Working Capital Management - Hindi - YouTube

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Namaskar, my name is Mukul & you are welcome to Asset Yogi

Where we unlock the knowledge of finance rather than locking it

In this video, we will talk about Working Capital Management

I have already made 3 videos on this, in which I have talked about the working capital operating cycle

Then in another video, we have talked about its calculation, then we have talked about types of working capital

So, you can watch those videos, the link is given below in the description

In this video, we will talk about which businesses are benefited from working capital management

What are the problems, if you don't manage working capital correctly

We will understand all these in detail

And why is it important to manage working capital?

So, watch the video till the last

If you have any business or you are interested or if you want to invest in the share market, then let's move to the blackboard

In this video, we will understand working capital management with an example

We will compare two companies & see if any company efficiently uses working capital

Or do management of working capital, then how they can improve their operations & do more business?

We will do a quick recap of working capital formulae & calculation

Working capital is the operation liquidity of a business

Working capital = current assets - current liabilities

Current Assets are the assets that are converted to cash in 1 operating cycle or max. 1 year

Current assets include cash (cash in hand, deposits in a bank, marketable securities like mutual funds, bonds, etc)

Accounts are receivable & inventory is also included

Accounts receivable, let's say you loan some money/goods to a retailer/wholesaler

If its payments come later, then it is called account receivable & inventory basically is a stock

Inventory = Raw material + WIP stocks + Finished goods

Current liabilities = Account payable (short term liabilities payable in 1 year)

For example, Bank loans, Cash Credit, Overdraft, Overdues such as Salaries, Rent, etc.

If current assets are more than current liabilities then it is called Working capital

Which basically is the money needed to run day-to-day operations

There is the same type of matric known as Current Ratio

Current Ratio = Current Assets/Current Liabilities

We will understand, what do Current Assets/Current Liabilities mean

If Current liabilities are greater than current assets (CL>CA), then, Current Ratio < 1

This means short term liabilities are more than current assets

Liabilities are so much more than cash or current assets can't even meet them

The company cannot meet its short term liabilities

It may have to raise additional financing

If current liabilities > current assets then you may need working capital finance, take a loan from somewhere

Its drawback is High liquidity risk

You are not left with money because the liabilities have become more

Risk of Insolvency, which means if there is a problem of liquidity in a company then it can also go bankrupt

So, these are the risks, if Current liabilities > current assets

So, before investing in stock check the company's liquidity, whether its CL > CA or not

If you own a business then to your CL should not be more than CA

The main reason a business fails is that their CL > CA

Now we will try to understand if CA > CL

If Current Ratio > 1, then CA > CL

This means a company can easily meet its short term liabilities because you may have more receivable or inventory or cash

You can cover short term liabilities by converting inventory or account receivable into cash

If the current ratio is between 1.2-2, then it is considered a healthy ratio

This means you are efficiently maintaining your working capital

Is it a good thing if, Current Ratio is > 3?

It is not a good thing as the company is in a comfortable position to meet STL

But it is not utilizing its current assets efficiently

As funds are either idle in form of cash or are locked up in inventories or receivables

That is why it is not a healthy ratio (>3)

We will understand it with an example, in which we will compare two companies

There is an ABC company which maintain its sports stores

I have already given this example in my another video, so we are continuing the same example

Let's say, Cricket Academy orders 10 cricket kits

Let's say, Sports stores sell 1 cricket kit for Rs.15,000

So, total price = Rs.1,50,000 & the cost for sports store of 10 kits = 1,00,000

The cricket academy & store have an old relation

Cricket academy says that they don't have immediate money & ask for 60 days credit period

So the store has to make good payment terms as they are their long time customer

So they agree to 60 days credit period

Let's assume, the cash position of the store is Rs.50,000

They maintain an inventory of Rs.2,00,000

And they sold goods of 1 lakh, here you will subtract 1lakh not 1.5lakhs as the cost of inventory is 1 lakh

So the current value of inventory, when they supply the kits is 1 lakh

In this case, accounts receivable = 1.5 lakhs, as you have supplied the kits but you will get the money after 60 days

So, accounts receivable = Rs.1,50,000

We will calculate current assets

Current assets = 50,000+1,00,000+1,50,000

Total = Rs.3,00,000

Now we will calculate current liabilities

If the company has a cash credit/loan of Rs.1,00,000

So they have short term liability of 1,00,000

Accounts payable = 0, which means, they do on-time payments to the cricket equipment factory

From which they take supply of cricket kits

So accounts payable = 0

Current Liability = 1,00,000 + 0 = Rs.1,00,000

Net working capital = 3,00,000 - 1,00,000 = 2,00,000

Current Ratio = 3,00,000/1,00,000 = 3

We have already talked that if the current ratio=3, then it is not a healthy ratio

