Worklng caplLal

W Worklng caplLal ls Lhe caplLal requlred for

Lhe day Lo day worklng of an enLerprlse lL ls
requlred for Lhe purpose of raw maLerlals and
for meeLlng Lhe day Lo day expendlLure on
salarles wages renLs adverLlslng eLc lL ls
needed for holdlng some converLlble asseLs
(currenL asseLs) such as sLock book debLs bllls
recelvables and cash lL conslsL of funds
lnvesLed ln currenL asseLs
acLors ueLermlnlng WC 8equlremenLs
W naLure of buslness
W roducLlon cycle
W Slze of buslness
W 1urnover
W 1erms of Lrade
W naLure and value of Lhe producLs
W Seasonal flucLuaLlon
W use of manual labour or machlnes
W CrowLh and expanslon of buslness
W Company pollcles
)naLure of buslness
1he manufacLurlng or Lradlng concerns requlre more amounL of
worklng caplLal because Lhey have Lo lnvesL heavlly ln lnvenLorles
and debLors ln Lhe case of publlc uLlllLles llke LransporL elecLrlclLy
underLaklng eLc mosL of Lhe LransacLlon are on cash basls urLher
Lhese concerns do noL requlre large lnvenLorles Pence Lhey requlre
less amounL of worklng caplLal
2) roducLlon cycle
AnoLher facLor deLermlnlng WC ls Lhe producLlon cycle lL slmply
refers Lo Lhe Llme requlred Lo manufacLure a producL lL covers Lhe
Llme span b/w Lhe procuremenL of maLerlal and producLlon of
goods 1he longer Lhe producLlon cycle Lhe larger wlll be Lhe
requlremenL of WC
)Slze of Lhe buslness
Cenerally large buslness concerns are requlred Lo malnLaln huge
lnvenLorles Pence blgger Lhe slze Lhe larger wlll be Lhe WC requlred
and vlce versa
4) 1urnover
1urnover means Lhe speed wlLh whlch Lhe WC ls recovered by Lhe
sale of goods lf Lhe Lurnover ls hlgher lL wlll requlre less amounL of
WC
Lg a hoLel whlch effecL qulck sales needs comparaLlvely low WC 8uL
lf Lhe sales are slow more WC wlll be requlred
)1erms of Lrade
A concern whlch purchases on credlL and sells on cash wlll
requlre less amounL of WC lf a concerns buys everyLhlng on
cash and sells on credlL lL wlll need a large amL of WC
6)naLure and value of producL
lf Lhe cosL of raw maLerlal ls a larger proporLlon of Lhe LoLal cosL
of Lhe flnlshed producL worklng caplLal requlred wlll be large
) Seasonal flucLuaLlon
CerLaln lndusLrles manufacLure and sell goods only durlng cerLaln
season such concern requlre large amounL of WC durlng Lhe
season
8)use of manual labour or machlnes
ln labour lnLenslve lndusLrles larger amounL of WC wlll be needed
Lhan ln Lhe mechanlzed lndusLrles
)CrowLh and expanslon of buslness
A growlng concern needs more WC Lo flnance lLs lncreaslng
acLlvlLles and expanslon 8uL WC requlremenLs are low ln case of
sLaLlc concern
) Company pollcy
Worklng caplLal requlremenLs are also lnfluenced by company
pollcles such as Lhose relaLlng Lo depreclaLlon dlvldends eLc
WC8klnC CAl1AL CLlC?
Worklng caplLal pollcy ls reflecLed ln a flrm's
currenL raLlo qulck raLlo Lurnover of cash and
securlLles and lnvenLory Lurnover
1hese raLlos lndlcaLe wheLher buslness has
good amounL of worklng caplLal relaLlve Lo lLs
level of sales based on LhaL lL ls sorLed LhaL
Lhey are havlng a relaxed pollcy or noL
ConLlnued
A relaxed pollcy may be approprlaLe lf lL
reduces rlsk more Lhan proflLablllLy
rlnclpals of Worklng CaplLal ollcy
PRINCIPLES OF
WORKING CAPITAL
MANAGEMENT
Principle of
Risk
Variation
Principle
of Cost of
Capital
Principle of
Equity
Position
Principle of
Maturity of
Payment
Worklng CaplLal lnanclng ollcles
ModeraLe MaLch Lhe maLurlLy of Lhe asseLs
wlLh Lhe maLurlLy of Lhe flnanclng
#MaLurlLy maLchlng"
#SelfllquldaLlng
Aggresslve use shorLLerm flnanclng Lo
flnance permanenL asseLs
ConservaLlve use permanenL caplLal for
permanenL asseLs and Lemporary asseLs
Years
$
Perm NOWC
Iixed Assets
1emp. NOWC
<
S-1
Loans
L-1 Iin:
Stock &
Bonds,
ModeraLe lnanclng ollcy
ConservaLlve lnanclng ollcy
Iixed Assets
Years
$
Perm NOWC
L-1 Iin:
Stock &
Bonds
Marketable Securities
Zero S-1
debt
lnLroducLlon
1he caplLal AsseL prlclng model (CAM) ls
a model developed by Mr Wllllam Sharpe !ohn
LlLner and !an Mossln lndependenLly ln mld
6s lL ls an exLenslon of porLfollo Lheory of Mr
Parry MarkowlLz 1he porLfollo Lheory ls a
descrlpLlon of how a raLlonal lnvesLor should bulld
efflclenL porLfollos and selecL Lhe opLlmal
porLfollo CAM derlves Lhe relaLlonshlp beLween
Lhe expecLed reLurn and rlsk of lndlvldual
securlLles and porLfollos ln Lhe caplLal markeL
8lsk and 8eLurn
W 8lsk and reLurn are Lwo lmporLanL aspecLs of every lnvesLmenL
8aLlonal lnvesLors prlmarlly base Lhelr lnvesLmenL declslon on Lhe
expecLed reLurn and rlsk of Lhe lnvesLmenLs 8lsk ls deflned and
measured by Lhe varlablllLy ln reLurns lnvesLors aLLempL Lo reduce
rlsk by consLrucLlng porLfollo of securlLles 1hls acLlvlLy ls known as
dlverslflcaLlon 8y alLerlng proporLlon of funds lnvesLed ln each
securlLy any number of porLfollos can be consLrucLed Among Lhese
porLfollos some domlnaLe oLhers because of Lhelr efflclency le lower
rlsk for a glven reLurn or hlgher reLurn for a glven level of rlsk
W 8lsk can be classlfled lnLo Lwo caLegorles vlz sysLemaLlc rlsk and
unsysLemaLlc rlsk SysLemaLlc rlsk comprlses of rlsk facLors common
Lo Lhe whole economy Such rlsks cannoL be ellmlnaLed by
dlverslflcaLlon 1hey are measured by 8eLa (.) unsysLemaLlc rlsk (or
nonmarkeL rlsk or flrmspeclflc rlsk facLors can be ellmlnaLed by
dlverslflcaLlon Pence ln a well dlverslfled porLfollo only sysLemaLlc
rlsk prevalls 1he CAM lndlcaLes Lhe naLure of relaLlonshlp beLween
Lhe reLurn and Lhe sysLemaLlc rlsk of a securlLy
CAPlTAL A33ET PRlClN0 V00EL
8aslc AssumpLlons
W lnvesLors hold efflclenL porLfollos hlgher expecLed
reLurns lnvolve hlgher rlsk
W unllmlLed borrowlng and lendlng are avallable aL Lhe rlsk
free raLe
W lnvesLors have homogeneous expecLaLlons
W 1here ls a oneperlod Llme horlzon
W lnvesLmenLs are lnflnlLely dlvlslble
W no Laxes or LransacLlon cosLs exlsL
W lnflaLlon ls fully anLlclpaLed
W CaplLal markeLs are ln equlllbrlum
Craphlcal represenLaLlon of CAM
W Craphlcally Lhe relaLlonshlp beLween Lhe
expecLed reLurns and 8eLa of a securlLy or porLfollo
ls expressed by a securlLy markeL llne as shown
below
W ln Lhe x? graph expecLed reLurns are ploLLed on
? axls 8eLa coefflclenLs are ploLLed on xaxls 8lsk
free asseL has an expecLed reLurns equlvalenL Lo 8f
and 8eLa coefflclenL zero
W 1he markeL porLfollo M has an expecLed reLurn
equlvalenL Lo and 8eLa coefflclenL of 1he sLralghL
llne [olnlng Lhese Lwo polnLs ls known as securlLy
markeL llne Whlch expresses Lhe CAM

