Corporate Financial Management

By Md. Monowar Hossain, FCA, CPA,

FCMA,CISA,CPFA(UK),FCGA,FCS
md.monowar@gmail.com

CFM
Corporate Financial Management
Module -05 05.Working Capital management
402.05 (22) Working capital and its importance
Working capital (23) Planning and control of cash and marketable securities,
management debtors, current liabilities and stock.
Learning outcomes:
(a) Working capital
(b) Working capital ratio
(c) Importance of working capital
(d) 4 main components of working capital
(e) Permanent working capital and
Temporary working capital
(f) Financing of the Working Capital
(g) Concept of working capital management
(h) Calculation of working capital
(i) Statement of sources and uses of net
working capital

(29) Working capital and its importance

Working capital Working capital management refers to a company’s managerial accounting
strategy designed to monitor and utilize the two components of working capital, current assets
and current liabilities, to ensure the most financially efficient operation of the company.
Working capital is a measure of both a
company’s efficiency and its short-term
financial health.
Working capital is calculated as:
WC = Current Assets – Current Liabilities.
That is working capital is equal to the value of
raw materials, work‐in‐progress, finished goods
inventories and accounts receivable less
accounts payable.

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12th Edition (September-2021)
 Corporate Financial Management
By Md. Monowar Hossain, FCA, CPA,
FCMA,CISA,CPFA(UK),FCGA,FCS
md.monowar@gmail.com
The working capital ratio (Current
Assets/Current Liabilities) indicates whether a
company has enough short term assets to
cover its short-term debt.
 Anything below 1 indicates negative
working capital.
 While anything over 2 means that the
company is not investing excess assets.
 Most believe that a ratio between 1.2
and 2.0 is sufficient.
 Also known as “net working capital”.

Things to Remember
• If the ratio is less
than one then they
have negative
working capital.
A high working capital ratio
isn’t always a good thing, it
could indicate that they have
too much inventory or they
are not investing their excess
cash.

Importance of working capital

Current assets are a major
financial position statement item
and especially significant to
smaller companies.
Mismanagement of working capital is
therefore a common cause of
business failure, e.g.:
• inability to meet bills as they
fall due
• demands on cash during
periods of growth being too
great (overtrading)
• overstocking
Working capital management is a
key factor in an organization’s long-
term success, that’s why it is very
important for the organization.

i) A considerable part of working fund is invested in current assets, which necessitates their
management in an efficient manner.
ii) There is a direct relationship between sales and working capital.
iii) Credit worthiness of the company depends upon the adequate amount of working capital.
iv) With adequate liquidity company get benefit of cash discount by making prompt payment.

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 Corporate Financial Management
By Md. Monowar Hossain, FCA, CPA,
FCMA,CISA,CPFA(UK),FCGA,FCS
md.monowar@gmail.com
v) Adequate working capital boosts morale of the workers.
vi) Adequate working capital improves goodwill and image of the firm.
vii) Adequate fund enables the management to take advantage of occasional opportunities.
viii) Over investment in current asset may improve the liquidity but it will affect the profitability so
optimum level of working capital should be maintained in organization.

The financial resources of businesses are always limited.

It is therefore desirable to minimize the Working Capital Requirement.

4 main components of working capital

4 Main Components of Working Capital:

• Cash Management: Cash is one of the important components of current assets.
• Receivables Management: The term receivable is defined as any claim for money owed to
the firm from customers arising from sale of goods or services in normal course of
business.
• Inventory Management:
• Accounts Payable Management:

Permanent working capital and Temporary working capital

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12th Edition (September-2021)
 Corporate Financial Management
By Md. Monowar Hossain, FCA, CPA,
FCMA,CISA,CPFA(UK),FCGA,FCS
md.monowar@gmail.com

Permanent working capital refers to a level of current assets which is to be maintained and vital
for the firm to carry its business regardless of the operation levels.

Temporary working capital refers to the working capital which is over and above
the permanent working capital.

