Working Capital-Definition,Importance,Nature,Methods Operating Cycle Estimation of Working Capital

1. WORKING CAPITAL
MANAGEMENT
MADE BY ANKIT SINGH AND GAURAV MISHRA
CLASS :- B.COM (H)
Semester :-4

2. CONTENT
• The content of this presentation are:-
• Definition
• Importance
• Types
• Nature
• Objective
• Concepts
• Financing
• Controlling and Monitoring
• Operating cycle-Concept
• Estimation of Working Capital
A) Factors
B) Methods
C) Points
• Thank You

3. DEFINITION
• 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.
• The primary purpose of working capital management is to make sure the company always
maintains sufficient cash flow to meet its short-term operating costs and short-term debt
obligations

4. IMPORTANCE
• IMPROVED ITS HIGHER RETURN ON CAPITAL:-
Firms with lower working capital will post a higher return on capital so shareholders will benefit from a higher return
for every dollar invested in the business.
• IMPROVED CREDIT PROFILE AND SOLVENCY:-
The ability to meet short-term obligations is a pre-requisite to long-term solvency and often a good indication of
counterparty’s credit risk. Adequate working capital management will allow a business to pay on time its short-term
obligations which could include raw materials, salaries, and other operating expenses.
• HIGHER PROFITABILITY:-
The management of account payables and receivables is an important driver of small businesses’ profitability.
• HIGHER LIQUIDITY:-
A large amount of cash can be tied up in working capital, so a company managing it efficiently could benefit from
additional liquidity and be less dependent on external financing. This is especially important for smaller businesses as they
typically have a limited access to external funding sources. Also, small businesses often pay their bills in cash from earning
so an efficient working capital management will allow a business to better allocate its resources and improve its cash
management.

5. • INCREASED BUSINESS VALUE:-
Firms with more efficient working capital management will generate more free cash flows which will result in a higher
business valuation and enterprise value..
• FAVORABLE FINANCING CONDITIONS:-
A firm with a good relationship with its trade partners and paying its suppliers on time will benefit from favorable
financing terms such as discount payments from its suppliers and banking partners.
• UNINTERRUPTED PRODUCTION:-
A firm paying its suppliers on time will also benefit from a regular flow of raw materials, ensuring that the production
remains uninterrupted and clients receive their goods on time.
• ABILITY TO FACE SHOCKS AND PEAK DEMAND:-
An efficient working capital management will help a firm to survive through a crisis or ramp up production in case of
an unexpectedly large order.
• COMPETITIVE ADVANTAGE:-
Firms with an efficient supply chain will often be able to sell their products at a discount versus similar firms with
inefficient sourcing.

6. KINDS OF WORKING CAPITAL

7. BASIS OF TIME
1. Permanent Working Capital: It is otherwise called as Fixed Working Capital..
• Permanent working capital implies the base investment amount in all types of current resources which is
respected at all times to carry on business activities. The value of current assets have been increased or
decreased over a period of time. Even though, there is a need of having minimum level of current assets at
all times in order to carry on the business activities effectively.
• Features of Permanent Working Capital
a) The gross value of permanent working capital remain constant but the value of components of current
assets is differing from each other.
b) There is a positive correlation between the size of business and the amount of permanent working
capital.
c) Only long term sources of funds are used for permanent working capital.

8. PERMANENT CAPITAL IS OF TWO
TYPES
• A) Regular Working Capital: The minimum amount of working capital to be maintained in
normal condition is called Regular Working Capital.
• . B) Reserve Working Capital: It is otherwise called as Cushion Working Capital. It refers to
the short term financial arrangement made by the business units to meet uncertain changes or
to meet uncertainties. A firm is always working with the expectation of some risks which may
be controllable or uncontrollable. The reserve working capital can be used in order to meet the
uncontrollable risks and sustain in the business world

9. 2. Temporary Working Capital: It is otherwise called as Fluctuating or Variable Working
Capital. There is a close relationship prevailing between temporary working capital and the level
of production and sales. There is no uniform production and sales throughout the year. If heavy
order is received for production and there is a large amount of credit sales, there is a need of
more amount of temporary working capital. At the same time, if production is carried on in
anticipation of demand in near future, temporary working capital is required.
• In nutshell, temporary working capital is an extra working capital required to support the
changing production and sales activities

10. TEMPORARY CAPITAL IS OF TWO
TYPES
2a) Seasonal Working Capital: Some products have seasonal demand. Seasonal demand
arises due to festival. In this way, seasonal working capital.
It means an amount of working capital maintained to meet the seasonal demand of the
product
.2b) Special Working Capital: Special programmes may be conducted for business
development. The programmes may be advertisement campaign, sales promotion activities,
product development activities, marketing research activities, launching of new products,
expansion of markets and the like. Therefore, special working capital means an amount of
working capital maintained to meet the expenses of special programmes of the company.

11. 2) BASIS OF CONCEPT
1. Gross Working Capital:
Gross working capital means an amount of funds invested in the various forms of current
assets in total. Current assets are those assets which are bought in the ordinary course of business
and converted into cash within a short period which is normally one accounting year.
2. Net working Capital
Net working capital is the excess of current assets over current liabilities. Again, the net
working capital is divided into two types. They are
• Positive net working capital and
• Negative net working capital.
The positive net working capital exists, whenever the current assets exceeds current liabilities.
The negative net working capital exists whenever the current liabilities exceeds the current assets.
Current liability means a liability payable within one accounting year in the ordinary course of
business or payable out of the current assets within a short period normally one year or payable
out of the revenue income of the business.

