Working Capital Management

Working Capital Concept

• Working capital is amount of funds necessary to cover the cost of

operating the enterprise.

• Working Capital refers to that part of the firm’s capital, which is required

for financing short-term or current assets like Cash, short term

marketable securities, debtors and inventories etc.

• Funds invested in current assets keep revolving fast and are constantly

converted into cash and this cash flow out again in exchange for other

current assets. Working Capital is also known as revolving or circulating

capital or short-term capital.

Classification of Working capital

Working
capital

BASIS OF BASIS OF
CONCEPT TIME

Net Working Temporary /

Gross Permanent / Variable WC
Capital Fixed WC
Working
Capital
Seasonal Special
Regular Reserve
 On the Basis of Concept:
• Gross working capital is the capital invested in total current
assets of the enterprise. Examples of current assets are : cash
in hand and bank balances, Bills Receivable, Short term
loans and advances, prepaid expenses, Accrued Incomes etc.

• Net Working Capital = Current Assets – Current Liabilities

• When current assets exceed the current liabilities the
working capital is positive and negative working capital
results when current liabilities are more than current assets.
• Examples of current liabilities are Bills Payable, Sunday
debtors, accrued expenses, Bank Overdraft, Provision for
taxation etc. Net working capital is an accounting concept of
working capital.
Contd.
 On the Basis of Time
• Permanent or Fixed working capital
• It is the minimum amount which is required to ensure
effective utilization of fixed facilities and for maintaining
the circulation of current assets.
• regular working capital is the capital required to ensure
circulation of current assets from cash to inventories, from
inventories to receivables and from receivables to cash and
so on.
• Reserve working capital is the excess mount over the
requirement for regular working capital which may be
provided for contingencies that may arise at unstated
periods such as strikes, rise in prices, depression etc.
Contd.
 Temporary or Variable working capital
It is the amount of working capital which is required
to meet the seasonal demands and some special
exigencies.
Variable working capital is further classified as
seasonal working capital and special working
capital.
The capital required to meet seasonal needs of the
enterprise is called seasonal working capital.
Special working capital is that part of working
capital which is required to meet special exigencies
such as launching of extensive marketing
campaigns for conducting research etc.
 Need of Working Capital

• For purchase of raw materials, components and spares.

• To pay wages and salaries.
• To incur day-to-day expenses and overhead costs such as
fuel, power etc.
• To meet selling costs as packing, advertisement
• To provide credit facilities to customers.
• To maintain inventories of raw materials, work in
progress, stores and spares and finished stock.
The amount of working capital needed goes on increasing
with growth and expansion of business till it attains
maturity.
 Importance of adequate working capital

• Solvency of the business

• Goodwill
• Easy loans
• Cash discounts
• Regular supply of raw materials
• Regular payment of salaries, wages and other day-to-
day commitments
• Exploitation of favourable market conditions
• Ability to face crisis
• Quick and regular ROI
• High morale
Disadvantages of excessive
working capital
• Idle funds
• Redundant working capital
• Excessive debtors and defective credit policy
• Overall inefficiency
• Maintains no good relationship with banks and FI
• Low ROI
• Speculative transactions
Disadvantages of inadequate
working capital
• Difficult to meet short term liabilities
• Difficult to avail discounts
• Challenge to exploit favourable market conditions
• Inefficiencies in operation
• No efficient use of fixed assets
• ROI will fall
 Factors determining working Capital Requirement
• Nature or Character of Business
• Size of Business
• Production Policy
• Length of Production cycle
• Seasonal variations
• Rate of stock turnover
• Credit Policy
• Business cycles
• Rate of Growth of Business
• Price Level Changes
• Working Capital Cycle
• Earning capacity and dividend policy
• Other factors
 Different Components of Working Capital
1. Current Assets:
Current assets are those assets which can be easily converted
into cash and which are required to meet the day to day
operations of the business. These includes
Cash and bank balances, Temporary investments, Temporary
investments, Inventory of raw materials, stores and spares, Work-
in-progress, Finished goods, Prepaid expenses etc.
2. Current Liabilities:
Current liabilities are those claims of outsiders which are
expected to mature for payment within an accounting year. These
includes
Creditors for goods purchased, Outstanding expenses, Short-
term borrowings, Advances received against sales,
 Accounts Payable Value Addition

