WORKING CAPITAL MANAGEMENT

Working capital is the life blood and nerve centre of a business. Just as circulation of blood is essential in
the human body for maintaining life, working capital is very essential to maintain the smooth running of
a business. No business can run successfully with out an adequate amount of working capital.

Working capital refers to that part of firm’s capital which is required for financing short term or current
assets such as cash, marketable securities, debtors, and inventories. In other words working capital is
the amount of funds necessary to cover the cost of operating the enterprise.

Meaning:

Working capital means the funds (i.e.; capital) available and used for day to day operations (i.e.;
working) of an enterprise. It consists broadly of that portion of assets of a business which are used in or
related to its current operations. It refers to funds which are used during an accounting period to
generate a current income of a type which is consistent with major purpose of a firm existence.
CASH MANAGEMENT

Introduction:

Cash management is one of the key areas of working capital management. Cash is the liquid current
asset. The main duty of the finance manager is to provide adequate cash to all segments of the
organization. The important reason for maintaining cash balances is the transaction motive. A firm
enters into variety of transactions to accomplish its objectives which have to be paid for in the form of
cash.

Meaning of cash:

The term “cash” with reference to cash management used in two senses. In a narrower sense it includes
coins, currency notes, cheques, bank drafts held by a firm. n a broader sense it also includes “near-cash
assets” such as marketable securities and time deposits with banks.

RECEIVABLES MANAGEMENT
Introduction:
Receivables constitute a significant portion of the total assets of the business. When a firm seller goods
or services on credit, the payments are postponed to future dates and receivables are created. If they
sell for cash no receivables created.

Meaning:

Receivable are asset accounts representing amounts owed to the firm as a result of sale of goods or
services in the ordinary course of business.

INVENTORY MANAGEMENIntroduction:

Inventories are stock of the product a company is manufacturing for sale and components. That make
the products. The various forms in which inventories exist in a manufacturing company are: Raw-
materials, work-in-process, finished goods.T

Introduction:

Inventories are stock of the product a company is manufacturing for sale and components. That makeup
the products. The various forms in which inventories exist in a manufacturing company are: Raw-
materials, work-in-process, finished goods.

EOQOne of the major inventory problems to be resolved is how many inventories should be added
when inventory is replenished. If the firm is buying raw materials it has to decide lots in which it has to
be purchased on each replenishment. If the firm is planning a production run, the issue is how much
production to schedule or how much to make. These problems are called order quantity problems and
the task of the firm is to determine the optimum or economic order quantity (or economic lot size)
determining an optimum inventory level involves two types of costs.

There are two definitions of working capital (1) Gross working capital (2) Net working capital

Gross working capital refers to working capital as the total of current assets, whereas the net
working capital refers to working capital as excess of current assets over current liabilities. In
other words net working capital refers to current assets financed by long term funds.

Accordingly,

Gross working capital = Total current assets

Net working capital = Current assets – Current liabilities

The net working capital position of the firm is an important consideration, as this will determine
the firm’s profitability and risk. Here the profitability refers to profits after expenses and risk
refers to the probability that a firm will become technically insolvent where it will be unable to
meet obligations when they become due for payment.

A finance manager has to make an appropriate financing mix, which will limit the risk and
increase the profitability. Financing mix refers to the proportion of current assets financed by
current liabilities and long term funds.

There are two approaches which determine the financing mix (1) Aggressive approach (2)
Conservative approach.

According to aggressive approach the long term funds are used to finance only the core or fixed
portion of current assets (e.g., minimum level of finished goods inventory, raw material etc) and
the other portion i.e. temporary and seasonal requirements are financed by short term funds. This
is of high risk and high profit financing mix.

According to conservative approach the total current assets are financed from long term sources
and short term sources are used only in emergency situation i.e. when there is an unexpected
cash outflow. This is of low-risk and low-profit financing mix.

