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Unit 4 of 4 · M.Com Sem 3

Unit 4: Working capital and corporate restructuring

Strategic Financial Management notes · PTU syllabus (MCOP302-18)

3 min read7 topics10 exam questions
On this page
  1. Unit summary
  2. Concept, types and planning of working capital
  3. Importance and determinants
  4. Sources of working capital
  5. Role of factoring and securitisation
  6. Financial distress and corporate restructuring
  7. Financial reconstruction of distressed firms
  8. Government policies for reviving sick units
  9. Key terms
  10. Quick revision
  11. Important questions

Unit summary

Working capital keeps the firm running, and restructuring keeps it alive or reshapes it. This unit covers the meaning and concepts of working capital, operating cycle, permanent and temporary working capital, approaches and sources of financing, factoring and securitisation, financial distress, methods of corporate restructuring and government policies for reviving sick units.

After this unit you can

  • Explain working capital concepts and the operating cycle
  • Explain approaches and sources of working capital finance including factoring and securitisation
  • Explain financial distress and methods of corporate restructuring
  • Explain government policies for reviving sick units

PTU syllabus topics

  • Meaning and concepts of working capital
  • operating cycle
  • permanent and temporary working capital
  • approaches and sources of financing
  • role of factoring and securitization
  • financial distress
  • methods of corporate restructuring
  • government policies for reviving sick units
ClassificationMethods of corporate restructuring
Corporate restructuring

  • Expansion

    Mergers, acquisitions, joint ventures

  • Contraction

    Demerger, spin-off, divestiture

  • Ownership change

    Buy-back, LBO, going private

  • Financial

    Debt restructuring, recapitalisation

1

Topic 1

Concept, types and planning of working capital

  • Gross working capital: total current assets. Net working capital: current assets − current liabilities.
  • Permanent (fixed) working capital: minimum level needed always; temporary (variable): fluctuates with seasons.
CycleOperating (cash conversion) cycle
Operating (cash conversion) cycle
1Cash
2Raw materials
3Work-in-progress
4Finished goods
5Debtors
6Cash
Key formulasOperating cycle

  • Operating cycle

    Raw material storage period + WIP period + Finished goods storage period + Debtors collection period − Creditors payment period

  • Raw material storage period

    Average RM stock ÷ RM consumed per day

  • Debtors collection period

    Average debtors ÷ Credit sales per day

Planning and forecasting

  • Methods: percentage of sales, operating cycle method, regression, cash forecasting.

Example

Estimate (per annum): production 60,000 units; RM ₹40, labour ₹20, overheads ₹10 per unit; RM held 1 month; WIP 0.5 month (fully material, 50% labour and overheads); FG 1 month at cost; debtors 2 months at cost; creditors 1 month. Monthly figures: RM 2,00,000; WIP = 0.5 × (2,00,000 + 50% of 1,50,000) = 1,37,500; FG 3,50,000; debtors 7,00,000; less creditors 2,00,000. Net WC = ₹11,87,500 (plus a safety margin if specified).

2

Topic 2

Importance and determinants

ComparisonAdequate vs inadequate vs excess working capital
Shortage
Excess

Effect on operations

Production stoppages, lost discounts, poor credit standing

Idle funds, low return on investment

Risk

Insolvency risk

Inefficiency, speculation, bad debts from liberal credit

Profitability

Lost opportunities

Lower ROI

  • Determinants: nature and size of business, production cycle, business cycle and seasonality, credit policy, growth and expansion, operating efficiency, availability of raw materials, dividend policy, price level changes.
  • Approaches to financing: matching (hedging) — finance permanent WC with long-term funds and temporary with short-term; conservative — mostly long-term; aggressive — mostly short-term.
3

Topic 3

Sources of working capital

Long-term (for permanent WC)Short-term (for temporary WC)
Equity and preference sharesTrade credit
Debentures and long-term loansBank overdraft and cash credit
Retained earningsBill discounting and factoring
Depreciation fundsCommercial paper
Public deposits (short-term), advances from customers
  • Bank finance norms: Tandon Committee (1975) — Maximum Permissible Bank Finance methods; Chore Committee (cash credit); now assessment by banks based on projected turnover and the working capital demand loan structure.
4

Topic 4

Role of factoring and securitisation

Factoring

Factoring is a financial service in which a business sells its receivables to a factor at a discount for immediate cash; the factor also manages the sales ledger and collections.

ProcessFactoring mechanism
  1. 1Seller supplies goods on credit to buyer
  2. 2Seller assigns invoice to factor
  3. 3Factor pays 75–90% advance
  4. 4Factor collects from buyer on due date
  5. 5Factor pays balance less charges to seller
  • Types: recourse (seller bears bad-debt risk) and non-recourse; disclosed and undisclosed; domestic and export factoring; forfaiting (export receivables, non-recourse, medium term).
  • Legal framework: Factoring Regulation Act, 2011 (amended 2021); TReDS platforms (RXIL, M1xchange, Invoicemart) for MSME invoices.

