Lesson No. 24 – WORKING CAPITAL FINANCE

***** Lesson no 24 *****

WORKING CAPITAL FINANCE

We have seen earlier that 3 essential assets are to be acquired to carry out any economic activity.
They are 1 FA 2 CA 3 NCA(including Intangible assets such as Know how etc). We have discussed the appraisal of TL/DPG with which FA are generally acquired.
Now let us again define WC- cycle , CA and NCA.
Working Capital Cycle
For day to day working most of the business have to acquire CA's, process or pack them,they may have to store them for some time and ultimately Sale them. Fixed Assets are used to carry out all these activities.
Thus the steps involved are (1) Acquiring assets and storing them. (2)Processing/packaging them(3)Storing The Finished goods (4)Selling the Goods (5) Recovering the value of goods sold on credit.
Thus two Stages are
i) Pre Sales:- Covers 1, 2 & 3
ii)Post Sales:- Covers 4 & 5.
Accordingly two types of Financing is needed.
Those assets which undergo the changes are CA and capital or money invested in them is Working Capital.
The WC cycle involves Acquiring
RM from Cash/Bank & On Credit -- processing them to get WIP or SIP, further processing them to convert to FG, packaging & holding/storing them and Selling them on Cash or on Credit (Debtors/Receivables) & recovering them to obtain Cash. Remember that at every stage there may be value addition like labour, electricity, stores etc. and the costs involved becomes the part of the WC and hence the CA.
The WC cycle can be converted to Number of days or months by working out various Ratios like RM holding period, SIP,FG and Debtors period. Longer or bigger the cycle more CA's will be needed and hence more WC as such more financing for WC.
For arriving at requisite level of WC finance the starting point is accepting a certain level of Sales in value and numbers.This is the most ticklish problem and need to be understood and studied. As once a Banker accepts certain level of Sales value, matching level of CA's are required to achieve them and hence Certain Level of or Amount of Working Capital Finance.
For the existing firms these aspects are valuable while accepting level of Sales. (A) The trends will continue (B) There will be lot of change from the existing trends.
(A)The past 2 or 3 years trend about the rise in Sales is accepted say average rise was 12%.Then say for 2015-16 sales were Rs356 then accepted projections may by 356+12%=398.72 or say 400. And rest of the working will be based on this.
(B) The borrower has projected that here will be Quantum jump in sales by 50%.For accepting this or accepting reduced projections or rejecting it requires logical and practical experiences.
For accepting there may be several arguments like (1) The new plant and machinery is purchased and hence rise in production. Supported by market survey.(2) Being the 3rd year the production is stabilized. (3)There are export orders(4) There is tie up.(5)The market trend has changed(6) High level of unfilled demand (7) The expertise in production and monopoly.(8)Got an order from Defence under make in India (9) R and D has resulted in a new molecule(10) The Govt has planned an Air Port; A super Highway; New hospital is coming up & we have tied up....... so on and and so forth.
Remember u accept the proposal on logic and facts and there is no thumb rule.
But remember that for any level of activity the other inputs must be available (say electricity, labour, suitable RM etc).Similarly these activities need Margin or own funds at appropriate time and the entrepreneur should be able to bring it. If u are convinced then go ahead or u may accept two or three step rise say 20% in 1st six months 30% in next 6 months etc.and WC finance levels.
For NEW projects the matter is really difficult. Client is always sure to reach the projected targets.We have to ask the questions whether the product has demand in the market, will it be absorbed at that costs, will it be able to stand the competition.The marketing support system is sufficient to yield results etc. The market survey is supporting the facts.The machinery and inputs are sufficient to produce the targeted products of that quality and costs.And remember the same facts about own funds/margin as stated above.
It is a tough decision.You may take help of your senior colleagues, peers, existing customers, economic survey, competitors. But remember listen to them but do not relay on them 100%,You are the best judge.
OF COURSE REDUCE THE ENTIRE JUDGMENT (of accepting level of sales) ON PAPER BY WRITING THE LOGIC AND FACTS U HAVE STUDIED OBSERVED AND AGREED UPON , BASED ON CIRCUMSTANCES.
We will close here with an Assurance to come back tomorrow
Good by.

Waman Gokhale
7350901500