Working Capital

Prepared By:
Luigi Miguel B. Antonio,
MBA
Definition of Working Capital
- Working Capital refers to that part of the firm’s
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.
Working Capital Concepts
Net working capital (NWC) - Net working capital
refers to the difference between current assets and
current liabilities. Current liabilities are those claims
of outsiders which are expected to mature for
payment within an accounting year and include
creditors, bills payable, and outstanding expenses.
Net working capital can be positive or negative. A
positive net working capital will arise when current
assets exceed current liabilities.
Gross working capital (GWC) - working capital
refers to the firm’s investment in current assets.
Current assets are the assets which can be converted
into cash within an accounting year and include cash,
short term securities, debtors(accounts receivable), bills
receivable and stock
Management of Working Capital
- The goal of working capital management is to
manage the firm’s current assets and liabilities in
such a way that a satisfactory level of working
capital is maintained.
- The interaction between current assets and current
liabilities is, therefore the main theme of the theory
of the working capital management
- The working capital management includes and
refers to the procedures and policies required to
manage the working capital.
- Working Capital in general practice refer to the
excess of Current Asset over Current Liability.
- Management of working capital therefore is
concerned with the problems that arise in
attempting to manage the Current Asset, the
Current Liability and the inter-relationship that
exists between them.
- The basic goal of Working Capital Management is
to manage the Current Asset & Current Liability of
a firm in such a way that a satisfactory level of
Working Capital is maintained.
- Working Capital Management Policies of a firm
have a great effect on its profitability, liquidity and
structural health of the organization
Classification of Working Capital
Components
• Cash
• Marketable Securities
• Receivables
• Inventory
Time
• Permanent
• Temporary
Significance of Gross WC
Optimum investment in CA
- Investment in CA must be adequate CA invest-
ment should not be inadequate or excessive
inadequate Working Capital can disturb production
and can also threaten the solvency of firm , if it
fails
to meet its current obligation excessive investment
in Current Asset should be avoided , since it
impairs firms profitability
Financing of Current Asset
- Need for Working Capital arises due to increasing
some time surplus fund may arises which should
be invested in Short term securities , they should
not be kept idle
Significance of Net Working Capital
Maintaining Liquidity position
- For maintaining liquidity position there is a
need to maintain CA sufficiently in excess of
Current Liability
Judge Financial Soundness of a firm
- The Net working capital helps creditors and
investors to judge financial soundness of a
firm
Determinants of Working Capital

1) Nature of Business - Working capital

requirements of a firm are basically influenced by
the nature of business. Trading and financial firms
have a very small investment in fixed assets, but
require a large sum of money to be invested in
working capital. Public utilities may have limited
need for working capital and have to invest
abundantly in fixed assets. Their working capital
requirements are nominal because they may have
only cash sales and supply services, not products.
2) Storage Time or Processing Period - Time
needed for keeping the stock in store is called storage
period. The amount of working capital is influenced
by the storage period. If storage period is high, a firm
should keep more quantity of goods in store and
hence requires more working capital. Similarly, if the
processing time is more, then more stock of goods
must be held in store as work in progress.

3) Credit Period - Longer credit period requires

more investment in debtors and hence more working
capital is needed. But, the firm which allows less
credit period to customers needs less working capital.
4) Operating Efficiency - The operating efficiency of
the firm relates to the optimum utilization of all its
resources at minimum costs. The efficiency in
controlling operating costs and utilizing fixed and
current assets leads to operating efficiency. The use of
working capital is improved and pace of cash
conversion cycle is accelerated with operating
Efficiency
5) Changes in Price Level - Change in price level
also effects the working capital requirements.
Generally, the rise in price will require the firm to
maintain large amount of working capital as more
funds will be required to maintain the sale level of
current assets.
6) Dividend Policy - The dividend policy of the firm
is an important determinant of working capital. The
need for working capital can be met with the retained
earning. If a firm retains more profit and distributes
lower amount of dividend, it needs less working
capital.
7) Access to Money Market - If a firm has good
access to capital market, it can raise loan from bank
and financial institutions. It results in minimization of
need of working capital.
8) Capital Cycle - When the working capital cycle of
a firm is long, it will require larger amount of working
capital. But, if working capital cycle is short, it will
need less working capital.
 Working Capital Financing Mix

- Funds available for a period of one year or less are

called short term finance. In India short term funds
are used to finance working capital.
The Hedging approach
 Hedging approach refers to a process of matching maturities
of debt with the maturities of financial need . In this approach
maturity of source of fund should match the nature of asset to
be financed
 This approach is also known as matching approach.
 The hedging approach suggests that the permanent working
capital requirement should be financed with fund from long
term sources while the temporary working capital
requirement should be financed with short term funds.
 Hedging approach to asset financing Fixed Assets Permanent
Current Assets Total Assets Fluctuating Current Assets Time
Short-term Debt Long-term Debt + Equity Capital
Conservative Approach
 This approach suggested that the entire estimated
investments in current asset should be finance from long
term source and short term should be use only for
emergency requirement
 Conservative approach to asset financing Fixed Assets
Permanent Current Assets Total Assets Fluctuating
Current Assets Time Short-term Debt Long-term Debt +
Equity capital
Aggressive approach
 The aggressive approach suggests that the entire
estimated requirement of current asset should be
financed from short-term sources and even a part of
fixed asset investment be financed from short -
term sources
 This approach make the finance mix : • More Risky •
Less costly • More Profitable
 Aggressive approach to asset financing Fixed Assets
Permanent Current Assets Total Assets Fluctuating
Current Assets Time Short-term Debt Long-term
Debt + Equity capital