The document discusses working capital, which refers to the capital required to finance short-term operating needs like inventory, accounts receivable, and cash. It provides definitions of working capital concepts like net working capital, gross working capital, and operating cycle. It also examines different approaches to calculating and financing working capital, including the balance sheet approach, operating cycle approach, hedging/matching approach, conservative approach, and aggressive approach. Key points covered include the importance of adequate but not excessive working capital, factors that influence working capital needs, and the trade-offs between different financing approaches in terms of liquidity, risk and profitability.

1. Working Capital
Management
Dr. S. Ghose

2. Definition of Working Capital
Working Capital refers to that part of the firm’s
capital, which is required for financing short-term
or current assets such a cash marketable
securities, debtors and inventories. Funds thus,
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.

3. “ circulating capital means current assets of
a company that are changed in the ordinary
course of business from one form to
another, as for example, from cash to
inventories, inventories to receivables,
receivable to cash”
……Genestenbreg

4. Concept of working capital
 There are two possible interpretations of working
capital concept:
1. Balance sheet concept
2. Operating cycle concept
Balance sheet concept
There are two interpretations of working capital
under the balance sheet concept.
a. Excess of current assets over
current liabilities
b. Gross or total current assets.

5.  Excess of current assets over current liabilities are
called the net working capital or net current assets.
 Working capital is really a part of long term
finance is locked in and used for supporting
current activities.
 The balance sheet definition of working capital is
meaningful only as an indication of the firm’s
current solvency in repaying its creditors.
 When firms speak of shortage of working capital
they in fact possibly imply scarcity of cash
resources.
 In fund flow analysis an increase in working
capital, as conventionally defined, represents
employment or application of funds.

6. Net Working Capital
Current Assets – Current Liabilities.
Gross Working Capital
The firm’s investment in current assets.
Working Capital Management
The administration of the firm’s current assets and the
financing needed to support current assets.
Working Capital Concepts

7. FACTORS DETERMINING WORKING CAPITAL
1. Nature and Demand of the Industry
2. Cash requirements
3. Nature of the Business
4. Manufacturing time
5. Volume of Sales
6. Terms of Purchase and Sales
7. Inventory Turnover
8. Business Turnover and Business Cycle
9. Current Assets requirements
10. Production Cycle
11. Credit control
12. Inflation or Price level changes
13. Profit planning and control
14. Repayment ability and Cash reserves
15. Operation efficiency
16. Change in Technology
17. Firm’s finance and dividend policy
18. Attitude towards Risk

8. EXCESS OR INADEQUATE WORKING CAPITAL
Every business concern should have adequate working capital
to run its business operations. It should have neither redundant
or excess working capital nor inadequate or shortage of working
capital.
Both excess as well as shortage of working capital situations are
bad for any business. However, out of the two, inadequacy or
shortage of working capital is more dangerous from the point of
view of the firm.

9. Disadvantages of Redundant or Excess Working Capital
1. Excessive Cash, Idle funds, non-profitable for business,
poor ROI
2.Unnecessary purchasing & accumulation of inventories
over required level
3.Excessive debtors and defective credit policy, higher
incidence of B/D.
4. Overall inefficiency in the organization.
5. When there is excessive working capital, Credit
worthiness suffers
6. Due to low rate of return on investments, the market
value of shares may fall

10. Disadvantages or Dangers of Inadequate or Short Working
Capital
1 Can’t pay off its short-term liabilities in time.
1 Economies of scale are not possible.
1 Difficult for the firm to exploit favourable market
situations
1 Day-to-day liquidity worsens.
1 Adoption of Tight Credit Policy
1 Improper utilization the fixed assets and ROA/ROI falls
sharply

11. Significance of Gross WC
 Optimum investment in CA
Investment in CA must be adequate CA investment should not
be inadequate or excessive inadequate WC can disturb
production and can also threaten the solvency of firm , if it fails
to meet its current obligation excessive investment in CA
should be avoided , since it impairs firms profitability
 Financing of CA
Need for WC arises due to increasing level of business activity
& it is to provided quickly some time surplus fund may arises
which should be invested in Short term securities , they should
not be kept idle

