Working capital refers to the capital required to run day-to-day business operations. It can be divided into gross and net working capital. Gross working capital is the sum of current assets like cash, debtors, and stock. Net working capital is the difference between gross working capital and current liabilities. The appropriate level of working capital depends on factors like the nature of business, sales patterns, credit policies, and product characteristics. Both excessive and inadequate working capital can hurt business performance. Firms must balance liquidity needs with profitability considerations in managing working capital.

1. WORKING CAPITAL
MGMT.
Working capital in the most
ordinary form of business
communication means -- that
part of the capital which is
used for running the day to
day business activities of a
company.

2.  The working capital of a company can be
divided in two parts.
 GROSS WORKING CAPITAL
 NET WORKING CAPITAL

3. Gross W.C. – It refers to the sum of the
firms investment in current assets.
Current assets – Those assets which can be
converted into cash within an accounting
year.
Eg. Cash, Short term securities, Debtors,
Stock etc.

4.  Net Working Capital – The difference
between the Gross working capital and the
total of current liabilities.
 Current liabilities – Claims of outsiders and
insiders which are to be paid within one
accounting year. Eg.Creditors, Bills
payable, Outstanding expenses etc.
 Hence Net working capital can be +ive or
–ive.

5.  INVESTMENT IN CURRENT ASSETS
 HOW MUCH ?
 EXECESSIVE OR INADEQUATE ARE THE
TWO DANGER SIGNALS.
 SHOULD BE JUST ADEQUATE NOT MORE
AND NOT LESS.

6.  EXCESSIVE INVESTMENT IN CURRENT
ASSETS.
 REDUCES PROFITABILITY.
 IDLE INVESTMENT EARNS NOTHING.(EXCESS
CASH)
 RAISES PROBABILITY OF LOSS – DEBTORS,
STOCK ETC.

7.  INADEQUATE OR LESSER INVESTMENT IN
WORKING CAPITAL.
 CANNOT MEET CURRENT OBLIGATIONS.
 EARNS A BAD NAME.
 REDUCES CONFIDENCE OF THE
STAKEHOLDERS.
 EVEN THE SOLVENCY MAY BE THREATENED.

8.  THE NEED OF WORKING CAPITAL OF A FIRM MAY
FLUCTUATE WITH THE AMOUNT OF BUSINESS
ACTIVITY.
 THIS MAY CAUSE AN “EXCESS” OR “SHORTAGE”
FREQUENTLY.
 PROMPT ACTION BY THE MANAGERS TO
CORRECT IMBALANCES IS A PART OF WORKING
CAPITAL MGMT.

9.  When, there is shortage of funds or
working capital due to any reason the
manager must quickly be able to arrange
such finance.
 Similarly, in case of excess funds they
should not be kept lying idle, but should
be invested properly.(Where ?)
 Thus the manager should be conversant
with the sources as well as the investment
avenues.

10.  NET WORKING CAPITAL is a qualitative
concept.
 It tells us about the LIQUIDITY position of
a company.
 If the Net W.C. is negative (CL is more
than the CA) the goodwill/brand/image of
the company may be tarnished both from
within and outside business world.
 The current assets should always be more
than the current liabilities.

11. OPERATING CYCLE
 Acquisition of resources & raw materials.
 Manufacturing process
 Sales (Cash / Credit)
 Collection.
 TOTAL TIME TAKEN IN THE ABOVE IS
CALLED THE OPERATING CYCLE.
THUMB RULE : HIGHER THE OPERATING CYCLE
MORE THE REQIREMENT OF WORKING CAPITAL.

12.  Cash inflows are very uncertain.
 Cash outflows are very certain.
Hence, maintenance of exact working
capital is almost impossible.
For safety purpose maintaining liquidity of
working capital is essential.(In the form of
cash, stock of raw materials and fg’s)

13. Calculation of operating cycle(time)
 RAW MATERIAL CONVERSION PERIOD
+WIP CONVERSION PERIOD
+FINISHED GOODS CONVERSION PERIOD
__________________________________
=INVENTORY CONVERSION PERIOD
+DEBTORS CONVERSION PERIOD
_________________________________
=OPERATING CYCLE =
OPERATING CYCLE.xlsx

14. PERMANENT & VARIABLE W.C.
 The amount of working capital required
keeps on changing from time to time.
 Hence, a fixed amount of working capital
or a minimum amount of working capital is
always maintained called the permanent
working capital.

15.  Over and above the minimum working
capital fresh working capital is replenished
as per requirement.
 For example extra inventory of finished
goods & raw materials may be kept during
the peak periods of sale. Investment in
receivables and debtors may also increase
during such period.

16.  HENCE, THE EXTRA WORKING CAPITAL
NEEDED, OVER AND ABOVE THE MINIMUM
LEVEL, IN ORDER TO SUPPORT THE
CHANGING PRODUCTION AND SALES
ACTIVITIES IS CALLED THE VARIABLE
WORKING CAPITAL.

17. Consequenses of excess working capital
 Accumulation of inventories ->
mishandling, waste, theft, spoilage etc.
 High incidence of bad debts -> defective
credit policy and slack collection period.
 Makes the management complacent
->managerial inefficiency.
 Accumulation of excess inventory gives
rise to the tendency of speculative profits
-> liberal dividend policy -> difficult days
ahead.

