INTRODUCTION TO WORKING CAPITAL

1. INTRODUCTION TO
WORKING CAPITAL
Unit - IV

2. INTRODUCTION
In financial management, two important decisions are very vital and crucial.
They are decision regarding fixed assets/fixed capital and decision
regarding working capital/current assets. Both are important and a firm
always analyses their effect to final impact upon profitability and risk.
Thus, in very simple words, working capital may be defined as “capital
invested in current assets.” Here current assets are those assets, which can be
converted into cash within a short period of time and the cash received is
again invested into these assets. Thus, it is constantly receiving or circulating.
Hence, working capital is also known as circulating capital or floating capital.

3. DEFINITION
According to Shubin, “Working Capital the amount of funds necessary to
cover the cost of operating the enterprise.
According to Hoagland ,” Working Capital is descriptive of that capital
which is not fixed. But, the more common use of working capital is to
consider it as the difference between the book value of the current assets
and the current liabilities.
Revolving Capital Or Circulating capital Or Short Term Capital

4. HOW IT WORKS (EXAMPLE):
Here is some balance sheet information about XYZ Company:
Using the working capital formula and the information above from Figure 1, we can
calculate that XYZ Company's working capital is:
$160,000 - $65,000 = $95,000

5. CONCEPT OF WORKING CAPITAL
Gross working capital
Net Working Capital
There are two concepts of working capital. These are :

6. 1. GROSS WORKING CAPITAL: (TOTAL CURRENT ASSETS)
Gross working capital (Total Current Assets) The gross working capital, simply called as
working capital refers to the firm’s investment in current assets. Current assets are the
assets, which can be converted into cash within an accounting year or operating cycle.
Thus, Gross working capital, is the total of all current assets. It includes
1. Inventories (Raw materials and Components, Work-in-Progress, Finished Goods, Others)
2. Trade Debtors
3. Loans and Advance
4. Cash and Bank Balances
5. Bills Receivables.
6. Short-term Investment

7. 2.NET WORKING CAPITAL
Net Working Capital (Total Current Assets – Total Current Liabilities) Net working
capital refers to the difference between current assets and current liabilities. Current
liabilities are those claims of outsiders, which are expected to mature for payment within
an accounting year. Net working capital may be positive or negative. A positive net
working capital will arise when current assets exceed current liabilities and a negative
net working capital will arise when current liabilities exceed current assets i.e. there is no
working capital, but there is a working capital deficit. It includes
1. Trade Creditors.
2. Bills Payable.
3. Accrued or Outstanding Expenses.
4. Trade Advances
5. Short Term Borrowings (Commercial Banks and Others)
6. Provisions
7. Bank Overdraft

8. IMPORTANCE OF WORKING CAPITAL
Working capital is one of the important measurements of the financial position. The
words of H. G. Guthmann clearly explain the importance of working capital. “Working
Capital is the life-blood and nerve centre of the business.”
In the words of Walker, “A firm’s profitability is determined in part by the way its
working capital is managed.”
The object of working capital management is to manage firm’s current assets and
liabilities in such a way that a satisfactory level of working capital is maintained. If the
firm cannot maintain a satisfactory level of working capital, it is likely to become
insolvent and may even be forced into bankruptcy.
Thus, need for working capital to run day-to-day business activities smoothly can’t be
overemphasized.

9. REQUIREMENTS OF WORKING CAPITAL
There are no set rules or formula to determine the working capital requirements of the
firms. A large number of factors influence the working capital need of the firms. All factors
are of different importance and also importance change for the firm over time. Therefore,
an analysis of the relevant factors should be made in order to determine the total
investment in working capital. Generally the following factors influence the working capital
requirements of the firm:
• Nature and size of the business
• Seasonal fluctuations
• Production policy
• Taxation
• Depreciation policy
• Reserve policy
• Dividend policy
• Credit policy:
• Growth and expansion
• Price level changes
• Operating efficiency
• Profit margin and profit appropriation

10. OPERATING AND CASH CONVERSION CYCLE
The time taken for the completion of the cycle of the process of
conversion of raw material into finished goods, sale of goods ,realisation
of sale proceeds, and receipt of cash is termed as “Operating and Cash
Conversion Cycle” or Working Capital Cycle”.
Operating Cycle of a company determine the requirements of working
capital.

11. OPERATING AND CASH CONVERSION CYCLE
Cash
Raw
Material
Work-in-
Progress
Finished
Goods
Account
Receivable
PurchaseRealization
Sale Production Process

12. CLASSIFICATION OR TYPES OF WORKING CAPITAL
Types of working capital
On the basis of Concepts
Gross
Working
Capital
Net
Working
Capital
On the basis of Time
Fixed
Working
Capital
Regular
Working
Capital
Reserve
Working
Capital
Variable
Working
Capital
Seasonal
Working
Capital
Special
Working
Capital

13. TYPES OF WORKING CAPITAL
Fixed 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.
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.

14. TYPES OF WORKING CAPITAL
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.
Regular Working Capital: The minimum amount of working capital to be maintained in normal
condition is called Regular Working Capital.
Seasonal Working Capital: Some products have seasonal demand. Seasonal demand arises due to
festival. In this way, seasonal working capital means an amount of working capital maintained to
meet the seasonal demand of the product.
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.

