PRESENTATION ON

WORKING CAPITAL
MANAGEMENT
 CHAPTER OBJECTIVES
After studying this Chapter you should
understand and be able to
 Define working capital
 Working capital concepts
 Types of Working Capital, Importance of Working Capital
 Significance of WC Management
 Factors determining WC Requirement
 Different components of WC
 Working capital cycle
 Working capital requirement forecast
 Working Capital Management
 Working Capital Concept
Working capital is amount of funds necessary to cover the cost of

operating the enterprise. Working Capital refers to that part of

the firm’s capital, which is required for financing short-term or

current assets like Cash,short term marketable securities, debtors

and inventories etc. Funds 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.
Classification of Working capital

Working
capital

BASIS OF BASIS OF
CONCEPT TIME

Net Temporary /
Gross Working Permanent / Variable WC
Working Capital Fixed WC
Capital
Seasonal Special
Regular Reserve
 On the Basis of Concept:
 Gross working capital is the capital invested in total current
assets of the enterprise. Examples of current assets are : cash in
hand and bank balances, Bills Receivable, Short term loans and
advances, prepaid expenses, Accrued Incomes etc.  
 Net Working Capital = Current Assets – Current Liabilities
 When current assets exceed the current liabilities the working
capital is positive and negative working capital results when
current liabilities are more than current assets.
 Examples of current liabilities are Bills Payable, Sunday
debtors, accrued expenses, Bank Overdraft, Provision for
taxation etc. Net working capital is an accounting concept of
working capital.
Contd.
 On the Basis of Time
 Permanent or Fixed working capital
 It is the minimum amount which is required to ensure effective
utilization of fixed facilities and for maintaining the
circulation of current assets.
 regular working capital is the capital required to ensure
circulation of current assets from cash to inventories, from
inventories to receivables and from receivables to cash and so
on.
 Reserve working capital is the excess mount over the
requirement for regular working capital which may be
provided for contingencies that may arise at unstated periods
such as strikes, rise in prices, depression etc.
Contd.
 Temporary or Variable working capital
It is the amount of working capital which is required to
meet the seasonal demands and some special
exigencies.
Variable working capital is further classified as
seasonal working capital and special working capital.
The capital required to meet seasonal needs of the
enterprise is called seasonal working capital.
Special working capital is that part of working capital
which is required to meet special exigencies such as
launching of extensive marketing campaigns for
conducting research etc.
 Need of Working Capital

 For purchase of raw materials, components and spares.

 To pay wages and salaries.
 To incur day-to-day expenses and overhead costs such
as fuel, power etc.
 To meet selling costs as packing, advertisement
 To provide credit facilities to customers.
 To maintain inventories of raw materials, work in
progress, stores and spares and finished stock.
The amount of working capital needed goes on increasing
with growth and expansion of business till it attains
maturity.
 Significance of Working Capital Management

 In a typical manufacturing firm, current assets

exceed one-half of total assets.
 Excessive levels can result in a substandard
Return on Investment (ROI).
 Current liabilities are the principal source of
external financing for small firms.
 Requires continuous, day-to-day managerial
supervision.
 Working capital management affects the
company’s risk, return, and share price.
Factors determining working Capital Requirement
 Nature or Character of Business
 Size of Business
 Production Policy
 Length of Production cycle
  Credit Policy
 Rate of Growth of Business
 Price Level Changes
 Working Capital Cycle
Different Components of Working Capital
1. Current Assets:
Current assets are those assets which can be easily converted into
cash and which are required to meet the day to day operations of
the business. These includes
Cash and bank balances, Temporary investments, Temporary
investments, Inventory of raw materials, stores and spares, Work-
in-progress, Finished goods, Prepaid expenses etc.
2. Current Liabilities:
Current liabilities are those claims of outsiders which are expected
to mature for payment within an accounting year. These includes
Creditors for goods purchased, Outstanding expenses, Short-term
borrowings, Advances received against sales,
 Accounts Payable Value Addition

Raw WIP
Materials

THE WORKING CAPITAL

Cash CYCLE Finished
(OPERATING CYCLE) Goods

Accounts SALES
Receivable
 FORECASTING / 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
 PROFORMA - WORKING CAPTIAL ESTIMATES
1. TRADING CONCERN
STATEMENT OF WORKING CAPITAL REQUIREMENTS
Amount (Rs.)
Current Assets
(i) Cash ----
(ii) Receivables ( For…..Month’s Sales)---- ----
(iii) Stocks ( For……Month’s Sales)----- ----
(iv)Advance Payments if any ----
Less : Current Liabilities
(i) Creditors (For….. Month’s Purchases)- ----
(ii) Lag in payment of expenses -----_
WORKING CAPITAL ( CA – CL ) xxx
Add : Provision / Margin for Contingencies -----

NET WORKING CAPITAL REQUIRED XXX

 2. MANUFACTURING CONCERN

STATEMENT OF WORKING CAPITAL REQUIREMENTS

Amount (Rs.)
Current Assets
(i) Stock of R M( for ….month’s consumption) -----
(ii)Work-in-progress (for…months)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(iii) Stock of Finished Goods ( for …month’s sales)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(iv) Sundry Debtors ( for …month’s sales)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(v) Payments in Advance (if any) -----
(iv) Balance of Cash for daily expenses -----
(vii)Any other item -----

Less : Current Liabilities

(i) Creditors (For….. Month’s Purchases) -----
(ii) Lag in payment of expenses -----
(iii) Any other -----
WORKING CAPITAL ( CA – CL )xxxx
Add : Provision / Margin for Contingencies -----

