UNIT

13 Working Capital Management

Names of Sub-Units

Introduction to working capital management, concept of working capital management, concept of

factors influencing working capital management, working capital estimation, meaning of working
capital financing, concept of inventory management.

Overview
This unit begins by explaining the meaning of working capital management, it discusses the concept
of working capital management. The unit explains the concept of factors influencing working capital
management. It also discusses the meaning of working capital financing and concept of inventory
management.

Learning Objectives

In this unit, you will learn to:

 Explain the working capital management
 State the concept of working capital management
 Identify the inventory management
 Classify the working capital financing
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Learning Outcomes

At the end of this unit, you would:

 Assess the working capital management
 Examine the working capital financing
 Analyse the inventory management
 Evaluate the concept of working capital management

13.1 INTRODUCTION
Working capital management is significant in financial management due to the fact that it plays a
vital role in keeping the wheel of the business running. Every business requires capital, without which
it cannot be promoted. Investment decision is concerned with investment in current assets and fixed
assets. There are two assets required to be financed by fixed capital and working capital. In other words,
the required capital can be divided into two categories, such as fixed capital and working capital. Fixed
capital required for establishment of a business, whereas working capital required to utilise fixed assets.
Fixed assets cannot be utilised without current assets. It is just like a blood in the human body, without
which there is no body.

13.2 OVERVIEW OF WORKING CAPITAL MANAGEMENT

Working capital refers to the funds invested in current assets, i.e., investment in sundry debtors, cash and
other current assets. Current assets are essential to utilise facilities provided by plant and machinery,
land and buildings. In case of the manufacturing organisation, a machine cannot be used without raw
material. The investment in the purchase of raw materials is identified as working capital. It is obvious
that a certain amount of funds is tied up in raw material inventories, work in progress, finished goods,
consumable stores, sundry debtors and day-to-day cash requirements. However, the organisation
also enjoys credit facilities from its suppliers by way of credit. Similarly, the organisation need not
pay immediately for various expenses, etc., the workers are paid only periodically. Therefore, a certain
amount of funds automatically become available to finance the current assets requirement. However,
the requirement of current assets is usually greater than the amount of funds provided through current
liabilities. The goal of working capital management is to manage the firm’s current assets and current
liabilities in such a way that a satisfactory level of working capital is maintained.
From the point of view of concept, the term, working capital, can be used in two different ways:
1. Gross working capital: The gross working capital refers to investment in all the current assets taken
together. The total of investments in all current assets is known as gross working capital.
2. Net working capital: Net working capital refers to the excess of total current assets over total
current liabilities. Current liabilities are those liabilities that are intended to be paid in the

From the point of view of time, the term, working capital, can be divided into two categories:
1. Permanent: It is also referred as hard-core working capital. It is the minimum level of investment
in the current assets that is carried by the business at all times to carry out maximum level of its
activities. It should be financed by long-term sources.
2. Temporary working capital: It refers to that part of working capital, which is required by the
business over and above permanent working capital. It is also called variable working capital. Since

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the quantum of temporary working capital keeps on fluctuating from time-to-time depending on
the business activities, at may be financed from short-term sources.

