capital refers to be a part of firm’s
capital which is required for financing short
term or current assets such as cash, marketable
securities, debtors and inventories etc.
It is also known as resolving or circulating
capital or short-term capital.
It refers to the funds, which company must
posses to meet its day to day expenses.
the accountants’ perspective- It refers to
current assets-current liabilities differentials.
From the financial managers’ angle it implies
the total investment made in current assets.
From the production managers’ view it refers
to the total funds that a firm needs to carry out
its day-to-day operations.
the words of Shubin, “Working capital is the
amount of funds necessary to cost of operating
According to Genestenberg, “Circulating capital
means current assets of a company that are
changed in the ordinary course of business from
one form to another. For example, from cash to
inventories, inventories to
receivables, receivables into cash”.
There are two concepts of working capital:
(A) Balance Sheet Concept
(B) Operating cycle or Circular Flow Concept
Balance Sheet Concept
There are two interpretation of working
capital under the balance sheet concept:
Gross Working Capital
is the amount invested in total current assets of
is the firm’s investment in short term assets such as
cash, short term securities, account receivables and
The concept helps in making optimum investment in
current assets and their financing.
(ii)Net working capital
is the excess of current assets over current
Net working capital = current assets – current
Net working capital refers to the portion of firm’s
current assets, which financed with long term funds.
It indicates or measures the liquidity and also suggest
an extent to which working capital need may be
financed by the permantant source of funds.
refers to the period that a business
enterprise takes in converting cash back
In case of a manufacturing concern the duration of
time required to complete the following sequence
of events is called the operating cycle.
1. Conversion of cash into raw materials
2. Conversion of raw materials into work-in-progress
3. Conversion of work-in progress into finished goods
4. Conversion of finished goods into debtors and B/R
5. Conversion of debtors and B/R into cash
THE WORKING CAPITAL
Permanent or fixed working capital is the
minimum investment kept in the form of
inventory or raw materials, work in progress etc
to facilitate uninterrupted operation in the firm.
It also grow with the size of the firm.
It could be financed out of ling term funds.
Temporary or Variable working capital is the
amount of working capital which is required to
meet the seasonal demands and some special
exigencies. Variable working capital can be further
classified into Seasonal and Special working
The capital required to meet the seasonal needs of
the enterprise is called seasonal working capital.
Special working capital is that part of working
capital which is required to meet special
exigencies such as launching of extensive
marketing, campaign for conducting research etc.
Variable Working Capital
Permanent Working Capital
Variable Working Capital
Permanent Working Capital
Solvency of the firm.
Regular supply of raw materials.
Regular payment of salaries, wages and other
Ability to faces crisis
Excess of working capital represents idle funds
which earn no profits for the business and hence
the business cannot earn a proper rate of return
on its investments.
Low rate of return
Unnecessary purchase inventories:
Defective Credit Policy
Speculative transaction: His working capitals in
excess give rise to speculative
Lowers credit worthless
Irregularity payment of day-to- day
Low Rate of Return
Nature of the business.
Sixe of the business.
Production cycle process.
Working capital cycle
Rate of stock turnover
8. Credit Policy
9. Business Cycle
10. Rate of growth of business
11. Earning capacity and dividend policy.
12.Price level changes
13. Other factors.
Management of working capital is concerned
with the problems that arises in attempting to
manage the current assets, the current liabilities
and the inter-relationship that exists between
them. In other words it refers to all aspects of
administration of both current assets and
Working Capital Management Policies of a firm
have a great effect on its profitability, liquidity
and structural health of the organizations.
Risk, & Liquidity
PRINCIPLES OF WORKING CAPIAL MANAGEMENT
firm’s policies for managing its working
capital should be designed to achieve three
1. Adequate liquidity
2. Minimization of risk
3. Contribute to maximizing firm’s value
1.Adequate liquidity- maintain sufficient
cash to pay its bills when due.
2. Minimization of risk - matching of assets
and liabilities among current assets.
