S.Y.

BMS SEMESTER-III
4- WORKING CAPITAL MANAGEMENT
Working Capital
Working capital is the part of the funds of a business which is used for day-to-day operations. It is the
money required to keep the business running smoothly. In the absence of working capital, fixed
assets cannot be employed gainfully. for example, a machine cannot be used without raw
materils. The investment on the acquisition of machine is known as fixed assets. Whereas money
spent on the purchase of raw material may be termed as working capital
Arithmetically,
Working Capital = Current Assets - Current Liabilities
Current Assets refers to cash and those assets which can be converted into cash or to other current
assets within a year and include such prepaid expenses services for which are receivable within 12
months.
Specifically, the current assets are made up of non-quick assets and quick assets.
current liabilities refer to those liabilities which have to be repaid within a year and includes such
income received in advance, services for which are to be given within 12 months. Specifically, the
current liabilities are made of non-quick liabilities and quick liabilities.
Types of Working Capital
Working capital is of the following types
1. Gross and Net Working Capital.
2. Permanent and Temporary Working Capital
3. Balance Sheet Capital and Cash Working Capital
4. Positive and Negative Working Capital
Gross working capital: Gross working capital refers to the sum of the current assets. In this concept the
total of the current liabilities is not deducted from the total of current assets. current assets may be
financed by both long-term sources and term sources of funds. Gross working capital is always a
positive figure. It is never a negative figure.
Gross Working Capital = Current Assets
Net working capital: Net working capital refers to the difference between current assets and current
liabilities. Excess of current assets over current liabilities is net working capital. Permanent net
working capital should be financed only by long term sources. Net working capital may be positive
or negative.
Permanent working capital: This is required as long as the business continues as a going concern.
permanent working capital never leaves the business. The size of permanent working capital
increases with the growth of business. The size of permanent working capital increases with the
growth of business. This minimum amount of working capital is required to enable the concern to
operate at the lowest level of activity such minimum amount of working capital is called Permanent
working capital. It is also called the Core working capital.
Temporary working capital: If the concern wants to increase its level of activity and produce and sell
more goods, naturally it will need additional amount of working capital. If the increase in the level
of activity is temporary or seasonal the additional amount of working capital required is called
Temporary working capital.
Temporary working capital is also referred to a Variable or fluctuating working capital.
Balance sheet working capital: It is the difference between the current assets and current liabilities as
per the Balance sheet prepared at the end of the financial year. The concept of balance sheet working
capital is static in nature as it does not reveal the flow of money occurring between the two balance
sheet dates.
Cash working capital: It refers to the working capital which is available in cash or cash resources. It is
reflected by the items contained in the income statement in between the two balance sheet dates. It
reveals the operational inflow as well as outflows of cash.
Positive working capital: When the current assets are more than the current liabilities such a situation
is known as positive working capital.
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Negative working capital: When the current liabilities are more than the current assets such a situation
is known as negative working capital.
Working Capital Cycle (Operating Cycle or Operating Period)
It is also known as operating cycle or operating period. The concept is based on the continuity of
flow of fund from business operations. This flow is operational activities caused during a given
period of time.
Operational activities of a manufacturing organizations:
1. Purchase of raw materials.
2. Payments of Wages and expenses for conversion of raw materials into finished products.
3. Production of finished goods.
4. Sale of finished goods on cash or credit.
5. Collection from debtors (Bills of exchange )

