold off in future in the
course of business operation.
Definition International Accounting Standards Committee defines inventory as
“Inventory is a tangible property (a) held for sale in the ordinary course
of business; (b) in the process of production of such sale or to be
consumed in the production of goods or services for sale”.
Inventory includes raw material, purchased parts.
Inventory includes raw material, purchased parts, work-in-progress,
finished goods and supplies.
Meaning Of Inventory
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Inventory ensures in maintaining undisturbed production and employment rates.
Inventory require valuable space and consumes taxation and insurance charges.
It provides production economies. It is the physical stock of items of tangible assets. Inventories are the result of many inter-related decisions and policies
within an organisation. Inventories are used in the production for sale in the ordinary course of
business.
Characteristics Of Inventory
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Need Of Holding Inventory
Transaction motive
Precautionary motive
Speculative motive
Factors Affecting Volume Of Inventory
Availability of financeQuantity discounts allowedStorage space availableOrdering costReceiving costRisk of loss due to price fluctuationsRisk of loss due to evaporation, obsolescence, theft, deterioration, etc.Economic ordering quantityTime to obtain delivery or lead time.
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It helps to avoid over-investment or under-investment in inventories.It helps to reduce the carrying cost and to maintain the optimum level of inventory management.It ensures uninterrupted production.Effective material handling/control is possibleLots of manual work may be eliminated.
Ensures minimum wastages
Facilitates prompt flow of finished goods for immediate sales
Effective utilisation of floor space.
Better forecasting is possible
Inventories reduce the risk of closing down the plant or keeping
workers and machine idle.https://www.youtube.com/watch?v=GutCKICOESw
Benefits Of Holding Inventory
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Excessive level of inventories consumes the funds of the firm, which
cannot be used for any other purpose.
Increase cost of storage, materials handling, insurance, transportation
and inspection.
Delay and inconvenience because of over crowding of materials.
High risk of liquidity due to inadequate inventories Inadequate inventories will affect continuous flow of production. Inadequate inventories fail to meet the delivery commitments. Ineffective supervision of stores due to mishandling and improper storage facilities. Losses, damages, deterioration of materials will be high when there are excessive inventories in storage. Failure to meet the demands of consumers needs due to inadequate finished goods inventories. Greater risk of loss due to devaluation through changes in price of production cost.
Demerits of excessive or inadequate
inventories
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Inventory control means control over materials lying in store.
Inventory control keeps continuous track of inventories. But it is not
merely record keeping. Inventory control aims to achieve maximum
possible inventory turnover.
Meaning Of Inventory Control
Definition Of Inventory ControlAccording to Jhon L.Burbridge, “Inventory control is concerned with
the control of quantities and monetary value of these items at
predetermined level or within safe limits”.
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Availability of materialsMinimising the wastageBetter services to customersIncrease operational efficiencyAchieving efficient production levelsOptimum level of inventoriesEconomy in purchasingOptimum level investment in raw materialsOptimum level investment in work-in-progressOptimum level investment in finished goods.
Risk Of Holding Inventory
Price decline
Product Deterioration
Product Obsolescence
Objectives of inventory control management
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Ordering costs
This cost includes the variable cost associated with placing an order
for the materials.
Inventory Carrying costs
Inventory carrying cost includes the expenses in keeping the
materials in stores.
Stock out cost
These include loss of sales if there were no stock of finished goods,
cost of production stoppage for want of material and costs
associated with placing urgent orders for replenishment.
Over stock cost
Another kind of cost associated with carrying inventory results when
there is a stock left on hand after the demand for the item has
terminated.
COSTS OF HOLDING INVENTORIES
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ABC stands for Always Better Control technique. ABC analysis is an
inventory management technique where inventory items are classified into
three categories namely: A, B, and C.
ABC Analysis
Just In Time (JIT)In Just in time method of inventory control, the company keeps only
as much inventory as it needs during the production process. With no
excess inventory in hand, the company saves the cost of storage and
insurance.
Material Requirements Planning (MRP)
Method Material Requirements Planning is an inventory control method in
which the manufacturers order the inventory after considering the
sales forecast. MRP system integrates data from various areas of the
business where inventory is utilized.
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Economic Order Quantity technique focuses on taking a decision
regarding how much quantity of inventory should the company order at
any point of time and when should they place the order.
Minimum Safety StocksThe minimum safety stock is the level of inventory which an organization
maintains to avoid stock out situation. It is the level at which the new
order is placed before the existing inventory is over.
