The term working capital refers to the amount of fund required to maintain day-to-day expenditure on operational activities

of a business enterprise. The basic financial formula for calculating working capital is; Working Capital= Current Assets (-) Current Liabilities The estimation of working capital of a firm is a difficult task for the management because of its varying characteristics. It varies across the companies in an industry as well as over the period under consideration for a particular firm. It also varies with the nature and size of the enterprise, level of production, operating cycle, credit policy of the firm and other different macro-economic factors (inflation, fiscal policy, business cycle etc.), availability of raw materials and so on and so forth. WORKING CAPITAL MANAGEMENT INTRODUCTION: Working capital management is a short term financial management. It is concerned with the problems that arise in attempting to manage the current assets, the current liabilities & the relationship that exists between them. The current assets refer to those assets which can be easily converted into cash in normal course of business. The Goal of WCM is to manage the firm s current assets & liabilities, so that a satisfactory level of working capital is maintained. If the firm cannot maintain the satisfactory level of working capital, it is likely to create problems in the liquidity and it may become insolvent. To maintain this margin of safety, current asset should be large enough to cover its current liabilities. Zero Working Capital The usual practice of a firm is to maintain a positive working capital at a level, which ensures better liquidity, good profitability with a reasonable level of risk. The situation of negative working capital is very unusual and mainly linked with financing decision of the firm. But nowadays, the concept of zero working capital is gaining importance in working capital management. It refers to the equality between current assets and current liabilities at all times. To avoid excess investment in current assets, firms try to meet their current liabilities out of the current assets fully matching with the concept. Consequently, smooth and uninterrupted working capital cycle is maintained to create an environment in which firm always try to improve the quality of the current assets at all times for maintaining cent-percent realization of current assets. This zero working capital always brings a fine balance in financial management and brings out the efficient performance of the financial managers.

Zero working capital= CA = CL

Finished Goods / Inventory Stage and 4. In the form of an equation. It is the average time between the acquisition of materials or services entering the process and the final cash realization from sales. The Operating Cycle (OC) refers to the period during which investment of one unit of money will remain blocked in the normal course of operation till it’s recovered out of revenue. the requirements of working capital depend on the operating cycle of a firm and the cost of all operational activities. Work-in-Progress Stage 3. and Conversion of accounts receivable into cash  The stage between purchase of raw materials and their payment is known as the creditor’s payables period. Receivables Collection Stage.  The period between sale of finished goods and the collection of receivables is known as the accounts receivable period. Conversion of raw-material into work-in-progress.Operating Cycle: Operating Cycle approach has been gaining more importance in the present business scenario. Under this concept. It may be broadly classified into the following four stages: 1.C R = Raw material storage period W = Work in progress holding period F = Finished goods storage period D = Debtors collection period C = Credit payment period . Conversion of finished stock into accounts receivable through sales.  The period between purchase of raw materials and production of finished goods is known as the inventory period. Raw Material Storage Stage 2. Conversion of work-in-progress into finished stock. The stages consist of the following:      Conversion of cash into raw-materials. the operating cycle process can be expressed as follows: Operating Cycle = R + W + F + D .

162 = 95 days . Gross operating Cycle = 48 + 23 + 5 + 181 = 257 days Net Operating Cycle = 257 . The fundamental formula for the calculation of cash conversion cycle is as follows: = = Inventory Period + Accounts Receivable Period – Accounts Payable Period Operating Cycle – Accounts Payable Period Some Illustrations depicting calculation of Operating Cycle Operating Cycle for the year 2010 1 RMCP = 59 days 2 WIPCP = 24 days 3 FGCP = 4 days 4 Debtors Conversion Period = 149 days 5 Payable Deferral Period = 132 days.Cash cycle also termed as net operating cycle or cash conversion cycle is interpreted as the number of days between the payment for inputs and getting cash by sales of commodities manufactured from that input. Gross operating Cycle = 59 + 24 + 4 + 149 = 236 days Net Operating Cycle = 236 . It is the time lag between the payment for raw materials purchases and the collection of cash from sales.132 = 104 days Operating Cycle for the year 2011 1 RMCP = 48 days 2 WIPCP = 23 days 3 FGCP = 5 days 4 Debtors Conversion Period = 181 days 5 Payable Deferral Period = 162 days.

It indicates the total time lag & the relative significance of its constituent parts. creditors and inventories 1. Stock Turnover ratio = Cost of goods sold / Average Stock 1.Thus the working capital cycle helps in the forecast. The following ratios will help in managing debtors. Material Storage Period (M) = Average Stock of raw materials / Daily average consumption OR = [(Opening stock + Closing Stock) /2] / (material consumed for the year / 365) WIP or Conversion Period (W) = Average Stock of WIP / Daily average production cost OR = [(Opening WIP + Closing WIP) /2] / (Total production cost / 365) Finished Goods Storage Period (F) = Average Stock of finished goods / Daily average cost of goods sold OR = [(Opening stock + Closing stock) /2] / (Total cost of goods sold / 365) . The duration may vary depending upon the business policies. control & management of working capital.