13.2.1 Factors Influencing Working Capital Management

The important factors are:
 General Nature of Business: In some organisations, the sales are mostly in cash basis and the
operating cycle (explained) later is also short. In these concerns, the working capital requirement
is comparatively low. Mostly, service companies come under this category. In manufacturing
companies, usually the operating cycle is very long and a firm is also required to give credit to
customers to boost sales. In such cases, working capital requirement is high. Similarly, a trading
concern requires lower working capital than a manufacturing concern.
 Production Policy: Working capital requirements also fluctuate according to production policy
adopted by the company. Example: In case of products having seasonal demand, a steady production
can be planned throughout the year in which case finished goods are to be kept for a longer period.
The other alternative is to produce only during the season in which case raw materials have to be
accumulated throughout the year.
 Credit Policy: A company, which allows liberal credit to its customers, may have higher sales, but
consequently will have larger amount of funds tied up in sundry debtors. Similarly, a company,
which has very efficient debt collection machinery and offers strict credit terms, may require lesser
amount of working capital that the one where debt collection system is not so efficient where the
credit terms are liberal. The creditability of a company in the market also has an effect on the
working capital requirement. Reputed and established concern can purchase raw material on credit
and enjoy many other services like door delivery after sales service This would mean that they could
easily have large current liabilities.
 Inventory Policy: The inventory policy of a company also has an impact on the working capital
requirements. An efficient firm may stock raw material for a smaller period and may, therefore,
require lesser amount of working capital.
 Abnormal Factors: Abnormal factors like strikes and lockouts require additional working capital.
Recessionary conditions necessitate a higher amount of stock of finished goods remaining in stock.
Similarly, inflationary conditions necessitate more funds, to maintain the same amount of current
assets.
 Market Conditions: In case of competitive pressure, large inventory is essential, as delivery has to
be off the shelf or credit has to be extended on liberal terms.
 Conditions of Supply: If prompt and adequate supply of raw materials, spares, stores, etc., is
available it is possible to manage with small investments in inventory or work on Just-In-Time (JIT)
inventory principles. However, if supply is erratic, scant, seasonal, channelised through government
agencies, etc., it is essential to keep larger stocks increasing working capital requirements.
 Business Cycle: Business fluctuations lead to cyclical and seasonal changes in the production and
sales and affect the working capital requirements.
 Growth and Expansion Activities: The working capital of the firm increases as it grows in terms of
sale or fixed assets.
 Level of Taxes: The amount of taxes to be paid is determined by the prevailing tax regulations. Very
often taxes have to be paid in advance on the basis of the profit of the preceding year. Management
has no discretion in regard to payment of taxes; in some Notes cases non-payment may invite penal
action. There is, however, wide scope to reduce the tax liability through proper tax planning.

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 Dividend Policy: Payment of dividend utilises cash while retaining profit acts as a source of working
capital. Thus, working capital gets affected by dividend policies.
 Operating Efficiency: Efficient and coordinated utilisation of capital reduces the amount required
to be invested in working capital.
 Price Level Charges: Inflationary trends in the economy necessitate more working capital to
maintain the same level of activity.
 Depreciation Policy: Depreciation charges do not involve any cash outflow. The effect of depreciation
policy on working capital is, therefore, indirect. In the first place, depreciation affects the tax liability
and retention of profits and on dividend.

13.3 WORKING CAPITAL ESTIMATION

The following points highlight the top five methods for estimating working capital requirements:
1. Percentage of Sales Method: This method of estimating working capital requirements is based on
the assumption that the level of working capital for any firm is directly related to its sales value. If
past experience indicates a stable relationship between the amount of sales and working capital,
then this basis may be used to determine the requirements of working capital for future period.
2. Regression Analysis Method (Average Relationship between Sales and Working Capital): This
method of forecasting working capital requirements is based upon the statistical technique of
estimating or predicting the unknown value of a dependent variable from the known value of an
independent variable. It is the measure of the average relationship between two or more variables,
i.e.; sales and working capital, in terms of the original units of the data.
3. Cash Forecasting Method: This method of estimating working capital requirements involves
forecasting of cash receipts and disbursements during a future period of time. Cash forecast will
include all possible sources from which cash will be received and the channels in which payments
are to be made so that a consolidated cash position is determined.
This method is similar to the preparation of a cash budget. The excess of receipts over payments
represents surplus of cash and the excess of payments over receipts causes deficit of cash or the
amount of working capital required.
4. Operating Cycle Method: This method of estimating working capital requirements is based upon
the operating cycle concept of working capital. The cycle starts with the purchase of raw material
and other resources and ends with the realisation of cash from the sale of finished goods.
It involves purchase of raw materials and stores, its conversion into stock of finished goods through
work-in-process with progressive increment of labour and service costs, conversion of finished
stock into sales, debtors and receivables, realisation of cash and this cycle continues again from
cash to purchase of raw material and so on. The speed/time duration required to complete one cycle
determines the requirement of working capital – longer the period of cycle, larger is the requirement
of working capital and vice-versa.
5. Projected Balance Sheet Method: Under this method, projected balance sheet for future date is
prepared by forecasting of assets and liabilities by following any of the methods mentioned here. The
excess of estimated total current assets over estimated current liabilities, as shown in the projected
balance sheet, is computed to indicate the estimated amount of working capital required.

