This document discusses principles of working capital management including concepts, needs, determinants, issues, and estimation of working capital requirements. It defines working capital as the amount of funds required to meet day-to-day expenses and finance short-term assets like cash, receivables, and inventory. The document outlines methods for estimating working capital needs including the operating cycle method and estimating components of working capital. It also discusses sources of working capital including trade credit, bank finance, retained earnings, and various debt and equity instruments.

1. AISHWARYA .P
ASSISTANT PROFESSOR
MAHER
1

2. 2
Principles of working capital
Concepts, Needs, Determinants, issues and estimation
of working capital
Accounts Receivables Management and factoring
Inventory management
Cash management
Working capital finance : Trade credit, Bank finance and
Commercial paper

3. 3
Firm needs to survive short term, in order to make
profit in long term.
Meaning of Working capital:
Amount of funds required for meeting day to day
expenses of the business.
Part of firm’s capital which is required for financing
short term or current assets such as cash,
marketable securities, debtors and inventories

4. Funds in current assets – revolving fast and
are constantly converted into cash and back
into asset.
4
Also known as revolving or circulatingor
short term capital

5. 5
Shubin : Working Capital is a part of capital
which is required to purchase
materials and for meeting day
expenditure on salaries, wages,
of raw
to day
rent and
advertisement etc.,
C.W. Gerstenberg: Working Capital is the
excess of current assets over current

6. Contd…
6
1. Gross concept: amount of funds invested in current
assets that are employed in the firm.
Current assets and working capital both used
interchangeably
Current assets: refers to those assets which can be
converted into cash in hand within a short period (one
accounting year)

7. Contd…
7
includes cash in hand, with banks, stock
finished, work in progress, receivables, sale
merchandise, marketable securities, prepaid
expenses and accrued income

8. 8
Net working capital = current assets – current
liabilities
Current liabilities includes: claims of outsiders
expected to mature within one accounting
period Contd…

9.  Current liabilities includes: sundry
creditors, bills payable, bank overdraft,
outstanding expenses , short term loans,
advances and deposits and etc.,
9
When current assets exceeds current liability – it
is positive working capital
When current liabilities exceeds current assets – it
is negative working capital

10. 10
Working capital
SpecialSeasonal
Temporary or variable/
fluctuating
Permanent or
fixed
Reserve Margin
(cushion)Regular

11. 11
Amount of funds required to produce goods and
services
Tandon Committee named it as “Core current
Assets”
Such capital is constantly changing from one
asset to another asset without leaving business
process and doesn't change over the time
period.

12. 1. REGULAR WORKING CAPITAL
Regular working capital is the
minimum amount of liquid capital
needed to keep up the circulation of the
capital from cash to inventories to
receivable and again to cash.
12

13. 2. RESERVEMARGIN/ CUSHION WORKING
CAPITAL
Reserve working capital is the excess over
the need for regular working capital
For contingencies that arise at unstated
period
Contingencies such as price rise, business
depression, war condition, strike, fire and
severe competition 13

14. FEATURES OF PERMANENT WORKING CAPITAL
Classified on the basis of timefactor
Constantly changes from one assetto
another asset
Size increases with the growth ofbusiness
Should be financed out of long termfunds
14

15. TEMPORARY WORKING CAPITAL
Working capital over and above
permanent working capital and is
dependent on factors like peak season,
trade cycle, boom and etc,.
15

16. Additional amount of capital asset
(cash, receivables and inventory)
required during the most active
business seasons of the year.
16

17. Required for financing special
operations
It is not always gainful
17
SPECIAL WORKING CAPITAL

18. 18
Working capital supply adequate funds
1. To equip raw materials (production)
2. Cash to meet wage bills
3. Capacity to wait for market for its finished
products
4. The ability to grant credit to its customers

19. 19
1. Cash discount
2. Sense of security and confidence
3. Credit worthiness
4. Continuous supply of raw materials
5. Exploitation of good opportunities
6. Increase in productivity
7. Attractive dividend
8. Meeting unforeseen contingencies

20. 20
1. Inefficient Management
2. Increased capital expenditure
3. Over capitalization
4. Lower return on capital employed
5. Misapplication of funds
6. Destruction of turnover ratios
7. Liquidity Vs profitability

21. 21
1. Nature of business
2. Length of production
cycle
3. Rate of stock turnover
4. Business cycle
5. Earning capacity and
dividend policy
6. Operating cycle
7. Operating efficiencies
8. Price level changes
9. Degree of
mechanization
10. Growth and expansion
of business
 Contd…

22. 11. Seasonal variations
12.Capital structure of
firm
13. Credit policy
14. Size of the business
15. Production policy
22
16. Profit margin
17. Liquidity Vs
profitability
18. Capacity to repay
19. Value of current
assets
20. Means of transport
and communication

23. 23
Working capital management – administration of all
aspects of current assets and current liabilities
Working capital management – excessive working
capital or inadequate working capital – both are
equally dangerous
Good working capital management ensures – higher
profitability, proper liquidity and sound structural
health of the organization.

