Factors affecting working capital

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Ch-9 Financial manaagement

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Working capital & Factors affecting working capital:

Working capital & Factors affecting working capital

Net Working Capital(NWC):

Excess of current assets(Current Assets) over current liabilities(Current LIbilities) NWC=Current Assets-Current LIbilities Investment in working capital facilitates smooth day to day operations of the business Net Working Capital(NWC)

Current Assets:

The assets that are converted in to cash or cash equivalents within a period of one year are called as current assets Example: cash, bank, B/R, Debtors, finished goods inventory, Work in progress(Semi finished goods), Raw materials, Prepaid expenses Current Assets

Current Liabilities:

Those payment obligations which ,when arise are due for payment within one year are called current liabilities Example B/P Creditors O/S Expenses Advances received from customers Current Liabilities

Effect of working capital on Liquidity and Profitability:

Effect of working capital on Liquidity and Profitability Sufficient Investment in current assts increase liquidity of business Insufficient investment in current assets may make it difficult for an organization to meet it’s payment obligation As compare to fixed assets ,current assets provide little or low return or profit Therefore balance need to be maintained between liquidity and Profitability Liquidity Profitability

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Factors affecting working capital

Nature of business:

Nature of business Manufacturing business Trading business Service Industry More Working Capital Less than manufacturing business Very less Working Capital Raw material need to be converted in to finished goods before any sales is possible There is no processing so No distinction between raw material and finished goods Do not maintain any inventory or stock

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Scale of business Small scale business Large scale business Less Working capital More Working capital Because quantum of debtors and inventory is more in large scale business

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Business cycle More Working capital Less Working capital Depression Boom the the sales as well as production are likely to be higher The sales as well as production will be low.

Seasonal Factors:

In peak season, higher level of activity higher amount of working capital is required. Seasonal Factors lean season the level of activity is lower Lower Working capital Peak season winters Lean season Summers

Production Cycle:

Production cycle is the time span between the receipt of raw material and their conversion into finished goods. Production Cycle Finished goods Raw material Factory 10 March 15 March Production Cycle in above case is 5 days

Production Cycle:

Production Cycle Duration and the length of production cycle, affects the amount of funds required for raw materials and expenses. longer processing cycle shorter processing cycle. More Working capital Less Working capital

Credit Allowed:

Different firms allow different credit terms to their customers . Credit Allowed These depend upon the level of competition that a firm faces as well as the credit worthiness of their clientele . A liberal credit policy results in higher amount of debtors, increasing the requirement of working capital. A strict credit policy results in Lower amount of debtors, increasing the requirement of working capital.

Credit Availed:

Firm may get credit from its suppliers. Credit Availed A liberal credit policy Less working capital. A strict credit policy More working capital.

Operating Efficiency::

Operating Efficiency: Higher efficiency Less working Capital Requirement higher inventory turnover ratio firm managing its raw materials efficiently Firm is able to manage with a smaller balance of raw materials higher debtor turnover ratio reducing the amount tied up in receivable. . resulting in lower debtors

Availability of Raw Material:

Availability of Raw Material Raw materials are available freely and Continuously lower stock levels are maintained Less Working Capital Interrupted Availability of Raw material higher stock levels may be required.. More Working Capital

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Supplier of raw material Business man When can I get Raw material It will take at least 10 days Lead time The time lag between the placement of order and actual receipt of the materials Lead time is 10 days It will supply raw material tomorrow Lead time is 1 day

Availability of Raw Material:

Availability of Raw Material Lead time The time lag between the placement of order and actual receipt of the materials Higher lead time Higher stock levels are maintained More Working Capital Lower lead time lower stock levels are maintained Less Working Capital

Growth Prospects:

Growth Prospects Growth potential be higher Higher production and sales target More Working Capital

Level of Competition:

Level of Competition Higher level of competitiveness Higher stocks of finished goods to meet urgent orders from customers. More Working Capital Competition may force the firm to extend liberal credit terms

Inflation:

Inflation Rising prices More working capital requirement Higher amounts are required to maintain a constant volume of production and sales Raw material cost is rising Labour cost is rising

Let us revise the concepts:

What is Net Working Capital(NWC)? Current Assets-Current Liabilities Current Assets Current Liabilities Current Liabilities-Current Assets Let us revise the concepts

Thank you I hope it is helpful :

Thank you I hope it is helpful Ms Mamta Narula

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