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13.4 WORKING CAPITAL FINANCING

Working capital financing is used to fund your company’s investment in short-term assets such as
accounts receivable and inventory, and to provide liquidity so that your company can fund its day- to-
day operations including payroll, overhead and other expenses. There are many types of working
capital financing. The best fit for your company will depend on its industry, business model, stage of
development and the current assets on its balance sheet.

Types of Working Capital Finance

Working capital financing includes loans, sales, assignments, guarantees and favorable terms from
customers and vendors. We have organised the types of working capital financing into categories as
follows:.
 Working Capital Revolver: A working capital revolver is a line of credit in which the maximum
amount available for borrowing is tied to the amount of accounts receivable and inventory on
the company’s balance sheet. This secured credit line is described as a revolver since funds can
be borrowed, repaid and then reborrowed over and over again. Working capital loans secured by
accounts receivable and/or inventory are a form of asset-based lending (ABL). A working capital
revolver is also known as a:
 working capital line of credit,
 working capital credit facility,
 working capital facility,
 revolving credit facility, or
 revolving loan facility.
Some lenders offer unsecured lines of credit, often referred to as a business line of credit. These
unsecured lines are usually targeted toward small businesses (with the owner providing a personal
guarantee) or very large businesses (with strong credit histories).
 Accounts Receivable Factoring: Accounts receivable factoring is the sale of accounts receivable to
a third-party at a discount to accelerate the receipt of cash. The discount is the fee charged by the
third-party buyer (or factor) for its service. The factor primarily relies on the creditworthiness of the
company’s customers in determining the amount of the discount. The customer is usually notified
about the sale and the factor is responsible for collection. Receivables may be sold on a recourse
or non-recourse basis. Spot factoring is the sale of a single invoice rather than all of a company’s
receivables. Accounts receivable factoring is also referred to as invoice factoring.
 Invoice Discounting: Invoice discounting is the assignment of accounts receivable to a third-party
as collateral for a loan. The customer is not usually notified about the assignment and the company
remains responsible for collection. The company receives a loan similar to the way it would with a
revolving line of credit.
 Purchase Order Financing: Purchase order financing or PO financing, is an advance given to your
supplier by a lender for goods your company needs to fulfill a customer order. The customer then
makes its payment directly to the lender. After deducting the amount of its loan and fees, the lender
sends the remainder to your company. PO financing provides capital to fulfill large orders that you
might not be able to finance otherwise.
 Trade Finance: Trade finance facilitates international trade by transferring to a third-party the risk
that an exporter will not receive payment, or an importer will not receive its goods. There are many

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forms of trade finance including letters of credit, bank guarantees, asset-based loans, accounts
receivable factoring and purchase order financing.
 Customer Advances: Customer advances are cash payments received before a company provide
goods or services to its customer. These advances provide an important source of “no-cost” working
capital financing. Of course, the company incurs an obligation to provide the goods or services to
the customer in the future, which is usually recognised as a deferred revenue liability on its balance
sheet.
 Vendor Credit: Vendor credit enables you to wait a specified period of time before paying for goods
or services provided by a supplier or vendor. Payment terms may offer a discount for paying early
or a penalty for paying late. Some vendors offer extended terms to select customers, which provide
a longer than normal period before payment is due.
 MRR Line of Credit: An MRR line of credit is a loan facility in which the amount available for
borrowing is tied directly to the borrower’s monthly recurring revenue. Software-as-a-service (SaaS)
companies have minimal accounts receivable because customers pay up front and no inventory
because they sell a service rather than the product. However, SaaS companies have recurring
revenue that lenders view as an asset that, in effect, can provide a collateral base for a loan.
 Merchant Cash Advances: Merchant cash advances (MCA) are upfront payments that you receive
in exchange for a percentage of your future daily credit/debit card receipts. An MCA is not a loan
but a sale of future revenue. This is expensive financing but might be the best bet for a business with
limited or poor credit history that also processes a lot of credit card transactions.