12. Significance of Net Working Capital
 Maintaining Liquidity position
For maintaining liquidity position there is a need to
maintain CA sufficiently in excess of CL
 Judge Financial Soundness of a firm
The Net working capital helps creditors and investors to
judge financial soundness of a firm

13. KINDS OF WORKING CAPITAL
WORKING CAPITAL
BASIS OF
CONCEPT
BASIS OF
TIME
Gross
Working
Capital
Net
Working
Capital
Permanent
/ Fixed
WC
Temporary
/ Variable
WC
Regular
WC
Reserve
WC
Special
WC
Seasonal
WC

14. Difference between permanent & temporary working capital
Amount Variable Working Capital
of
Working
Capital
Permanent Working Capital
Time
Permanent and temporary working capital for Stable firm

15. Variable Working Capital
Amount
of
Working
Capital
Permanent Working Capital
Time
Permanent and temporary working capital for Growing firm

16.  Operating cycle concept
 Successful sales activity is necessary for earning profit but
sales do not convert into cash immediately
 There is invisible time lap between the sale of good and receipt
of cash
 The time taken to convert raw material into cash is known as
operating cycle :
 Conversion of cash into raw material
 Conversion of raw material into work in progress
 Conversion of Work in progress into finished goods
 Conversion of finished good into Sales ( Debtors and cash )

17.  Operating cycle concept
 A company’s operating cycle typically consists of
three primary activities:
 Purchasing resources,
 Producing the product and
 Distributing (selling) the product.
These activities create funds flows that are both
unsynchronized and uncertain.
Unsynchronized because cash disbursements (for example,
payments for resource purchases) usually take place before
cash receipts (for example collection of receivables).
They are uncertain because future sales and costs, which
generate the respective receipts and disbursements, cannot
be forecasted with complete accuracy.

18.  The firm has to maintain cash balance to pay the bills
as they become due.
 In addition, the company must invest in inventories to
fill customer orders promptly.
 And finally, the company invests in accounts receivable
to extend credit to customers.
 Operating cycle is equal to the length of inventory and
receivable conversion periods.

19. Operating Cycle in
Manufacturing firm
Cash
Raw
Materials
W I P
Finished
Goods
Debtors SALES

20. Operating cycle of Non
Manufacturing Firm
cash
Receivables
Stock of finished goods

21. Formula for calculating Operating cycle
for Manufacturing firm
OC = ICP+ARP
OC = Operating cycle
ICP = Inventory Conversion period
ARP = Account Receivable Period
ICP = Average Inventory
Cost of good sold /365
ARP = Average Account Receivable
Sales/365

22. COMPONENTS OF OPERATING CYCLE
 GROSS OPERATING CYCLE =
Raw Material Storage Period + WIP Holding Period +
Finished Goods Storage Period + Debtors Collection Period
 NET OPERATING CYCLE =
Gross Operating Cycle – Credit Period Allowed by Supplier.

23. Particulars Actual Balance as at
1/4/14 (Rs.)
Projected Balance
as on 31/3/15 (Rs.)
Raw Materials 45000 65356
WIP 35000 51300
Finished Goods 60181 70175
Debtors 112123 135000
Creditors 50079 70469
Annual Purchase of raw materials
(all in credit)
400000
Annual Cost of Production 750000
Annual COGS 915000
Annual Operating Cost 950000
Annual Sales (all in credit) 1100000
The following information is forecasted by Z Ltd for the year
ending 31/3/15. Taking 365 days in one year, calculate Net
Operating Cycle period, Number of Operating Cycles in a year,
Amount of Working Capital Requirement.