Securitisation of debt

  • Pooling illiquid loans (home, auto, microfinance) and selling them to an SPV that issues pass-through certificates (PTCs) to investors.
  • Benefits: liquidity for lenders, risk transfer, capital relief, new investment instruments.
  • Legal framework: SARFAESI Act, 2002; RBI Master Direction on securitisation (2021) — minimum holding period and minimum retention requirement.
ComparisonFactoring vs securitisation
Factoring
Securitisation

Assets

Short-term trade receivables

Long-term loans and receivables

Buyer

Factor (bank/NBFC)

SPV funded by investors

Instrument issued

None

Pass-through certificates

Users

Businesses, MSMEs

Banks, NBFCs, HFCs

5

Topic 5

Financial distress and corporate restructuring

  • Signs of distress: continuous losses, negative net worth, defaults, delayed salaries and creditors, falling credit ratings; prediction models — Altman Z-score.
Key formulasAltman Z-score (listed manufacturing)

  • Z

    1.2 X1 + 1.4 X2 + 3.3 X3 + 0.6 X4 + 1.0 X5

  • Variables

    X1 working capital/total assets; X2 retained earnings/TA; X3 EBIT/TA; X4 market value of equity/total liabilities; X5 sales/TA

  • Zones

    Z > 2.99 safe; 1.81–2.99 grey; < 1.81 distress

ClassificationMethods of corporate restructuring
Restructuring

  • Expansion

    Mergers, acquisitions, takeovers, joint ventures

  • Contraction

    Divestment, spin-off, carve-out, demerger

  • Corporate control

    Buy-backs, going private, LBO/MBO

  • Financial restructuring

    Debt restructuring, debt-equity swaps, capital reduction

  • Organisational restructuring

    Delayering, outsourcing, business process re-engineering

6

Topic 6

Financial reconstruction of distressed firms

Financial reconstruction reorganises the capital structure of a company in financial difficulty so that it can survive — involving shareholders and creditors.

ProcessDesigning a reconstruction scheme
  1. 1

    Estimate position if liquidated

    What each stakeholder would get

  2. 2

    Estimate future earnings and funding needs

  3. 3

    Propose sacrifices

    Shareholders write down capital; creditors convert debt to equity or accept lower interest

  4. 4

    Inject new finance

    Rights issue, new investors

  5. 5

    Check each party is better off than in liquidation

  6. 6

    Obtain approvals

    Section 66, 230–232, NCLT; or IBC resolution plan

  • Capital reconstruction (non-distress): changes in capital such as consolidation, conversion, reduction of surplus capital.
  • Insolvency and Bankruptcy Code, 2016: Corporate Insolvency Resolution Process — resolution plan approved by the Committee of Creditors (66%) and NCLT; else liquidation.

Exam tip

The key test of any reconstruction scheme: every class of stakeholder must be no worse off than in liquidation, or they will not agree.

7

Topic 7

Government policies for reviving sick units

ProcessEvolution of sickness and revival framework
  1. 1

    SICA 1985

    BIFR declared units sick (net worth eroded) and sanctioned revival schemes

  2. 2

    RBI guidelines

    Rehabilitation packages, CDR mechanism (2001)

  3. 3

    SARFAESI 2002

    Enforcement by secured creditors

  4. 4

    SICA repealed (2016)

    BIFR dissolved

  5. 5

    IBC 2016

    Time-bound CIRP before NCLT; resolution plans; liquidation as last resort

  6. 6

    MSME support

    Pre-packaged insolvency (2021), RBI MSME restructuring, ECLGS (2020)

  • Insolvency and Bankruptcy Code: default of ₹1 crore triggers CIRP; Committee of Creditors approves a resolution plan (66% vote); 330-day outer limit; IBBI regulates insolvency professionals.
  • Outcomes: large recoveries in cases like Essar Steel and Bhushan Steel; challenges — delays, low recovery in many cases, haircuts.

Key terms

Operating cycle
Time from cash outflow on inputs to cash inflow from sales
Factoring
Sale of receivables to a factor
Altman Z-score
Model predicting probability of bankruptcy
Corporate restructuring
Changes in a firm's business, ownership or capital structure
CIRP
Corporate insolvency resolution process under the IBC

Quick revision

  • Gross and net WC; permanent and temporary; operating cycle.
  • Financing approaches: matching, conservative, aggressive; sources.
  • Factoring and securitisation for liquidity.
  • Distress prediction (Z-score); restructuring — expansion, contraction, control, financial.
  • Revival: SICA/BIFR → CDR → SARFAESI → IBC (CIRP, CoC, NCLT).

Important exam questions

Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).

Short-answer questions

  1. Q1.What is the operating cycle?
  2. Q2.Distinguish permanent and temporary working capital.
  3. Q3.What is the matching approach?
  4. Q4.What is the Altman Z-score?
  5. Q5.What is a demerger?
  6. Q6.What is CIRP?

Long-answer questions

  1. Q1.Explain working capital concepts, the operating cycle and approaches to financing.
  2. Q2.Explain the role of factoring and securitisation in working capital finance.
  3. Q3.Explain financial distress and methods of corporate restructuring.
  4. Q4.Explain government policies for reviving sick units in India.

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