Financing of the Working Capital

Current assets less current liabilities, properly called
net working capital.
Working capital is a measure of a company’s
liquidity. Sources of working capital are
(1) net income,
(2) increase in noncurrent liabilities,
(3) increase in stockholders’ equity, and
(4) decrease in noncurrent assets.

Sometimes, deferred payment of taxes is also a source of working capital.

Concept of Working Capital Management

Problem No. 31 (working capital)

From the following information, prepare a statement showing the working capital requirements.
In total and (ii) As regards each constituent part of working capital.

Budgeted sales ($10 per unit) $260,000 per annum

Analysis of Costs $
Raw Materials 3.00
Direct Labor 4.00
Overheads 2.00
Total Cost 9.00
Profit 1.00
Sales 10.00

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12th Edition (September-2021)
 Corporate Financial Management
By Md. Monowar Hossain, FCA, CPA,
FCMA,CISA,CPFA(UK),FCGA,FCS
md.monowar@gmail.com
It is estimated that
(a)Raw materials are carried in stock for three weeks and finished goods for 2 weeks.
(b) Factory processing will take three weeks.
(c ) Suppliers will give full five weeks’ credit.
(d) Customers will require 8 weeks’ credit.
(e) It may be assumed that production and overheads accrue evenly throughout the year.

Solution of problem No. 31 (working capital)

Statement of Working Capital Requirement
Current Assets $
Raw Materials 78,000 x 3/52 = 4,500
Work in Progress (Note-iii) = 9,000
Finished Goods 234,000 x 2/52 = 9,000
Debtors 2,60,000 x 8/52 = 40,000
62,500
Less : Current Liabilities
Trade Creditors (5 weeks) 5/52 x 78,000 = (7,500)
Working Capital Required 55,000

Working Notes:
(i) Number of Units = 26,000
(ii) Finished Goods (iii)Work in Progress
Raw Materials 26,000 x 3 = 78,000 Raw Material 78,000 x 3/52 = 4,500
Direct Labour 26,000 x 4 = 1,04,000 Labour 1,04,000 x 3/52 x ½ = 3,000
Overheads 26,000 x 2 = 52,000 Overhead 52,000 x 3/52 x 1/2 = 1,500
Finished Goods 2,34,000 Work in Progress 9,000

NOTE:
a. Normally finished goods and work in progress are taken as same value. Suppose wages and overheads accrue
evenly throughout the year given in the problem, we have to find out the work in progress value separately. At
that time of computing work in progress labor, overhead value is reduced to half.

b. At the time of calculating working capital, debtor value will be taken as either including profit element or excluding
profit element.
Problem No. 32 (working capital forecast)
As a company secretary of FYR, prepare a working capital forecast from the following
information:
Issued share capital 4,00,000
12% Debentures 1,50,000

The fixed assets are valued at $300,000. Production during the previous year is 100,000 units.
The same level of activity is intended to be maintained during the current year.
The expected ratios of cost to selling price are
Raw materials 50%
Direct Wages 10%
Overheads 25%
The raw materials ordinarily remain in stores for 2 months before production. Every unit of
production remains in process for 2 months. Finished goods remain in the warehouse for 4
months. Credit allowed by creditors is 3 months from the date of delivery of raw materials and
credit given to debtors is 3 months from the date of dispatch. Selling price is $ 6 per unit. Both
the production and sales are in a regular cycle.

Required:
As the Company Secretary of FYR, prepare a working capital forecast from the above
information.

Page # 105
12th Edition (September-2021)
 Corporate Financial Management
By Md. Monowar Hossain, FCA, CPA,
FCMA,CISA,CPFA(UK),FCGA,FCS
md.monowar@gmail.com

Solution of problem No. 32 (working capital forecast)

Working Capital Statement
$
Raw Materials 50,000
Work in Progress 67,500
Finished Goods 1,70,000
Debtors 1,27,500
4,15,000
Less: Creditors (75,000)
Working capital required $3,40,000

Working Notes :
Number of units = 1,00,000
Sales Value = 1,00,00x$6 = $6,00,000
Material = 6,00,000 x 50/100 = $3,00,000
Labour= 6,00,000 x 10 /100 = $60,000
Overheads = 6,00,000 x 25 /100 = $1,50,000

