WORKING CAPITAL

MANAGEMENT
Course : BBA.L.LB Presented by :
Semester : VI Simpy Bansal
Batch : 2021-26
Introduction

▪ 2 types of capital required by the business :

– Fixed capital
– Working capital

▪ Every business needs funds for two purposes :

– for its establishment and
– to carry out its day-today operations

▪ Long-term funds are required to create production facilities through purchase of fixed
assets such as plant and machinery, land, Building etc.
▪ Investments in these assets represent that part of firm’s capital which is blocked on
permanent basis and is called fixed capital
▪ Funds are also needed for short-term purposes for purchase of raw materials, payment
of wages and other day-to-day expenses etc. These funds are known as working capital
which is also known as Revolving or circulating capital or short term capital.
MEANING (1)

▪ Working capital affects many aspects of the business, from paying the employees and
vendors to keeping the lights on and planning for sustainable long-term growth

▪ In short, working capital is the money available to meet your current, short-term obligations
and to carry out day-to-day business operations

▪ The capital which is required to finance current assets is called working capital

▪ According to Shubin, “Working capital is amount of funds necessary to cover the cost of
operating the enterprise”.

▪ Very few companies pay attention to the management of working capital

 MEANING (2)
▪ WCM is concerned with the management of short term assets and liabilities

▪ Assets included here are cash, marketable securities, accounts receivable, inventory, prepaid
expenses and other current assets and liabilities such as accounts payable, wages payable, and
accruals

▪ Working capital management is thus the process of planning, monitoring, controlling the mix of
current assets and liabilities in a firm

▪ It also involves deciding how the current assets are to be financed. Financing choices could include
the mix of current as well as long term liabilities

▪ One aspect of working capital management is the trade-off between profitability and risk
(liquidity). Hence, the firm has to strike a balance between the profitability and the liquidity.

▪ Many profitable companies fail because their management could not manage the working
capital effectively
CONCEPT OF WORKING CAPITAL
Gross working capital
▪ Gross working capital refers to the
firm's investment in current assets
▪ Current assets are the assets which
can be converted into cash within an
accounting year and include cash,
short-term securities, debtors,
(accounts receivable or book debts)
bills receivable and stock (inventory)
▪ It focuses on what should be the
level of each current asset
Net working capital
▪ Net working capital refers to the difference
between current assets and current
liabilities.
▪ Current liabilities are those claims of
outsiders which are expected
to mature for payment within an accounting
year and include creditors (accounts
payable), bills payable, and outstanding
expenses. Net working capital can be
positive or negative.
▪ A positive net working capital will arise
when current assets exceed current
liabilities
▪ It focuses on financing of current assets
 WC AND CAPITAL BUDGETING
 The management of current assets is similar to that of fixed assets in the sense that
in both cases a firm analyses their effects on its return and risk
 The management of fixed and current assets, however, differs in three important ways
 First, in managing fixed assets, time is a very important factor; consequently,
discounting and compounding techniques play a significant role in capital budgeting
and a minor one in the management of current assets

 Second, the large holding of current assets, especially cash, Strengthens the firm's
liquidity position (and reduces riskiness), but also reduces the overall profitability.
Thus, a liquidity and profitability trade off is involved in holding current assets.

 Third, levels of fixed as well as current assets depend upon expected sales, but it is
only current assets which can be adjusted with sales, fluctuations in the short run.
Thus, the firm has a greater degree of flexibility in managing current assets.
 IMPORTANCE/BENEFITS OF ADEQUATE WC (1)
 Solvency of the Business
 Adequate working capital helps in maintaining solvency of business by providing uninterrupted flow of
production.

 Goodwill
 Sufficient working capital enables a business concern to make prompt payments and hence helps in
creating and maintaining goodwill.

 Easy Loans
 A concern having adequate working capital, high solvency and good credit standing can arrange loans
from banks and others on easy andfavourable terms.

 Cash Discounts
 Adequate working capital also enables a concern to avail cash discounts on purchases and hence it reduces
cost.

 Regular Supply of Raw Material

 Sufficient working capital ensure regular supply of raw materials and continuous production.
 IMPORTANCE/BENEFITS OF ADEQUATE WC (2)
 Regular payment of salaries, wages and other day to day commitments:
 A company which has ample working capital can makeregular payment of salaries, wages and other day to
day commitments which raises morale of its employees, increases their efficiency, reduces costs
and wastages.

 Ability to face crisis:

 Adequate working capital enables a concern to face business crisis in emergencies such as depression.

 Quick and regular return on investments:

 Every investor wants a quick and regular return on his investments. Sufficiency of working capital enables a
concern to pay quick and regular dividends to is investor as there may not be much pressure to plough back
profits which gains the confidence of investors and creates a favourable market to raise additional funds in
future.

 Exploitation of Favourable market conditions:

 Only concerns with adequate working capital can exploit favourable market conditions such as purchasing its
requirements in bulk when the prices are lower and by holding its inventories for higher prices.

 High Morale:
 Adequacy of working capital creates an environment of security, confidence, high morale and creates overall
efficiency in a business.
 DISADVANTAGES OF EXCESSIVE WC

 Excessive working capital means idle funds which earn no profits for
business and hence business cannot earn a proper rate of return
 Chances of inventory mishandling, waste, theft and losses increase
 It may result into overall inefficiency in organization
 Due to low rate of return on investments, the value of shares may also fall
 When there is excessive working capital, relations with banks and other
financial institutions may not be maintained
 May lead to defective credit policy and slack in collection period
 May make dividend policy liberal and difficult to cope with in future
 DISADVANTAGES OF INADEQUATE WC

▪ The firm cannot pay its short-term liabilities in time. Thus, it will lose its
reputation and shall not be able to get good credit facilities.
▪ Results in Operating inefficiencies
▪ Fixed assets are not efficiently utilized
▪ Firm may face tight credit terms
▪ It cannot buy its requirements in bulk and cannot avail of discounts
▪ The firm cannot pay day-to-day expenses of its operations and it created
inefficiencies, increases costs and reduces the profits of business
▪ Becomes difficult for the firm to undertake profitable projects
▪ It becomes difficult to implement operating plans and achieve the firm’s profit
target
 Factors Determining Working Capital
Requirements (1)
▪ Nature and Character of Business
– Cash sales, service sector (less requirement)
– Trading, manufacturing (more requirement)

▪ Size of Business/Scale of operations

– Large scale (more requirement)
– Small scale (less requirement)

▪ Production policy
– Steady production by accumulating inventories during slack periods (more requirement)
– Less production during slack season and increased during peak season (less requirement)

▪ Length of production cycle

– Longer manufacturing process, the raw materials and supplies have to be carried for longer
period

▪ Credit policy
– A concern which buy on credit and sell for cash requires less WC
– A concern which buy for cash and sell on credit requires large WC
 Factors Determining Working Capital
Requirements(2)

▪ Business cycle
– In period of boom, there is need for larger amount of working capital due to increase in
sales, rise in prices etc.

▪ Rate of growth of business

– In fast growing concerns large amount of working capital is required

▪ Earning capacity and dividend policy

– A firm that maintains a steady high rate of cash dividend irrespective of its generation of
profits need more working capital than firm that retains larger part of its profits and does
not pay so high rate of cash dividend

▪ Price level changes

▪ Working capital cycle/Operating cycle
▪ the working capital cycle starts with the purchase of raw material and ends with realization
of cash from the sale of finished products
Thank You