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PART – 1
DSK
 f WORKING CAPITAL
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MANAGEMENT
a
n Part –1: WORKING CAPITAL
c
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 Definition of WC
a
l  Why WC ....???
m  Objectives and Aspects of WC
a
 Purpose and Need of WC
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a  Components of WC
g  Concepts of WC
e
 WC in case of Stable firm &
m
e Growing firm
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DSK
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i INTRODUCTION:
n
a
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c • Working Capital plays the
i
a crucial role in the business as
l
m the role of heart in the human
a
n body.
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i
n DEFINITION:
a
n  Working capital refers to funds required
c
i
to be invested in the business for a short
a period usually upto one year.
l
m
 It is also known Short-term capital or
a Circulating capital
n
a
 “Working capital is the amount of funds
g necessary to cover the cost of operating the
e enterprise.”
m
e --- Acc.. to Shubin
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DSK
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i
n WHY WC...??
a
n  The firm has to maintain cash balance to pay
c
i
bills as they come due.
a  In addition, the company must invest in
l
m
inventories to fill customer orders promptly.
a  And finally, company invests in accounts
n
a
receivable to extend credit to customers.
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i
n OBJECTIVES OF WC:
a
n → To optimize investments in current assets.
c
i → To see that company meets its current
a liabilities obligation.
l
m → Manage current assets to see that the return
a on current assets is more than cost of capital.
n
a → Proper balance between current assets &
g current liabilities.
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Example:
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n ASPECTS OF WC:
a
n There are many aspects of WCM which makes
c
i
it important function of financial
a management.
l
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 Time
a  Investment
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a  Credibility
g
 Growth
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DSK
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n PURPOSE OF WC:
a
n  To hold the stock of raw materials for such a
c
i
period
a  To hold the stock of work in progress for
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m
process period
a  To hold the stock of finished goods for such
n
a
a period
g  To grant credit to customers
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m  To hold cash balances to meet the expenses
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DSK
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n NEED FOR WC:
a
n ֍ Operating Cycle.
c
i
a ֍Operating cycle in a Trading firm is the
l
m length of time required.
a
n
a Inventory Receivable
Cash
g of FG s
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a ֍ Operating cycle in a Manufacturing firm is
n
c
the length of time required
i
a
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Inventory Inventory Inventory
m Cash
of RM of WIP of FG
a
n
a Receivable
g s
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e ֍ Distinct Phases in Operating Cycle
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DSK
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n Components of Operating Cycle:
a
n  Gross Operating Cycle:
c
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a
l R W F D GOC
m
a
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a RM storage Gross
g period Operating
e WIP holding Cycle
m period
e FG storage
period
n
Debtors Collection
t
Period
DSK
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 Net Operating Cycle:
n
a
n
cR W F D C NOC
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a
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RMSP WIPHP FGSP DCP
m Creditors
a Collection Period
n
a
g
e Net
Operating
m
Cycle
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DSK
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i How to Calculate Components of OC:
n
a Average RM Storage Period Average stock of RM
n (in days) Average Cost of RM Consumption per day
c
Average WIP Holding Period Average stock of WIP
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( in days) Average Cost of WIP per day
a
l Average FG Storage Period
m (in days ) Average stock of FG
a Average Cost of Goods Produced per day
n
a Average Debtors Collection Average Trade Debtors
g Period ( in days)
Average Cost of Credit Sales per day
e
m Average Creditors Payment Average Trade Creditors
e Period (in days) Average Credit Purchases per day
n Average Time-Lag in Average Creditors for Expenses
t Payment of exp’s (in days) Average Expenses per day
DSK
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a
How to Calculate Number of Operating
n Cycles in a year:-
c
i The no. Of Operating Cycles in a year may be
a
l calculated as follows:
m
a
n
No.of days in a year
a No. of Operating Cycles in a year =
g Net Operating Cycle(in days)
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i Illustration-1:
n 1. RM Inventory Consumed during the year 60,00,000
a
2. Average stock of RM 10,00,000
n
c 3. Factory Cost of Goods Produced 1,05,00,000
i 4. Average stock of WIP 4,37,500
a
l 5. Office Cost of Goods Produced 1,14,00,000
m 6. Average stock of FG 9,50,000
a 7. Average trade debtors 11,25,000
n
a 8. Cost of Credit Sales 90,00,000
g 9. Average trade creditors 5,00,000
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10. Expenses for the year 30,00,000
m
e 11. Average creditors for Expense 5,00,000
n 12. No.of working days in a year (assume 360days)
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DSK
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a
n  From the above following information of
c
i Company , Calculate ---
a
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1. Gross Operating Cycle
m 2. Net Operating Cycle
a
n 3. No.of Operating Cycles in a
a year
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i Concepts Of WC:
n
a
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c Gross working
i On the capital
a basis of
l Concept Net working
m capital
a WC Permanent
n
a On the working capital
g
e
basis of
Time Temporary
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working
n capital
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DSK
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i On the basis of Concept/Value:
n
a  Gross W/C: It refers to the firm’s investment in
n current assets.
