Working

Capital
Management
CONTENTS
1. What is working capital?
2. Drivers of working capital
3. Types of working capital
4. Working Capital Cycle
5. Why Manage Working Capital?
6. 5 strategies to effectively manage your working capital
7. Working Capital Management Ratios
8. Limitations of Working Capital Management
1. What is Working Capital ?

• Working capital is the money used to cover all of a company's short-term

expenses, including inventory, payments on short-term debt, and day-to-
day expenses called Operating Expenses.

• Working capital is critical since it is used to keep a business operating

smoothly and meet all its financial obligations within the coming year.
2. Drivers of Working Capital
• Companies have both short-term assets and liabilities.
• A company's short-term assets are called current assets, while short-
term liabilities are called current liabilities.
• A company's working capital is the difference between the value of the
current assets and its current liabilities for the period.
1. Current Assets
2. Current Liabilities
 2.1 Current Assets
• A Current Assets is an asset that is available for use within the next 12 months.
Current assets are a company's short-term assets that can be easily liquidated or
converted into cash and used to pay debts within the next year.
• Current assets typically include:
1. Cash and cash Equivalents:- Including cash, such as funds in checking or savings
accounts, while cash equivalents are highly-liquid assets, such as money-market
funds and Treasury bills
2. Marketable Securities:- Such as stocks, mutual fund shares, and some types of
bonds
3. Inventory:-The merchandise that can be quickly sold or liquidated in less than
one year
4. Accounts receivable or money owed to the company by its customers or other
debtors for products and services sold
2.2 Current Liabilities
• A Current liabilities is a short-term expense that a company owes and
must pay within a 12-month period. Current liabilities can include:
1. Short-term debt payments, which can include payments for bank
loans or commercial paper issued to fund operations
2. Suppliers and vendors owed for inventory, raw materials, and services,
such as technology support
3. Accounts Payable , which are short-term bills owed 
4. Interest payments due to bondholders and banks, which can include
interest owed on short-term debt as well as the current interest
payments due for long-term debt
5. Taxes owed, such as income and payroll taxes due in the next year
3. Types of Working Capital
• In its simplest form, working capital is just the difference between current
assets and current liabilities.
• However, there are many different types of working capital that each may be
important to a company to best understand its short-term needs.
1. Permanent Working Capital: Permanent working capital is the amount of
resources the company will always need to operate its business without
interruption. This is the minimum amount of short-term resources vital to
operations.
2. Regular Working Capital: Regular working capital is a component of
permanent working capital. It is the part of the permanent working capital
that is actually required for day-to-day operations and makes up the "most
important" part of permanent working capital.
3. Reserve Working Capital: Reserve working capital is the other component
of permanent working capital. Companies may require an additional
amount of working capital on hand for emergencies, seasonality, or
unpredictable events.
4. Fluctuating Working Capital: Companies may be interested in only
knowing what their variable working capital is. For example, companies
may opt into paying for inventory as it is a variable cost. However, the
company may have a monthly liability relating to insurance it does not
have the option to decline. Fluctuating working capital only considers the
variable liabilities the company has complete control over.
5. Gross Working Capital: Gross working capital is simply the total amount of
current assets of a business before considering any short-term liabilities.
6. Net Working Capital: Net working capital is the difference between current
assets and current liabilities.
4. Working Capital Cycle
• Working capital management helps maintain the smooth operation of
the net operating cycle, also known as the cash conversion cycle the
minimum amount of time required to convert net current assets and
liabilities into cash. The working capital cycle is a measure of the time it
takes for a company to convert its current assets into cash, or:
• Working Capital Cycle in Days = Inventory Cycle + Receivable Cycle -
Payable Cycle  
• The working capital cycle represents the period measured in days from
the time when the company pays for raw materials or inventory to the
time when it receives payment for the products or services it sells.
During this period, the company's resources may be tied up in
obligations or pending liquidation to cash.
5. Strategies to effectively manage your
working capital
1. Manage procurement and inventory efficiently
2. Improve receivables management
3. Automate input tax credit claims, and GST returns filing
4. Automate vendor communication and vendor payments
5. Use real-time data analytics to detect anomalies
5.1 Manage procurement and inventory
efficiently
• Inventory is one of the most critical components of a business’s working capital, but
the efficient management of inventory is sometimes neglected.
• While the inventory shortage leads to lost revenue opportunities, hoarding too much
inventory blocks capital. This is why inventories need to be closely monitored.
• A subset of overall inventory management also includes an enterprise’s focus on
reducing its slow-moving inventory and increasing its inventory turnover cycle.
• From a working capital perspective, every business should optimize its inventory by
analyzing past and present performance metrics and implementing inventory
management processes. Digitizing this function could help identify key trends,
forecast demand, and make more precise ordering decisions.
 5.2 Improve receivables management
• Another strategy to improve working capital is to keep the sales to cash cycle as
short as possible.
