Working Capital - Explained in Hindi - YouTube

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Namaskar, my name is Mukul and welcome to asset yogi.

Where we people do not lock but unlock the knowledge of finance.

In this video, we will understand the calculation of working capital by example

This video is a part of a series

in which we are discussing working capital management.

In the last video, I've discussed the working capital operating cycle.

If you have not seen that video, then watch it,

you will find the link in the description below.

In this video, we will understand the working capital factor in a bit more detail.

What is its formula and what is its calculation?

So, do watch this video till the end.

Let's get straight to the blackboard.

Let's do a quick recap.

So, if you are in a manufacturing industry then you first procure the raw material

let's say it takes 30 days to buy and store it

Then you do the manufacturing,

then the time of work-in-progress, let's say is about 10 days

then they become finished goods,

then it takes about 20 days, you keep it in the warehouse for 20 days

after that, it gets sold.

After the sales, the retailers and wholesalers pay the money within 30 days.

So this is your total cash cycle, it becomes about 90 days.

So, you get your money back after 3 months

this is what we call working capital, which is where your money gets stuck.

Now let's understand its calculation What is its formula exactly?

Before that, understand that these raw materials, work-in-progress

and these finished goods,

these are basically your inventory

This inventory is of different types.

the cost of raw material cost + the inventory of work-in-progress + the inventory of finished goods.

This has to be added right.

This is your inventory

this is your debtors, this is what we call Accounts Receivables

So you are not getting this money immediately

this comes into your accounts receivables

rest is your cash possession.

All the cash you have lying around becomes your case possession.

Now let us see the formula for the working capital.

So, what actually is working capital?

Working capital is the amount of money that you need to run day-to-day operations

for your business.

I have already talked about this and we've seen this in the operating cycle as well

now Its formula is working capital = current assets - liabilities

this is current liabilities, right.

So Basically, Current Assets - Current Liabilities is your working capital

and what are current assets?

current assets are those assets

which get converted into cash within an operating cycle.

We have already understood the operating cycle, right?

So, your cash-to-cache cycle was of your 3 months, right

so, within 3 months that asset is basically converted into your cash

or gets converted into cash in a maximum of a year

if any asset takes more than a year to get converted into cash,

then we don't take it as a current asset, we take it as a fixed asset

So, is this difference clear now?

So, What comes into your current assets?

in current asset, one is the cash, the hard cash which you have or

the cash which is in your office or in the company's bank account.

The second is your account receivables.

I have already talked about Accounts Receivables

so basically, these debtors, whom you've given goods on credit

to retailers or wholesalers.

These are your accounts receivables

because you are not getting the money immediately

but will be given, right.

So, it will be converted into cash.

in 30 days or 25 days. whatever your time period is

whatever time you've given them credit for.

Then comes your inventory.

So as I have already said, you have to first calculate the raw material inventory separately

work-in-progress's stocks and the finished goods

whatever the total value comes, will have to be added.

This way you'll get your current assets.

Then, there are current liabilities which are basically your account payables.

Now accounts payables, for example

Your supplier can also give you credit,

and you will pay for it later, so basically, you get the goods on credit from there,

so this becomes your accounts payables

So these are your creditors whom you have to pay back, right.

So this is the working capital formula.

Now, let us understand this with an example

that Why is working capital so important?

Let me write it again current assets- current liabilities

So, let's understand an example

Suppose there is a sports shop

and a cricket academy is trying to be their client

it comes to them

Someone comes from cricket academy and says we need ten cricket balls

now this owner of the sports shop thinks why should I invest so much money

how will start with 50,000 cash only, right

He thinks these balls cost me Rs.1000

Let's say 10 balls are there, so 1 ball costs him Rs. 100

the cost of 1 ball is Rs.100

which he sells for Rs.200.

So this is the cost and this is the price,right

So, for finished goods i.e 10 cricket balls

Rs.1000 will be its cost and Rs.1500 will be its price

So here, he hasn't invested any money

so he operates in "just in time"

that is as soon as the order arrives I will place it on that time

and I will sell the goods.

But this doesn't happen in real life

Now, basically, he is maintaining the cash position. Let's say he has Rs.50,000

that if I immediately need any material, then i will buy it and send it immediately.

He has kept the inventory at 0.

Let's say he doesn't have any cricket equipment with himself.

So, he says ok these are 10 cricket balls

then he goes to the factory to place the order

that send me 10 cricket balls then they said ok brother, we will send

just give us some time

you'll get these cricket balls in, let's say, 7 days.

Now, will the cricket academy wait for 7 days for mere 10 balls?

Definitely not.

They will go to the other store, store 2, and will buy immediately

So here, there's no order, there's no business at all.

He has zero inventory, right.

So account receivables don't make any sense here.

There's no business, no buying or selling, account receivables become zero

accounts payables also become zero

because if this sports shop doesn't receive any order

so it has to cancel this previous order also

So, neither it bought nor did it send anything, right

What will be the networking capital here?

The cash possession he had i.e Rs.50,000 were left as it is

nor it did any business, working capital was already less

but the profit also becomes 0 for this fellow.

What happens now, cricket academy again comes to this store after a month

places same order i.e of 10 cricket balls

same thing again cost is Rs.1000, price is Rs.1500

but now this sports shop's owner becomes little smart

he starts managing inventory now

he says if I do not keep goods in my shop then how the goods will get sold?

So, he says I'll invest 2 lakhs in my business

Rs. 50,000 cash I've already kept

let's invest 2 lakh extra in the inventory now.

So, in total, he investest 2.5 lakhs.

