The matter includes concept and types of Working Capital. Further it explains Optimum Level of Current Assets, Various Approaches to Working Capital Financing. Then Operating Cycle, Cash Cycle and Working Capital Estimation Techniques are discussed.

1. Working Capital Management
By: Navin Chandra

2. A Few Facts…
• Every Business requires Funds for financing day to day
operations.
• Requirement of these Funds varies according to various
factors like nature of business, size, technology, production
policy, creditability, operating efficiency etc.
• These Funds are available from various Long Term and Short
Term sources.
• Cost of Long Term Sources of Funds is more than that of
Short Term Funds. Similarly rate of return from Long Term
Asset is more than that of Short Term Asset.
• Shortage of these Funds may lead a Business to Technical
Insolvency due to default in payment of dues. It may
ultimately result in Bankruptcy.

3. A Few Facts…
Resource flows for a manufacturing Organisation
Used in
Used in
Production
Process
Generates
Raw Materials,
Labour and
Variable expenses
Working
Capital
cycle
Inventory
Sales Generated
Accounts
receivable
Accrued Fixed
Operating
expenses
Used for
Cash
Collection
process
Used to
purchase
External Financing
Return on Funds Invested
Suppliers of
Long Term Funds
Fixed
Assets

4. Definition of Working Capital
• Working Capital refers to that part of the
Organisation’s capital which is required for
financing short-term or current assets such
as cash, debtors and inventories.
• Working Capital is also known as revolving or
circulating capital or short-term capital.

5. Concept of working capital …
•
Two interpretations are possible:
- Balance sheet concept
- Operating cycle concept
Balance sheet concept
•
•
Gross Working Capital= Total Current Assets
Net Working Capital = Total Current Assets
- Total Current Liabilities

6. Concept of working capital …
WORKING CAPITAL
(WC)
ON BASIS
OF CONCEPT
Gross
WC
Net WC
ON BASIS
OF TIME
Permanent
or Fixed
WC
Temporary
or Variable
WC
Seasonal
WC
Special
WC

7. Concept of working capital …
Operating cycle concept
Operating Cycle= Inventory Conversion Period +
Receivables Collection Period
Cash Cycle = Operating Cycle – Payment Deferral
Period
-An Organisation’s Cash Cycle consists of following
activities:
• Purchasing resources and making payment
• Producing the product
• Selling the product and receiving money

8. Operating cycle of an Organisation
Purchase
resources
Pay for
Resources
purchased
Inventory
Conversion
Period
Payable
Deferral
Period
Operating
Cycle
Sell
Product
on credit
Receivable
Collection
Period
Cash Cycle
Receive
Cash

9. MANAGEMENT OF WORKING CAPITAL
• Refers to management of current assets and
current liabilities consistently in an efficient
manner.
• Working Capital Management Policies of an
Organisation greatly affect its profitability,
liquidity and financial health.

10. Dimensions of Working
Capital Management
Liquidity, Profitability
& Risk
l
eve
& L ts
n
itio t Asse
pos ren
Com Cur
of
Com
of C positio
n&
urr
ent
Lia Level
bilit
ie s

11. Optimum Level of Current Assets…
Assumptions
• Maximum production:
50,000 units per year
• Production process is
evenly spread out during
the year
• Current Assets Levels:
High Level
:A
Average Level: B
Low Level
:C
ASSETS LEVEL
Optimum Amount (Level) of Current Assets
A
B
C
Current Assets
0
25,000
OUTPUT (units)
50,000

12. Optimum Level of Current Assets…
Impact on Liquidity
Higher level of current
asset lead to more
liquidity.
A
B
C
ASSETS LEVEL
Liquidity Analysis
Approach
Liquidity
A
High
B
Average
C
Low
Current Assets
0
25,000
OUTPUT (units)
50,000

13. Optimum Level of Current Assets…
Impact on Profitability
Return on Assets =
Return on Assets =
Net Profit X100
Current Assets+ Fixed
Assets
Assets
A
B
C
ASSETS LEVEL
Net Profit X100
Total Assets
Current Assets = (Cash +
Receivables + Inventory)
Current Assets
0
25,000
OUTPUT (units)
50,000

14. Optimum Level of Current Assets…
Profitability Analysis
Approach Profitability
A
Low
B
Average
C
High
As current asset levels
decline, total assets will
decline and the ROA will
increase.
ASSETS LEVEL
Impact on Profitability
0
A
B
C
Current Assets
25,000
OUTPUT (units)
50,000

