Working capital management

Definition
• Working capital means operating capital
• Part of the total capital which is required for
running the day to day operations of the
business.
 Types of working capital
• On the basis of concept
– Gross Working Capital
Total amount of current assets in the business
– Net Working Capital
Amount of contribution which business enterprise
makes to enhance the gross working capital
 On the basis of time
• Permanent working capital
Amount of capital locked up in business for
continuous basis as long as it continues to
exist.

• Variable/Temporary working capital

– Seasonal
– Special
Working capital operating cycle
 Principles of working capital
• Principle of risk variation
• Principle of cost of capital
• Principle of Equity position
• Principle of maturity payments
 Factors determining working capital
• Nature of the business
• Labour requirement
• Cost of raw material
• Credit policy
• Seasonal variations
• Size of business unit
• Production process
• Terms of purchase and sale
• Turnover of Inventory
• Seasonal variations
• Need to store finished goods
• Business Cycle
Methods of Assessing Working Capital

• Operating Cycle Method

• Maximum Permissable Bank Finance(MPBF)
• Drawing Power Method
• Turnover Method
• Cash Budget Method
 Operating Cycle Method

a. Procurement of raw materials

b. Process time
c. Average Time for Holding Finished Goods
d. Average Collection period
e. Operating Cycle (a+b+c+d)
– Operating cycles per year= 365/e
 Example
a. Procurement of raw materials= 30 days
b. Process time= 15 days
c. Average Time for Holding Finished Goods = 15 days
d. Average Collection period= 30 days
e. Operating Cycle= __________________
Operating cycle per year = 365/e

Working capital requirement= Operating expenses per

annum/Number of operating cycles per annum
If operating expenses per annum is Rs. 60 lakhs. Calculate
the working capital requirement.
 MPBF
• It relates to banking sector
• Indicates the maximum level of holding inventory and receivables in the
industry
• Used when the working capital requirement is greater than 5 crores in
small scale industries or in others greater than 1 crore

• 1st method- Finance maximum of 75% of the working capital gap

– MPBF= 0.75 * (Total Current Assets[TCA]-Other Non-bank Current
Liabilities[ONBCL])
• 2nd method- Borrower is required to provide a minimum of 25% of the
total current asset out of the long term funds.
– MPBF= (0.75*TCA)-ONBCL
• 3rd method
– MPBF=0.75*(TCA-CCA)-ONBCL
• Where CCA= Core current assets
 Example
Current Assets (in Rs lakhs) Amount Amount
Raw material 20
Work in Progress 5
Finished Goods 10
Receivables 10
Other Current Assets 7
(CCA=27) 52

Current Liabilities ( in Rs. Lakhs)

Creditors 10
Other Current Liabilities 6
Bank Borrowings 11
27
Drawing Power Method
 Turnover Method
• Applicable for SSI units who have working
capital requirement of upto Rs. 5 crores
• Assumption – 4 operating cycles
• Working capital is estimated at 25%
• Bank can finance up to 20% of the project
turnover
• Balance 5% is bought in by borrower as
his/her margin
Explanation
 Sum
• Suppose projected annual turnover is Rs. 160 crores for 1
working capital cycle and actual working capital available is
Rs. 7 crores

A Projected Sales Turnover 160cr

B WC required (25%) 40cr
C Minimum Margin from Borrower (20%) 8cr
Minimum Bank Borrowing (80% of
D 25%) or (20% of sales) 32cr
E Actual NWC Available 7cr
F Stipulated Margin (Max of C or E) 8cr
G Permissable Limit (B-F) 32cr
• Ratio of bank borrowing to net working capital =32:8= 4:1
 Sum for practice
A Projected Turnover 200 cr
B WC required 50 cr
C Minimum Margin from Borrower 10 cr
D Minimum Bank Borrowing 40 cr
E Actual NWC Available 10 cr
F Stipulated Margin 10 cr
G Permissable Limit 40 cr
 Cash Budget Method
• Borrower submits the cash budget for a future
period and then the working capital is
calculated.
 Finance of Working Capital
• Bank credit
• Loans for Financial Institutions
• Public deposits
• Prepaid Income
• Retained Earnings
• Overdraft
• Factoring
• Invoice discounting
 Working capital factoring
• Way of converting the accounts receivables
into money which can be further invested into
the working capital
– Client: Organisation with receivables
– Factor: A financial service organization/bank
– Debtor: One who is creating receivables
 Benefits of factoring
• Provides liquidity for the organization
• Provides better asset-liability management
• Helps in recycling the assets easily
• Improves transparency of the assets
 Sum for practice
a. Procurement of raw materials= 20 days
b. Process time= 10 days
c. Average Time for Holding Finished Goods = 10
days
d. Average Collection period= 20 days
e. Total operating expenses in the current year are
Rs. 3 crores
Calculate the Operating Cycle, Operating cycle per
year and Working capital requirement.