24. A. Raw Material Holding Period = Avg Stock of Raw Material / Avg daily consumption of
raw materials = { (45000 + 65356)/2 } / { ( 45000 + 400000 – 65356) /365} = 53 days.
B.WIP period = Avg WIP / Avg daily cost of production =
{ (35000 + 51300)/2 } / { 750000 /365} = 21 days.
C.Finished Goods Holding period = Avg Stock of Finished Goods / Avg daily COGS =
{ (60181 + 70175)/2 } / { 915000 /365} = 26 days.
D. Debtors Collection period = Avg Debtors / Avg daily credit sales =
{ (112123 + 135000)/2 } / { 1100000 /365} = 41 days.
E. Creditor Payment period = Avg Creditors / Avg daily credit purchase =
{ (50079 + 70469)/2 } / { 400000 /365} = 55 days.
Net Operating Cycle = A + B + C + D – E = 86 days
Number of Operating Cycles = 365 / Net Operating Cycle Period = 365/86 = 4.244 = 4
cycles
Amount of Working Capital = Annual Operating Cost / Number of Operating Cycle =
950000/4.2444 = 223845

25. 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

26. 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

27. 1. 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

28. Important Points 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.

29. Working Capital Financing Mix
Approaches to Financing
Mix
The Hedging or
Matching Approach
The Conservative
Approach
The Aggressive
Approach

30. Hedging approach to asset financing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-term
Debt
Long-term
Debt +
Equity
Capital

31. The Hedging approach
Hedging approach refers to a process of matching
maturities of debt with the maturities of financial need.
In this approach maturity of source of fund should
match the nature of asset to be financed
This approach is also known as matching approach.
The hedging approach suggests that the permanent
working capital requirement should be financed with
fund from long term sources while the temporary
working capital requirement should be financed with
short term funds.

32. Conservative Approach
This approach suggested that the entire estimated
investments in current asset should be finance from
long term source and short term should be use only for
emergency requirement
Distinct features of this approach :
 Liquidity is greater
 Risk is minimized
 The cost of financing is relatively more as interest has
to be paid even on seasonal requirement for the entire
period

33. Conservative approach to asset financing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-term
Debt
Long-term
Debt +
Equity
capital

34. Trade off between Hedging and
conservative approaches
 The hedging approaches implies low cost , high profit
and high risk while the conservative approach leads to
high cost , low profit , low risk.
 A trade off between the two will then be an acceptable
approach , One way of determining the trade off is by
finding the AVG of maximum and minimum
requirement of current asset or working capital

35. Aggressive approach to asset financing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-term
Debt
Long-term
Debt +
Equity
capital

36. Aggressive approach
 The aggressive approach suggests that the entire
estimated requirement of current asset should be
financed from short-term sources and even a part of
permanent current asset be financed from short - term
sources.
This approach makes the finance mix :
 More Risky
 Less costly
 More Profitable

37. Comparative Study of Aggressive,
Conservative and Matching Approach
Basis Aggressive Conservative Matching
Permanent
Current
Assets
Some portion financed
with Short Term Sources
and some with Long
Term Sources of Funds
All financed with Long
Term Sources of Funds.
All financed
with Long
Term Sources
of Funds
Temporary
Current
Assets
All financed with Short
Term Sources of Funds
Some portion financed
with Short Term Sources
and some with Long
Term Sources of Funds.
In the absence of
Temporary Assets, LT
Finance released can be
invested in Marketable
Securities to build up
the Liquidity Position of
the firm.
All financed
with Short
Term Sources
of Funds
Liquidity Lower Higher Moderate
Profitability Higher Lower Moderate

38. • 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.
Significance of Working Capital
Management

39. Management of Working Capital
 Working capital in general practice refer to the
excess of CA over CL.
 Management of working capital therefore is
concerned with the problems that arise in
attempting to manage the CA, the CL and the
inter-relationship that exists between them.
 The basic goal of WCM is to manage the CA & CL
of a firm in such a way that a satisfactory level of
WC is maintained.
 Working Capital Management Policies of a firm
have a great effect on its profitability, liquidity and
structural health of the organization

