1. Working Capital Management
www.pace2race.com
1

2. Session Outline
• What is working capital?
• Importance of working capital
• Factors affecting working capital
• Sources of working capital finance
• Finance mix for working capital
• Working capital cycle
• Calculation over working capital requirement
Prabhat Mittal
Put your queries on www.financeclubb.com 2

3. 3
Working capital management?
Working capital management involves the relationship between a firm's short-term
assets and its short-term liabilities. The goal of working capital management is to
ensure that a firm is able to continue its operations and that it has sufficient ability to
satisfy both maturing short-term debt and upcoming operational expenses.
Sources of
Finance
Short
Long Tem
Term
Finance required to meet capital Finance required to meet day-to-day
expenditure Business requirements
Put your queries on www.financeclubb.com
Prabhat Mittal

4. Working Capital <-----> Net Current Assets
Current
Assets
Inventory Accounts
Receivables Cash
Management
/Payables
Working Capital is the difference between resources in cash or readily
convertible into cash (Current Assets) and organizational commitments for which
cash will soon be required (Current Liabilities)
Prabhat Mittal
Put your queries on www.financeclubb.com 4

5. Importance of adequate working capital
• A large amount of working capital would mean that the company
has idle funds. Since funds have a cost, the company has to pay
huge amount as interest on such funds.
• If the firm has inadequate working capital, such firm runs the risk of
insolvency. Paucity of working capital may lead to a situation where
the firm may not be able to meet its liabilities
Prabhat Mittal
Put your queries on www.financeclubb.com 5

6. Factors affecting working capital
• Nature of Business/Industry; Size of Business/Scale of
Operations; Growth prospects
• Business Cycle; Manufacturing Cycle; Operating Cycle &
Rapidity of Turnover;
• Operating Efficiency; Profit Margin; Profit Appropriation
• Depreciation Policy; Taxation Policy; Dividend Policy and
Government Regulations
Prabhat Mittal
Put your queries on www.financeclubb.com 6

7. Working Capital Cycle across Industries
Prabhat Mittal
Put your queries on www.financeclubb.com 7

8. Sources of Working Capital Finance
Sources of
Working Capital
Long Tem Short Term
Internal Sources Internal Sources External Sources
External Sources
(Retained (Accrual, (Trade Credit,
(Equity, Loan)
Earnings) Depreciation funs) advances)
Prabhat Mittal
Put your queries on www.financeclubb.com 8

9. Current asset policy
Assuming a constant level of fixed assets, a higher current assets/fixed assets ratio
indicates a conservative current assets policy and a lower current assets/fixed assets
ratio means an aggressive current assets policy assuming all factors to be constant.
Put your queries on www.financeclubb.com 9
Prabhat Mittal

10. Financing mix for Working Capital
Hedging Approach Conservative Approach
(Long + Short Term) (Mostly Long Term)
Financing Mix
Trade off Approach
Aggressive Approach (Avg. of min/max WC to be funded
(Mostly Short Term) by Long term and rest by short
term)
Prabhat Mittal
Put your queries on www.financeclubb.com 10

11. Working Capital Cycle
Working Capital cycle indicates the length of time between a company’s purchasing
materials, entering into stock and receiving the cash from sales of finished goods.
It can be determined by adding the number of days required for each stage in the
cycle.
Prabhat Mittal
Put your queries on www.financeclubb.com 11

12. Calculation
In the form of an equation, the operating cycle process can be
expressed as follows:
Working Capital Cycle = I + D – C
Where,
I = Inventory period
D = Debtors collection period.
C = Credit period availed.
Prabhat Mittal
Put your queries on www.financeclubb.com 12

13. Calculation ……cont.
The various components of operating cycle may be calculated as shown below:
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝐼𝐼 𝐼𝐼 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝐼𝐼 𝐼𝐼𝐼𝐼
𝐼𝐼 𝐼𝐼 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝐼𝐼 𝐼𝐼𝐼𝐼 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝 𝑝𝑝 =
𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 / 𝑑𝑑𝑑𝑑𝑑𝑑
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝 𝑝𝑝 =
𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝 𝑝𝑝 =
𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝ℎ𝑎𝑎𝑎𝑎𝑎𝑎
Prabhat Mittal
Put your queries on www.financeclubb.com 13

14. Illustration
From the following information of XYZ Ltd., you are required to calculate :
(a) Operating cycle period.
(b) Cash Cycle
(c) Number of operating cycles in a year.
1.1.2012 31.12.2012
P&L Data Balance Sheet Data
Sales 1000 Inventory 100 120
COGS 700 AR 80 90
AP 50 60
Prabhat Mittal
Put your queries on www.financeclubb.com 14

15. Illustration
Inventory Period = 57.3 days
Accounts Receivable Period = 31 days
Accounts Payable Period = 28.6 days
Operating Cycle = 57.3 + 31 = 88.3 days
Cash Cycle = 88.3 – 28.6 = 59.7 days
No. of Operating Cycles in a year = 365 / 88.3 = 4.13
Prabhat Mittal
Put your queries on www.financeclubb.com 15

16. How to calculate working capital?
Daily requirement in Rs. x Average holding period
Illustration
On 1st January, the Managing Director of Naureen Ltd. wishes to know the amount of working
capital that will be required during the year. From the following information prepare the
working capital requirements forecast.
Production during the previous year was 60,000 units. It is planned that this level of activity
would be maintained during the present year.
The expected ratios of the cost to selling prices are Raw materials 60%, Direct wages 10% and
Overheads 20%.
Raw materials are expected to remain in store for an average of 2 months before issue to
production. Each unit is expected to be in process for one month, the raw materials being fed
into the pipeline immediately and the labour and overhead costs accruing evenly during the
month. Finished goods will stay in the warehouse awaiting dispatch to customers for
approximately 3 months.
Credit allowed by creditors is 2 months from the date of delivery of raw material. Credit allowed
to debtors is 3 months from the date of dispatch. Selling price is ` 5 per unit. There is a regular
production and sales cycle. Wages and overheads are paid on the 1st of each month for the
previous month. The company normally keeps cash in hand to the extent of ` 20,000.
Prabhat Mittal
Put your queries on www.financeclubb.com 16

17. Statement of working capital required
` `
Current Assets
Raw materials inventory 30,000
Debtors 75,000
Working–in-process 18,750
Finished goods inventory 67,500
Cash 20,000
2,11,250
Current Liabilities
Creditors 30,000
Direct wages payable 2,500
Overheads payable 5,000
Estimated working 37,500
capital requirements 1,73,750
Prabhat Mittal
Put your queries on www.financeclubb.com 17

18. Summary
• Current assets have a short life span and are swiftly
transformed into other asset forms.
• The working capital needs of a firm are influenced by
numerous factors : nature of business, seasonality of
operations, production policy, market conditions, and
supply conditions.
• Determining the optimal level of current assets involves a
tradeoff between carrying costs and shortage costs.
• According to the matching principle, the maturity of the
sources of finance should match the maturity of assets
being financed.
Prabhat Mittal
Put your queries on www.financeclubb.com 18

19. Summary ………..cont..
• The operating cycle of a firm begins with the acquisition of
raw materials and ends with the collection of receivables.
• The cash requirement of working capital is calculated by
estimating the cash cost of various current assets required
by the firm and deducting the spontaneous current liabilities
from the cash cost of current assets.
Prabhat Mittal
Put your queries on www.financeclubb.com 19