15. Optimum Level of Current Assets…
Impact on Risk
•
•
Lower cash reduces the
Organisation’s ability to
meet its financial
obligations. Greater risk!
Stricter credit policies
reduce receivables and
possibly lose sales and
customers. Greater risk!
Lower inventory levels
increase stock outs and
lead to loss of sales.
Greater risk!
A
B
C
ASSETS LEVEL
•
Current Assets
0
25,000
OUTPUT (units)
50,000

16. Optimum Level of Current Assets…
Impact on Risk
Risk increases as the level
of current assets are
reduced.
A
B
C
ASSETS LEVEL
Risk Analysis
Approach
Risk
A
Low
B
Average
C
High
Current Assets
0
25,000
OUTPUT (units)
50,000

17. Optimum Level of Current Assets…
SUMMARY OF OPTIMUM CURRENT ASSETS ANALYSIS
Approach
A
B
C
Liquidity
High
Average
Low
Profitability
Low
Average
High
Risk
Low
Average
High
1. Profitability varies inversely with Liquidity.
2. Profitability moves together with risk.
(remember- higher the risk, higher the returns)

18. Approaches to Current Assets Financing
Approaches to
Financing Mix
The Hedging or
Matching
Approach
The
Conservative
Approach
The
Aggressive
Approach

19. Hedging approach to assets financing
Total Assets
Short-term
Sources
Fluctuating Current Assets
Permanent Current Assets
Amount
Fixed Assets
Time
Long-term
Sources

20. Conservative approach to assets financing
Total Assets
Short-term
Source
Fluctuating Current Assets
Amount
Permanent Current Assets
Fixed Assets
Time
Long-term
Source

21. Aggressive approach to assets financing
Total Assets
Short-term
Source
Fluctuating Current Assets
Permanent Current Assets
Amount
Fixed Assets
Time
Long-term
Source

22. Concept of Operating cycle
•Maximization of share holders’ wealth of an
Organisation is possible only when there are sufficient
returns from the operations.
•Successful sales activity is necessary for earning profit.
But sales are not converted into cash immediately.
•There is time gap between the sale of goods and
receipts of cash.
•The time taken to convert cash into cash (Cash-Raw
Material-Work in Progress-Finished Goods-ReceivablesCash) is known as operating cycle.

23. Operating cycle of a Trading Organisation
Receivables
Cash
Stock in Trade

24. Operating cycle of a Manufacturing Organisation
Raw
Materials
WIP
Cash
Finished
Goods
Receivables
Sales

25. Ascertaining Operating Cycle and Cash Cycle
for a Trading Organisation
Operating Cycle= Inventory Conversion Period(ICP) +
Receivables Collection Period(RCP)
Cash Cycle = Operating Cycle – Payment Deferral
Period (PDP)
ICP = Average Inventory X365
Cost of good sold
RCP = Average Accounts Receivable X365
Net Credit Sales
PDP = Average Accounts Payable X365
Net Credit Purchases

26. Ascertaining Operating Cycle and Cash Cycle
for a Trading Organisation
• X Limited has provided following information:
• Sales Rs.4,000 Lacs
• Inventory - Opening Rs. 610 Lacs ; Closing Rs. 475
Lacs
• Receivables- Opening Rs. 915 Lacs; Closing Rs. 975
Lacs
• Payables- Opening Rs. 355 Lacs; Closing Rs. 410 Lacs
• Cost of Goods Sold: Rs. 2,675 Lacs
Compute the Operating Cycle and Cash Cycle.

27. Ascertaining Operating Cycle and Cash Cycle
for a Manufacturing Organisation
Operating Cycle= Raw Material Conversion Period (RMCP) +
Work in Progress Conversion Period (WIPCP)
+
Finished Goods Conversion Period (FGCP)+
Receivables Collection Period(RCP)
Cash Cycle = Operating Cycle – Payment Deferral
Period (PDP)
RMCP = Average Inventory of Raw Material X365
Raw Material Consumed
WIPCP = Average Inventory of WIP X365
Cost of Production
FGCP = Average Inventory of Finished Goods X365
Cost of Goods Sold

28. Working Capital Estimation…
•
Factors to be considered:
– Total costs incurred on materials, wages and overheads.
– The length of time for which raw materials remain in store before
they are issued to production.
– The length of the production cycle or WIP, i.e., the time taken for
conversion of Raw Material into Finished Goods.
– The length of the Sales Cycle during which Finished Goods are kept
waiting for sales.
– The average period of credit allowed to customers.
– The amount of cash required to pay day-to-day expenses of the
business.
– The amount of advance payments if any.
– The average period of credit to be allowed by suppliers.
– Time – lag in the payment of wages and other overheads.