24. Two functions of finance manager in
working capital management:
1. Forecasting the working capital
requirements
2. Finding the sources of working capital
24

25. I. FORECASTING THE WORKING CAPITAL
REQUIREMENT S
25
There are
forecast
two methods adopted to
the working capital
requirements
1. Operating cycle method
2. Estimation of components of
working capital method

26. 26
Cash
Raw
material
Debtors
Work in
progress
Finished
goods Finished
goods
Cash
Debtors
Operating cycle of
Manufacturing
firm
Operating cycle of Trading
firm
Contd…

27. 27
Operating cycle length differs from one firm to
another. More the length of operating cycle,
then more the risk of working capital
inadequacy

28. 1. Surplus generation of funds
2. Funds rotation
3. Going concern
28
SIGNIFICANCE OF OPERATING CYCLE

29. 29
Days
Raw materials storage period xx
Add: WIP holding period xx
Finished goods holding period xx
Debtors collected period xx
Less : creditors payment period xx
Net operating cycle period xx

30. 30
1. Raw material storage period = (Average stock of raw materials / cost
of raw materials consumed) * 365
2. Work in progress holding period = (Average stock of work in
progress/ Cost of Work in progress consumed)* 365
3. Finished holding period = (Average stock of finished goods/ cost of
goods sold) * 365
4. Debtors collection period = (Average accounts receivable/ credit
sales) * 365
5. Creditors payment period = (Average accounts payable/credit
purchases) * 365

31. 31
Computation of components of operating cycle period:
Raw material holding period = (Average stock of raw materials / Raw material
consumption) * 365
= (3,20,000/44,00,000)*365 = 27 days
Work in progress holding period = (Average WIP stock/WIP consumption) *365
= (3,50,000/1,00,00,000) *365 = 13 days
Finished goods holding period = (Average finished goods/ Finished goods
consumption ) * 365
= (2,60,000/1,05,00,000) * 365 = 9 days
Debtors collection period = (Average debtors/sales) * 365
= (4,80,000/1,60,00,000) * 365 = 11 days
Creditors payment period = 16 days

32. 32
Compute the operating cycle in days from the following
information extracted from the books of a manufacturing
company.
Period covered: 365 days
1. Average total of debtors = Rs. 4,80,000
2. Average cost of raw materials = Rs. 44,00,000
3. Average WIP consumed = Rs. 1,00,00,000
4. Average cost of goods sold = Rs. 1,05,00,000
5. Average raw material stock = Rs. 3,20,000
6. Average WIP stock = Rs. 3,50,000
7. Average Finished goods in stock = Rs. 2,60,000
8. Total sales of the year = 1,60,00,000
9. Credit allowed by suppliers = 16 days

33. 33
1. Raw material holding period = 27
2. Add: WIP holding period = 13
3. Add: Finished goods holding = 9
period
= 11
= 16
4. Add: Debtors collection
5.Less: creditors payment
Net operating cycle period = 44 days

34. II. ESTIMATION OF COMPONENTSOF WORKING
CAPITAL METHOD
Working capital can be estimated by working
out different constituents of current assets
and current liabilities.
2 components of estimation 1. current assets
2. current liabilities
34

35. 35
a. Stock of raw materials = [ estimated production
* estimated cost of RM/unit]*Average RM
holding period/365
b. Stock of finished goods = [estimated
production * estimated cost of production/unit] *
average holding period of finished goods/365
Contd…

36. =
[estimated production * estimated cost of Work in
progress]* average WIP holding period/365
xxx
Add: Labor
[estimated production * estimated cost of labor in
progress]* average WIP holding period/365 * 1/2 =
xxx
Add: overheads
[estimated production * estimated cost of overheads]*
average WIP holding period/365*1/2
xxx
=
36
Contd…

37. 37
D, Trade debtors = [estimated credit
sales*cost of sales/units]* debt collection
period

38. 38
a. Trade creditors = [estimated production (units)* cost of raw
material/ unit] * average payment period/ 365
b. Outstanding expenses:
Outstanding wages = [estimated production(units) * Direct labor] *
average time lag in payment of wages/365
Outstanding overheads = [estimated production (units)*
overheads/unit] * average time lag of payment of OH/365
Note: In case of selling overheads, the relevant item would be
sales volume instead of production volume

39. 39
Working capital = current assets – current
liabilities + contingencies
Current assets Rs.
1. Stock :
Raw materials xxx
WIP: RM (100%) xxx
WIP (50%) xxx
Overheads (50%) xxx
Finished goods xxx
2. Trade debtors xxx
3. Cash balance xxx
Total current assets xxx
Contd…