As we observed two methods of financing mix, one method is of high risk high profit and other
is of risk low profit. A finance manager has to trade off between these two extremes.

Operating Cycle:

The objective of financial management is to maximize the shareholders wealth. So it is needed to

generate sufficient profits. The profits generated depend mainly on sales volume. When the
goods are being sold on credit as is the normal practice of business firms today to cope with
increased competition the sale of goods cannot be converted into cash instantly because of time
lag between sales and realization of cash.

As there is a time lag between sales and realization of receivables there is a need for sufficient
working capital to deal with the problem which arises due to lack of immediate realization of
cash against goods sold. The operating cycle is the length of time required for conversion of non-
cash assets into cash. This operating cycle refers to the time taken for the conversion of cash into
raw material, raw materials into work-in-progress, work-in-progress into finished goods, finished
into receivables into cash and this cycle repeats.

The operating cycle length differs from firm to firm. If a firm has lengthy production process or a
firm has liberal credit policy the length of operating cycle will be more. On the other hand, if a
firm does not extent credit or the firm is not a manufacturing concern i.e. where cash will be
converted into inventory directly then the length of operating cycle will be reduced to a greater
extent.

The length of operating cycle can be calculated by calculating periods of raw material storage,
work in process, finished gods storage and debtors collection period.

1. Raw materials storage period

= Average stock of raw materials and stores/ Average daily consumption of raw material and
stores
2. Work in process period

= Average work in process inventory /Average cost of production per day

3. Finished goods storage period

 = Average finished goods inventory / Average cost of goods sold per day

4. Debtors collection period

= Average book debts / Average credit sales per day

Length of operating cycle = 1+2+ 3+4.
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Working Capital Cycle

The working capital cycle refers to the length of time between the firms paying cash for materials, etc.,
entering into the production process/stock and the inflow of cash from debtors (sales). Suppose a
company has a certain amount of cash it will need raw materials. Some raw materials will be available on
credit but, cash will be paid out for the other part immediately. Then it has to pay labour costs and incurs
factory overheads. These three combined together will constitute work-in-progress. After the production
cycle is complete, work-in-progress will get converted into finished products. The finished products when
sold on credit gets converted into sundry debtors. Sundry debtors will be realized in cash after the expiry
of credit period. This cash can again be used for financing of raw material, work-in-progress, finished
goods, debtors and finally into cash again. Short term funds are required to meet the requirements of
funds during this time period. This time period is dependent upon the length of time within which the
original cash gets converted into cash again. This cycle is also known as operating cycle or cash cycle.
 
 
The working capital cycle is depicted below:
Working capital cycle indicates the length of time between a company’s paying for materials, entering into
stock and receiving the cash from sales of finished goods. It can be determined by adding the number of
days required for each stage in the cycle. For example, company holds raw-materials on an average for
60 days, it gets credit from the supplier for 15 days, production process needs 15 days, finished
goods are held for 30 days and 30 days credit is extended to debtors. The total of all these, 120 days, i.e.,
60- 15 + 15 + 30 + 30 days is the total working capital cycle.
 
The determination of working capital cycle helps in the forecast, control and management of working
capital. It indicates the total time lag and the relative significance of its constituent parts. The duration of
working capital cycle may vary depending on the nature of the business.
 
 
The operating cycle (working capital cycle) consists of the following event which continues throughout the
life of business.
 

 Conversion of cash into raw-materials;

 Conversion of raw-materials into work-in-progress;
 Conversion of work-in-progress into finished stock;
 Conversion of finished stock into accounts receivables through sales; and
 Conversion of account receivables into cash.

INVENTORY MANAGEMENT

There are three types of inventories: raw materials, work in process, and finished goods. Raw materials are
materials and components that are inputs in making the final product. Work-in-process, also called stock-in-
process, refers to goods in the intermediate stages of production. Finished goods consist of final products
that are ready for sale. While manufacturing firms generally hold all the types of inventories, distribution
firms hold mostly finished goods.