Finished Goods
Raw Materials = $3,00,000
Direct Labor = $60,000
Overheads = $1,50,000
i.e., $5,10,000 x 4months /12months = $5,10,000
$1,70,000
Work in Progress
Raw Materials = 3,00,000 x 2/12 = $50,000
Direct Labor = 60,000 x2/12 x ½ = $5,000
Overheads = 1,50,000 x 2 /12x ½ = $12,500
$67,500

Debtors = 5,10,000 x 3/12 = $1,27,500

Creditors = 3,00,000 x 3/12 = $75,000

Problem No. 33 (working capital forecast)

The management of MUTTAKEEN Ltd has called for a statement showing the working capital
needed to finance a level of 300,000 units of output for the year. The cost structure for the
company’s product, for the above-mentioned activity level is detailed below.

Cost Element Cost per unit ($)

Raw Materials 20
Direct Labor 5
Overheads 15
Total Cost 40
Profit 10
Selling Price 50
a) Past trends indicate that raw materials are held in stock on an average for two months.
b) Work in progress will approximate to half a month’s production.
c) Finished goods remain in warehouse on an average for a month.
d) Suppliers of materials extend a month’s credit.
e) Two months’ credit is normally allowed to debtors.
f) A minimum. Cash balance of $25,000 is expected to be maintained.
g) The production pattern is assumed to be even during the year.
Required: Prepare the statement of working capital determination.

Page # 106
12th Edition (September-2021)
 Corporate Financial Management
By Md. Monowar Hossain, FCA, CPA,
FCMA,CISA,CPFA(UK),FCGA,FCS
md.monowar@gmail.com
Solution of problem No. 33 (working capital forecast)
Working Capital Statement (or)
Statement of Working Capital Requirement
Amount ($)
Current Assets
Raw Materials 60,00,000 x 2/12 = 10,00,000
Work in Progress = 3,75,000
Finished goods 1,20,00,000 x 1/12 = 10,00,000
Debtors 1,50,00,000 x 2/12 = 25,00,000
48,75,000

Less: Current Liabilities 5,00,000

Sundry Creditors 60,00,000 x 1/ 2 43,75,000
25,000
Add: Minimum Cash Balance 44,00,000
Working Capital

Workings:
Finished Goods 60,00,000
Raw Materials 3,00,000 x 20 15,00,000
Direct Labor 3,00,000 x 5 45,00,000
Overheads 3,00,000 x 15 1,20,00,000
Finished Goods
Problem No. 34 (statement of sources and uses of net working capital)

FYR Limited:
The fixed assets and equities of the company are supplied to you at het beginning and ending of
the year 2019-2020:

01/07/2019 30/06/2020
Amount (Tk.) Amount (Tk.)

Required : Prepare a statement of sources and uses of net working capital.

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12th Edition (September-2021)
 Corporate Financial Management
By Md. Monowar Hossain, FCA, CPA,
FCMA,CISA,CPFA(UK),FCGA,FCS
md.monowar@gmail.com

Solution of problem no. 34 (statement of sources and uses of net working capital)

Q. [CS Jul’15] [Marks- 5]

The risk of becoming technically insolvent is measured by using the tool of net working
capital by the Finance Manager.
Ans. The risk of becoming technically insolvent is measured by using the tool of net working capital by the
Finance Manager. Because working capital management refers to the planning, execution and control of
investment in and financing of working capital by using the tool of net working capital. Working capital
management is concerned with the problems that arise in attempting to manage the current assets, the
current liabilities and the inter-relationships that exist between them. The basic ingredients of the theory of
working capital management may be said to include its definition, need, optimum level of current assets, the
trade-off between profitability and risk associated with a firm’s level of current assets and current liabilities,
financing-mix strategies and so on by the Finance Manager as follows:
• To meet the short-term obligations as and when they arise
• to ensure short-term liquidity
• interaction between the current assets and the current liabilities and arrives at the optimum
level of both. The optimum level thus arrived must have provision for contingencies
• the relationship between liquidity, net working capital and risk is such that if either net
working capital or liquidity increases, the firm’s risk decreases
• determining the proper and effective financing mix, etc.

