WORKING CAPITAL

MANAGEMENT
 Types of Capital

Two types of Capital are needed in the busienss

enterprise—

• Fixed Capital
• Working Capital
 Fixed Capital
• Business operations demand few Assets to be used in the
business for a longer period of which are known as Fixed
Assets.

• And Capital invested in the acquisition of such Assets is

known as FIXED CAPITAL
 WORKING CAPITAL
• Capital is also needed for short-term purposes, i.e. meeting
day to day operations.

• Capital invested for this purpose is known as

- Current Capital OR Working Capital
• Thus, Working Capital refers to concern’s investment
in short term assets like—
• Cash,
• Short term Securities,
• Debtors (Customers to whom goods have been sold
on credit),
• And, Inventories of all types.

It can also be regarded as that portion of company’s

total capital which is employed in short term
operations. In other words, Working Capital is the
investment needed for carrying out day-to-day
operations of the business smoothly.
 TWO CONCEPTS OF WORKING CAPITAL

CURRENTLY TWO SCHOOLS OF THOUGHT ARE

ACCEPTABLE NAMELY—

• Gross Working Capital Concept- Quantitative Aspect,

• Net Working Capital Concept- Qualitative Aspect.

 Gross Working Capital concept
According to this concept-
• Company’s investment in total current assets signifies the
Working Capital.
• Amount of Current Liabilities is not considered and hence
not deducted from total Current Assets.

Gross Working Capital is also known as ‘ Circulating

Capital’ or ‘Current Capital.
 Valid reasons for Gross Working Capital

1. When we consider fixed capital as the amount invested in fixed

assets, then amount invested in current assets should be
considered as ‘Working Capital’.
2. Current Assets, Whatever may be the sources of acquisition, are
used in activities relating to day-to-day operations and their
forms keep on changing. Therefore, they should be considered as
Working Capital.
3. Total Current Assets represent the total funds available for
operating purpose, naturally, management is more concerned
with total Current Assets rather with the sources of the funds i.e.
Current Liabilities.
 Net Working Capital concept
According to this concept Current Assets minus Current
Liabilities is known as Working Capital.

W.C. = C.A.- C.L.

Positive W.C.= C.A.> C.L. (company position is sound)
AND
Negative W.C. = C.A.< C.L. (it indicates financial crisis)

Thus, the concept lays emphasis on qualitative aspect

which indicates the liquidity position of the concern.
 Valid Reasons for net Working Capital

1. The material thing in the long run is the surplus of

current assets over current liabilities.
2. Financial health/soundness can easily be judged with
this concept.
3. Excess of current assets over current liabilities
represents the amount which is not liable to be
returned and which can be relied upon to meet any
contingency.
 Components of Working Capital

Working Capital as per Net Concept has two components-

1. Current Assets and,

2. Current Liabilities.
 Current Assets
Assets which can easily be converted into cash in the normal
course of the business are known as current assets. These assets
may include:-
1. Cash in hand or at Bank,
2. Debtors and Bills Receivable,
3. Stock or inventory of– raw materials, stores, and spares,
-- Works in Progress,
-- Finished Goods.
4. Advance payments towards expenses, purchases and other short
term advances.
5. Temporary investment of surplus funds.
6. Accrued incomes.
One common characteristics of all the above items of current
assets is that each component is swiftly transformed into other
assets forms.
 Current Liabilities
A part of the need for the funds to finance the current
assets may be met from supply of goods on credit and
deferment, on account of custom, usage of arrangement
of payment of expenses.

The remaining part of the need for Working Capital may

be met from short term borrowings from financial
institutions and bankers. These are collectively called
CURRENT LIABILITIES.

These are the liabilities which are to be met in the

normal course of the business within an accounting
period out of Current Assets or profit from operation.
 Current Liabilities Includes -

Typical items of Current Liabilities are—

1. Trade creditors i.e. goods purchased on credit and Bills

Payable.
2. Outstanding and Accrued expenses.
3. Short term borrowings.
4. Taxes and Dividend payable.
5. Advances received from parties against goods to be sold to
them or as short term deposits.
6. Bank overdraft.
7. Outstanding liabilities currently payable.
Kinds of WORKING CAPITAL
1. CORE, PERMANENT OR FIXED WORKING
CAPITAL.

2. FLUCTUATING OR VARIABLE WORKING

CAPITAL.
 Fixed or Permanent Working Capital
• This is irreducible minimum amount necessary for
maintaining the circulation of the current assets.
• This is permanently locked up in the business and
therefore, it is referred to fixed or Permanent Working
Capital.
• This is minimum level of current assets which must be
kept in order to carry on the business.
• It is the investment in current assets which is
permanently locked up in the business.
• Fixed working capital constantly changes its form from
one assets to another. It always remains in the business
in one form or other.
 Variable Working Capital
• Variable working capital refers to that portion of total
working capital which is needed over and above fixed
working capital.
• Such need for Variable Working Capital arise on account
of:-
- Seasonal changes,
- Abnormal and Unanticipated conditions,
- To face tough conditions in the market,
- To meet contingencies like strikes and lockouts,
- Special Advertising Campaigns or other Promotional
activities,
Are financed by variable working capital
 Operating Cycle
• Operating cycle is the time duration required
to convert sales, after the conversion of
resources into inventories, into cash. The
operating cycle of a manufacturing company
involves three phases:
 Acquisition of resources such as raw material, labour, power
and fuel etc.
 Manufacture of the product which includes conversion of raw
material into work-in-progress into finished goods.
 Sale of the product either for cash or on credit. Credit sales
create account receivable for collection.
 Working Capital Cycle
The operating cycle begins with the arrival of the stock and ends when the cash is received.
The cash cycle begins when the cash is paid for materials,
and ends when cash is collected from receivable.