Operational activities of a Trading organisation

1. Purchase of finished goods.
2. Sale of finished goods on cash or credit
3. Collection from debtors bills of exchange

Factors Determining Working Capital Requirements

Working capital required by a business organisation depends on many factors. They are as follows.
1. Nature of Business : The requirement of working capital changes from industry to industry.
Manufacturing and trading organisation requires more amount of working capital , because it has to
carry large stock and allow credit to the customers. on the other hand, public utilities require less
working capital because they sell on cash basis only.
2. Production Process: If the production process takes a long time, greater amount of working capital
will be required. Short production process requires less working capital.
3. Size of Business unit : Large organisation require more working capital than a small organisations
due to large size of business operation.
4. Terms of Purchase and Sales : A business organisation making purchase on credit and selling on
cash terms would require less working capital, Where as an organisation selling goods on credit
would require more working capital.
5. Turnover of Inventories: A business organisation having low inventory turnover would necessitate
more working capital and vice versa.
6. Seasonal Variations : In case of seasonal industries like sugar company, more working capital is
required during peak seasons as compared to off seasons.
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7. Business Cycle : More working capital is required during period of prosperity and less required
during the period of depression.
8. Changes in Technology : Changes in technology changes the production pattern and there by
affects working capital requirements.
Consequences of Insufficient working capital
1. Inability to purchase enough raw material or finished goods for utilizing the business capacity
fully.
2. Inability to earn cash discount and take advantage of other profitable opportunities.
3. Inability to make timely payment to the workers, creditors and the shareholders.
4. Inability to keep up maintenance repairs and replacement.
5. Inability to maintain the prestige and credit worthiness of the company.
WORKSHEET 1: ESTIMATING WORKING CAPITAL
(Level of Activity in units)
₹ ₹
Current Assets
1. Stock of Raw Material Units X Rate X Period of holding XX
2. Stock (Work in Progress)
Raw Materials Units X Rate X Processing Period XX
Labour Units X Rate X Processing Period X-1 XX
2
1
Units X Rate X Processing Period X -
Overheads XX XX
2
3. Stock of Finished Goods
Raw Materials Units X Rate X Period Holding XX
Labour Units X Rate X Period Holding XX
Overheads Units X Rate X Period Holding XX XX

XX
4. Debtors (at S.P.) [OR] Units X S.P X Period of Credit
Debtors (at Cost)
Raw Material Units X Rate X Period Credit XX
Labour Units X Rate X Period Credit XX XX
Overheads Units X Rate X Period Credit XX

5. Prepaid Expenses Units X Rate X Prepayment Period XX

6. Advance to Suppliers XX
7. Cash and Bank XX
Total (A) XX
Less : Current Liabilities
1. Creditors
2. Lag in Payment Wages Overheads Units X Rate X Period Credit XX
3. Advance from Customers Units X Rate X Lag in Payment XX
Total (B) Units X Rate X Lag in Payment XX XX
Net current Assets
XX
Add: Margin of Safety XX
Working Capital Required XX
XX
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Estimation Duration of Net Operating Cycle
Which items enters How its duration is calculated What the result indicates Result
(I) Current Assets
1. Stocks RM Stock
12 No. of Months RM is in stock
XX R
Raw - Material (RM) RM Consumed
Work-in progress (WIP) WIP Stock No. of Months WIP is in stock
12 XX
Cost of Goods Produced
Finished Goods (FG) FG Stock No. of Months FG is in stock
12 XX
Cost of FG Sold
2. Debtors Debtors No. of Months credit to debtors
12 XX
Current Assets cycle (1+2) Cr. Sales
(II) CURRENT LIABILITIES No. of Months to credit by
1. Creditors Creditors creditors
12
Cr. Purchase
NET OPERATING CYCLE
(MONTHS ) (I-II) XX

Approaches in estimation of working capital

There are 2 approaches in practice for estimation of working capital requirements :
i) Total Approach
ii) Cash cost approach
Items Total Approach Cash Cost Approach
Stock of raw Net purchase cost after adjustment of Net Purchase cost after adjustment of discount
materials discount is considered is considered
Stock of work in 100% cost of material + 50% labour cost + 100% cost of material + 50% labour cost + 50%
progress 50% overheads including depreciation overheads excluding depreciation
Debtors Valued at sales including profit Valued at cash cost ie sale less depreciation and
profit
Stock of finished Cost of production including depreciation Cost of production excluding depreciation
goods