Working Capital Management

Definition of Working Capital

 Working capital refers to funds required to be invested in

the business for a short period usually up to one year.

 It is also known Short-term capital or Circulating capital

 “Working capital is the amount of funds necessary to cover the cost of

operating the enterprise.”

--- Acc.. to
Shubin
 WHY WC...??

 The firm has to maintain cash balance to pay bills as

they come due.
 In addition, the company must invest in inventories to
fill customer orders promptly.
 And finally, company invests in accounts
receivable to extend credit to customers.
• Working capital management means the management of working
capital, or to be more precise, the management of current assets.

• If the working capital level is not properly maintained and

managed, then it may result in unnecessary blocking of scarce
resources of the firm.

• The insufficient working capital on the other hand, put different

hindrances in smooth working of the firm.
 Objectives Of WCM

The finance manager cannot simply decide the level of current assets and stop
there. The level of investments in each of the current assets varies from day to
day, and the financial manager must therefore, continuously monitor the assets to
ensure that the desired levels are being maintained.

• To optimize investments in current assets.

• To see that company meets its current liabilities obligation.

• Manage current assets to see that the return on current assets is

more than cost of capital.

• Proper balance between current assets & current liabilities.

 PURPOSE OF WC

 To hold the stock of raw materials for such a period

 To hold the stock of work in progress for process period

 To hold the stock of finished goods for such a period

 To grant credit to customers

 To hold cash balances to meet the expenses

Working capital management decision involves some of the following
considerations:

1. What should be the total investments in working capital of the

firm?
2. What should be the level of individual current assets?
3. What should be the relative proportion of different sources to
finance the working capital requirements?
 Types of Working Capital

Gross working
On the capital
basis of
Concept Net working
capital
WC Permanent
On the working
basis of capital
Time
Temporar
y capital
working
 On the Basis of Concept/ Value
 Gross W/C: It refers to the firm’s investment in
current assets.
CA includes – stock of rawmaterial, WIP, FGs,
etc.
Inbelow:-
the form of Equation , Gross W/C
CASHcan be
shown
Inventories
Gross i. Raw-materials
Workin ii. Work-in-progress
g iii. Finished Goods
Capital
Short term Marketable
securities and other current
assets
 Net W/C: It refers to diff b/w current
assets and current liabilities.
CL includes – trade creditors , bills payable,
o/s exp’s, etc.

Net Working Capital is a Qualitative Concept,

which indicates:
i. Liquidity position of the firm
ii. Part of current assets which should be
financed with long-term funds

In the form of an equation , Net Working
Capital has been shown below:
Gross Working Capital
(or) current Assets
Net Working
LESS
Capital
Current Liabilities

 Example: A company buys stocks of raw material for cash. It

implies that company is financing raw material stock from its
internal sources. Suppose, the company gets a two months credit
for the same purchase. It implies the stock is financed by
creditors.
On the basis of Time:

Regular wc
Permanent /
fixed WC
Reserve wc
Time
Seasonal wc
Temporary WC
Special wc
Permanent Working Capital:

It refers to a certain minimum level

of current assets, which is essential
for firm to carry on its business
irrespective of the level of
operations.
 Characteristics of PWC:

 Classified on the basis of Time factor

 Always remain in process
 Size increases according to the Growth of enterprise
 suitable for business, which is the same for all the year long
 Constantly changes from one asset to another
 Temporary Working Capital:

It refers to the amount of working capital over and above the

fixed minimum amount of WC, which is required to meet

seasonal and other temporary requirements.

 Working Capital in case of a Stable firm
In case of a Stable firm , the Permanent working capital is stable over time and takes
the shape of a Horizontal line. while temporary working capital is fluctuating –
sometimes increasing and sometimes decreasing
 Working Capital in case of a Growing firm
In case of a Growing firm , the Permanent working capital may also keep on
increasing over time to support a rising level of activity and hence PWC line may not
always be Horizontal. while Temporary working capital is fluctuating – sometimes
increasing and sometimes decreasing.
Operating Cycle and the Working Capital
• The working capital requirement of a firm depends to a great extent
upon the operating cycle of the firm.

• The operating cycle may be defined as the time duration starting from
the procurement of goods or raw materials and ending with the sales
realisation..

• The length and nature of the operating cycle may differ from one firm
to another
The operating cycle of the firm consists of the time required for the completion of the
chronological sequence of some or all of the following:

The requirement of funds depend upon the operating cycle period of the firm and is
also denoted as the working capital needs of the firm.
 Operating Cycle Period

The length or time duration of the operating cycle of any firm can be defined as the sum of
its :

1. Inventory Conversion Period

2. Receivables Conversion Period

(i) Inventory Conversion Period (ICP): it is the time required for
the conversion of raw materials into finished goods for sales. In a
manufacturing firm ICP consists of Raw Materials Conversion Period
(RMCP), Work–in-Progress Conversion Period (WPCP) and the
Finished Goods Conversion Period (FGCP).

(ii) Receivable Conversion Period: time period required to convert

the credit sales into cash realisation. It refers to the period between
the occurrence of the credit sales and collection of debtors.
• The total of ICP and RCP is known as TOCP (Total Operating Cycle Period).

• The firm might be getting some credit facilities from the supplier of raw materials,

wage earners etc. the period for which the payment for these parties are deferred

or delayed is known as Deferral Period (DP).

• The Net operating Cycle (NOC) of the firm is arrived at by deducting the DP from

the TOCP. Thus,

NOC = TOCP – DP

= ICP + RCP – DP
The Operating Cycle
For calculation of TOCP and NOC, various conversion periods may be
calculated as follows:
On the basis of above conversion periods, the TOCP and NOC may be
ascertained as follows:

Particulars No. of Days

RMCP ………Days The TOCP and NOC do not measure the
+ WPCP ………Days
absolute amount of funds invested in the
+FGCP ………Days
+RCP ………Days working capital. However, a longer NOC
TOCP ………Days
will generally indicate a requirement for
- DP ………Days
NOC ………Days more working capital.
 Factors Determining Working Capital Requirement

• Basic Nature of Business The working capital requirement of a

firm is determined by a host of factors.

• Business Cycle Fluctuations Every consideration is to be weighted

relatively to determine the working

• Seasonal Operations
capital requirement. This is not a one

• Market Competitiveness time exercise, rather a continuous

review must be made in order to assess

• Credit policy the working capital requirements in the

changing world.
• Supply Conditions