15. FACTORS DETERMINING THE WORKING CAPITAL
Nature of Business
Production Policy
Dividend Policy
Manufacturing Cycle
Price Level Changes
Nature of Demand
Credit Policy
Business Period
Effect of External Business Environment Factors

16. CURRENT ASSETS MANAGEMENT
Cash management has assumed importance because it is the most significant of all
the current assets. It is required to meet business obligations and it is productive when
not used.
Cash management need strategies to deal with various facets of cash.
Following are some of its facets:
(a)Cash Planning: Cash Planning is technique to plan and control the use of cash. A
projected cash flow statement may be prepared, based on the present business
operations and anticipated future activities. The cash inflows from various sources may
be anticipated and cash outflows will determine the possible uses of cash.
(b)Cash Forecasts and Budgeting: A cash budget is the most important device for the
control of receipts and payments of cash. A cash budget is an estimate of cash
receipts during a future period of time. It is an analysis of flow of cash in a business
over a future, short or long period of time. It is a forecast of expected cash intake
and outlay.

17. RECEIVABLE MANAGEMENT
INVENTORY MANAGEMENT
1
2

18. RECEIVABLE MANAGEMENT
The term receivable is defined as debt owed to the concern by customers arising from
sale of goods or services in the ordinary course of business. Receivables are also one
of the major parts of the current assets of the business concerns. It arises only due to
credit sales to customers, hence, it is also known as Account Receivables or Bills
Receivables.
Definition :
Management of account receivable is defined as “the process of making decision
resulting to the investment of funds in these assets which will result in maximizing the
overall return on the investment of the firm”.
The objective of receivable management is to promote sales and profit.

19. COSTS ASSOCIATED WITH THE EXTENSION OF CREDIT
AND ACCOUNTS RECEIVABLES
Collection Cost
Capital Cost
Administrative Cost
Default Cost

20. 1.Collection Cost : These costs incurred in collecting the receivables from the customers,
to who credit sales have been made.
2.Capital Cost : This is the cost on the use of additional capital to support credit sales
which alternatively could have been employed else where.
3.Administrative Cost : This is an additional administrative cost for maintaining account
receivable in the form of salaries to the staff kept for maintaining accounting records
relating to customers, cost of investigation etc.
4.Default Cost : Default costs are the over dues that cannot be recovered. Business
concern may not be able to recover the over dues because of the inability of the
customers.

21. FACTORS CONSIDERING THE RECEIVABLE SIZE
1. Sales Level
2. Credit Policy
3. Credit Terms
4. Credit Period
5. Cash Discount
6. Management of Receivable

22. 1. Sales Level
Sales level is one of the important factors which determines the size of receivable of the firm. If the
firm wants to increase the sales level, they have to liberalise their credit policy and terms and
conditions. When the firms maintain more sales, there will be a possibility of large size of
receivable.
2. Credit Policy
Credit policy is the determination of credit standards and analysis. It may vary from firm to firm or
even some times product to product in the same industry. Liberal credit policy leads to increase the
sales volume and also increases the size of receivable. Stringent credit policy reduces the size of the
receivable. Example : Home Appliances
3. Credit Terms
Credit terms specify the repayment terms required of credit receivables, depend upon the credit
terms, size of the receivables may increase or decrease. Hence, credit term is one of the factors
which affects the size of receivable.
4. Credit Period
It is the time for which trade credit is extended to customer in the case of credit sales. Normally it is
expressed in terms of ‘Net days’. For Example Credit Card facility by banks.

23. 5. Cash Discount
Cash discount is the incentive to the customers to make early payment of the due
date. A special discount will be provided to the customer for his payment before the
due date. For Example : Whole Sale shops to retail shop keepers
6. Management of Receivable
It is also one of the factors which affects the size of receivable in the firm. When the
management involves systematic approaches to the receivable, the firm can reduce
the size of receivable.

24. INVENTORY MANAGEMENT
MEANING :
The dictionary meaning of the inventory is stock of goods or a list of goods. In accounting language,
inventory means stock of finished goods. In a manufacturing point of view, inventory includes, raw
material, work in process, stores, etc.
KINDS OF INVENTORIES
Inventories can be classified into five major categories.
A. Raw Material: It is basic and important part of inventories. These are goods which have not yet
been committed to production in a manufacturing business concern.
B. Work in Progress: These include those materials which have been committed to production process
but have not yet been completed.
C. Consumables: These are the materials which are needed to smooth running of the manufacturing
process.
D. Finished Goods: These are the final output of the production process of the business concern. It is
ready for consumers.
E. Spares: It is also a part of inventories, which includes small spares and parts.

25. OBJECTIVES OF INVENTORY MANAGEMENT
Inventory occupies 30–80% of the total current assets of the business concern. It is
also very essential part not only in the field of Financial Management but also it is
closely associated with production management.
• To efficient and smooth production process.
• To maintain optimum inventory to maximize the profitability.
• To meet the seasonal demand of the products..
• To ensure the level and site of inventories required.
• To plan when to purchase and where to purchase
• To avoid both over stock and under stock of inventory.
• To avoid price increase in future.

26. Techniques Of Inventory
Management
Techniques Based on Order
Quantity
Determination of Stock Level
Determination of Stock
Economic Order Quantity
Techniques Based on
Classification
ABC Analysis
VED Analysis
HML Analysis
Aging Schedule
Based on Records
Inventory Report
Inventory Budget