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Working Capital Management

A perspective

Some basics

Business requires money to generate more money Tasks of Entrepreneur to

envisage the process accumulate resources take risks enjoy the return

Resources and their funding is primarily of two


Long-term Assets

Short-term Assets

Long-term Funds

Short-term Assets

Working Capital

Centuries old concept Necessity of every business Needed for various purposes Requirement varies according to industry, size,
technology, creditability, etc.

Available from numerous sources

Working Capital


capital typically means the firms holding of current or short-term assets such as cash, receivables, inventory and marketable securities. These items are also referred to as circulating capital Corporate executives devote a considerable amount of attention to the management of working capital.

Definition of Working Capital

Working Capital refers to that part of the firms

capital, which is required for financing short-term or current assets such a cash marketable securities, debtors and inventories. Funds thus, invested in current assets keep revolving fast and are constantly converted into cash and this cash flow out again in exchange for other current assets. Working Capital is also known as revolving or circulating capital or short-term capital.

Part of long term finance is locked in and used for

supporting current activities

Concept of working capital 1

Two possible interpretations :

Balance sheet concept Operating cycle concept

Balance sheet concept

There are two interpretations of working capital under the balance sheet concept.
o Excess of current assets over current liabilities (Net working capital)

Gross or total current assets.

The definition is meaningful only as an indication of the firms current solvency in repaying its creditors. When firms speak of shortage of working capital they in fact possibly imply scarcity of cash resources.

Concept of working capital 2

Operating cycle concept

A companys operating cycle typically consists of three primary activities:
o Purchasing resources,

The firm has to maintain cash balance to pay the bills as they come due

o Producing the product and

In addition, the company must invest in inventories to fill customer orders promptly

o Distributing (selling) the product.

And finally, the company invests in accounts receivable to extend credit to customers

Operating cycle is equal to the length of inventory and receivable conversion periods.


Gross Working Capital Net Working Capital

Permanent / Fixed WC Temporary / Variable WC

Operating cycle of a typical company

Purchase resources Pay for Resources purchases Sell Product On credit Receive Cash

Inventory conversion period Payable Deferral period

Receivable Conversion period Cash conversion cycle

Operating cycle

Importance of working capital

Risk and uncertainty involved in managing the cash flows Uncertainty in demand and supply of goods, escalation in cost both operating and financing costs.

Accounts Payable


Raw Materials



Finished Goods

Accounts Receivable


Matching approach to asset financing

Total Assets Short-term Debt Fluctuating Current Assets


Permanent Current Assets

Long-term Debt + Equity Capital

Fixed Assets



How to manage the current assets, the current

liabilities and the inter-relationship that exists between them.

Working Capital Management Policies of a firm

have a great effect on its profitability, liquidity and structural health of the organization.

Nature of Working Capital Management

Dimension I Profitability, Risk, & Liquidity

Estimation of working capital requirements

Factors to be considered
Total costs incurred on materials, wages and overheads The length of time for which raw materials remain in stores before they are issued to production. The length of the production cycle or WIP, i.e., the time taken for conversion of RM into FG. The length of the Sales Cycle during which FG are to be kept waiting for sales. The average period of credit allowed to customers. The amount of cash required to pay day-to-day expenses of the business.

The amount of cash required for advance payments if any.

The average period of credit to be allowed by suppliers. Time lag in the payment of wages and other overheads

Management of cash
1. Importance of Cash When planning the short or long-term funding requirements of a business, it is more important to forecast the likely cash requirements than to project profitability etc.

More businesses fail for lack of cash than for want of profit.

Calculating Cash Flows


flow planning entails forecasting and tabulating all significant cash inflows relating to sales, new loans, interest received etc., and then analyzing in detail the timing of expected payments relating to suppliers, wages, other expenses, capital expenditure, loan repayments, dividends, tax, interest payments etc.


Cash Management will be successful only if cash collections are accelerated and cash payments, as far as possible, are delayed Methods of ACCELERATING CASH INFLOWS

Prompt payment from customers (Debtors)

Quick conversion of payment into cash Decentralized collections Lock Box System (collecting centers at different locations) Paying on the last date Payment through Cheques and Drafts Adjusting Payroll Funds (Reducing frequency of payments)


Centralization of Payments
Inter-bank transfers Making use of Float

Sources of Working Capital

Cash Credit / Overdraft Cash Management Working Capital Demand Loan Bill Discounting / Receivable Discounting Export Finance / Bill Negotiation Term Loans Letter of Credit Bank Guarantee Foreign Currency Loans

Bank criteria for typical WC lending

Age of Business > 2 years Turnover > Rs. 2 cr. Tangible Net Worth > Rs.1 cr. EBITDA margin > 5% PAT margin : profitable operations for the last 2

Receivables beyond 6 months < 5% of annual


Usual Qualitative Assessment by Banks

Borrower/ Promoter Scale

Experience in Industry; commitment to timely order execution; consistency in quality Large scale servicing capability for different clients; location of base in areas of good quality labour, rentals & power Wide range of services; USP in the services offered; value added/ premium services


Company Profile

Long term buyers; clients well distributed


Key management must be technically qualified; relevant domain knowledge pool; reputation of promoters