40. Less : current liabilities
1. trade creditors xxx
2. outstanding wages xxx
3. outstanding OH xxx
Net working capital (CA-CL)
Add: provision for
contingencies xxx
Working capital required xxx
40

41. 41
Long term sources
1. Issue of equity shares
2. Issue of preference shares
3. Issue of bonds / debentures
4. Retained earnings
5. Loans from financial institutions

42. 42
2. Provision for taxation
3. Outstanding expenses
External sources:
Internal sources: 1. Trade credit
1. Depreciation fund 2. Commercial paper
3. Advances from
customers
4. Bank credit

43. 43
- Also called as “working capital ratio” Contd…
Ratio analysis – tool of financial analysis of working capital
1. Current ratio = current assets/ current liabilities
Current assets = stocks + debtors + cash in hand + cash in
bank + bills receivable + prepaid expenses + accrued
income
Current liabilities = creditors + bills payable + bank OD +
outstanding expenses + income received in advance

44. 44
Contd…
Quick ratio = liquid assets/current liabilities
Liquid assets = current assets – stock –
prepaid expenses
Ratio between quick assets and current
liabilities – also known as “Acid test ratio or
liquid ratio”

45. 1. Cash ratio = (cash in hand + cash in bank + marketable
securities) / current liabilities
It is the measure of liquidity – otherwise called as
“Absolute liquidity ratio”
2. Debtors Turnover ratio = net credit sales/average
account receivable
- Measures no. of times receivable rotated in a year
- Measures efficiency of credit collection and credit policy
Contd…
45

46. 3. Creditors turnover ratio = net credit
purchases/average accounts payable
- Measures payment of firm on time
4. Stock turnover ratio = cost of goods
sold/average stock
Average stock = opening stock + closing stock/2
Cost of goods sold = sales – gross profit
- Measures how quick stock converted into sales
Contd…
46

47. 5. Working capital turnover = cost of goods sold
per sales/ net working capital
- Indicates no. of times working capital converted
into sales
6. Current assets turnover = sales/current assets
- Measures how effective management is in
controlling the current asset.
47

48. 48
Cash is the beginning and end of one cash
accounting cycle.
Keeping excessive cash will reduce the
profitability and at the same time inadequate
cash will results in dangerous situation.
Optimum cash balance required for smooth
running of business.

49.  Refers to legal mediumexchange
 May be coins, notes, cheques, drafts,
saving deposits, postal orders and bank
deposits
 Cash management – balancing between
the liquidity and profitability
49

50. OBJECTIVES OF CASH MANAGEMENT
1. To make payment according to
payment schedule
2. To minimize cash balance
50

51. 51
A cash budget shows the cash inflows
and outflows expected in a budget period
and net effect of these flows on cash
balances

52. 52
1. Indicates effect on the cash position – seasonal requirements,
large inventories, unusual receipts and payments.
2. Cash need for expansion project
3. Additional funds taken from external sources
4. Indicates the availability of cash
5. Helps in planning of liquidity and investment
6. Shows the excess availability of funds for long and short term
investments

53. 53
1. Receipts and payments method
2. Adjusted profit and loss method
3. Balance sheet method

54. 54
All expected cash receipts from various sources cash
sales, cash collected from debtors, dividends, bonds
and etc.,
Added to opening cash balance
Then the
purchases,
expected cash payments such as
payment to creditors, payment of
expenses, dividends, taxes and etc., were deducted
Contd…

55. 55
Particulars April
month
(Rs.)
Estimated cash opening balance Xxx
Add: Estimated cash receipts:
1. Cash sales
Xxx
2. Collection from debtors Xxx
3. Sale of assets Xxx
4. Dividends Xxx
5. Interest on bonds Xxx`
6. Other receipts Xxx
Total receipts (A) Xxx

56. Less: Estimated cash payments
1. Cash purchases
Xxx
2. Payment to creditors Xxx
3. Payment to expenses Xxx
4. Purchase of fixed assets Xxx
5. Other payments Xxx
Total payments (B) Xxx
Estimated cash balance (A-B) xxx
56

57. 57
Profit and loss account is added with
many non cash fictious assets and
liabilities. These are deducted or added
from P&L accounts and which gives
adjusted P&L method .

58. 58
In this method, the cash flows are found out
by balance sheet prepared at the end of the
year.
Defects in this method are 1. ignores income
and expense 2. cash position known after
balance sheet prepared.