Raw Materials Purchased

←--------------------→

Order Placed Stocks arrives Finished goods sold Cash Received

work-in-process inventory period Accounts receivable Period
←----------------------------------------------r-----------------------------------------------→
Time

←--------------------------------→
Accounts Payable period
Invoice received Cash paid for materails
←--------------------------------------------------------------------------------------------------
Operating Cycle
←-----------------------------------------------------------
Cash Cycle
 Operating Cycle
• The length of the operating cycle of a
manufacturing firm is the sum of:

• inventory conversion period (ICP).

• Debtors (receivable) conversion period (DCP).

• Creditors or payables deferral period (CDP)

Inventory conversion period (ICP)
 Inventory conversion period is the total time needed for producing
and selling the product. Typically, it includes:

 raw material conversion period (RMCP)

Average Raw Materials
=------------------- x 365
Raw material consumed

 work-in-process conversion period (WIPCP)

Average work in process
=------------------- x 365
Total cost of production

 finished goods conversion period (FGCP)

Average stock (FG)
=------------------- x 365
Total cost of goods sold
 Debtors (receivable) conversion period
(DCP)

• The debtors conversion period is the time

required to collect the outstanding amount
from the customers.
Average debtors
=------------------- x 365
Total credit sales
Creditors or payables deferral period
(CDP)
• Creditors or payables deferral period (CDP) is
the length of time the firm is able to defer
payments on various resource purchases.
Average Creditors
=------------------- x 365
Total credit Purchases
 Gross operating cycle (GOC)
• Gross operating cycle (GOC)
The total of inventory conversion period and debtors
conversion period is referred to as gross operating
cycle (GOC).

• Gross Operating Cycle =

Raw Material Storage Period + Conversion period +
Finished Goods Storage Period + Average Collection Period
 Net operating cycle (NOC)

• Net operating cycle (NOC)

NOC is the difference between GOC and CDP.
• Net Operating Cycle =
Gross Operating Cycle – Average Payment period
 OPERATING CYCLE
• RMCP -----
• +WPCP -----
• +FGCP -----
• +RCP(DCP) -----
• TOCP(Gross operating cycle) -----
• - CDP -----
• NOC -----
 OPERATING CYCLE APPROACH TO WORKING
CAPITAL MANAGEMENT
• What has been considered in figure above as working capital
cycle is more popularly known as the operating cycle.

• This title is more expressive in the sense that the normal

business operations of a manufacturing and trading company
start with cash, go through the successive segments of the
operating cycle, viz, raw material storage period, conversion
period, finished goods storage period and average collection
period before getting back cash along with profit.

• The total duration of all the segments mentioned above is

known as ‘gross operating cycle period’.
 OPERATING CYCLE
• Gross Operating Cycle =
Raw Material Storage Period + Conversion period +
Finished Goods Storage Period + Average Collection Period

• Net Operating Cycle =

Gross Operating Cycle – Average Payment period
 Statement of working capital Requirements
for a Trading Concern
Current Assets:
(i) Cash ----
(ii)Debtors or Receivables(for ..month’s sales ) ----
(iii)Stock (for…month’s sales) ----
(iv)Advance payment, if any ----
(v)Others ----
Total Current Assets ----
Less: Current Liabilities
(i) Creditors (for..month’s Purchases) ----
(ii)Lag in payment of expenses(o/s expenses, if any) ----
Total Current Liabilities ----
Working capital(C.A. – C.L. ) ----
Add: Provision / Margin For Contingencies ----
Net Working Capital Required ----
Working Capital Requirements
Prepare an estimate of working capital requirement from the
following information of a trading concern
(a)Project annual sales 100000 units
(b)Selling price Rs. 8 per unit
(c)Net profit on sales 25%
(d)Average credit period allowed to customers 8 weeks
(e)Average credit period allowed by suppliers 4 weeks
(f)Average stock holding in terms of sales
requirement 12 weeks
(g) Allow 10% for contingencies
 Statement of Working Capital Requirement

Current Assets:
Debtors(8 weeks) 92,308
Stock (12 weeks) 1,38,462
2,30,770
Less: Current Liabilities:
Creditors(4 weeks) 46,154
Net Working Capital 1,84,616
Add 10% for Contingencies 18,462
Working Capital Required 2,03,078
CRITERIA FOR EVALUATION OF WORKING
CAPITAL MANAGEMENT

• Liquidity

• Availability of Cash

• Inventory Turnover

• Credit Extended to Customers

• Credit Obtained from Suppliers

 IMPORTANT WORKING CAPITAL
RATIOS
• Current Ratio

• Quick Ratio

• Cash to Current Assets

• Sales to Cash

• Average Collection Period

• Inventory Turnover Ratio

• Working Capital to Sales