WORKING CAPITAL

MANAGEMENT
CONCEPT
• Working capital helps any organization to meet its day-to-day operating
expenditures. It is apart of financial management.

• In working capital, we must manage current assets in such a way so that

there should be handsome amount to meet the expenses.

• As well as there should not be excess of cash which we have to keep it

ideally.
• It is conventional rule to maintain the level of current assets twice the
level of current liabilities.
PERMANENT & VARIABLE WORKING
CAPITAL
There is always a minimum level of current assets are required to carry
on its business operations and that is called Permanent or fixed
working capital.

Fluctuating or Variable working capital is extra working capital needed

to support the changing level of production or sales activity of the firm.

Both are necessary to facilitate the smooth running of business

activities.
CONTD…

Temporary W.C.
Amt. of Permanent W.C.
working capital

Time
OPERATING AND CASH CONVERSION
CYCLE
• There is always an operating cycle involved in conversion of sales into
cash.
• The firm must invest enough funds in current assets for generating
sales.
• Current assets are required because sales do not convert into cash
instantaneously.
• Operating cycle is the time duration required to convert sales, after
conversion of resources into cash.
• Three phases are involved in operating cycle of any manufacturing firm.
CONTD…
• Acquisition of resources
• Manufacturing of the product
• Sale of the product.

• These phases affect cash flows because cash outflows occur before
cash inflows. Cash inflows are not certain because sales and collection
which give rise to cash inflows are difficult to forecast accurately.
• The firm is therefore required to invest in current assets for smooth
functioning.
Length of Operating cycle
• Raw material conversion period(RMCP)+ Work in process conversion
period(WIPCP)+ Finished goods conversion period(FGCP)+ Debtors conversion
period = Gross Operating Cycle
• The debtors conversion period is the time required to collect the outstanding
amount from the customers.
• GOC – CDP(Creditors deferral period) = NOC
• The creditors deferral period is the length of time the firm is able to defer
payments on various resources purchased.
• Net operating cycle also represents cash conversion cycle. It is the net time
interval between cash collection from sales and cash payment for resources
acquired by the firm
ISSUES IN WORKING CAPITAL MGMT.
• Working capital mgmt. refers to the administration of all components
of W.C.
• Finance manager must determine the level and composition of
current assets.
• Working capital is critical for all firms but particularly for small firms.
• There is a direct relationship between a firm’s growth and its W.C.
needs.
• The finance manager should pay particular attention to the levels of
current assets.
LEVEL OF CURRENT ASSETS

Conservative
Moderate
level of
C.A. Aggressive
Fixed Assets

Output
CONTD…
• It is not possible to estimate the working capital need accurately, the
firm must decide about the levels of current assets to be carried.
• Based on firm’s technology, production policy, sale and demand
conditions, operating efficiency etc.
• It may follow any of the three policies of maintaining W. C.
• These policies involved risk return trade off.
• Conservative policy means lower risk and return, and in case of
aggressive policy both will be higher
• The two important aims of working capital management is
profitability along with liquidity.
THE COST TRADE-OFF
• There are two types of cost involved in maintaining current assets,
cost of liquidity and cost of illiquidity.
POLICIES FOR FINANCING C.A.
• Long term financing includes share capital, debentures, long term
borrowings form financial institutions, reserves and surplus.
• Short term financing is obtained for a period less than one year. It
includes advances form banks, working capital loan, public deposits
etc.
• Spontaneous financing refers to the automatic sources of short-term
funds arising in a normal course of business-like outstanding exp.
There is no explicit cost of this financing.
• The firm is expected to utilize these sources of finances to the full
extent.
CONTD…
• Depending on the mix of short term and long-term financing the
approach followed by the company may be referred to as:

• Matching Approach

• Conservative Approach

• Aggressive Approach
MATCHING APPROACH
• A firm can adopt a financial plan which matches the expected life of
assets with the expected life of source of funds raised to finance the
assets.
• The justification of this approach is that the purpose of financing is to
pay for the assets.
• Using long term financing for short term assets will be expensive as
funds will not be utilized for the full period.
• In the same way short term financing for log term assets is costly as
well as firm have to made arrangements on continuous basis.
CONTD…
• MATCHING PLAN

• SHORT TERM FINANCING

ASSETS
PERMANENT C.A. LONG TERM FINANCING
FIXED ASSETS
TIME
CONSERVATIVE APPROACH
• The firm financing policy is said to be conservative when it depends
more on long term financing.
• Under this plan a firm finances its permanent assets and also a part of
temporary current assets with long term financing.
• In the period when firm has no need of current assets, the idle long-
term funds can be invested in tradable securities to converse the
liquidity.
• This plan relies more on long term financing, so the firm has less risk
of facing the problem of shortage of funds.
CONTD…
AGGRESSIVE APPROACH
• When firm uses more of short-term financing. Under this plan firm
finances part of its permanent C.A. with short term financing.