availability and future requirements of cash for current assets are ascertained to maintain liquidity. To solve this problem. Order placed Stock arrives Inventory Period Accounts Receivable period Accounts payable period Cash Paid for Material Firm receives invoice Operating cycle Cash Cycle Figure 4. With the help of these cash flows. Following methods are generally used in estimating working capital for the future period: a) b) c) d) e) Operating Cycle Method Net Current Assets Forecasting Method Projected Balance Sheet Method Adjusted Profit and Loss Method Cash Flow Forecast Method . estimates of future requirements of current assets and cash flows are made.Debtors Turnover ratio = [(Debtors+ Bills receivable*365] / Net credit sales Creditors Turnover ratio = [(Creditors + Bills payable)*365] / Credit purchases Depicts the operating cycle and the cash cycle.3: Operating cycle Estimation of Working Capital Requirement The determination of the amount of working capital requirement at a particular level of production is a problem for finance managers.

This is followed by an estimate of current liabilities comprising of outstanding payments for material.a) Operating Cycle Method In this method. bank finance is to be subtracted. an estimate of all the current assets is made on a monthly basis. rent. total operating expenses for a period are divided by the number of operating cycles in that period to calculate the cash requirement for working capital.C Net Current Assets Forecasting Method This is the most practical method of estimating working capital requirements. Under this method. Thus. …. This method is based on ‘cash’ technique as all transactions are shown on cash cost basis. …. a working capital forecast is prepared. The difference between the forecasted amount of current assets and current liabilities gives the networking capital requirements of the firm. and administrative and other expenses. as discussed below: 1. From this. (iii) . …. Operating Cycle Period: It means the total number of days involved in the different stages of operation starting from the purchase of raw materials till collection of sale proceeds from debtors after adjusting the number of days credit allowed by suppliers. if available. Depreciation write off of intangible assets. estimate of stock of raw materials. OC= M + W +F + D . amount of raw material in process. The resulting figure will be the amount of total estimated working capital required. To this amount. Rs. Thus. The remaining balance will be the amount of working capital that is to be managed by the firm. 2. stock of finished goods and outstanding amount from debtors and other receipts will have to be made. In preparing this forecast. the operating cycle is the total period involved in different stages of operations. Operating Expenses: These expenses include purchase of raw materials. Statement showing working Capital Requirements (A) (i) (ii) Current Assets Stock of Raw Material (for …month consumption) (a) Work-in-Process (for months) (b) Direct Labor (c) Overheads Stock of finished Goods (for …month’s sales) Amount …. tax and dividend and Capital expenses are not included. the computation of total operating expenses. operating cycle period and number of operating cycles in the year is essential for estimating the working capital. wages. administrative and selling and distribution expenses for a specific period for which estimates can be obtained from cost records. Thus. a percentage would be added by way of provision for contingencies. fuel and power. direct labor cost.

It is similar cash flow statement. Net Income Add: (i) Non-cash Items Working Capital Provided Operations …………. …………… ………… . Computation of Working Capital Rs. a balance sheet is prepared based on these estimates and is called ‘Projected balance sheet’.(a) Raw Material (b) (b) Labor (c) Overheads (iv) Sundry Debtors or Receivables ( for …month’s sales) (a) Raw Material (b) Labor (c) Overheads -------------(v) (vi) Payment in Advance (if any) Balance of Cash (required to meet day-to-day expenses) (B) Current Liabilities (i) Creditors (for month’s purchase of Raw Materials) (ii) Lag in Payment of Expanses (Outstanding expenses …month’s) (iii) Others (if any) Net Working Capital (A) – (B) Add: Provision for Contingencies Total Working Capital Required -------------------------------------- c) Projected Balance Sheet Method Under this method. The difference between assets and liabilities of this balance sheet is treated as shortage or surplus cash of that period.. estimates of different assets (excluding cash) and liabilities are made taking into consideration the transactions in the relevant period. Then. d) Adjusted Profit and Loss Method In this method. estimated profit based on transactions of the relevant period is calculated. Thereafter. A specimen of such a method is given below. increase or decrease in working capital is computed adjusting the estimated profit by cash inflows and cash outflows.

. This means they have a negative WC cycle and has more capital available to fund growth. if the company has a strong market position and can dictate purchasing terms to suppliers. the more healthy a company generally is. for instance. a company that pays contractors in 7 days but takes 30 days to collect payments has 23 days of working capital to fund. e) Cash Forecasting Method In this method. This method is a form of cash budget. . CCC can even be negative. . having a working capital cycle of 23 days Businesses attempt to shorten the cash conversion cycle by speeding up payments from customers and slowing down payments to suppliers. Example. The management formulates plans to cover the amount of deficit. The lower the cash conversion cycle. cash receipts and payments estimate is made for a relevant period. The difference of these receipts and payments indicates deficiency or surplus of cash..Add: (ii) Cash inflow Items Less: Cash Outflow items Net Changes in Working Capital …………. …………. collects money before it pays for goods. A short WC cycle suggests a business has good cash flow and allows to quickly obtain cash that can be used for additional purchases or debt repayment.

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