Working capital refers to the capital required to finance short-term assets like cash, inventory, and accounts receivable. It is needed to ensure a company has enough liquidity to operate day-to-day and take advantage of opportunities. There are two main concepts of working capital - the balance sheet approach looks at it as current assets minus current liabilities, while the operating cycle approach sees it revolving as assets are purchased, produced as inventory, and sold to generate receivables. Proper management of working capital is important, as too much can be unprofitable while too little can threaten solvency. Forecasting working capital needs considers factors like production costs, credit terms, and cash requirements.

1. Working Capital capital Management
and Finance - I

2. Working capital
Introduction
Working capital typically means the firm’s holding of current
or short-term assets such as cash, receivables, inventory and
marketable securities.
These items are also referred to as circulating capital
Corporate executives devote a considerable amount of
attention to the management of working capital.

3. Definition
Working Capital refers to that part of the firm’s capital, which isWorking Capital refers to that part of the firm’s capital, which is
required for financing short-term or current assets such a cashrequired for financing short-term or current assets such a cash
marketable securities, debtors and inventories. Funds thus,marketable securities, debtors and inventories. Funds thus,
invested in current assets keep revolving fast and are constantlyinvested in current assets keep revolving fast and are constantly
converted into cash and this cash flow out again in exchange forconverted into cash and this cash flow out again in exchange for
other current assets. Working Capital is also known asother current assets. Working Capital is also known as revolvingrevolving
or circulating capital or short-term capital.or circulating capital or short-term capital.

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. GROSS WORKING CAPITAL
b. NET WORKING CAPITAL

5. GROSS WORKING CAPITAL
Funds invested in current assets
Constituents of Current assets
1. Cash in hand and bank balance
2. Bill receivables
3. Sundry debtors
4. Short term loans and advances
5. Inventories
a) Raw material
b) Work-in-progress
c) Stores and spares
d) Finished goods
6. Temporary investment of surplus funds
7. Prepaid expenses
8. Accrued incomes

6. NET WORKING CAPITAL
CURRENT ASSETS – CURRENT LIABILITIES
Constituents of current liabilities
1. Bills payable
2. Sundry creditors
3. Accrued expenses
4. Short term loans, advances and deposits
5. Dividends payable
6. Bank overdraft

7. 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.

8. “ 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”
…………
GenestenbregGenestenbreg

9. OPERATING CYCLE OR CIRCULAR FLOW
CONCEPT

10. The firm has to maintain cash balance to pay the bills as they come
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.

11. TYPES 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

12. Difference between permanent & temporaryDifference between permanent & temporary
working capitalworking capital
Amount Variable Working CapitalAmount Variable Working Capital
ofof
WorkingWorking
CapitalCapital
Permanent Working CapitalPermanent Working Capital
TimeTime

13. Variable Working Capital
Amount
of
Working
Capital
Permanent Working Capital
Time

14. Importance or advantages of adequate
working capital
Solvency of the business
Goodwill
Easy loans
Cash discounts
Regular supply of raw material
Regular payment of salaries, wages and other day to day
commitments
Exploitation of favorable market conditions
Ability to face crisis
Quick and regular return on investment
High morale

15. FACTORS DETERMINING WORKING CAPITAL
Nature of the Business
Size of business
Production policy
Length of production cycle
Seasonal variations
Working capital cycle
Rate of stock turnover
Credit policy
Business cycles
Rate of growth of business
Earning capacity and dividend policy
Price level changes
Other factors

16. Working capital investment
The size and nature of investment in current assets is a
function of different factors such as type of products
manufactured, the length of operating cycle, the sales level,
inventory policies, unexpected demand and unanticipated
delays in obtaining new inventories, credit policies and
current assets.

17. Three alternative working capital investment
policies
Sales ($)
CurrentAssets($)
Policy C
Policy A
Policy B

18. 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

19. Financing needs over time
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
$

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

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

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

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

24. Disadvantages of Redundant or Excess WorkingDisadvantages of Redundant or Excess Working
CapitalCapital
 Idle funds, non-profitable for business, poor Idle funds, non-profitable for business, poor
ROIROI
 Unnecessary purchasing & accumulation of Unnecessary purchasing & accumulation of
inventories over required levelinventories over required level
 Excessive debtors and defective credit Excessive debtors and defective credit
policy, higher incidence of B/D.policy, higher incidence of B/D.
Overall inefficiency in the organization.Overall inefficiency in the organization.
When there is excessive working capital,When there is excessive working capital,
Credit worthiness suffersCredit worthiness suffers
 Due to low rate of return on investments, Due to low rate of return on investments,
the market value of shares may fallthe market value of shares may fall

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

26. FORECASTING / ESTIMATION OF WORKING CAPITALFORECASTING / ESTIMATION OF WORKING CAPITAL
REQUIREMENTSREQUIREMENTS
Factors to be consideredFactors to be considered
 Total costs incurred onTotal costs incurred on materials, wages and overheadsmaterials, wages and overheads
 TheThe length of timelength of time for which raw materials remain in stores before theyfor which raw materials remain in stores before they
are issued to production.are issued to production.
 The length of the production cycle or WIP, i.e.,The length of the production cycle or WIP, i.e., the time taken forthe time taken for
conversion of RM into FG.conversion of RM into FG.
 TheThe length of the Sales Cyclelength of the Sales Cycle during which FG are to be kept waiting forduring which FG are to be kept waiting for
sales.sales.
 The average period ofThe average period of credit allowed to customers.credit allowed to customers.
 TheThe amount of cash required to pay day-to-day expenses of the business.amount of cash required to pay day-to-day expenses of the business.
 TheThe amount of cash required for advance payments if any.amount of cash required for advance payments if any.
 The average period ofThe average period of credit to be allowed by suppliers.credit to be allowed by suppliers.
 Time – lag in the payment of wages and other overheadsTime – lag in the payment of wages and other overheads