3. Contribute to maximizing firm’s value –
The investment of excess cash, minimizing of
inventories, speedy collection of receivables and elimination
of unnecessary and costly short term financing contribute to
maximizing the value of the firm
is the risk-return trade off associated with
the appropriate mix between:
Current assets and fixed assets
Short - term and long –term funds.
High level of current assets
Lower chance of technical insolvency
Higher current ratio
Minimum investment in current assets
Greater chance of technical insolvency
Lower current ratio
A compromise between the extreme
Policy C represents conservative approach
Policy A represents aggressive approach
Policy B represents a moderate approach
Optimal level of working capital investment
Risk of long-term versus short-term debt
Working capital is the fund invested in
current assets and is needed for meeting
day to day expenses .
It is an operating liquidity available to a
Along with fixed assets such as plant and
equipment, working capital is considered
a part of operating capital.
Permanent or long term or fixed working
Temporary or variable or short term
working capital requirement
Fixed working capital is that portion of the
total capital that is required to be maintained
in the business on the permanent basis or
uninterrupted basis. This working capital is
required to invest in fixed assets. The
requirement of this type of working capital is
unaffected due to the changes in the level of
Variable working capital is that portion of the
total capital that is required over and above
the fixed working capital. This working capital
is required to meet the seasonal needs and
some contingencies. The requirement of this
type of working capital changes with the
changes in the level of activity.
Permanent or fixed
5.Loans from financial
Temporary or variable
7. commercial paper
A company can issue various kinds of shares as equity
shares, preference shares and deferred shares.
According to the Companies Act, 1956 a company
cannot issue deferred shares. Preference shares carry
preferential rights in respect of dividend at a fixed rate
and in regards to the repayment of capital at the time
of the winding up the company.
A debenture is an instrument issued by the company
acknowledging its debt to its holders. The debentureholder are the creditors of the company. A fixed rate of
interest is paid on debentures. The interest of the
debentures is a charge against profit and loss account.
The debentures are giving floating charge on the assets
of the company.
Public deposits are the fixed deposits accepted by a business
enterprise directly from the public. This source of raising
short term and medium term finance was very popular in
the absence of banking facilities.
Ploughing Back of Profits
It means the reinvestments by concern of its surplus earnings
in its business. It is an internal source of finance and is most
suitable for an established firm for its expansion,
modernization and replacement etc. This method of finance
has number of advantages as it is the cheapest rather than
cost free source of finance.
from Financial Institutions
Financial Institutions such as Commercial Banks, Life
Insurance Corporation, Industrial Finance Corporation
Of India, State Financial Corporations, State Industrial
Development Corporations, Industrial Development
Bank Of India etc also provides short term, medium
term and long term loans. This source of finance is
more suitable to meet the medium term demands of
working capital. Interest is charged on such loans at a
fixed rate and the amount of loan is to be repaid by way
of installments in a number of years.
Private money lenders and other country bankers used to be
the only source of finance prior to the establishment of
commercial banks. They used to charge very high rates of
interest and exploited customers to the largest extent
Some business house get advances from their customers and
agents and this source is a short term source of finance for
them. It is a cheap source of finance in order to minimize
their investment in working capital
Trade Credit refers to the credit extended by the
suppliers of goods in the normal course of business. At
present day, commerce is built upon credit, the trade
credit arrangement of a firm with its suppliers is an
important source of short term finance. The credit
worthiness of a firm and the confidence of its suppliers
are the main basis of securing trade credit.
This is another method by which the assets are
purchased and the possession of goods is taken
immediately but the payment is made in installment
over a pre-determined period of time.
Deferred incomes are incomes received in advances
before supplying goods or services in future. These
funds increase the liquidity of a firm and constitute an
important source of short term finance.
Accrued Expenses are the expenses which have been
incurred but not yet due and hence not yet paid also.
These simply increases the liquidity that a firm has to
pay for the services already received by it.
It represents unsecured promissory notes issued by the
firm to raise short term funds. It is an important
money market instrument in advanced countries like