• Reassessing contracts and credit terms from time to time will ensure that you do not
give debtors a larger than the necessary window to settle dues for goods and
services.
• Another major challenge enterprises face bad debts. To reduce bad debts,
enterprises should implement rigorous credit checks. Bringing technology to
automate the accounts receivables process can shorten the receivables period
through faster invoice processing and collections. It could also facilitate automated,
timely reminders and potentially reduce bad debts.
• Businesses should also use digital supply chain financing options like invoice
discounting and factoring, as they offer quick cash conversion at meagre costs.
5.3 Automate input tax credit claims, and GST
returns filing
• While indirect tax compliance did not affect a business’s working capital in the past, now
businesses find their working capital blocked due to the tight restrictions surrounding input
tax credit (ITC). The government has recently amended the Goods and Services Tax (GST)
law to ensure that a business can claim ITC only if the same is reflected in their GSTR-2B
statement.
• This puts increased pressure on enterprises to reconcile their input tax credit carefully and
frequently and communicate any missing information to their supplier. Given the tight
restrictions on ITC claims and the effect on working capital, every enterprise should look at
automating their GST return filing and input tax credit claims process. Automation
guarantees the accuracy, and if ITC claims are not 100% accurate, then besides working
capital taking a hit, a business could also be liable to interest, penalties, and demand
notices.
 5.4 Automate vendor communication and
vendor payments
• Maintaining a strong relationship with vendors typically results in a better quality of products
supplied, higher discounts, and more favorable credit terms. At the same time, every
enterprise needs to ensure payment discipline and ensure that their suppliers are paid on time.
Automating the vendor management function helps streamline all vendor-related processes
such as onboarding, invoice processing, communication and coordination, and payment
management.
• Further, with the stringent input tax credit rules imposed, the dependency on vendors to
upload invoices on time has increased manifold. When a vendor does not upload invoices on
time, an enterprise cannot claim ITC, which hits the enterprise’s working capital.
Withholding payments in such a case might push vendors to upload invoices. However, it is
not possible to track each invoice manually. Hence, automating the vendor management
process serves a two-fold purpose.
5.5 Use real-time data analytics to detect
anomalies
• Business leaders can make financially viable decisions only if they have the
relevant information at hand. Gone are the days of month-end and year-end
reporting. Now, every business leader wants access to reports and metrics on
tap. Every enterprise should implement a system of real-time reporting and
data analytics that provides the necessary financial visibility to implement
and monitor a working capital strategy. Data visualization not only helps
monitor performance but indicates areas of profitability, highlights trends,
and flags discrepancies even before they become issues.
6. Why Manage Working Capital?
• Working capital management can improve a company's cash flow
management
• Working capital management can improve a company's earnings quality
through the efficient use of its resources.
• A company can conserve cash by choosing to stretch the payment of
suppliers and to make the most of available credit or may spend cash by
purchasing using cash—these choices also affect working capital
management.
 7. Interpreting and Adjusting Working Capital
• Since working capital is equal to the difference between current assets and
current liabilities, it can be either a positive or a negative number. Of
course, positive working capital is always preferable since it means a
company has enough to pay its operating expenses. However, the net
working capital figure can change over time, causing the company to
experience periods of negative working capital due to unexpected short-
term expenses.
• Conversely, a company that has consistently excessive working capital may
not be making the most of its assets. While positive working capital is good,
having too much cash sit idle can hurt a company. Those idle funds could
be used for paying down debt, or investing in the long-term future of the
company by purchasing long-term assets, such as technology.
• Companies monitor their accounts receivables to determine when
they're expected to receive payment from their customers. On the
other hand, companies also monitor their accounts payables to
determine the dates in which payments are due to suppliers. If the
accounts payables are due sooner than the money due from the
accounts receivables, the company can experience a working capital
shortfall.
• As a result, companies may offer incentives to their customers to
collect the receivables sooner. Conversely, a company may also ask
its supplier for better terms allowing the company to pay at a later
date. Monitoring and analyzing working capital helps companies
manage their Cash flows needs so that they can meet their
operating expenses in the coming months.
8. Working Capital Management Ratios

• Three ratios that are important in working capital management are

1. Current Ratio
2. Collection Ratio
3. Inventory Turnover Ratio
9. Limitations of Working Capital
Management
• Working capital management only focuses on short-term assets and
liabilities. It does not address the long-term financial health of the
company and may sacrifice the best long-term solution in favor for short-
term benefits.
• working capital management cannot guarantee success. The future is
uncertain, and it's challenging to predict how market conditions will
affect a company's working capital.
• Last, while effective working capital management can help a company
avoid financial difficulties, it may not necessarily lead to increased
profitability.
• As that bottom line improves, working capital management can simply
enhance the company's position.