financial management

1. [Financial Management- Jia Dhingra]
WORKING CAPITAL MANAGEMENT
WORKING CAPITAL
The capital of a business which is used in its day-by-day trading operations, calculated as the
current assets minus the current liabilities. Working capital is also called operating assets or net
current assets. WC= CA-CL
WORKING CAPITAL MANAGEMENT
Working capital management refers to a company’s managerial accounting strategy designed to
monitor and utilize the two components of working capital, current assets and current liabilities,
to ensure the most financially efficient operation of the company.
GROSS WORKING CAPITAL (GWC)
Current assets in the balance sheet of a company are known as gross working capital. Current
assets are those short-term assets which can be converted into cash within a period of one year.
The grey area in the management of current assets or gross working capital is its unpredictability
i.e. it is very difficult to ascertain the exact time of conversion of such assets. Why is such a
nature problematic? It is because the liabilities occur at their time and do not wait for our current
asset to realize. This mismatch or the gap creates a need for arranging working capital financing.
NET WORKING CAPITAL (NWC)
Net working capital is a very frequently used term. There are two ways to understand networking
capital. First, one says it is simply the difference between current assets and the current liabilities
on the balance sheet of a business. The other understanding discloses little deeper or hidden
meaning of the term. As per that, NWC is that part of current assets which are indirectly financed

2. [Financial Management- Jia Dhingra]
by long-term assets. Compared to gross working capital, net working capital is considered more
relevant for effective working capital financing and management.
PERMANENT / FIXED WORKING CAPITAL
Dealing with current asset and fixed assets is totally different. Determining the financing
requirement in the case of fixed assets is simply the cost of the asset. Same is not true for current
assets because the value of current assets is constantly changing and it is difficult to accurately
forecast that value at any point in time. To simplify the complexity to some extent, on the basis
of past trend and experience, we can find a level below which current asset has never gone.
1. Regular Working Capital: It is the permanent working capital which is normally required
in the normal course of business for the working capital cycle to flow smoothly.
2. Reserve Working Capital: It is the working capital available over and above the regular
working capital. It is kept for contingencies which may arise due to unexpected
situations.
TEMPORARY / VARIABLE WORKING CAPITAL
Temporary working capital is easy to understand after getting hold over the permanent working
capital. In simple terms, it is the difference between net working capital and permanent working
capital. The main characteristic which can be made out of the example is “fluctuation”. The
temporary working capital, therefore, cannot be forecasted. In the interest of measurability, this
can be further bifurcated as below which can create at least some base to forecast.
1. Seasonal Working Capital: Seasonal working capital is that temporary increase in
working capital which is caused due to some relevant season for the business. It is
applicable to businesses having the impact of seasons, for example, the manufacturer of
sweaters for whom relevant season is the winters. Normally, their working capital
requirement would increase in that season due to higher sales in that period and then go
down as the collection from debtors is more than sales.
2. Special Working Capital: Special working capital is that rise in the temporary working
capital which occurs due to a special event which otherwise normally does not take place.
It has no basis to forecast and has rare occurrence normally. For example, a country
where Olympic Games are held, all the business require extra working capital due to a
sudden rise in business activity.

3. [Financial Management- Jia Dhingra]
NEED OF WORKING CAPITAL MANAGEMENT
1. Inventory Management-
What is inventory? Inventory refers to those goods which are held for eventual sale by the
business enterprise. In other words, inventories are stocks of the product a firm is manufacturing
for sale and components that make up the product. Thus, inventories form a link between the
production and sale of the product.
The forms of inventories existing in a manufacturing enterprise can be classified into three
categories:
(i) Raw Materials:
These are those goods which have been purchased and stored for future productions. These are
the goods which have not yet been committed to production at all.
(ii) Work-in-Progress:
These are the goods which have been committed to production but the finished goods have not
yet been produced. In other words, work-in-progress inventories refer to ‘semi-manufactured
products.’
(iii) Finished Goods:
These are the goods after production process is complete. Say, these are final products of the
production process ready for sale. In case of a wholesaler or retailer, inventories are generally
referred to as ‘merchandise inventory’.
2. Cash Management
In the real world, organizations have strict cash management controls to monitor its inflows and
outflows while retaining a sufficient amount in order to take advantage of attractive investments
or handle unforeseen liabilities. Efficient management of cash prevents loss of money due to
theft or error in processing transactions. Numerous best practices are adopted to enhance
management of company’s funds.This involves shortening of cash collection periods, regular
follow ups for collections, negotiation of favorable terms with suppliers allowing delay in
payment periods, and preparation of cash flow forecasts. Businesses also use of technology to
speed up cash collection process. They must do all of this while maintaining adequate amount of
funds to meet daily operations.
The cash is required for 3 motives:
• Transaction Motive: to pay for goods or services. It is useful for conducting everyday
transactions or purchases.
• Precautionary Motive: it's a relatively safe investment. ...
• Asset or Speculative Motive: it can provide a return to their holders.

