Working Capital

Management
Working Capital - the amount of
funds needed for meeting day-to-day
operations of a concern.
•This is related to short-term
assets and short-term sources of
financing.
•It deals with both, assets and
liabilities. 
 Nature of Working Capital
• It is used for purchase of raw materials,
payment of wages and expenses.
• It changes constantly to keep the wheels
of business moving.
• It enhances the liquidity, solvency,
creditworthiness, and reputation of the
enterprise.
• It enables the enterprise to take the cash
discount facilities offered by its suppliers.
 Need For Working Capital
• Working capital is needed in order to
pay a fair rate of dividend and
interest in time, which increases the
confidence of the investors in the
firm.
• It provides the necessary funds to
meet unforeseen contingencies and
thus helps the enterprise run
successfully during periods of crisis.
 Cont….
• Adequate WC is needed to maintain a
regular supply of raw materials, which in
turn facilitates smooth running of
production process.
• WC ensures the regular and timely
payment of wages and salaries, thereby
improving the morale and efficiency of
employees.
• It is necessary to build a good reputation
and to make payments to creditors in time.
 Classification of WC
Gross Working Capital - the amount of
funds invested in vari­ous components of
current assets. It consists of raw
materials, work in progress, debtors,
finished goods, etc.

Net Working Capital - The excess of

current assets over current liabilities
 Cont……
Positive Working Capital- the surplus of
current assets over current liabilities.
Negative Working Capital - the excess of
current liabilities over current assets.
Permanent Working Capital - The
minimum amount of working capital
which even required dur­ing the dullest
season of the year.
 Cont….
Temporary or Variable Working
Capital - the additional current
assets required at different times
during the operating year to meet
additional inventory, extra cash,
etc.
Components of Working Capital

1. Current assets
2. Current liabilities
 Determinants of WC
1. Credit Policy
If a business offers easy credit terms to its
customers, the company is investing in accounts
receivable that may be outstanding for a long time.
2. Growth Rate
If a business is growing at a rapid rate, it is likely to
increase its investments in receivables and
inventory.
3. Payables Payment Terms
If a company can negotiate longer payment terms
with its suppliers, it can reduce the amount of
investment needed in working capital.
 Cont…
4. Production Process Flow
If a company estimates its production
needs, what it manufactures will likely vary
somewhat from actual demand, resulting in
an excess amount of inventory on hand.
5. Seasonality
If a company sells most of its goods at one
time of the year, it may need to build its
inventory asset in advance of the selling
season.
 Cash Conversion Cycle
The three components of the cash conversion
cycle are as follows:
1. Days sales outstanding (DSO)- is the
number of days between the sale of a product
and the receipt of a cash payment.
•The formula is:
Compare it with your own credit policy
or industry average. The lower DSO is
preferable.
 Cont…..
2. Days in inventory (DII). The number
of days it takes for a company to convert
its finished goods inventory into product
sales.
The formula is:
DII=Average Inventory/Cost of Sales * 365
Average Inventory = (Beginning Inventory
+ Ending Inventory) / 2
 Cont…..
3. Days payables outstanding (DPO) -
measures the number of days a company
takes on average before paying
outstanding supplier/vendor invoices for
purchases made on credit.
The formula is:
 Example
A company whose accounts payable for
the quarter are $100,000. The value of
inventories at the beginning of the quarter
is $250,000, total purchases made during
the quarter $1,000,000, and inventories of
$100,000 remain unsold at the end of the
quarter. Calculate:
•Days payable outstanding for the quarter
•Days in inventory
CGS = Beg. Inv. + Purchase – Ending Inv.
= 250,000 + 1,000,000 – 100,000
= 1,150,000
DPO = A/payable / CGS*90 Days
= 100,000 / 1,150,000 *90
= 8 days
The higher is preferable
DII = Average Inv. / CGS *90
= (250,000+100,000/2) / 1,150,000*90
= 175,000 /1,150,000*90
= 14 days
The lower is preferable
 Financing Current Assets
Financing Strategies - It involves a strategic plan as
to how the organization can finance its overall
operations.
Example of Financing
Debt Financing - borrow money from banks or other
lending institutions for using it in your business.
Equity Financing
Personal Financing
This is the less formal financing strategy whereby
you can cater to your funding needs by asking your
friends and family.
Financing Approaches for Current
Assets 
Matching Approach - the organization
matches the expected life of the current asset
with the estimated life of the source of fund to
raise these financial assets.
Conservative Approach - the organization
relies on the long-term funds to acquire
permanent assets and a part of temporary
assets.
As this financing strategy uses long-term
funds, it has less risk of a shortage of
immediate funds.
 Cont…....
Aggressive Approach - the organization
uses its short-term funds to finance a part
of its permanent assets.
This is a very risky approach as there are
chances that the organization might have
a hard time dealing with its short-term
obligations.