WORKING

CAPITAL
MANAGEMENT
NEED FOR WORKING CAPITAL
 Any business wants to maximize the wealth of the
shareholder, this is possible only when the company earns
sufficient profits. The amount of such profits largely
depends upon the magnitude of sales.

 However, sales do not convert into cash instantly. There is

always a time gap between the sale of goods and receipt of
cash. Working capital is needed for this period in order to
sustain the sales activity.

 In case adequate working capital is not available for this

period, the company will not able to sustain and it may not
be in a position to purchase raw materials, pay wages and
other expenses required for manufacturing the goods to be
sold. 2
OPERATING CYCLE
 Working capital is required because of the time gap
between the sales and actual realization of cash. This
time gap is technically termed as Operating Cycle of the
business.
 In case of Manufacturing company, Operating cycle is
the length of time necessary to complete following
events:
 Conversion of Cash into Raw Materials;
 Conversion of Raw Materials into Work in progress;
 Conversion of Work in progress into Finished goods;
 Conversion of Finished goods into Accounts Receivables, &
 Conversion of Accounts Receivables into Cash.
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Alaknanda Lonare
 Accounts Payable Value Addition

Raw WIP
Materials

THE WORKING CAPITAL

Cash CYCLE Finished
(OPERATING CYCLE) Goods

Accounts SALES
Receivable
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Alaknanda Lonare
 Operating Cycle= R+W+F+D-C
Where,
 R= Raw Material Storage Period

 W= Work-in-Process holding Period

 F= Finished Goods Storage Period

 D= Debtors Collection Period

 C= Credit Period Availed

 Therefore the goal of Working Capital Management is to

ensure that the firm is able to continue its operations and
that it has sufficient cash flow to satisfy both maturing
short term debts and upcoming operational expenses.

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TYPES OF WORKING CAPITAL
 Working Capital can be divided into two categories:

 Permanent Working Capital: This refers to that minimum

amount of investment in all current assets which is required at all
times to carry out minimum level of business activities. In other
words, it represents the current assets required on a continuing
basis over entire year.
 It also refers to as hard core Working Capital.

 Temporary working Capital: The amount of such working

capital keeps on fluctuating from time to time on the basis of
business activities. In other words, it represents additional current
assets required at different times during the operating year.
 It refers to that part of total working capital, which is required by a
business over and above permanent working capital.
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 It is also called variable working capital.
Alaknanda Lonare
DETERMINANTS OF WORKING CAPITAL
MANAGEMENT

 Cash
 Inventory

 Debtors

 Short term Financing Options

 Nature of Business

 Market and demand Conditions

 Technology and Manufacturing Policies

 Operating Efficiency

 Price Level Changes

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IMPORTANCE OF ADEQUATE
WORKING CAPITAL:
 Every business concern should have adequate working
capital to run its business operations. It should have
neither redundant or excess working capital nor
inadequate or shortage of working capital.

 Both excess as well as shortage of working capital

situations are bad for any business. However, out of
the two, inadequacy or shortage of working capital is
more dangerous from the point of view of the firm.

Alaknanda Lonare
 Q.1. From the following information of XYZ ltd. you
are required to calculate: Net Operating Cycle and
No. of cycles in a year.
Particulars Amounts
Raw materials inventory consumed during the year 6,00,000
The average stock of raw material 50,000
Work in Progress inventory 5,00,000
Average work-in-progress inventory 30,000
Finished Goods inventory 8,00,000
Average Finished Goods Stock held 40,000
Average collection period from debtors 45 days
Average Credit period availed 30 days
No. days in a year 360 days

Alaknanda Lonare
 Q.2. From the following information, extracted from
the books of a manufacturing company, compute the
operating cycle in days and amount of working
capital required.
Particulars Amounts
Period Covered 365 days
The average period of Credit allowed by suppliers 16 days
Average debtors outstanding 48,000
Raw material consumption during the year 4,40,000
Total Production Cost 10,00,000
Total Cost of Sales 10,50,000
Sales for the year 16,00,000
Value of Average Stock Maintained:
Raw material 32,000
Work in Progress inventory 35,000
Finished Goods 26,00010