R
f
R
m
Beta
E
x
p
e
c
t
e
d

r
e
t
u
r
n
Security market line
Y
lmpllcaLlons of CAM
W lL sLlpulaLes LhaL Lhe sysLemaLlc rlsk ls Lhe only
lmporLanL facLor deLermlnlng expecLed reLurns 8ecause Lhe
lnvesLors can ellmlnaLe all unsysLemaLlc rlsks Lhrough
dlverslflcaLlon Pence Lhe relevanL rlsk of an asseL ls lLs
sysLemaLlc rlsk and noL Lhe LoLal rlsk 8eLa whlch ls Lhe raLlo
of Lhe covarlance beLween Lhe asseL reLurns and Lhe markeL
reLurns dlvlded by Lhe markeL varlance () ls Lhe mosL
approprlaLe measure of rlsk 1he CAM also lmplles LhaL
lnvesLors can expecL reLurns from Lhelr lnvesLmenL accordlng
Lo lLs sysLemaLlc rlsk le Lhere ls a llnear relaLlonshlp beLween
an asseL's reLurn and lLs beLa
W lnanclal managers use Lhe concepL of CAM ln a number
of flnanclal declslon maklng such valuaLlon of securlLles cosL
of caplLal measuremenL lnvesLmenL rlsk analysls eLc
LlmlLaLlons of CAM
1hough Lhe CAM glves valuable lnslghLs for Lhe
lnvesLors lL ls noL free from llmlLaLlons 1hey are as follows
1he assumpLlons upon whlch CAM are based are
unreallsLlc 1hey are far from reallLy
2 lL ls dlfflculL Lo flnd a rlsk free securlLy A shorL
Lerm hlghly llquld governmenL securlLy ls consldered as a rlsk
free securlLy 8ecause lL ls unllkely LhaL Lhe governmenLs wlll
defaulL buL lnflaLlon causes uncerLalnLy abouL Lhe real raLe of
reLurn
8eLas of lndlvldual securlLles are noL sLable over
Llme Pence Lhe hlsLorlcal beLas are poor lndlcaLors of Lhe fuLure
rlsk of securlLles lnvesLors do noL have fuLure daLa Lo esLlmaLe
beLa
Concluslon
W 1he CAM descrlbes Lhe expecLed reLurn for all
asseLs and porLfollo of asseLs ln economy lL proves
LhaL Lhe dlfference ln Lhe expecLed reLurns of any
Lwo asseLs can be relaLed Lo Lhe dlfference ln Lhelr
beLa values
W lnsplLe of Lhe llmlLaLlons of Lhe model CAM ls a
useful devlce for undersLandlng Lhe rlsk reLurn
relaLlonshlp lL provldes a loglcal and quanLlLaLlve
approach for esLlmaLlng rlsk lL provldes a LheoreLlcal
supporL Lo Lhe lnvesLors ln caplLal markeL for maklng
reasonably loglcal lnvesLmenL declslons