27. PROFORMA - WORKING CAPTIAL ESTIMATESPROFORMA - WORKING CAPTIAL ESTIMATES
1. TRADING CONCERN1. 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
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

28. Points to be remembered while estimating WCPoints to be remembered while estimating WC
 (1) Profits should be ignored while calculating working capital(1) Profits should be ignored while calculating working capital
requirements for the following reasons.requirements for the following reasons.
 (a) Profits may or may not be used as working capital(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,(b) Even if it is used, it may be reduced by the amount of Income tax,
Drawings, Dividend paid etc.Drawings, Dividend paid etc.
 (2) Calculation of WIP depends on the degree of completion as regards(2) Calculation of WIP depends on the degree of completion as regards
to materials, labour and overheads. However, if nothing is mentionedto materials, labour and overheads. However, if nothing is mentioned
in the problem, take 100% of the value as WIP. Because in such a case,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 equivalentthe average period of WIP must have been calculated as equivalent
period of completed units.period of completed units.
 (3) Calculation of Stocks of Finished Goods and Debtors should be(3) Calculation of Stocks of Finished Goods and Debtors should be
made at cost unless otherwise asked in the question.made at cost unless otherwise asked in the question.

29. Forecast/Estimate WC
requirements
Percentage of sales method
Regression analysis method
Cash forecasting method
Operating cycle method

30. Tondon Committee Report
The study group headed by Shri Prakash Tandon, the then
Chairman of Punjab National Bank, was constituted by the
RBI in July 1974 with eminent personalities drawn from
leading banks, financial institutions and a wide cross-section
of the Industry with a view to study the entire gamut of
Bank's finance for working capital and suggest ways for
optimum utilisation of Bank credit. This was the first
elaborate attempt by the central bank to organise the Bank
credit. The report of this group is widely known as Tandon
Committee report. Most banks in India even today
continue to look at the needs of the corporates in the
light of methodology recommended by the Group.

31. Terms of reference of committee
To suggest guidelines for commercial banks to follow up and
supervise credit
To suggest type of operational data and other information
that can be obtained from borrowers by RBI
To suggest prescribing inventory norms for different
industries; both public and private
To make recommendations regarding resources for financing
the minimum working capital requirements
To suggest criteria regarding satisfactory capital structure
To make recommendations as to whether exiting pattern of
financing working capital requirements to be modified.

32. First Method of Lending:
Banks can work out the working capital gap, i.e. total
current assets less current liabilities other than bank
borrowings (called Maximum Permissible Bank Finance or
MPBF) and finance a maximum of 75 per cent of the gap; the
balance to come out of long-term funds, i.e., owned funds
and term borrowings. This approach was considered suitable
only for very small borrowers i.e. where the requirements of
credit were less than Rs.10 lacs

33. Second Method of Lending:
Under this method, it was thought that the borrower should
provide for a minimum of 25% of total current assets out of
long-term funds i.e., owned funds plus term borrowings. A
certain level of credit for purchases and other current
liabilities will be available to fund the build up of current
assets and the bank will provide the balance (MPBF).
Consequently, total current liabilities inclusive of bank
borrowings could not exceed 75% of current assets. RBI
stipulated that the working capital needs of all borrowers
enjoying fund based credit facilities of more than Rs. 10 lacs
should be appraised (calculated) under this method.

34. Third Method of Lending: Under this method, the
borrower's contribution from long term funds will be to the
extent of the entire CORE CURRENT ASSETS, which has
been defined by the Study Group as representing the absolute
minimum level of raw materials, process stock, finished
goods and stores which are in the pipeline to ensure
continuity of production and a minimum of 25% of the
balance current assets should be financed out of the long
term funds plus term borrowings.
(This method was not accepted for implementation and hence is of
only academic interest).

35. CHORE COMMITTEE REPORT
The quality of lending improved considerably but the cash
credit system continued to pose few difficulties. Bifurcation
of working capital limit in two parts as demand loan and a
fluctuating cash credit component, as suggested by Tandon
Group, was not done by many banks. It was, therefore,
considered necessary by Reserve Bank to review the system
of cash credit in all its aspects and for this purpose a
'Working Group' headed by Sh. K. B. Chore was appointed
in 1979. The terms of reference to the 'Group' were as
follows:

36. Important recommendations
The bank should obtain quarterly statements in prescribed
format from all borrowers having working capital credit
limits of rs.50 lacs and above
The banks should undertake a periodical review of limits of
rs.10 lacs and above
The bank should not bifurcate cash credit accounts into
demand loan and cash credit components
If a borrower does not submit the quarterly returns in time,
the banks may penal interest of one percent on total amount
outstanding
Banks should discourage sanction of temporary limits by
charging additional one percent interest over the normal rate
of interest

37. Bank should fix separate credit limits for peak and non-peak
levels ; if possible
Banks should take steps to convert cash credit limits into bill
limits for financing sales.`

38. THANKS…..