VED AnalysisVED stands for Vital essential and desirable. Organizations mainly use
this technique for controlling spare parts of inventory.
https://www.youtube.com/watch?v=1_1nqU3lZh4
Economic Order Quantity (EOQ) Model
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Methods of pricing of materials issuesAll receipts and issues of materials are the important aspects to
continuous flow of production. A systematic procedure should be
adopted for movement of materials from one place to another place.
Materials received and stores are issued on the basis of stores
requisition, bills of materials, stock in balance, etc.
Ascertainment of accurate material cost, fixing of material issue and
effective cost control are the primary objectives to fulfill the needs of the
management. For these reasons the following aspects are considered:
1. valuation of total cost of materials purchased.
2. materials issue procedure
3. important methods of pricing of materials issued.
https://www.slideshare.net/Kalpanaudhay/inventory-pricing-valuation
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Unit IV –Syllabus
Receivables management
Credit policy
Credit evaluation credit granting decisions
Control receivables
Collection policy.
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The term „Receivables‟ refers to the sum of all monies owned to the
firm by its customers arising from sale of goods or services in the
ordinary course of business.
Meaning of receivable management Receivable management is the
process of making decisions relating to the investment of funds in the
assets which will result in maximising the overall return on the
investment of the firm.
Meaning of Receivables
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Growth in sales
Increase in profits
Capability to face competition
Helps to increase customer satisfaction
Takes control of sales processes
Benefits Of Receivable Management
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Capital costs:
The increased level of accounts receivable as an investment in current
assets results in blocking of the firm‟s capital. There is a time lag
between the sale of goods and payments for them. Meanwhile, the firm
has to arrange for additional funds while waiting for payment from its
customers. The firm incurs a cost on account of raising additional capital
to support credit sales, the capital which alternatively could be earned
profitably if employed elsewhere.
Administration costs
This cost is involved in the form of clerical working involved in checking
additional accounts serving the added volume of receivables,
maintaining accounting records and cost of conducting investigation to
assess the credit worthiness of the customers.
Cost Of Maintaining Receivables
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Some costs are to be incurred by the firm for collecting the amount
from the customers on account of credit sales. Sometimes, additional
expenses involves sending frequent follow-up letters, cost of collection
of exchange or cost of discounting bills, expenses of stringent action
against default customers, etc
Delinquency cost
These cost are incurred by the firm when extending credit to the
defaulting customers:
The delinquency costs include the following:
Committing funds to the investments, additional receivables for
extended credit period.
Cost involved in putting extra effort to recover the overdues from the
customers
Cost associated with frequent reminders.
Cost incurred on account of legal charges
Collection cost
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Credit policy(i) Credit standards
a. collection costb. investment in receivables or the average collection periodc. bad debtsd. sales volume
(ii) Credit termsa. credit periodb. cash discount
Credit analysisCredit ratingDecision tree analysis of credit granting
Control of receivablesCollection policyMonitoring of receivables
Aspect Of Management Receivables
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Published information
Bank reference
Trade reference
Salesman‟s interview and report
Credit bureau reports
Reports from other agencies
Past experience
Sources to collect credit information
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Unit V –Syllabus
Financing Current Assets
Trade Credit
Short term Bank Finance
Committees on Working Capital
Regulation of Bank credit
Recommendation
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Funds are required to meet the day to day expenses of the firm. For example, raw materials, wages, power charges etc.Purpose of short term finance:It facilitates smooth running of operationsEnables to hold stock of raw materials and finished product.Goods can be sold on credit.To increase the volume of production at a short notice.It allows flow of cash during the operating cycle. Operating cycle refers to the time gap between production and sales.
Short Term Finance
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Trade credit: it is the credit extended by the suppliers of goods in the
normal course of business. The period of credit is 15 to 90 days. The
credit is given without security. No interest is charged.
MERITS OF SHORT TERM FINANCE
Easy to purchase goods on an open book account.
Spontaneous source of financing compared to other sources
Small firms are benefited if they cannot get credit elsewhere
No need to create any charge against assets.
Sources of short term finance
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https://www.youtube.com/watch?v=aiGcXd2_u7I
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It a “promissory note” issued by a firm, approved by RBI, negotiable by endorsement and delivery, issued at such discount on the face value as may be determined by the issuing firm. These are issued by a firm to raise funds for a short period varying from few days to few months.No cp can be issued for a period less that 15 days from the date of issue.The issuing firm should have tangible net worth of not less than Rs. 4 croresWorking capital of not less then Rs. 4 crores.Current ratio to be 1.33 atleastMinimum p2/A2 rating from CRISIL.