12. ESTIMATES

16. TYPES

17. IMPORTANCE

25. CONTROLLING AND MONITORING OF
WORKING CAPITAL
• MONITORING OF MANAGEMENT OF WORKING CAPITAL Monitoring of working
capital management requires following procedure:-
1)Monitoring of components of working capital: Concerned manager should know as to
how much funds have been blocked in cash, receivables, inventory, loan and advances on daily or
weekly basis. He should also see whether funds blocked in components of the working capital are
at optimal level, are as per firm’s standard and as per industry norms. If there is any deviation, the
reasons of the same should be analysed for taking corrective measures.

26. 2.) Calculating the percentage of funds invested in working capital: In most of the
companies huge funds are invested in working capital. Manager should make equilibrium between
funds invested in fixed assets and working capital .He should know the affiliation between current
and fixed assets and any deviation in the percentages of these funds may be analysed accordingly
for taking corrective measures.
3) Recording time spent in managing of working capital: In most companies substantial
time is spent by the financial manager in managing of working capital. He should know as to how
much time is being devoted by the members of finance department in managing working capital.
This type of monitoring will assist him to propose an insight into the effective management of
working capital.

27. OPERATING CYCLE

30. OPERATING CYCLE PERIOD
• The length or time duration of the operating cycle of any firm can be defined as sum of its inventory
conversion period and receivable conversion period.
• Inventory Conversion Period:- It is the time required for the conversion of raw materials into
finished goods sale.
• In a manufacturing firm the ICP is consisting of RMCP+WPCP+FGCP
• Receivable conversion Period:- It is the time required to convert the credit sales into cash
realization.It refers to the period between occurrence of credit sales and collection from debtors.
• The total of icp+rcp=Total operating cycle period

31. FORMULA
• 1) RMCP= Average raw material /total raw material consumed *365
• 2)WPCP= Average work in progress/total cost of production*365
• 3)FGCP= Average finished goods/COGS*365
• 4) ICP= RMCP+WPCP+FGCP (1+2+3)
• 5) RCP= Average receivable/total credit sales*365
• 6) TOCP=ICP+RCP (4+5)
• 7)DP(Deferral period) = Average creditors/total credit purchase*365
• 8) NOC (Net operating cycle)= TOCP-DP (6-7)

32. PRACTICAL QUESTION
Q1) Compute Total operating cycle period and Net operating cycle? Pg no.378
Period Covered 365 DAYS
Avg period of credit allowed by
suppliers (Defferal)
16 days
Avg debtors 480
Raw material consumption 4400
Total cost of production 10000
cogs 10500
Sales 16000
Value of avg stock maintained
a) Raw material
b) Work in progress
c) Finished good
320
350
260

33. •Estimation of working
capital Management

37. ESTIMATION -METHODS
(1) Working Capital as a Percentage of Net Sales: This approach to estimate the working capital
requirement is based on the fact that the working capital for any firm is directly related to the sales volume of
that firm. So, the working capital requirement is expressed as a percentage of expected sales for a particular
period. This approach is based on the assumption that higher the sales level, the greater would be the need for
working capital. There are three steps involved in the estimation of working capital.
a) To estimate total current assets as a % of estimated net sales.
b) To estimate current liabilities as a % of estimated net sales, and
c) The difference between the two above, is the net working capital as a % of net sales.

38. • (2) Working Capital as a Percentage of Total Assets or Fixed Asset: This approach of
estimation of working capital requirement is based on the fact that the total assets of the firm
are consisting of fixed assets and current assets. On the basis of past experience, a relationship
between (i) total current assets i.e., gross working capital; or net working capital i.e. Current
assets – Current liabilities; and (ii) total fixed assets or total assets of the firm is established. The
estimation of working capital therefore, depends upon the estimation of fixed capital which
depends upon the capital budgeting decisions.
Both the above approaches to the estimation of working capital requirement are simple in
approach but difficult in calculation.

39. • (3) Working Capital based on Operating Cycle: In this approach, the working capital
estimate depends upon the operating cycle of the firm. A detailed analysis is made for each
component of working capital and estimation is made for each of these components. The
different components of working capital may be enumerable as follows:
Current Assets Current Liabilities
Cash and Bank Balance Creditors for Purchases
Inventory of Raw Material Creditors for Expenses
Inventory of Work-in-Progress
Inventory of Finished Goods
For manufacturing organisation, the following factors have to be taken into consideration while
making an estimate of working capital requirements.

40. PRACTICAL QUESTION
ON ESTIMATION ON WC
Find out the working capital requirement from the following information:- Pg no.411
Production during the year 60000 units
Selling Price rs 5 per unit
Raw material 60%
Wages 10%
Overheads 20%
Raw material storage period 2 months
Work in progress storage period 1 month
Finished goods storage period 3months
Credit allowed by supplier/customers 2/3 months
Minimum cash balance rs 20000
Wages and overhead payment 1 month