4. [Financial Management- Jia Dhingra]
3. Receivables Management
A sale is realized as and when the invoice is generated but usually, a time period is provided to
the customers for the payment of the amount due. This practice of conducting business on credit
terms gives rise to Accounts Receivable (AR) in the financial statements. This credit facility is
laid down to ensure a smooth flow of the working capital into the businesses. There are
complexities involved with the accounts receivable i.e its management, the process of recording
in financial statements, credit period etc. Let’s discuss briefly on all the terms connected to
Accounts Receivable.
Accounts receivable management is the process of ensuring that customers pay their dues on
time. It helps the businesses to prevent themselves from running out of working capital at any
point of time. It also prevents overdue payment or non-payment of the pending amounts of the
customers. It builds the businesses financial and liquidity position. A good receivable
management contributes to the profitability by reducing the risk of any bad debts. Management
is not only about reminding the customers and collecting the money on time. It also involves
identifying the reasons for such delays and finding a solution to those issues.
WORKING CAPITAL CYCLE / OPERATING CYCLE
Working capital is also called a circulating capital or revolving capital. That is the money/capital
which circulates in various forms of current assets in a continued manner. For example, at a point
of time, funds may be tied up in raw materials, then later converted into semi-finished products,
then into finished/ final products and when these finished products are sold, it is converted either
into account receivables or cash.
This cash is reinvested in current assets. Thus, the amount always keeps on circulating or
revolving from cash to current assets and back again to cash. That is why some people prefer to
use the term liquidity management instead of working capital management. Although this
circulation takes place at short intervals, the money is required again and again.
The American Institute of Certified Public Accountants defined the operating cycle as: “the
average time intervening between the acquisition of material or services entering the process and
the final cash realization.”
According to I. M. Pandey, “Operating cycle is the time duration involved in the acquisition of
resources, conversion of raw materials into work- in-process into finished goods, conversion of
finished goods into sales and collection of sales.”
Thus, operating cycle of a manufacturing enterprise involves three phases:
1. Acquisition of resources such as raw material, labour, power and fuel etc.
2. Manufacture of the product which includes conversion of raw material into work-in-
progress into finished goods.

5. [Financial Management- Jia Dhingra]
3. Sale of the product either for cash or on credit. Credit sales create account receivable for
collection.
The operating cycle or circulation flow of money can best be projected in the following manner:
FACTORS AFFECTING WORKING CAPITAL OR DETERMINANTS OF WORKING
CAPITAL
Requirements Of working capital depend upon various factors such as nature of business, size of
business, the flow of business activities. However, small organization relatively needs lesser
working capital than the big business organization. Following are the factors which affect the
working capital of a firm:
1. Size of business
The requirement of working capital depends on the nature of business. The nature of business is
usually of two types: Manufacturing Business and Trading Business. In the case of
manufacturing business, it takes a lot of time in converting raw material into finished goods.
Therefore, capital remains invested for a long time in raw material, semi-finished goods and the
stocking of the finished goods. Working capital requirement of a firm is directly influenced by
the size of its business operation. Big business organizations require more working capital than
the small business organization. Therefore, the size of organization is one of the major
determinants of working capital. Consequently, more working capital is required. On the
contrary, in case of trading business the goods are sold immediately after purchasing or
sometimes the sale is affected even before the purchase itself. Therefore, very little working
capital is required. Moreover, in case of service businesses, the working capital is almost nil
since there is nothing in stock.
2. Nature of Business
Working capital requirement depends upon the nature of business carried by the firm. Normally,
manufacturing industries and trading organizations need more working capital than in the service
business organizations. A service sector does not require any amount of stock of goods. In
service enterprises, there are less credit transactions. But in the manufacturing or trading firm,
credit sales and advance related transactions are in large amount. So, they need more working
capital.