Now, he started managing the Rs.2 lakhs inventory.

Now, if he has kept inventory worth 2 lakhs

Now what happens here is that he sells goods worth 1500

and its cost was Rs. 1000.

Now this Rs 1500 that he got, it changes its cash position possession

and Rs.1500 gets added to it

So, its cash possession becomes Rs.51,500.

And inventory gets subtracted by Rs.1000 so Rs.1000 will be subtracted from here.

So how much will be the inventory left for him?

1 lakh 99 thousand

account receivables are nothing but zero

because they have done the cash payment for the small order.

Accounts Payable is also 0, there is no Liability, every transaction is done on cash

so what will be the net working capital?

cash possession is Rs.51,500

plus add the inventory of Rs.1,99,000

plus account receivables are zero -0 because account payables are also zero

how much is the net working capital then?

Rs.2,50,500

Initially, he has invested Rs.2.5 lakhs so 500 is the profit here

so what's the profit here?

he has invented a lot of money but the profit is coming less in this case.

Now let us see how this scenario turns out if it was a big order

now let's save this cricket academy comes again next month

and says we want to order cricket kits

let's says we want to order 10 complete cricket kits

whose total cost will be Rs. 1,50,000

a get is of 15,00 so 10 kits will be of 1.5 lakh, right

so this costs him Rs. 1 lakh

so, what will happen in this case?

here the order size increased cash possession is still Rs.50,000

he has kept the inventory of 2 lakhs

Now, in this case, if he sells goods worth 1 lakh

so we will subtract 1 lakh

how much will be your inventory?

Rs. 1 lakh

Now only the cricket academy says that we won't give you this Rs.1L immediately.

inventory gets subtracted he gave the goods at that time only

but now this cricket academy says that give us these goods in credit

but now this cricket academy says that give us these goods in credit.

So he asked for 30 days on credit.

Now this sports owner says I should give it on credit because the order is huge

otherwise, how will I make money? and I want to maintain good relations with them

Then he gives it but he has left with only 50,000 cash possession.

His Rs. 1 lakh extra goes out

So how much is his account receivable now?

Rs. 1 Lakh 50 Thousand

So this 1.5 lakhs become his accounts receivables

and he sent the goods on credit

his accounts payables are still zero

he hasn't borrowed anything from anyone else, right.

So how much is our net working capital now?

Rs.50,000 cash + Rs. 1 lakh inventory

we have left with an inventory of worth 1 lakh now

+ account receivables of 1.5 lakhs

minus, account payables are still zero

What is our working capital in total?

it comes out to be ₹ 3 lakh, right

and how much did the profit make in this case?

He had invested Rs.2.5 lakh initially, then here, his profit will be Rs.50,000

Right now he has not made any profit.

As long as his money is stuck for 30 days he has no profit, right

But now see, he needs 3 Lakhs here, now his working capital has become very high.

which was 2.5 lakh earlier, now it has become 3 lakh

so to run his day to day operations of every month

Let's suppose, every month he gives a credit period of 30 days for big orders

so his working capital requirement increased

now he needs Rs.3 lakhs to manage his business

Now, he will become smarter.

Let's see what changes is he going to make in 4th case.

Again after a month, cricket academy places an order for 10 cricket kits

again it's a Rs. 1.5 lakhs order

Now, his cash possession is 50,000

Rs. 1 lakh will be subtracted from the inventory because 1 lakh is its cost

Rs.1 lakh will be left in inventory now

Account receivables are fine. He fives money on credit again

that okay i will take money from you after 30 days.

Now, there's a slight change in the case of accounts payables

he says if I am giving on credit for 30 days

then I can also take credit for 30 days from the cricket cement factory

if I am placing such big order from them every month

then I will take credit from them also

so he goes to them and asks for the credit

now this equipment factory also says that this shop owner does business with me

then definitely we can also give credit to him

so this credit period also gets set for 30 days.

But the sport's owner says that give me whole inventory on credit.

Whatever their inventory of 2 lakh was, which they were taking from the factory,

they take it completely on credit

then the accounts payable here become Rs.2 lakhs

so now the amount, which was for 30 days,

He has made an account payable of Rs. 2 lakh for himself.

So, how working capital will be calculated now?

So basically this Rs. 50,000 will be your cash

plus an inventory of Rs. 1 lakh

and plus account receivables of Rs.1.5 lakhs

minus

here he has taken an inventory of Rs.2 lakh on credit

so you will subtract 2 lakhs from here

Now, how much will be our net working capital?

Here our working capital in total was only one lakh rupees.

Now see, this businessman has actually become a smart businessman.

He will still get a profit of Rs.50,000

Now see, how the scene gets changed?

here, he is maintaining a working capital at very low but still getting a profit of 50,000

Now, if we do a quick recap of what has happned till now

in case 1, case2 case 3 and case 4

In case 1, he was saying whenever older will get places then only I will order

so in this way, he was not getting any business, right

so working capital was very less but profit was also zero

so less working capital and no profit

in case 2, he was doing less business, he sold the goods worth 1500 only

orders were small

which he was easily managing with his inventory

but here his working capital was very high, still profit was very low

So more working capital and less profit

In 3rd case, his orders start rising

and his working capital requirement also got increased

it resulted in more working capital and more profit

he was making a profit of 50,000 but

his major chunk of money was getting blocked

in case 4 he started investment smartly

started applying smart business

and he started maintaining working capital of 1 lakh rupees only

and was still making a profit of 50,000

so less working capital and more profit

this is what we call a smart company or smart business.

Now you decide yourself, which quarter you want to be in.

I leave this thought on you.

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