c
i CA includes – stock of rawmaterial, WIP, FG’s, etc.
a In the form of Equation , Gross W/C can be shown
l
m
below:- CASH
a
n Inventories
a Gross i. Raw-materials
g Working ii. Work-in-progress
e Capital iii. Finished Goods
m
e
n Short term Marketable
t securities and other current
assets
DSK
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 Net W/C: It refers to diff b/w current assets
n
a and current liabilities.
n
c CL includes – trade creditors , bills payable,
i o/s exp’s, etc.
a
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a Net Working Capital is a Qualitative Concept,
n which indicates:
a
g i. Liquidity position of the firm
e ii. Part of current assets which should be financed
m
e with long-term funds
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DSK
 f  In the form of an equation , Net Working
i
n Capital has been shown below:
a
n Gross Working Capital (or)
c current Assets
i Net Working
a LESS
l
Capital
m Current Liabilities
a
n
a  Example: A company buys stocks of raw material
g
e
for cash. It implies that company is financing raw
m material stock from its internal sources. Suppose,
e the company gets a two months credit for the same
n
purchase. It implies the stock is financed by
t
DSK creditors.
 f Difference b/w Gross WC & Net WC :
i Gross working capital Net working capital
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a 1. Quantitative in nature 1. Qualitative in nature
n
c
2. It indicates total sum 2. It expressed as
i of current assets current assets minus
a current liabilities
l
m 3. It is suitable for 3. It is suitable for sole
a companies trading & partnership
n
a 4. It is a concept very 4. It is a concept very
g popular in financial popular in accounting
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management system
e 5. It cannot reveal the 5. It is very useful to find
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true financial position of out true financial position
DSK company of the company
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On the basis of Time:
a
n
c Regular wc
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Permanent /
a
fixed WC
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m Reserve wc
a Time
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a Seasonal wc
g
e Temporary WC
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Special wc
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Permanent Working Capital:
a
n
c
It refers to a certain
i minimum level of current assets, which
a
l is essential for firm to carry on its
m
a
business irrespective of the level of
n operations.
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DSK
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i Characteristics of PWC:
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a
n  Classified on the basis of Time factor
c  Always remain in process
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a  Size increases according to the Growth of
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enterprise
a  suitable for business, which is the same
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a for all the year long
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 Constantly changes from one asset to
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i Temporary Working Capital:
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a
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c
It refers to the amount of
i working capital over and above the
a
l fixed minimum amount of WC,
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a
which is required to meet seasonal
n and other temporary requirements.
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i Working Capital in case of a Stable firm
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a
n  In case of a Stable firm , the
c
i Permanent working capital is
a
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stable over time and takes the
m shape of a Horizontal line.
a
n while temporary working
a
g capital is fluctuating –
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sometimes increasing and
e sometimes decreasing.
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DSK
 f Working capital in case of Stable Firm Diagram
i
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a Y
n
c Temporary
Amount of working capital

i working capital
a line
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a Permanent
n Level of temporary working capital working capital
a line
g
e Level of permanent working capital
m X
e Time
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DSK
 f Working Capital in case of a
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Growing firm
a
n  In case of a Growing firm , the Permanent
c
i working capital may also keep on
a increasing over time to support a rising
l
m level of activity and hence PWC line may
a not always be Horizontal. while
n
a Temporary working capital is fluctuating –
g sometimes increasing and sometimes
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m decreasing.
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i Working capital in case of a Growing Firm Diagram
n
a
n Y
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Temporary
Amount of working capital

a
l working capital
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Permanent
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working capital
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line
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Prepared by ...
g Sravan Kumar . D
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DSK