Commercial paper
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Companies accepts deposits for short periods from their members,
directors and the general public.
According to the existing provisions, a company cannot accept deposits
for a period of not less than 6 months and not more than 36 months.
However, deposits up to 10% of the paid up capital and free reserves can
be accepted for a minimum period of three months for short term
requirement. Moreover, a company cannot accept or renew deposits in
excess of 35% of its paid-up capital and free reserves.
MERITS OF PUBLIC DEPOSITS
Public Deposits
Not much complicated formalities involved. The company has to
advertise and inform the public that it is interested in and authorised to
accept public deposits.
It is less costly method for raising short-term as well medium term
funds required by the business.
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There is no need of creation of any charge against any of the
assets of the company for raising funds through public deposits.
The company take advantage of trading on equity since the rate
of interest and the period for which the public deposits have been
accepted are fixed.
DEMERITS
This type of finance is not suitable in a period of depression and
financial stringency. So raising funds through public deposits is not a
reliable and definite source of finance.
This mode of financing sometimes puts the company into serious
financial difficulties. i.e. slight rumor will lead to asking for premature
payment.
The system may prove injurious for the growth of a healthy capital
market. This would affect the supply of industrial securities, particularly
shares and debentures, to general public.
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REGULATION OF BANK CREDIT
Trade credit and bank credit are the important sources of working
capital finance. Guidelines are needed to be framed for effective
control and equitable productive distribution of resources to various
sectors of the Indian economy. The guidelines for working capital
financing have been formulated on the basis of the reports
submitted by the Tandon Committee(1975) and Chore Committee
(1980).
Tandon committee In July 1974, the Reserve Bank of India appointed a committee
under the chairmanship of Sri. P.L. Tandon to suggest guidelines for
the follow-up and supervision of bank credit.
The Tandon committee interviewed commercial banks, cutomers,
large number of professionals, industrialists and others before
formulating their recommendations.
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The committee framed the necessary guidelines on bank credit, particularly
the following:
To suggest guidelines for commercial banks for safety of the fund vis-à-
vis supervise credit for optimum end use of funds and to develop an
information base required by banks periodically from borrowers and also by
RBI from the lending banks.
To give recommendation on prescribed inventory norms for different
industries.
To make suggestions on sources for financing the minimum working
capital requirements.
To suggest criteria regarding satisfactory future credit norms.
To suggest / recommend any other related matters.
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Chore Committee In 1979, Reserve Bank of India appointed a committee under the
chairmanship of Shri. K.B.Chore to find out and review the system of
cash credit.
Terms of reference: To frame guidelines, the study group reviewed the
following aspects.
To analyze the gap between the credit limits sanctioned and credit
limits utilised.
To study on the limits fixed on the basis of the maximum
requirements of individual borrowers and draws are made according
to actual needs at any point of time.
To give suggestions for modification of existing cash credit system,
to ensure the effective utilisation of credit facilities and to increase the
output or other product ways.
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Martha committeeThis committee was constituted by the RBI to suggest measures for
giving meaningful directions to the credit management function of
RBI. The two major recommendations of this committee are:
(a) The third method of lending as suggested by Tandon Committee is
found to be impractical.
(b) „Fast track scheme‟ is to be introduced to improve the quality of
credit appraisal in banks. The commercial banks can release
without prior approval of the RBI 50% of the additional credit
required by the borrowers where the following requirements are
fulfilled.
(i) the estimates in regard to production, sales, current assets,
current liabilities other than bank borrowings and net working
capital are reasonable in terms of the past trendsand assumptions
regarding most likely trends during the future projected period.
(ii) the projected current ratio is not below 1.33:1
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(iii) the borrower has been submitting quarterly information and operating
statements for the past six months within the prescribed time. (iv) the
borrower undertakes to submit to the banks his annual accounts
regularly.
Dehejia committee This committee was constituted by National Credit Council under the
chairmanship of Shri. V.T. Dehejia in 1968. The following are the
findings
1. There was a tendency on the part of industry to avail of more short-
term credit than their actual requirement.
2. A diversion of short-term credit had taken place to the acquisition of
long term assets.
3. The credit limits related to the security offered not to the overall
financial position of the borrowers through a cash flow analysis.https://www.slideshare.net/rpadiaassociates/working-capital-finance