59.  Receipts of cash speed up and the
cash receipts ensured by two
collection process:
1. Concentration banking –
make bank to accept
payment
2. Lock box system – nearest 59

60. 60
Objective to maintain optimum cash balance
2 categories of estimating optimal cash
balance
1. Inventory type model
2. Stochastic model

61. 61
Developed by William J. Baumol
Formula, C = root of (2.A.F)/O
Here, C= Optimum cash balance;A=Annual
cash requirement; F=Fixed conversion
cost/transaction; O=Opportunity cost of
holding cash

62. 62
Miller-Orr cash management model
Formula, Z = 3 root of (3.b.σ 2)/4 I
Here, b= fixed cost/ selling marketable securities
to cash
σ 2 = variance of daily/monthly changes in
expected cash balance
i = daily / monthly interest rate

63. 63
Refers to the length of time between the
payment for purchase of raw materials and
the receipt of sales revenue
Cash cycle = Average age of inventory +
average age of receivable – average age of
payment

64. 64
Refers to no. of times between the payment of
raw materials and the receipt of sales
revenue
- Completion of cash cycle
Cash turnover = no. of days in operating period
/ Duration of cash cycle (in days)

65. 65
Receivables – major components of working
capital
Sales credit – increases the volume of sale
Investment in receivables – 5 to 10% for
manufacturing firms, and 20-25% for trading
firms

66. 66
Refers to all the sum of cash owned to firm by
the customers arising from the sales of
goods.
Asset side of balance sheet contains debtors,
accounts receivable, trade receivable

67. 67
Process of taking decisions regarding the
amount of investment in receivables
Higher the receivables; higher sales ; higher
bad debts, interest rate and collection cost.
Lower the receivables; lower sales;
opportunity cost; loss of customers; lower
bad debts

68. 68
1. Increase in sales
2. Increase in profits
3. Meeting competition

69. 1. Capital cost – cost incurred to pay the outsider
2. Administrative cost – cost incurred for
maintaining the customer accounts
3. Collection cost – cost of expenses for
collecting credit back from customers
4. Defaulting cost – cost incurred for taking
serious steps in collecting from defaulting customers
69

70. ASPECTS OF MANAGEMENTOF RECEIVABLES
3 aspects are:
1. Credit policy
2. Credit analysis
3. Control of receivables
70

71. 71
Criteria/standard set by thecompany
- If below standard, then lenient credit policy
followed.
- If above the standard, then tight credit policy
is followed
Contd…

72. 1. In liberal/lenient credit policy – high
collection cost; increased average collection
period; high bad debts and high sales
72
2. In restrictive credit policy – low collection
cost; decreased average collection period;
low bad debts and low credit sales

73. 73
- Terms and conditions of credit sales.
Two components are 1. credit period 2. cash
discount
1. Credit period – duration of time period,
credit extended
2. Cash discount – discounts offered to
creditors and induce the prompt payment

74. 74
- Rate the various customers who seek credit
facility
-Credit worthiness of the project
Sources of credit information:
1. Published information 2. Bank references
3. Trade references 4. Salesman’s interview
5. Report from the agencies 6. Past

75. 75
Grant
Pay probability 0.9
Rs. 60,000
Rs. 40,000
Does not pay probability 0.1
Do not Grant

76. 76
1. Degree of collection efforts
2. Type of collection efforts

77. 77
be monitored
the revenue of
Receivables have to
continuously to ensure
collection efforts
1. Average collection period
2. Ageing schedule

78. 78
- Risk reduced considerably by holding
inventory
Meaning of inventory:
1. Refers to the stock pile of the product
2. Composed of assets that will be sold off in
the course of business operation.

79. 79
According to International Accounting
Standards committee
Inventory is a tangible property
a. Held for sale in ordinary course of business
b. In the process of production of such sale (Or)
c. To be consumed in the production of goods or
services for sale

80. 80
1. Raw material
2. Purchased parts
3. Work in progress
4. Finished goods
5. Supplies

81. 81
1. Transaction motive: smooth and uninterrupted
production and sale operations
2. Precaution motive: the firm may like to hold them to
guard against risk of unpredictable changes in
demand and supply forces
motive: price advantage for bulk
or anticipated price rise risk in near
3. Speculative
purchasing
future

82. 82
1. Avoiding loss of sales
2. Gaining quality discount
3. Reducing ordering cost
4. Achieve efficient production runs
5. Reducing risk of production shortages

83. 83
Focuses on determining and maintaining an
optimum level of inventory in the firm
It minimizes the procurement cost and
maintaining the optimum inventory level

84. TECHNIQUES OF INVENTORYMANAGEMENT
84
1. Economic order
quantity (EOQ)
2. Determination of
stock levels
3. ABC analysis
4. Inventory turnover
ratio
5. JIT (Just in time)
inventory system
6. VED analysis
7. FSN analysis
8. Min-Max method
9. Perpetual inventory
system
10. Automatic order
system

85. 85