Raw
WIP
Materials

THE WORKING CAPITAL

Cash CYCLE Finished
(OPERATING CYCLE) Goods

Accounts SALES
Receivable
 FORECASTING / ESTIMATION OF WORKING CAPITAL
REQUIREMENTS

Factors to be considered
• Total costs incurred on materials, wages and overheads
• The length of time for which raw materials remain in stores before they are
issued to production.
• The length of the production cycle or WIP, i.e., the time taken for conversion
of RM into FG.
• The length of the Sales Cycle during which FG are to be kept waiting for
sales.
• The average period of credit allowed to customers.
• The amount of cash required to pay day-to-day expenses of the business.
• The amount of cash required for advance payments if any.
• The average period of credit to be allowed by suppliers.
• Time – lag in the payment of wages and other overheads
 PROFORMA - WORKING CAPTIAL ESTIMATES
1. TRADING CONCERN
STATEMENTOF
STATEMENT OFWORKING
WORKINGCAPITAL
CAPITALREQUIREMENTS
REQUIREMENTS
Amount(Rs.)
Amount (Rs.)
CurrentAssets
Current Assets
(i)Cash
(i) Cash ----
----
(ii)Receivables
(ii) Receivables((For…..Month’s
For…..Month’sSales)----
Sales)---- ----
----
(iii)Stocks
(iii) Stocks((For……Month’s
For……Month’sSales)-----
Sales)----- ----
----
(iv)AdvancePayments
(iv)Advance Paymentsififany
any ----
----
Less::Current
Less CurrentLiabilities
Liabilities
(i)Creditors
(i) Creditors(For…..
(For…..Month’s
Month’sPurchases)-
Purchases)- ----
----
(ii)Lag
(ii) Lagininpayment
paymentofofexpenses
expenses -----_
-----_
WORKINGCAPITAL
WORKING CAPITAL((CA CA––CLCL)) xxx
xxx
Add::Provision
Add Provision //Margin
MarginforforContingencies
Contingencies -----
-----

NETWORKING
NET WORKINGCAPITAL
CAPITALREQUIRED
REQUIRED XXX
XXX
 2. MANUFACTURING CONCERN

STATEMENT OF WORKING CAPITAL REQUIREMENTS

Amount (Rs.)
Current Assets
(i) Stock of R M( for ….month’s consumption) -----
(ii)Work-in-progress (for…months)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(iii) Stock of Finished Goods ( for …month’s sales)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(iv) Sundry Debtors ( for …month’s sales)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(v) Payments in Advance (if any) -----
(iv) Balance of Cash for daily expenses -----
(vii)Any other item -----

Less : Current Liabilities

(i) Creditors (For….. Month’s Purchases) -----
(ii) Lag in payment of expenses -----
(iii) Any other -----
WORKING CAPITAL ( CA – CL )xxxx
Add : Provision / Margin for Contingencies -----

NET WORKING CAPITAL REQUIRED XXX

 PRINCIPLES OF WORKING CAPITAL
MANAGEMENT / POLICY

PRINCIPLES OF
WORKING CAPITAL
MANAGEMENT

Principle of Principle Principle of Principle of

Risk of Cost of Equity Maturity of
Variation Capital Position Payment
• Principle of Risk Variation: Risk refers to inability of firm to
meet its obligation as and when they become due for payment.
Larger investment in current assets with less dependence on
short-term borrowings increases liquidity, reduces risk and
thereby decreases opportunity for gain or loss.
• Principle of Cost of Capital: The various sources of raising
working capital finance have different cost of capital and
degree of risk involved. Generally, higher the risk lower is
cost and lower the risk higher is the cost. A sound working
capital management should always try to achieve proper
balance between these two.
• Principle of Equity Position: This principle is concerned with
planning the total investment in current assets. According to
this principle, the amount of working capital invested in each
component should be adequately justified by firm’s equity
position.
• Principle of Maturity of Payment: This
principle is concerned with planning the
sources of finance for working capital.
According to this principle, a firm should
make every effort to relate maturities of
payment to its flow of internally generated
funds.

.
Sources of working capital
• Loans from financial institutions
• Floating of debentures
• Accepting public deposits
• Issue of shares
• Internal financing