NET WORKING CAPITAL REQUIRED XXX

Points to be remembered while estimating WC
 (1) Profits should be ignored while calculating working
capital requirements for the following reasons.
 (a) Profits may or may not be used as working capital
 (b) Even if it is used, it may be reduced by the amount of
Income tax, Drawings, Dividend paid etc.
 (2) Calculation of WIP depends on the degree of completion
as regards to materials, labour and overheads. However, if
nothing is mentioned in the problem, take 100% of the value
as WIP. Because in such a case, the average period of WIP
must have been calculated as equivalent period of completed
units.
 (3) Calculation of Stocks of Finished Goods and Debtors
should be made at cost unless otherwise asked in the
question.
Steps in Determination of Working Capital:
Step 1:
 Identify the various items of current assets and current liabilities
which consist in determination of working capital. The current assets
include inventory of raw materials, WIP and finished goods, sundry
debtors, prepaid expenses, desired cash balance etc. The current
liabilities include creditors for raw materials, stores and
consumables, creditors for wages, creditors for expenses, etc.
Step 2:
 (a) Estimate the holding period of each item stock
i.e., raw materials, work-in- progress and finished
goods.
 (b) Estimate the collection period of sundry
debtors.
Continued.
 (c) Estimate the desired cash balance for meeting the
requirements of day to day operations.
 (d) Estimate the payment deferral period of creditors for
raw materials.
 (e) Estimate the lag in payment of wages and
expenses.
Step 3:
 (i) Determine the raw material, labour and overheads
cost per unit.
 (ii) Determine the operating level.
 (iii) Determine the percentage of conversion cost
incurred on WIP.
 (iv) Determine the cost of sale and selling price per unit.
Continued
Step 4:
 Ascertain the value of each item of current
assets and current liabilities taking into
account the information in step (2) and step
(3).
Step 5:
 Put the values of current assets and current
liabilities in a statement form and ascertain the
net working capital (i.e. current assets –
current liabilities) after adding up the desired
cash balance and amount needed for meeting
contingencies.
Management of Working Capital
 Management of working capital is concerned
with the problems that arise in attempting to
manage the current assets, the current liabilities
and the inter-relationship that exists between
them. In other words, it refers to all aspects of
administration of current assets and current
liabilities.
 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
 Working capital Management policies of a firm have a
great effect on its profitability, liquidity and structural
health of organization. In this context, evolving capital
management is three dimensional in nature.
 Dimension I is concerned with formulation of policies
with regard to profitability, risk and liquidity.
 Dimension II is concerned with decisions about
composition and level of current assets.
 Dimension III is concerned with decisions about
composition and level of current liabilities.
 PRINCIPLES OF WORKING CAPITAL
MANAGEMENT / POLICY

PRINCIPLES OF
WORKING CAPITAL
MANAGEMENT

Principle of Principle Principle of Principle of

Risk of Cost of Equity Maturity of
Variation Capital Position Payment
 Principle of Risk Variation: Risk refers to inability of firm to
meet its obligation as and when they become due for payment.
Larger investment in current assets with less dependence on
short-term borrowings increases liquidity, reduces risk and
thereby decreases opportunity for gain or loss. 
  Principle of Cost of Capital: The various sources of raising
working capital finance have different cost of capital and
degree of risk involved. Generally, higher the risk lower is cost
and lower the risk higher is the cost. A sound working capital
management should always try to achieve proper balance
between these two.
 Principle of Equity Position: This principle is
concerned with planning the total investment in current
assets. According to this principle, the amount of working
capital invested in each component should be
adequately justified by firm’s equity position.
 Principle of Maturity of Payment: This principle is concerned with
planning the sources of finance for working capital. According to this
principle, a firm should make every effort to relate maturities of
payment to its flow of internally generated funds.

 Hedging Vs Conservative Approach

The Hedging Approach says that permanent requirement should be

financed by long term sources while the temporary requirement should
be financed by short-term sources of finance. The Conservative
approach on the other hand says that the working capital requirement
be financed from long-term sources. The Aggressive approach says
that even a part of permanent requirement may be financed out of
short-term funds.

 
 Lets Sum Up
 The term working capital may be used to denote either the gross working
capital which refers to total current assets or net working capital which
refers to excess of current asset over current liabilities.
 The working capital requirement for a firm depends upon several factors
such as Nature or Character of Business, Credit Policy, Price level
changes, business cycles, manufacturing process, production policy.
 The working capital need of the firm may be bifurcated into permanent
and temporary working capital.
 The Hedging Approach says that permanent requirement should be
financed by long term sources while the temporary requirement should be
financed by short-term sources of finance. The Conservative approach on
the other hand says that the working capital requirement be financed from
long-term sources. The Aggressive approach says that even a part of
permanent requirement may be financed out of short-term funds.
 Every firm must monitor the working capital position and for this purpose
certain accounting ratios may be calculated.
Cash operating cycle

 The cash operating cycle (also known

as the working capital cycle or the cash
conversion cycle) is the number of days
between paying suppliers and receiving
cash from sales.
 Cash operating cycle = Inventory days +
Receivables days – Payables days.
Topple Co has the following forecast
figures for its first year of trading:
 Sales Rs3,600,000
 Purchases expense Rs3,000,000
 Average receivables Rs306,000
 Average inventory Rs495,000
 Average payables Rs230,000
 Average overdraft Rs500,000
 Gross profit margin 25%
 Industry average data:
 Inventory days  53
 Receivables days  23
 Payables days  47
 Current ratio  1.43
 Assume there are 365 days in the year.
 REQUIRED:
Calculate and comment on Topple
Co’s cash operating cycle, current
ratio, quick ratio and sales to working
capital ratio.