31-08-2012, 11:02 AM
WORKING CAPITAL MANAGEMENT QUESTION & ANSWERS
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1) Discuss the various factors that you as a finance manager would have to take into consideration before assessing the working capital requirements of your firm?
Ans). The working capital requirements of a corporate differ from company to company. There are no rules or formulas to determine the working capital requirements of a firm. The management has to consider a number of factors to determine the level of working capital. The following are some important factors:
1) Nature of business: The nature and volume of business is an important factor in deciding the needed working capital. Public utility service (like railway companies) as compared to manufacturing concerns requires a lesser amount of working capital. A larger amount of working capital is required for trading or merchandising institutions. Similarly, basic and key industries or those engaged in the manufacture of producer’s goods, usually have less proportion of working capital to fixed capital than industries producing consumer’s goods.
2) Size of business unit: It is an important factor for determining the proportion of working capital. The general principal in this connection is that the bigger the size of the unit, the more will be the amount of working capital required. But it is quite likely that the bigger sized business unit, i.e., consumer goods industry may require a larger amount of fixed capital than working capital.
3) Time consumed manufacture: The longer the period of manufacture, the larger the inventory required. However, if the flow of product is quite steady, although the value of goods in process is large, the working capital will not vary much from time to time.
4) Need to store finished goods: In business like retail stores, where unit is required to store finished goods, (because in the absence of adequate stocks, customer may return disappointed) naturally more working capital is required.
5) Turnover of circulating capital: Turnover of circulating capital plays an important and decisive role in judging the adequacy of working capital. The speed with which the circulating capital completes its round, i.e., conversion of cash into book debts or bills receivables, and book debts or bills receivables into cash again plays an important role.
6) Terms and conditions of purchase and sale: The place given to credit by a concern in its dealings with creditors and debtors may also be considered to assess the adequacy of working capital. A business unit, making purchase on credit basis and selling its finished products on cash basis, will require lower amount of working capital than a concern having no credit facilities and which may further be forced to grant credit to its customers.
7) Conversions of current assets into cash: A company having ample stock of liquid current assets will require lesser amount of working capital, because adequate funds can easily be procured by disposed of current assets are much more than the current liabilities.
8) Impact of cyclical and seasonal variation: In periods of the boom and depression, more working capital is needed than during the other stages of cyclical fluctuations.
For arriving at a satisfactory working capital position in time of prosperity the firm should conserve current capital by avoiding wasteful expenditure. When inflationary pressure has been created during a period of emergency like a war, unnecessary hoarding should be avoided because such periods of rising prizes are temporary.
2) ‘Ascertaining and analyzing the credit worthiness of customers, before extending credit, is an important and difficult task’, comment?
Ans). Different loan applicants have different risk characteristics. So it is necessary to evaluate the credit worthiness and customers. Ultimately, the decision whether to make a loan must reflect the perceived level of risk or uncertainty of repayment relative to the loan’s gross return.
The credit evaluation process varies from an individual loan officer who scrutinizes the borrower’s financial statement to a computer routine that receives financial data, computes ratios, and presents printouts of comparative data. The evaluation process is affected by factors such as the size of the loan, the computer technology, the historical relationship between the client and the CB. Whatever the process, credit evaluation is intended to provide an indication of the likelihood of loan repayment within the terms of the initial agreement.
In attempting to evaluate the applicant’s willingness and ability to repay the loan, most credit reviews focus (in some matter) on the “five Cs of credit”:
1. character
2. Capacity
3. Capital
4. Collateral
5. Conditions