Alaknanda Lonare
 Q. 3. ABC co. has following assets and liabilities,
calculate Gross Working Capital and net Working
Capital:
 Cash 45,000
 Retained Earnings 1,60,000
 Equity Share Capital 1,50,000
 Debtors 60,000
 Inventory 1,11,000
 Debentures 1,00,000
 Provision for taxation 57,000
 Expenses Outstanding 21,000
 Land and Building 3,00,000
 Goodwill 50,000
 Furniture 25,000
 Creditors 39,000 11

Alaknanda Lonare
 POINTS TO BE REMEMBERED WHILE ESTIMATING
THE AMOUNT OF WORKING CAPITAL
 Profits should be ignored while calculating working capital
requirements for the following reasons.
 Profits may or may not be used as working capital
 Even if it is used, it may be reduced by the amount of Income
tax, Drawings, Dividend paid etc.
 Calculation of Stocks of Finished Goods and Debtors should be
made at cost

 Calculation of WIP depends on the degree of completion as

regards to materials, labour and overheads.

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Alaknanda Lonare
 Q.4. On 1st January, the managing director of MN Ltd. wishes to know the
amount of working capital that will be required during the year. From the
following information prepare the working capital requirement forecast.

 Production during the previous year was 60,000units. It is planned that this
level of activity would be maintained during the present year. The expected
ratios of the cost of selling prices are Raw materials 60%, Direct Wages 10%
and Overheads 20%. Raw materials are expected to remain in store for an
average of 2 months before issuing to production. Each unit is expected to be in
process for one month, the raw material being fed into the pipeline immediately
and labor and overhead cost accruing evenly during the month. Finished goods
will stay in warehouse awaiting to dispatch to customers for approximately 3
months. Credit allowed by creditors is 2 months from the date of delivery of
raw material. Credit allowed to debtors is 3 months from the date of dispatch.
Selling price is Rs.5/unit. There is a regular production and sales cycle. Wages
and Overheads are paid on the 1st of each month for the previous month. The
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company normally keeps cash in hand to the extent of Rs.20,000.

Alaknanda Lonare
 Q.5. The following particulars are available:
Elements of Costs Per Unit (Rs.)
Raw Materials 80/unit
Direct Labour 30/unit
Overheads (inclusive of Depreciation of Rs.10) 70/unit
Total 180/unit
Profit 30/unit
Selling Price 210/unit
 Raw materials are in stock on an average one month; Materials are in
process on an average half month; Finished goods are in stock on an
average one month.
 Credit allowed by the supplier is one month; credit allowed to debtors is 2
months.
 Average time lag in payment of wages 1.5 weeks and one month in
overhead expenses.
 One-fourth of output is sold against cash. Cash in hand and at a bank is
expected to be Rs.3,65,000. You are required to prepare a statement
showing the working capital needed on cash cost basis to finance a level
of activity of 1,04,000units of production. 14
 You may assume that production carried out evenly throughout the year
and wages and overhead accrue similarly. Alaknanda Lonare
 Q.6.The following annual figures relate to XYZ co.
Sales (at two months credit) 36,00,000
Materials consumed (supplier extend two months credit) 9,00,000
Wages paid (monthly in arrear) 7,20,000
Manufacturing expenses outstanding at the end of the year 80,000/month
(cash expenses are paid one month in arrear)
Total Administrative expenses paid as above 2,40,000
Sales Promotion expenses, paid quarterly in advance 1,20,000

 The company sells its products on a gross profit of 25%

counting depreciation as part of the cost of production.
It keeps one months’ stock each of raw materials and
finished goods and cash balance of Rs.1,00,000.
 Assuming a 20% safety margin, work out the working
capital requirements of the company on a cash cost
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basis. Ignore Work in process.
Alaknanda Lonare
Q.7. X co. is desirous to purchase a business and has consulted you to advise them
on the requirements of working capital in the first year with the following
information.
Particulars Rs.
a. Amount blocked up in stock:
Finished goods 5,000
Stores & materials 8,000

b. Average credit sales:

Inland credit-6 weeks 3, 12,000
Export sales-1 1/2 months 78,000

c. Lag in payments:
Wages-1 1/2 weeks 2, 60,000
Materials-1 1/2 months 48,000
Rent royalties- 6 months 10,000
Salaries -1/2 months 67,200
Miscellaneous expenses- 1 1/2 months 48,000

d. Payment in advances:
Sundry expenses paid quarterly In advance 8,000
Undrawn profits on an average throughout the year 11,000
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Set up your calculations for the average amount of working capital required.
Alaknanda Lonare