Working Capital Financing Lecture Notes

Introduction

• Presenter: Dr. Mahir Shah
• Subject: Strategic Financial Management
• Target Audience: TYBMS students, Semester 6
• Objective: Learn to solve problem sums based on working capital financing

Key Concepts

Definition of Working Capital

• Formula: Working Capital = Current Assets - Current Liabilities
• Current Assets Must Include:
  • Raw Material
  • Work in Process (WIP)
    • Components: Raw material, labor, overheads
  • Finished Goods
  • Debtors
  • Cash

Current Liabilities

• Components:
  • Creditors
  • Outstanding Payments (labor and overheads)

Transition from Gross Working Capital to Net Working Capital

• Gross Working Capital: Total Current Assets
• Net Working Capital:
  • If a margin of safety is given: Gross Working Capital + Margin of Safety
  • If no margin is given: Gross Working Capital = Net Working Capital

Formulas and Rules

Basic Formula for Capital Calculation

• General Formula: Units × Rate × Period
• Ensure to note down:
  1. WIP: Labor and Overheads are considered as half of the calculated amount
  2. Finished Goods: Rate based on Cost of Production
  3. Debtors: Rate based on Selling Price
  4. Creditors: Rate based on Raw Material Cost

Working Notes

1. Cost Structure: To find rates (Raw Material, Labor, Overheads, Profit, Sales)
2. Number of Units Calculation:
   • Annual Production / 12 (for monthly), / 52 (weekly), / 360 (daily)

Maximum Permissible Bank Financing (Tandon Committee Methods)

1. 75% of Current Assets - Current Liabilities
2. 75% of Current Assets - 4 * Current Assets
3. 75% of Current Assets - Core Current Assets (25% of Total Assets) - Current Liabilities

Problem Solving Example

Given Data:

• Selling Price per Unit: ₹10
• Units: 30,000 per year
• Raw Material: 60% of Selling Price
• Direct Wages: 1/6 of Raw Material
• Overheads: Twice the Direct Wages

Steps to Solve:

1. Calculate Cost Structure

   • Raw Material = ₹6
   • Labor = ₹1
   • Overheads = ₹2
   • Total Cost Structure: Raw Material + Labor + Overheads + Profit = Selling Price

2. Calculate Number of Units: 30,000 units annually = 2,500 units monthly

3. Calculate Current Assets:

   • Raw Material in Hand: ₹30,000
   • WIP: Raw Material, Labor, Overheads
   • Finished Goods: ₹67,500
   • Debtors: ₹75,000
   • Cash: ₹40,000
   • Total Current Assets: ₹2,31,260

4. Calculate Current Liabilities:

   • Creditors: ₹30,000
   • Outstanding Wages: ₹2,500
   • Outstanding Overheads: ₹5,000
   • Total Current Liabilities: ₹37,500

5. Calculate Working Capital:

   • Working Capital = Total Current Assets - Total Current Liabilities = ₹1,93,750

6. Calculate Maximum Permissible Bank Finance:

   • Method 1: ₹1,45,330
   • Method 2: ₹1,35,938
   • Method 3: ₹92,578

Conclusion

• Emphasized understanding of working capital calculations and importance in strategic financial management.
• Summary reflects on the complete process from determining working capital to calculating maximum bank financing.