13.5 OPERATING CYCLE AND CASH CYCLE

Operating Cycle
Raw material >>> Work-in-Process >>> Finished Goods >>> Accounts Receivable >>> Cash
This cycle of raw material conversion to cash is called operating or working capital cycle. In terms of
time, it is the time taken after the purchases of raw material till its translation into cash. The total of
inventory holding period and a receivable collection period of a firm is the operating cycle time of that
firm.
Operating cycle and cash operating cycle are used interchangeably but it’s a misconception. They are
different by a small margin but that makes a big difference.

Cash Operating Cycle

Like working capital, operating cycle can also be gross operating cycle (operating cycle) and net
operating cycle (cash operating cycle). Cash operating cycle is gross operating cycle less creditor’s
collection period. It is the time period for which the working capital is required.

How to Calculate using Formula?

The time of operating cycle can be broken as follows:
1. Inventory Holding Period
 Raw Material Holding Period
 Work-in-process Period
 Finished Goods Holding Period
2. Receivables Collection Period

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Formula for Operating Cycle

Operating Cycle = Inventory Holding Period + Receivable Collection Period

Or, Operating Cycle = Raw Material Holding Period + Work-in-process Period + Finished Goods Holding
Period + Receivable Collection Period

Formula for Cash Operating Cycle

Cash Operating Cycle = Inventory Holding Period + Receivable Collection Period – Creditor’s Payment
Period

Or, Cash Operating Cycle = Raw Material Holding Period + Work-in-process Period + Finished Goods
Holding Period + Receivable Collection Period – Creditor’s Payment Period

Operating Cycle Example

Suppose $500 Dollar worth of inventory is purchased from a supplier on 20 days credit and it was sold
after 40 days of purchasing it. The credit of 40 days is given to the buyer. The buyer paid on completion
of the credit period.

Here,

The Operating Cycle = Inventory Holding Period + Receivable Collection Period

= 40 + 40
= 80 Days.

Cash Operating Cycle = 80 Days – 20 Days (Supplier’s Credit)

= 60 Days

OPERATING vs. CASH OPERATING

CYCLE

This cycle of raw material conversion

OPERATING

to cash
CYCLE

Inventory Holding Period +

Receivable Collection Period
CASH OPERATING

Operating cycle less creditor’s

collection period
CYCLE

Inventory Holding Period +

Receivable Collection Period –
Creditor’s Payment Period

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Analysis of Operating and Cash Cycle

Operating cycle is extremely important because business is all about the running the operating cycle
smoothly. If it is running smoothly, almost everything will be smooth. If any part of the operating cycle
is stuck, the whole business gets disturbed. For a manager to effectively manage the business, he should
have a deep understanding of his business cycle and potential threats and risks to it. Proactively, he
should have ways and means to mitigate those threats and risks.
In this example, operating cycle is 80 days. The entrepreneur should always focus to reduce it as more
as possible and that will ensure better utilisation of their fixed assets. In turn, they will gain the higher
return on their investment.
On the other hand, cash operating cycle is the base for working capital estimations. In our example,
working capital requirement is $500 for 60 days. Banks take this as a base for funding their client. A
manager handling finance should focus on reducing the cash cycle as that will save him the interest
cost. Reducing this cycle means reducing the inventory holding period and increasing the supplier’s
payment period. Other than normal strategies, Japanese techniques ‘Just-in-Time (JIT)’ can reduce the
inventory holding time practically zero. Bigger companies are trying to adopt JIT with the help of tools,
like supplier system integration.
The continuing flow from cash to suppliers, to inventory, to accounts receivables and back into cash is
what is called the operating cycle. The operating cycle involves the following procedure:
1. Conversion of cash into raw materials.
2. Conversion of raw materials into work-in-process.
3. Conversion of work-in-process into finished goods.
4. Conversion of finished goods into sales [debtors and cash]
5. Conversion of debtors into cash
The following Figure shows the operating cycle:

Debtor
Sales

Cash

Finished Goods

Raw Materials

Work-in-Process

Cash Conversion Cycle

The amount of time a firm’s resources is tied up calculate by subtracting the average payment period
from the operating cycle.