29. Working Capital Estimation…
Statement of Working Capital Required-Trading
Concern
Particulars
Amount (Rs.)
Particulars
Amount (Rs.)
Current Assets
Current Assets
(i) Cash
(i) Cash
(ii) Receivables For…..Months’ Operating Cost)
(ii) Receivables ((For…..Months’ Operating Cost)
(iii) Stocks For……Months’ COGS)
(iii) Stocks ((For……Months’ COGS)
(iv)Advance Payments if any
(iv)Advance Payments if any
Less Current Liabilities
Less ::Current Liabilities
(i) Creditors (For….. Months’ Purchases)
(i) Creditors (For….. Months’ Purchases)
(ii) Lag in payment of expenses
(ii) Lag in payment of expenses
WORKING CAPITAL CA CL
WORKING CAPITAL ((CA ––CL ))
Add Provision Margin for Contingencies
Add ::Provision //Margin for Contingencies
NET WORKING CAPITAL REQUIRED
NET WORKING CAPITAL REQUIRED
XXX
XXX
-----------------------------------_
-----_
xxx
xxx
---------

30. MANUFACTURING CONCERN
STATEMENT OF WORKING CAPITAL REQUIRED
Amount (Rs.)
Current Assets
(i) Stock of R M( for ….months’ consumption)
(ii)Work-in-progress (for…months’ production)
(a) Raw Materials
(b) Direct Labour
(c) Overheads
(iii) Stock of Finished Goods ( for …months’ COGS)
(a) Raw Materials
(b) Direct Labour
(c) Overheads
(iv) Sundry Debtors ( for …months’ operating Cost)
(a) Raw Materials
(b) Direct Labour
(c) Overheads
(v) Payments in Advance (if any)
(iv) Balance of Cash for daily expenses
(vii)Any other item
Less : Current Liabilities
(i) Creditors (For….. Months’ Purchases)
(ii) Lag in payment of expenses
(iii) Any other
WORKING CAPITAL ( CA – CL )
Add : Provision / Margin for Contingencies
NET WORKING CAPITAL REQUIRED
----------------------------------------------------________________
-------------___
xxx
----_________________
XXX

31. Working Capital Estimation…
Prepare an estimate of Working capital requirement from the
following information of a trading concern:
Projected annual sales
100000 units
Selling price
Rs 8 per unit
% age of Gross profit on sales
25%
Average Credit Period allowed to customer
8 weeks
Average Credit Period allowed by supplier
4 weeks
Average stock holding in terms of sales
requirement
12 weeks
Provide for Contingencies
10%

32. Working Capital Estimation…
Special Points:
•Profits should be ignored while calculating working capital
requirements for the following reasons:
(a) Profits may or may not be used as working capital
(b) Even if these are used, these may have to be
reduced
by the amount of Income tax, Drawings, Dividends etc.
•Calculation of WIP depends on the degree of completion as regards to
materials, labour and overheads.
•Calculation of Stocks of Finished Goods at cost of Goods Sold and that
of Receivables at COGS+ Operating Expenses.
•Depreciation should be ignored in Working Capital Estimation as it is
non-cash expense.

33. Working Capital Estimation…
Prepare a statement of working capital required,
Profit & Loss Account and Balance Sheet from
following Figures:
• Share Capital Rs.1,50,000
• 8% Debentures Rs.2,00,000
• Fixed asset
Rs.1,30,000
The Cost Component is made up as follows:
• Material
40%
• Direct Labour 20%
• Overheads
20%

34. Working Capital Estimation…
• It is proposed to maintain a level of activity of
2,00,000 units per annum
• Selling price is Rs. 12/- per unit
• Raw Material are expected to remain in store for
an average period of one month.
• Material will be in process on average for half a
month.
• Finished goods are required to be in stock for an
average period of one month.
• Credit allowed to debtors is two months.
• Credit allowed by supplier is one month.

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