That means your money has been locked somewhere

Your money (Rs.1,50,000) has been locked here in accounts receivable

Now, there is an XYZ company, they have similar sports stores

They got a similar order of Rs.1,50,000 whose cost is Rs.1,00,000

Here, cricket academy says to give them kits but ask for 60 days period

XYZ company agrees on this & they are ready to make good payment terms

They agree to 60 days credit period

Now, we will see the calculations here

Let's say, cash position = 50,000, Inventory = 2,00,000 - 1,00,000 = 1,00,000 (cost of finished goods)

Here we are talking about finished goods as it is a retail store

Here, we are not talking about work in progress or raw material as we only store finished goods in a retail store

Inventory = 2,00,000 - 1,00,000 = 1,00,000

Accounts receivable = 1,50,000, as they have agreed for 60 days credit period

Here Current Assets are also Rs.3,00,000

Now we will talk about current liabilities

Cash credit = 1,00,000

Now we will talk about accounts payable

Here, the XYZ company purchase the kits & ask for 60 days credit period from the Cricket Equipment Factory

As our costumers also demand it from us & we have to store inventory, so you should also give 60 days period

So it is important for Cricket Equipment Factor to make good payment terms as the XYZ company is their old term customer

So Cricket Equipment Factor agrees to 60 days credit period

Accounts payable = 1,00,000

Let's say you they have taken inventory of 1 lakh on credit, so Accounts payable = 1,00,000

So, Current liabilities = 1,00,000 + 1,00,000 = 2,00,000

Now we will calculate Net working capital

Net working capital = 3,00,000 - 2,00,000 = 1,00,000 I mistakenly wrote 3 here, your Net-Working capital of 1lakh has come

for the Current Ratio, you divide 3lakh by 2lakh

Your current ratio has come to 1.5, It is a healthy ratio as we talked earlier a healthy ratio is from 1.2-2

Now let's see this XYZ company can do what smartness other than this to unlock its capital

What XYZ Company does

Cash position and inventory is this

But its account receivable comes 1,50,000 here

What they say is how he can get this capital now rather than 60 days

To buy more inventory & do other business from this capital

So they go to the bank

The bank says that I will give you the amount now, which you are going to get in 60 days.

Bank says you take the money from me today

And the money you are going to get from the academy, I will take it in 60 days

Basically, in some way bank brought these accounts receivable

Now Cricket academy will pay to the bank, and the bank

Pays today to sports authority

And this store sells his account receivable to the bank

How do bank make money here, by charging interest for 60 day

We call it Bill discounting

I have already made a detailed video on Bill discounting, so please watch that video

What happens here the bank said I will give you less money by cutting interest of 2 months on 150000 account receiveable

Let's say according to bill discount interest is charged 12% per annum for two month

How much is your interest on 1,50,000

Calculating for 2 months, 2/12 * 0.12(12%) * 1,50,00

Your interset portion comes about Rs.3000

Bank will give you now is 1,50,00-3000

Bank will give you 1,47,000 upfront

This sports store says if he gets money now, he can buy more inventory from this 1,47,000 and do more business from that

The company has no problem with that, and say

Alright today our account receiveable is zero, and we got cash of 1,47,000 immediately

By using the banking system they convert accounts receiveable to cash immediately

Now how much are your current assets

The cash portion in your current asset is 197000 now

Plus your inventory of Rs.200000, no sorry it is Rs.100000 here

Basically, you here add inventory of Rs.100000

How much is Your account receivable, is 0

Now your current assets are Rs.2,97,000

And your current liability is as it as

Your cash credit and account payable of Rs.1,00,000

In accounts payable, you use this one and the supplier's credit and banking systems also

Your current liability is Rs.2,00,000, now your Networking capital will come

Net W.C. 1,97,000- 2,00,000(current liability) comes out 97,000

In current ratio 2,97,000/2,00,000, you ratio comes out 1.485

Look this is also a comfortable Ratio

What advantage you have now, is this cash comes to your hand

You can use this cash as you want

This way you can manage your working capital smartly

We do a quick recap of ABC vs XYZ company

ABC company has a high current ratio of 3

They can easily meet their short time liabilities

But they don't use supplier credit, which they can use very easily or they can ask for credit period of 60D from the cricket factory

They did not use the banking system, by using it they can unlock their cash easily

His money is locked in an account receivable, around 1,50,000

Whereas, XYZ company has a healthy current ratio of 1.5 in the first case

In the second case, it is 1.485, No problem in that

This is also comfortable in meeting short term liabilities because his current asset is also reasonably good

Has a ratio of more than 1.2

They use supplier's credit very efficiently, so it is some kind of working capital financing

They use a banking system nicely, they

Convert accounts receivable into a cash

So they have more cash in hand

Basically, they can increase their inventory turnovers easily

Basically can do more business

They have more cash, they may enter new markets

So If the company manage its working capital nicely it can run a business more efficiently or can do more business

So, I hope you may have clear the concept of working capital management after watching this video

In the next video, we will talk about working capital finance which will contain supplier credit, banking system

So, watch my next video on working capital finance

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