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In other words, the time period between the dates from when pays it suppliers to the date till it receives
the cash from its customers.
Calculation of Cash Conversion Cycle (CCC)
CCC = OC – APP
where, OC = Operating Cycle
APP = Accounts Payable Period
OC = AAI + ARP. AAI = Average Age of Inventory
ARP = Account Receivables Period.
From the financial statements, it can be determined as the constituents of Cash Conversion Cycle, i.e.,
AAI, ACP, APP:
Average Inventory
AAI 
Cost of Gold Sold/365
Average Accounts Receivable
ARP 
Annual Sales/365
Average Accounts Payables
APP 
Cost of good sold/365

13.6 CONCEPT OF INVENTORY MANAGEMENT

Working capital refers to short-term funds to meet operating expenses. It refers to the funds, which a
company must possess to finance its day-to-day operations. It is concerned with the management of
the firm’s current assets and current liabilities. It relates with the problems that arise in attempting to
manage the current assets, current liabilities and their inter-relationship that exists between them. If
a firm cannot maintain a satisfactory level of working capital, it is likely to become insolvent and may
even be forced into bankruptcy.
The concept of working capital has been a matter of great controversy, among the financial wizards
and they view it differently. There is no universally accepted definition of working capital. Broadly, there
are two concepts of working capital commonly found in the existing literature of finance such as:
1. Gross Working Capital (Quantitative Concept) and
2. Net Working Capital (Qualitative Concept).

Both these concepts of working capital have operational significance. The two concepts are not to be
regarded as mutually exclusive. Each has its relevance in specific situations from the management
point of view.
Each concept of working capital has its own significance – the ‘gross concept’ emphasising the ‘use’ and
the ‘net concept’ the ‘source’ – an integration of both these concepts is necessary to understand working
capital management in the context of risk, return and uncertainty.
 Gross Working Capital Concept: According to this concept, the total current assets are termed
as the gross working capital or circulating capital. Total current assets include; cash, marketable
securities, accounts receivables, inventory, prepaid expense, advance payment of tax, etc. This
concept also called as ‘quantitative or broader approach’. To quote Weston and Brigham, “Gross

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Working Capital refers to firm’s investments in short term assets such as cash, short term securities,
accounts receivables and inventories”. The concept helps in making optimum investment in current
assets and their financing. According to Walker, “Use of this concept is helpful in providing for the
current amount of working capital at the right time so that the firm is able to realise the greatest
return on investment”. The supporters of this concept, like Mead, Field, and Baker and Malott, argue
that the management is very much concerned with the total current assets as they constitute the
total funds available for operating process.
 Net Working Capital Concept: As per this concept, the excess of current assets over current liabilities
represents net working capital. Similar view is expressed by Guthmann and Dougall, Gerstenberg,
Goel, Park and Gladson, Kennedy and McMullen, and Myer in their distinguished works. ‘Accounts
Hand Book’ has also fully supported this view. The famous economists like, Sailer, Lincoln, and
Stevens, fully supported this concept and viewed that the net working capital helps creditors and
investors to judge the financial soundness of a firm.

Net Working Capital Concept represents the amount of the current assets, which would remain after
all the current liabilities were paid. It may be either positive or negative. It will be positive, if current
assets exceed the current liabilities and negative, if the current liabilities are in excess of current assets.
Another alternative definition is that net working capital refers to that portion of firm’s current assets,
which financed with long-term funds.
Net Working Capital Concept indicates or measures the liquidity and also suggests the extent to which
working capital needs may be financed by the permanent source of funds. To quote Roy Chowdary,
“Net Working Capital indicates the liquidity of the business whilst gross working capital denotes the
quantum of working capital with which business has to operate”.
Net working capital = Current Assets – Current Liabilities

13.7 LEVELS OF INVENTORY

Inventory accounting deals with valuing and accounting for changes in assets. Inventory involves goods
in three stages of production: raw goods, in-progress goods, and finished goods. An accurate inventory
accounting system keeps track of changes to inventory at all three stages and adjusts asset values and
costs accordingly.