40. 3 dimensional Nature of Working
capital management
Dimension I
Profitability,
Risk, & Liquidity

41. Working Capital Issues
Assumptions
 50,000 maximum
units of production
 Continuous
production
 Three different
policies for current
asset levels are
possible
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL
Current Assets
Policy C
Policy A
Policy B

42. Impact on Liquidity
Liquidity Analysis
Policy Liquidity
A High
B Average
C Low
Greater current asset
levels generate more
liquidity; all other
factors held constant.
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL
Current Assets
Policy C
Policy A
Policy B

43. Impact on Expected Profitability
Return on Investment =
Net Profit
Total Assets
Let Current Assets = (Cash
+ Rec. + Inv.)
Return on Investment =
Net Profit
Current + Fixed Assets
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL
Current Assets
Policy C
Policy A
Policy B

44. Impact on Expected Profitability
Profitability Analysis
Policy Profitability
A Low
B Average
C High
As current asset levels
decline, total assets will
decline and the ROI will
rise.
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL
Current Assets
Policy C
Policy A
Policy B

45. Impact on Risk
 Decreasing cash reduces
the firm’s ability to meet its
financial obligations. More
risk!
 Stricter credit policies
reduce receivables and
possibly lose sales and
customers. More risk!
 Lower inventory levels
increase stockouts and lost
sales. More risk!
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL
Current Assets
Policy C
Policy A
Policy B

46. Impact on Risk
Risk Analysis
Policy Risk
A Low
B Average
C High
Risk increases as the level
of current assets are
reduced.
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL
Current Assets
Policy C
Policy A
Policy B

47. Summary of the Optimal Amount of
Current Assets
SUMMARY OF OPTIMAL CURRENT ASSET ANALYSIS
Policy Liquidity Profitability Risk
A High Low Low
B Average Average Average
C Low High High
1. Profitability varies inversely with liquidity.
2. Profitability moves together with risk.
(risk and return go hand in hand!)

48. Techniques of analysis of working
capital
The analysis of working capital can be conducted
through a number of devices such as
Ratio analysis
Fund flow analysis
Working capital Budgeting

49. The following ratios may be calculated for this
purpose
Liquidity Ratio
a) Current Ratio
b) Acid test ratio/quick ratio/liquid ratio
c) Cash Position ratio/absolute liquid ratio
Inventory turnover ratio
Receivable turnover ratio
Payable turnover ratio
Working capital turnover ratio

50. Inventory turnover ratio
Inventory turn over ratio = Cost of good sold
Average Inventory at cost
Generally , the cost of good sold may not be known from the published
financials , in such circumstances
Inventory turn over ratio = Net Sales
Average Inventory at cost
Inventory turn over ratio = Cost of good sold
Average Inventory at selling price
Inventory conversion period = Days in a year
Inventory Turnover Ratio

51. Debtor/Receivable turnover ratio/Debtor velocity
Debtor(Receivable) = Net credit Annual sales
Average Trade debtors
Trade debtors = Sundry debtor + Bill Receivable and
account receivable s
Average Trade Debtors = Opening Trade debtor +
Closing Trade Debtor /2
Note : Debtor should always be taken at gross value , No
provision for doubtful debt be deducted from them but
when the information about opening and closing balance
of trade debtor and credit sales is not available , then the
debtors turnover ratio calculated by dividing the total sales
by the balance of debtors(inclusive of Bills receivables)
given
Debtors turn over Ratio = Total sales
Debtors

52. Average Collection Period
The average collection period represent the average
number of days for which a firm has to wait before its
receivable are converted into cash
Average Collection period =
Average Trade Debtors (Drs + B/R)
Sales per day
Sales Per day = Net Sales
No of working days

53. Or
Average collection period =Average trade debtors
Net Sales
No of working days
If the period is in months:
Average collection period =No of working days
Debtors turnover ratio
The two basis component of the ratio are debtors and
sales per day