6. [Financial Management- Jia Dhingra]
3.Storage time or processing period
Time needed for keeping the stock in store is called storage period. The amount of working
capital is influenced by the storage period. If storage period is high, a firm should keep more
quantity of goods in store and hence requires more working capital. Similarly, if the processing
time is more, then more stock of goods must be held in store as work-in-progress.
4.Credit Period
Credit period allowed to customers is also one of the major factors which influence the
requirement of working capital. Longer credit period requires more investment in debtors and
hence more working capital is needed. But, the firm which allows less credit period to
customers’ needs less working capital.
5.Seasonal requirement
In certain business, raw material is not available throughout the year. Such business
organizations have to buy raw material in bulk during the season to ensure an uninterrupted flow
and process them during the entire year. Thus, a huge amount is blocked in the form of raw
material inventories which gives rise to more working capital requirements.
6.Potential growth or expansion of business
If the business is to be extended in future, more working capital is required. More amount of
Working capital is required to meet the expansion need of business.
7.Changes in price level
Change in price level also affects the working capital requirements. Generally, the rise in price
will require the firm to maintain large amount of working capital as more funds will be required
to maintain the sale level of current assets.
8.Dividend Policy
The dividend policy of the firm is an important determinant of working capital. The need for
working capital can be met with the retained earnings.
If a firm retains more profit and distributes lower amount of dividend, it needs less working
capital.
9.Access to money market
If a firm has good access to capital market, it can raise loan from bank and financial institutions.
It results in minimization of need of working capital.
10.Working capital cycle
When the working capital cycle of a firm is long, it will require larger amount of working
capital. But, if working capital cycle is short, it will need less working capital.
11.Operating efficiency
The operating efficiency of a firm also affects the firm's need of working capital. The operating
efficiency of the firm results in optimum utilization of assets. The optimum utilization of assets
in turn results in more fund release for working capital.
12. Scale of Operation
There is a direct link between the working capital and the scale of operations. In other words,
more working capital is required in case of big organisations while less working capital is needed
in case of small organizations.

7. [Financial Management- Jia Dhingra]
13. Business Cycle
The need for the working capital is affected by various stages of the business cycle. During the
boom period, the demand of a product increases and sales also increase. Therefore, more
working capital is needed. On the contrary, during the period of depression, the demand declines
and it affects both the production and sales of goods. Therefore, in such a situation less working
capital is required.
14. Seasonal Factors
Some goods are demanded throughout the year while others have seasonal demand. Goods which
have uniform demand the whole year their production and sale are continuous. Consequently,
such enterprises need little working capital. On the other hand, some goods have seasonal
demand but the same are produced almost the whole year so that their supply is available readily
when demanded. Such enterprises have to maintain large stocks of raw material and finished
products and so they need large amount of working capital for this purpose. Woolen mills are a
good example of it.
15. Production Cycle
Production cycle means the time involved in converting raw material into finished product. The
longer this period, the more will be the time for which the capital remains blocked in raw
material and semi-manufactured products. Thus, more working capital will be needed. On the
contrary, where period of production cycle is little, less working capital will be needed.
16. Credit Allowed
Those enterprises which sell goods on cash payment basis need little working capital but those
who provide credit facilities to the customers need more working capital.
17. Credit Availed
If raw material and other inputs are easily available on credit, less working capital is needed. On
the contrary, if these things are not available on credit then to make cash payment quickly large
amount of working capital will be needed.
18. Operating Efficiency
Operating efficiency means efficiently completing the various business operations. Operating
efficiency of every organization happens to be different. Some such examples are:
(i) converting raw material into finished goods at the earliest,
(ii) selling the finished goods quickly, and
(iii) quickly getting payments from the debtors. A company which has a better operating
efficiency has to invest less in stock and the debtors. Therefore, it requires less working
capital, while the case is different in respect of companies with less operating efficiency.
19. Availability of Raw Material
Availability of raw material also influences the amount of working capital. If the enterprise
makes use of such raw material which is available easily throughout the year, then less working
capital will be required, because there will be no need to stock it in large quantity. On the
contrary, if the enterprise makes use of such raw material which is available only in some
particular months of the year whereas for continuous production it is needed all the year round,
then large quantity of it will be stocked. Under the circumstances, more working capital will be
required.

8. [Financial Management- Jia Dhingra]
20. Growth Prospects
Growth means the development of the scale of business operations (production, sales, etc.). The
organisations which have sufficient possibilities of growth require more working capital, while
the case is different in respect of companies with less growth prospects.
21. Level of Competition
High level of competition increases the need for more working capital. In order to face
competition, more stock is required for quick delivery and credit facility for a long period has to
be made available.
22. Inflation
Inflation means rise in prices. In such a situation, more capital is required than before in order to
maintain the previous scale of production and sales. Therefore, with the increasing rate of
inflation, there is a corresponding increase in the working capital.