18.  Stagnates growth -> cannot take up new
projects and ventures as funds are
blocked in either stock or receivables.
 Paucity of funds render the firm unable to
avail attractive discounts and credit
opportunities.
 The firm looses its goodwill -> not being in
a position to honour its short term
obligations.

19. DETERMINANTS OF WORKING
CAPITAL(FACTORS)
 NATURE OF BUSINESS :
Trading houses : Less investment in fixed assets
and more investment in current assets.
Financial houses : Less investment in fixed assets
and more investment in current assets.
Retail shops : Less investment in fixed assets and
more investment in current assets.
SAME IS THE CASE WITH MANUFACTURES OF
TOBACO AND MEDIUM SIZED CONSTRUCTION HOUSES.

20.  On the other hand big manufacturing
houses of steel, cement and other public
utilities require lessor current assets as
compared to their requirement of fixed
assets.

21.  SALES & DEMAND CONDITIONS :
Sales depend on demand conditions. Many
firms experience the seasonal and cyclical
fluctuations in the demand for their
products.Such variations in demand and
consequently sales effect the requirement
of working capital of the firm specially the
variable part. Eg. Raincoat,
Sunglass,Icecream etc.

22.  NATURE OF PRODUCT & MANUFACTURING
POLICY :
The operating cycle required for a boiler or
a hot rolling mill or an automobile may
range from 06 to 24 months whereas the
operating cycle required for detergent
powder, soaps or chocolates may be a few
days or even hours.
REMEMBER :THUMB RULE : HIGHER THE
OPERATING CYCLE MORE THE REQIREMENT OF
WORKING CAPITAL.

23.  CREDIT POLICY : The credit policy
decides the level and quality of debtors.
Industry norms and credit rating before
offering credit are important factors to be
looked into.
Whom to offer credit and what terms and
whom not to offer must be critically
examined.

24.  Availability of credit :
The credit terms the firm receives from its
creditors also decides the amount of
requirement of working capital.
A firm which can get bank credit easily
will operate with less working capital
than a firm without such facility.

25. ESTIMATING WORKING
CAPITAL REQUIREMENTS
 THERE ARE THREE WAYS TO DO IT.
CURRENT ASSETS HOLDING PERIOD :
THIS IS ESTIMATION OF WORKING
CAPITAL REQUIREMENT ON THE BASIS OF
AVG. HOLDING PERIOD OF CURRENT
ASSETS & RELATING THEM TO COST ON
THE BASIS OF EXPERIENCE IN PREVIOUS
YEARS.

26. ESTIMATING WORKING
CAPITAL REQUIREMENTS
RATIO OF SALES :
THIS IS ESTIMATION OF WORKING
CAPITAL REQUIREMENT AS A RATIO OF
SALES ON THE ASSUMPTION THAT
CURRENT ASSETS CHANGE WITH SALES.

27. ESTIMATING WORKING
CAPITAL REQUIREMENTS
RATIO OF FIXED INVESTMENT :
THIS IS ESTIMATION OF WORKING
CAPITAL REQUIREMENT AS A RATIO OF
FIXED INVESTMENT.

28. LIQUIDITY VRS.PROFITABILITY
 If it were possible to estimate the working
capital needs exactly -- a firm would
make just enough investment in working
capital.
 Under perfect certainity conditions the
working capital would be at the minimum
level.
 A larger investment in current assets
would mean a low ROI.
 A smaller investment in current
assets would mean inturruptions in
production and sales.

29. ESTIMATING WORKING
CAPITAL REQUIREMENTS
ILLUSTRATION :
WORKING CAPITAL ASSESSMENT.xlsx

30. LIQUIDITY VRS.PROFITABILITY
 Let us consider the following example.
 Example :
 However, in order to increase profitability
keeping very low current assets is not always
advisable.

31. APPROACHES TO WORKING CAPITAL
 CONSERVATIVE APPROACH :
The financing policy of the firm is said to
be conservative when it depends more on
long term funds for financing needs. Under
this arrangement the firm finances its
permanent assets as well as a part of its
temporary current assets with long term
financing.(LESS RISK OF SHORTAGE)
In the periods when the firm does not
require temporary current assets the idle
long term funds can be invested.

32. APPROACHES TO WORKING CAPITAL
 AGGRESSIVE APPROACH :
Under this approach the firm finances a
part of its permanent current assets by
short term financing.
Some firms even finance a part of their
fixed assets with short term financing.
VERY HIGH PROFITABILITY BUT VERY
RISKY.

33. APPROACHES TO WORKING CAPITAL
 MATCHING APPROACH :
Under this approach the firm finances its
fixed assets and permanent current assets
with long term finance and its temporary
current assets with short term finance.
REDUCES PROFITABILITY AND RISK.

34. RISK RETURN TRADE OFF
 There is always a conflict between long
term and short term financing.
 Short term financing is less expensive
than long term financing BUT at the same
time it involves greater risk.
 The choice between long term & short
term requires a trade off between risk and
return.
 EXAMPLE : trade off.xlsx