So, we can say that, the risk of becoming technically insolvent is measured by using the tool of
net working capital by the Finance Manager.

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12th Edition (September-2021)
 Corporate Financial Management
By Md. Monowar Hossain, FCA, CPA,
FCMA,CISA,CPFA(UK),FCGA,FCS
md.monowar@gmail.com
Q. [CS Jul’15] [Marks- 5]
A stable dividend policy is always preferable to a fluctuating dividend policy.
Ans. Stabile dividends have a positive impact on the market price of shares. If dividends are
stable it reduces the chance of speculation in the market and investors desiring a fixed rate of
return will naturally be attracted towards such securities. Stability of dividend means either a
constant amount per shares or a constant percentage of net earnings. Stable dividend policy
would most commonly imply – stable dividends per share.
The fluctuation of dividends created by the residual policy significantly contrasts with the certainty
of the dividend stability policy. With the stability policy, quarterly dividends are set at a fraction
of yearly earnings. This policy reduces uncertainty for investors and provides them with income.
Suppose a company, FYR, earned $1,000 for the year (with quarterly earnings of $300, $200,
$100 and $400). If FYR decided on a stable policy of 10% of yearly earnings ($1,000 x 10%), it
would pay $25 ($100/4) to shareholders every quarter. Alternatively, if FYR decided on a cyclical
policy, the dividend payments would adjust every quarter to be $30, $20, $10 and $40,
respectively. In either instance, companies following this policy are always attempting to share
earnings with shareholders rather than searching for projects in which to invest excess cash.
That’s why a stable dividend policy is always preferable to a fluctuating dividend policy.
Q.[CS Jul’15] [Marks- 5]
Deferred payment of taxes is a source of working capital
Ans. Current assets less current liabilities, properly called net working capital.
Working capital is a measure of a company’s liquidity. Sources of working capital are
1) net income,
2) increase in noncurrent liabilities,
3) increase in stockholders’ equity, and
4) decrease in noncurrent assets.
Funds invested in a company’s cash, accounts receivable, inventory, and other current assets
(gross working capital); usually refers to net working capital-that is, current assets minus current
liabilities. Working capital finances, the cash conversion cycle of a business-the time required
to convert raw materials into finished goods, finished goods into sales, and accounts receivable
into cash. These factors vary with the type of industry and the scale of production, which varies
in turn with seasonality and with sales expansion and contraction. Internal sources of working
capital include retained earnings; savings achieved through operating efficiencies and the
allocation of cash flow from sources like depreciation or deferred taxes to working capital.
External sources include bank and other short-term borrowings, trade credit, and term debt and
equity financing not channeled into long-term assets.
So, we can say that the deferred payment of taxes is an internal source of working
capital.

Problem No. 35 (working capital)

FYR Ltd. produces a product with the following revenue cost structure:

The following additional information is available:

a. Average raw materials in stock; one month.

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 Corporate Financial Management
By Md. Monowar Hossain, FCA, CPA,
FCMA,CISA,CPFA(UK),FCGA,FCS
md.monowar@gmail.com
b. Average work in process: half-a-month – Raw Materials 100%, Direct labour 50%,
Overheads 50% complete.
c. Average finished gods in stock: one month.
d. Credit allowed by suppliers: one month.
e. Credit allowed to debtors: two months.
f. Time lag in payment of wages: half-a-month.
g. Overheads: one month.
h. Cash balance is expected to be Tk.165,000.
i. One fourth of sales are on cash basis.
j. Debtors are to be taken at cost.
k. Uniform production throughout the year.
l. Wages and overheads accrue uniformly.
Required: Prepare a statement showing the Working Capital requirement of the company to
finance a level of activity of 60,000 units of annual output.

Solution of problem No. 35 (working capital)

Statement showing estimate of Working Capital

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