WORKING CAPITAL

MANAGEMENT
 PRESENTED BY

KHALID AZIZ 8069

HIDAYATULLAH 8039
SHAFIQ AHMAD 8042
 PRESENTED TO

ALL FINANCE STUDENTS ESPECIALLY

TO THE HONOURABLE
SIR ABID USMAN
 Working Capital
 A business requires cash to start, so that it may
purchase property, inventory, and hire
employees.
 The company then uses its employees to sell the
goods and generate more cash and account
receivable.
 This cash is then converted into more inventory.
 This continuous conversion of corporate assets —
comprised, in this example, of the inventory,
receivables and cash — is known as working
capital.
 WORKING CAPITAL
MANAGEMENT
 Decisions relating to working capital and short
Decisions relating to working capital and short
term financing are referred to as working
capital management.
 These involve managing the relationship
between a firm's short-term assets and its
short-term liabilities.
 The goal of working capital management is to
ensure that the firm is able to continue its
operations and that it has sufficient cash flow to
satisfy both maturing short-term debt and
upcoming operational expenses.
 Objectives:
 Optimize investments in current assets.

 To see that the company meets its current

liabilities obligations.
 Manage current assets to see that the return on
current assets is more than cost of capital.
 Proper balance between current assets &
current liabilities .
 CONCEPTS
1) Net Working Capital.
The excess of total current assets over total
current liabilities.
Current assets minus current liabilities.
It is the dollar difference between current assets
and current liabilities.
WORKING CAPITAL=CURRENT ASSETS – CURRENT LIABILITIES
 2) Gross Working
Capital
 The total of investments in all current assets is
known as gross working Capital.
 Gross working Capital is the total cash, and
cash equivalents, that a business has on-hand.
 Cash equivalents may include inventory,
accounts receivable and marketable securities
that can be converted into cash in one year.
 Significance of working capital
management
 The current assets of a typical manufacturing
firm account for over half of its total assets.
 For a distribution company, they account for
even more.
 Excessive levels of current assets can easily
result in a firm realizing a substandard return
on investment. However, firms with too few
current assets may incur shortage and
difficulties in maintaining smooth operations.
 For small companies, current liabilities are the
principal source of external financing. These do
not have access to the longer term capital
markets, other than to acquire a mortgage on a
building.

 The fast growing but larger company also

makes use of current liability financing. For
these reasons, the financial manager and staff
devote a considerable portion of their time to
working capital matters.
 The management of cash, marketable
securities, accounts receivable, accounts
payable and other means of short-term
financing is the direct responsibility of the
financial manager.
 More fundamental, however, is the effect that
working capital decisions have on the
company’s risk and return.
 Working capital issues
1.optimal amount of current
Asset.
We should keep in mind that for every output
level firm need working capital just to continue
the operation.
To determined optimal level or amount of current
assets,management must consider the trade off
between profitability and risk.To explain this
trade off ,we suppose that
 Policy A
Policy B
Asset level

Policy C

Current Assets

0 50,000 100,000

Output(units)
 High Low

Liquidity Policy A policy B policy c

Policy A clearly provides highest liquidity.
If we rank these policies according to
profitability.
ROI = net profit

(cash+receivables+inventory) +fixed asset

From equation we can see
lower level of
cash,receivable,inventory
would reduce the
denominator in eq.
But
1.Decreasing cash, reduces
firm’s ability to meet
financial obligation.
 2.Decreasing receivables
3.Decreasing inventory
so policy c more profitable but
also more risky.

High Low
Liquidity Policy A Policy B Policy C
Profitability Policy C Policy B Policy A
Risk policy C Policy B Policy A
 1.permanent working
capital:
The amount of current assets
required to meet a firm’s long
term minimum needs.
2.Temporary working
capital:
The amount of current asset
that varies with seasonal
requirement.
 FINANCING THE CURRENT
ASSETS

Trade off between the Profitability and Risk

 Spontaneous Financing
Trade credit and other payables and
accruals that arises in the firm day to day
operations. The firm has fix policy for
these. These are not active decision
variables, so current asset financing means
that spontaneous financing is deducted
and the remaining portion is concluded.
 1. Hedging approach
A method of financing where each asset
would be offset with a financing
instrument of the same approximate
maturity.
Short term or seasonal variations
with short term

Long term with long term

(permanent current asset)
 Hedging (or Maturity
Matching) Approach

Short-term financing**
DOLLAR AMOUNT

Current assets*

Long-term financing
Fixed assets

TIME
 Benefits
If the long term financing is used to finance
the short term they have to pay the
interest in the time when they not needed.
 Self liquidating principle

To pay the loan from the funds generated by

the project for which the loan was taken
Short Versus Long Term Financing

Relative risk involved

Shorter maturity schedule , high risk to
pay obligations and to pay principle and
interest payment when they become due.
 Three ways
1. Long term financing
2. Bankruptcy
3. To sell assets
 Interest

By long term financing it precisely know

interest cost over the period, while in short
term it is uncertain
 Risk versus cost trade-off
Long term ----- more cost----- low risk
Short term -----low cost--------high risk

While the situation is not clear the

management decide to finance a portion of
its short term current asset with long term
financing for the safety.
 Risks vs. Costs Trade-Off
(Conservative Approach)

Short-term financing
DOLLAR AMOUNT

Current assets

Long-term financing
Fixed assets

TIME
 Risks vs. Costs Trade-Off
(Aggressive Approach)
Firm increases risks associated with short-term borrowing by using a
larger proportion of short-term financing.

Short-term financing
DOLLAR AMOUNT

Current assets

Long-term financing
Fixed assets

TIME
 Summary of Short- vs.
Long-Term Financing
Financing
Maturity
SHORT-TERM LONG-TERM
Asset
Maturity

SHORT-TERM Moderate Low

(Temporary)
Temporary Risk-Profitability Risk-Profitability

LONG-TERM High Moderate

(Permanent) Risk-Profitability Risk-Profitability
Permanent
 COMBINING LIABILITY
STRUCTURE AND CURRENT
ASSET DECISION

level of the current asset How to finance

interdependent
 Uncertainty and the marginal
safety
Certain about the future sales. Receivables
and production schedule, arrange its debt
according to the future cash flows.

The greater the probability difference of

possible net cash flows greater the margin
of safety that management will wish to
provide
 Risk and profitability
Increasing liquidity, lengthening the
maturity schedule or combination of two
are determine by the attitude of the
management towards the risk and
profitability and firm of the organization.
If can borrow on short notice no need of
applying the above solution.
Thank
you