13.7.1 EOQ
Economic order quantity (EOQ) is the ideal order quantity a company should purchase to minimise
inventory costs such as holding costs, shortage costs, and order costs. This production-scheduling
model was developed in 1913 by Ford W. Harris and has been refined over time. The formula assumes
that demand, ordering and holding costs all remain constant. The formula for EOQ is:

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2DS
Q 
H

where:
Q = EOQ units
D = Demand in units (typically on an annual basis)
S = Order cost (per purchase order)
H = Holding costs (per unit, per year)

13.7.2 JIT
Just In Time inventory is the reduced amount of inventory owned by a business after it installs a just- in-
time manufacturing system. The intent of a JIT system is to ensure that the components and sub-
assemblies used to create finished goods are delivered to the production area exactly on time. Doing
so eliminates a considerable investment in inventory, thereby reducing the working capital needs of a
business. This type of system is called a “pull” system. Under the JIT concept, inventory may be reduced
by the following means:
 Reduced production runs: Fast equipment setup times make it economical to create very short
production runs, which reduces the investment in finished goods inventory.
 Production cells: Employees walk individual parts through the processing steps in a work cell,
thereby reducing scrap levels. Doing so also eliminates the work-in-process queues that typically
build up in front of a more specialised work station.
 Compressed operations: Production cells are arranged close together, so there is less work-in-
process inventory being moved between cells.
 Delivery quantities: Deliveries are made with the smallest possible quantities, possibly more than
once a day, which nearly eliminates raw material inventories.
 Certification: Supplier quality is certified in advance, so their deliveries can be sent straight to the
production area, rather than piling up in the receiving area to await inspection.
 Local sourcing: When suppliers are located quite close to a company’s production facility, the
shortened distances make it much more likely that deliveries will be made on time, which reduces
the need for safety stock.

Conclusion 13.8 CONCLUSION

 Working capital management is significant in financial management due to the fact that it plays a
vital role in keeping the wheel of the business running.
 Every business requires capital, without which it cannot be promoted.
 Investment decision is concerned with investment in current assets and fixed assets.
 Working capital refers to the funds invested in current assets, i.e., investment in sundry debtors,
cash and other current assets.
 Current assets are essential to utilise facilities provided by plant and machinery, land and buildings.
 The gross working capital refers to investment in all the current assets taken together.

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 In some organisations, the sales are mostly in cash basis and the operating cycle (explained) later
is also short.
 Working capital requirements also fluctuate according to production policy adopted by the company.
 A company, which allows liberal credit to its customers, may have higher sales, but consequently
will have larger amount of funds tied up in sundry debtors.
 Working capital financing is used to fund your company’s investment in short-term assets.
 Invoice discounting is the assignment of accounts receivable to a third-party as collateral for a loan.
 Trade finance facilitates international trade by transferring to a third-party the risk that an exporter
will not receive payment, or an importer will not receive its goods.
 Merchant cash advances (MCA) are upfront payments that you receive in exchange for a percentage
of your future daily credit/debit card receipts.
 Operating cycle is extremely important because business is all about the running the operating
cycle smoothly.
 The amount of time a firm’s resources is tied up calculate by subtracting the average payment
period from the operating cycle.
 Working capital refers to short-term funds to meet operating expenses. It refers to the funds, which
a company must possess to finance its day-to-day operations.
 Inventory accounting deals with valuing and accounting for changes in assets.
 Economic order quantity (EOQ) is the ideal order quantity a company should purchase to minimise
inventory costs such as holding costs, shortage costs and order costs.
 Just in time inventory is the reduced amount of inventory owned by a business after it installs a
Just-In-Time manufacturing system.

13.9 GLOSSARY

 Working capital management: Business tool that helps companies effectively make use of current
assets, helping companies to maintain sufficient cash
 Financial management: Planning, organising, directing and controlling the financial activities
such as procurement and utilisation of funds
 Investment decision: The decision made by the investors or the top-level management with respect
to the amount of funds
 Gross working capital: The sum of a company’s current assets
 Net working capital: The difference between a company’s total current assets and current liabilities.

