This document discusses concepts and management of working capital. It defines key terms like gross working capital, net working capital, fixed working capital and variable working capital. It also outlines factors that affect working capital requirements and methods for estimating working capital needs like the operating cycle method and regression equation method. The document concludes by discussing policies for financing current assets through long term, short term and spontaneous sources.

1. WORKING CAPITAL MANAGEMENT
Dr. Mohamed Kutty Kakkakunnan
Associate Professor
P.G. Dept. of Commerce
NAM College Kallikkandy
Kannur - Kerala – India

2. CONCEPTS OF WORKING CAPITAL
A. Gross Working Capital
Total investment in current assets
B. Net Working Capital
Difference between current assets and current
liabilities (Current Assets - Current Liabilities)
Positive Working Capital And Negative Working Capital
(Positive when CA>CL and negative when CA<CL)
Two concepts have equal significance
Gross working capital – adequacy / inadequacy of working
capital
Net working capital – liquidity and sources of funds or mix
of funds for financing working capital (short term sources
and long term sources)

3. COMPONENTS OF WORKING CAPITAL
Current Assets And Current Liabilities
Kinds of working capital
a. Permanent or fixed working capital
Business is a continuous process and thus, to carry on its
operations continuously and smoothly it require minimum
investment in current assets. This minimum investment in CA.
The minimum amount of working capital (CA) required to
carry on business during the dullest period.
b. Variable or fluctuating or seasonal or temporary
Working capital required to meet the varying or changing
production and business conditions or to meet seasonal
demand of customers.

4. Sources of funds for working capital
a. Fixed working capital
b. Variable working capital
Both concepts have equal importance
Fixed working capital = long term sources
Variable working capital = short term sources
Depends upon the financial policy and risk
perspective of management

5. Factors Affecting Working Capital Requirements
1. Nature of business
2. Terms and conditions of sales or purchases
3. Manufacturing cycle
4. Rapidity of turnover
5. Business cycle
6. Changes in technology
7. Seasonal variations in demand
8. Availability of raw materials
9. Market conditions (competition, monopoly)
10. Dividend policy
11. Operating cycle

6. O P E R AT I N G C Y C L E
Gross working capital – amount invested in currents
assets (meaning and definition)
Assets that can be converted into cash within a short
span of time (within an operating cycle)
The period required to convert cash into cash (conversion
period)
Trading concern: Cash → inventories →debtors →cash
Manufacturing concerns
Cash → raw materials → WIP → Finished goods →
debtors/receivables → cash
Working capital requirements depends upon operating
cycle – the longer, the more working capital
Depends upon the briskness or speed with which the
business if carried on

7. Gross Operating Cycle – considers current assets
only- the period required to convert current
assets into its next liquid form
= R M conversion period + WIP conversion
period + FG conversion period + Receivables
conversion period
Net Operating Cycle (Cash Operating Cycle)
A part of the current asset is financed by
creditors also. Net working capital concept
Gross conversion period – creditors conversion
period or creditors deferral period

8. CALCULATION OF CONVERSION PERIODS
Raw Material
Conversion Period
Average Stock of Raw Materials / Raw Material
Consumption Per Day
WIP Conversion
Period
Average Sock of WIP / Total Cost of Production Per
Day
Finished Goods
Conversion Period
Average Stock of Finished Goods / Total Cost of
Goods Sold Per Day
Receivables
Conversion Period
Average Accounts Receivables / Net Credit Sales Per
Day
Payables Deferral
Period
Average Payables / Net Credit Purchases Per Day
Gross Operating Cycle RMCP+WIPCP+FGCP+RCP
Net Operating Cycle Gross Operating Cycle – Payables Deferral Period
Working Capital
Requirement
Cost Of Goods Sold X (Operating Cycle (Days) / 360
Or 365) + Desired Cash Balance

9. Working Capital Management
An important part of overall financial management
The firm should have optimum working capital
Both inadequate and excessive working capital are
dangerous
• Process of ensuring optimum investment in Current
Assets in such a way that the business is carried on
efficiently
 Process of estimating working capital requirements
and ensuring funds as and when required in such a
way that there is no overinvestment of funds and
inadequacy of funds.
It involves
a. Forecasting the working capital requirements and
b. Financing of working capital needs.

10. Estimating Working Capital Requirements
1. Current asset holding period method (based on operating
cycle concept)
2. Ratio of sales (as a percentage of sales)
3. Ratio of fixed investment (as a percentage of investment
in fixed assets)
4. Cash forecasting method
5. Regression equation method
Current Asset Holding Method
Under this method each element in the working capital is
estimated on the basis of the operating cycle or
conversion period.
Gross working capital is estimated by adding the values of
current assets and net working capital is calculated by
deducting the sum of current liabilities from the gross
working capital.

11. CALCULATION OF VALUES OF CURRENT ASSETS AND CURRENT LIABILITIES
Stock Of Raw
Material
Budgeted Annual Production X Estimated Cost Of Raw
Material Per Unit X (RM Conversion Period / Number Of
Working Days Per Week or Month or Year
Stock Of Work In
Progress
Budgeted Annual Production X Estimated Cost WIP Per
Unit X (WIP Conversion Period / Number Of Working
Days Per Week or Month or Year
Stock Of Finished
Goods
Budgeted Annual Production X Estimated Cost Of
Production Per Unit X (FG Conversion Period / Number
Of Working Days Per Week or Month Or Per Year
Debtors
Budgeted Credit Sales (Units) X Cost Of Sales Per Unit X
(Average Collection Period/ Number Of Working Days)
Cash And Bank Estimation Based On Experience
Total Current Assets (Gross Working Capital)

12. Calculation of current assets and current liabilities (continues)
Trade Creditors Estimated Annual Production (Units) X Raw
Material Cost Per Unit X (Payable Deferral Period /
Number Of Working Days Per Week Or Month Or
Year
Creditors For Expenses
(Outstanding)
Budgeted Annual Production X Estimated Labor Or
Expenses Cost Per Unit X ( Average Time Lag In
Payment / Number Of Working Days Per Week Or
Month Or Year
Total Current
Liabilities
Net working capital (CA-CL)

13. Regression Equation Method
This is based on statistical technique of estimating
or predicting unknown value of a dependent
variable from the known value of an independent
variable. It measures the average relationship
between two or more variables like working
capital and sales
For estimating working capital requirement the
equation is solved
y= a+bx
Where y is working capital , a is the intercept and b
is the slop of the regression line and x is the
independent variable (sales)

14. For determining the values of a and b the
following two normal equations are to be
solved
∑y=na+b∑x
∑xy=a∑x+b∑x2

15. Policies of Financing Current Assets
Sources of funds
1. Long term financing
2. Short term financing
3. Spontaneous financing (the automatic sources
of short-term funds arising in the normal course
of business. Trade suppliers, outstanding
expenses and other current liabilities constitute
spontaneous financing. A firm is expected to
utilize this source to the fullest level)
The mix or proportion of these sources depend
upon the financial policy followed by the
management

16. Three policies / approaches
1. Matching approach
Permanent working capital – long term sources
Temporary working capital – short term sources
2. Conservative approach
A part of the variable working capital
requirement is met out of long term sources
3. Aggressive approach
A part of the permanent working capital is met
out of short term sources
Note: Liquidity v/s Profitability consideration