54. Creditor/Payable turnover ratio
The analysis for credit turnover is basically the same as of
debtors turnover ratio except that in place of trade debtor,
the trade creditor are taken and in place of sales , average
daily purchase are taken as the other component of the
ratio.
Creditors turnover ratio
= Net credit annual purchase
Average Trade creditors

55. Average Payment period Ratio
= Average Trade Creditors( Creditors+ Bills
payable)/Average Daily purchases.
Average daily purchase = Annual Purchase /No of working
days in a year.
Average Payment Period = Trade creditor * No of working
days / Net annual purchase.
Average Payment Period = No of working days / Credit
turnover Ratio.

56. Working capital turnover ratio
Working capital of a concern is directly related to sales
and current asset like debtors , bills receivable , cash ,
stock etc .
Working capital turnover ratio = Cost of Sales / Average
working capital
Average working capital = Opening working capital +
Closing Working capital/2
** If cost of sales is not given , then the figure of sale can
be used . O n the other hand if opening working
capital is not disclosed then working capital at the end
of the year will be used.
Cost of sale /Net working capital

57. Fund flow analysis : Fund flow analysis is a
technical device designated to study the sources from
which additional fund were derived and the use to
which these sources were put . It is an effective
management tool to study change in the financial
position of business
The fund flow analysis consists of
Preparing schedule of change in working capital
Statement of sources and application of funds

58. Working capital Budgeting : Working
capital budget as a part of total
budgeting process of a business , is
prepared estimating future long term
and short term working capital need
and the sources of finance them .
The objective of a working capital
budget is to ensure availability of fund
as and when needed and to ensure
effective utilization of these resources
.

59. Purchase of Sale of Goods Collection of
Raw Material on Credit Account Receivables
On credit
Average age of Account receivable
Inventory (AII) period (ARP)
Account Payable
Period (APP)
Payment to
suppliers
Receipt of Invoice Operating Cycle (OC)
Cash Conversion cycle

60. Resource flows for a manufacturing firm
Fixed
Assets
Production
Process
Generates
Inventory
Via Sales Generator
Accounts
receivable
Used in
Accrued Direct
Labour and
materials
Accrued Fixed
Operating
expenses
Cash and
Marketable
Securities
Suppliers
Of Capital
External Financing
Return on Capital
Collection
process
Used to
purchase
Used to
purchase
Used in
Working
Capital
cycle

61. Credit
Policy
Increase in Credit
Period (Days)
Increase in
sales (Rs)
Bad Debt %
of Total Sales
B 15 35000 1.5
C 30 40000 1.8
A Company currently has annual sales of Rs. 500000 and
an average collection period of 30 days. It is considering a
more liberal credit policy. If credit policy is extended, the
company expects sales and bad debt losses to increase as
follows:
The S.P. p.u. is Rs.2. V.C. p.u. is Rs. 1.20. If the current bad
debt loss is 1% of sales and the required ROI is 20%, which
credit policy should be undertaken? Ignore tax and assume
360 days in a year.

62. Particulars Existing 15 days 30 days
A. Credit Period (days) 30 45 60
B. Annual Sales (Rs.) 500000 535000 540000
C. Levels of Receivables (on existing sales value)
[(A*5000000/360]
41667 62500 83333
D. Incremental investment on increase in Sales
(B – 500000)* (1.2/2)* A/360
- 2625 4000
E. Additional Investment in Receivables ( C – 41667) + D - 23458 45666
F. Opportunity Cost @ 20% (0.2*E) - 4692 9133
G. Incremental Contribution on additional sales @ 40% 5000 14000 16000
H. Bad Debt Losses (B* Bad Debt %) 5000 8025 9720
I. Incremental Bad Debt Losses ( H – 5000) - 3025 4720
J. Incremental Expected Profit (G – I) - 10975 11280
K, Net Gain - 6283 2147
The firm will maximize the shareholders value if it extends
its credit period by additional 15 days for the highest net gain.