13.10 CASE STUDY: MYSORE LAMPS LIMITED

Case Objective
The case study explains the need for working capital.
Mysore Lamps Limited is a company specialising in the production of fluorescent lamps. The company
has been maintaining the quality of its products and due to the efforts of its marketing manager, the

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company has been able to capture a sizeable share of the product market in the recent past. The company
is planning to expand in the same product line. Mr. Mysore, the Managing Director of the company, is
confronted with the problem of increasing working capital due to the expansion plans of the company.
Mysore Lamps Limited was set up in 1991 with an authorised capital of ` 110 crore and faced heavy
competition in the initial years of commencement of business. During 2006, the company could make a
dent in the fluorescent lamps market and its position as on December 31, 2006, was as shown in Exhibit 1

Liabilities Rs. Assets Rs.

Capital 1500 Fixed assets 1000

Reserves 762 Current assets 1862

Long-term loan 400 Raw materials 200

Current liabilities 200 Work-in-progress 287

Finished goods 450 Account’s receivables 675

Bank overdraft 962 Cash 250

Total 4274 Total 4274

During the year 2006, the company was able to sell 50 lakh pieces of fluorescent lamps a ` 60 with a
profit margin of 10 per cent. The raw material comprised about 50 per cent of the selling price; while
wages and overheads accounted for 12 and 18 per cent, respectively. As a policy, the company keeps
raw material stock for two months of its requirements. To make prompt supply to customers on orders
received, finished goods stock for two months requirements are maintained, and sales credit of 3 months
is given to customers. Due to the standing of the company in the market, the company is able to enjoy 2
months from its suppliers. The production process is of 30 days duration.
Mr. Mysore is seriously considering the proposal for expansion by installing an automatic plant costing
` 30 crores. The expansion will bring in an additional capacity of 100 lakh units per annum. Mr. Mysore
is not worried about the financing of this plant as the same would be done for the retained earnings
supplemented by finances from Mr. Mysore’s personal sources. He expects that the company would be
able to increase its sale from 50 lakh pieces after the expansion scheme.
Questions
1. As a manager, what steps would you take to effectively manage the working capital in an inflationary
situation?
(Hint: After observing balance sheet)
2. What is the need for working capital?
(Hint: Your working capital is used to pay short-term obligations, such as your accounts payable
and buying inventory.)
3. What is permanent working capital?
(Hint: Permanent working capital refers to the minimum amount of working capital, i.e., the amount
of current assets over current liabilities which is needed to conduct a business even during the
dullest period.)

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JGI JAINDEEMED-TO-BE UNI VE RSI TY
Accounting and Finance

13.11 SELF-ASSESSMENT QUESTIONS

A. Essay Type Questions

1. What do you understand by working capital management?
2. What is gross working capital?
3. What is net working capital?
4. What do you understand by MRR line of credit?

13.12 ANSWERS AND HINTS FOR SELF-ASSESSMENT QUESTIONS

A. Hints for Essay-Type Questions

1. Working capital management is significant in financial management due to the fact that it plays a
vital role in keeping the wheel of the business running. Refer to Section Overview of Working Capital
Management
2. The gross working capital refers to investment in all the current assets taken together. The total of
investments in all current assets is known as gross working capital. Refer to Section Overview of
Working Capital Management
3. Net working capital refers to the excess of total current assets over total current liabilities. Refer to
Section Overview of Working Capital Management
4. An MRR line of credit is a loan facility in which the amount available for borrowing is tied directly
to the borrower’s monthly recurring revenue. Refer to Section Working Capital Financing

@ 13.13 POST-UNIT READING MATERIAL

 https://www.bajajfinserv.in/what-is-working-capital-management
 https://corporatefinanceinstitute.com/resources/knowledge/finance/working -capital-
management/
 https://www.accaglobal.com/an/en/student/exam-support-resources/fundamentals-exams-study-
resources/f9/technical-articles/wcm.html
 https://efinancemanagement.com/working-capital-financing/working-capital-management
 https://cleartax.in/s/working-capital-management-formula-ratio

13.14 TOPICS FOR DISCUSSION FORUMS

 Discuss with your friends about the practical application of working capital management

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