For a company, total assets minus total liabilitiesalso called owner's equity, shareholders' equity, or net assets.Read more: http://www.investorwords.com/3267/net_worth.html#ixzz15K5bQgFZRead more: http://www.investorwords.com/3267/net_worth.html#ixzz15K4yG6GD
O Concept and meaning of working capital –
Liquidity and profitability – identification of
factors affecting working capital
requirements – theories of working capital
O Approaches to estimation of working
capital – operating cycle approach.
O Management of inventories –
determination of optimum inventory – lead
time – Safety stock – EOQ approach
O Management of receivables – credit and
Collection policy – Credit standards –
Credit terms – Credit analysis –
management of payables – Maturity
O Management of cash – Accelerating cash
inflows – Managing collections –
Concentration banking – lock box system
– Control of disbursements – models for
determining optimum level of cash –
inventory model, stochastic – Cash
budgeting – Investment of surplus cash.
O Sources of working capital finance –
Approaches to optimum mix of funds –
trade credit, accrual accounts – money
market instruments, commercial
paper, Certificate of deposits – Bill
discounting and factoring – Inter corporate
loans – short term bank loans.
1st Group- Introduction to Inventory
Management, objectives, importance
2nd Group- Different techniques for inventory
management, lead time, safety stock
3rd Group- EOQ Approach
O Fund for establishment and to carry
out day- to –day business
O Capital classified into two:
i. Fixed Capital
ii. Working Capital
MEANING OF WORKING
O WC refers to short-term funds to
meet operating expenses.
O The funds which a company must
possess to finance its day-to-day
CONCEPTS OF WORKING
O Balance Sheet Concept
O Operating Cycle or Circular Flow
Balance sheet Concept
O There are two interpretations of balance
sheet under the balance sheet concept.
-Gross Working Capital (Quantitative
- Net Working Capital (Qualitative
Gross Working Capital
*According to this concept, the
total current assets are termed
as the gross working capital or
*this is also called as quantitative
or broader approach
Net Working Capital Concept
O It is the excess of current assets over
O Net working Capital = Current asset-
O It helps creditors and investors to judge
the financial soundness of a firm.
O It may be positive or negative.
O Trade Debtors
O Prepaid Expenses
O Loan and Advances
O Cash and Bank Balance
O I. Sundry Creditors.
O II. Bank Overdrafts
O III. Short-term Loans
O IV. Provisions
Operating Cycle or Circular
O WC refers to part of firm’s capital which is
required to financing short term or current
O Funds invested in current assets keep
revolving fast and are constantly
converted into cash and this cash flows
out again in exchange for other current
Operating Cycle or Circular Flow
KINDS OF WORKING CAPITAL
Kinds of working capital
Concept base Time Base
Gross WC or
Net WC or
Permanent Working Capital
O It is minimum investment kept in the form
of inventory of raw materials, WIP, finished
goods, stores & spares and books debts
to facilitate uninterrupted operation in a
O The minimum level of CA maintained in a
firm is usually known as permanent wc.
Temporary Working Capital
O Any additional WC apart form permanent
working capital required to support the
changing production and sales activities is
referred to as temporary or variable
O In other words, and amount over and
above the permanent level of working
capital is temporary, fluctuating or variable
Importance of Working
O It considered as life blood and central
nervous system of a firm.
O Advantages of maintaining adequate
amount of wc are
i. Solvency of the business
iii. Easy loans
iv. Cash discounts
v. Regular Supply of raw materials
vi. Regular payment of salaries, wages and
other day to day commitments.
vii. Exploitation of favorable market
viii. Ability to face crisis
ix. High morale.
The Dangers of Excessive WC
O Excessive wc means idle funds which
earns no profits for the business –
business cannot earn proper rate of return
on its investments.
O It results in unnecessary accumulation of
inventories it leads to waste, theft and
mishandling of inventories.
O It is indication of excessive debtors and
defective credit policy. It leads to higher
O Whenever there is excessive wc, relations
with other banks and financial institutions
may not be maintained.
O Due to low rate of return on
investments, the value of shares may also
O It degenerates in to overall inefficiency in
Dangers of Inadequate WC
O Cannot pay short term liabilities in time –
loses reputation-not able to get good
O It stagnates growth
O It become difficult to exploit favourable
O Difficult to meet day to day commitments
O not able to avail attractive credit
opportunities and cash discounts
O Impossible to utilize fixed assets due to
non-availability of liquid funds.
Factors influencing Working
1. Nature of Business
2. Size of Business/ Scale of operation
3. Production Policy
4. Manufacturing Process/ Length of
5. Seasonal variations
6. Credit Policy or terms of Purchase and
7. Rate of stock turnover
8. Business Cycles
9. Rate of growth of business
10. Dividend policy
11. Price level changes
12. Other factors
Determination of required WC
O Estimation of cash cost of the various
current assets required by the firm.
O Estimation of spontaneous current
liabilities of the firm.
O Compute net working capital by
subtraction the estimate current liabilities
O Add some percentage of net working
capital if there is any contingency or
safety working capital required, to get the
required working capital.
Principles of Working Capital
O Principle of Risk variation
O Principle of cost of capital
O Principle of Equity Position
O Principle of maturity of payment
1. Principle Of Risk variation
(Current assets policies)
O Risk refers to inability of firm to meet its
obligation when they become due for
O Larger investment on current assets with
less dependence on short term
borrowings : increases liquidity and
O Less investment on current assets with
great dependence on short term
borrowings : reduces liquidity and
increases risk and profitability.
2. Principle of cost of capital
O Various sources of wc have different cost
of capital and degree of risk involved.
O Higher the risk lower is the cost and lower
the risk higher is the cost.
O A sound wcm should try to achieve proper
balance between these two.
3. Principle of Equity Position
O It concerned with planning the total
investment in current assets.
O According to this principle, the amount of
wc invested in each component should be
justified by a firm’s equity position.
O Every rupee invested in current asset
should contribute to the net worth of firm.
4. Principle of maturity of
O According to this principle, a firm should
make every effort to relate maturities of
payment to its flow of internally generated
O Shorter the maturity schedule of current
liabilities in relation to expected cash
inflows, greater the inability to meet its
obligations in time.
Functions of WCM
1. Estimating the working capital
2. Financing of working capital needs
3. Analysis and control of working capital
Estimating Working Capital
i. Percentage of Sales method
iii. Cash forecasting method
iv. Operating Cycle method
v. Projected BS method
1.Percentage of sales method
O Based on the assumption that the level of
working capital for any firm is directly
related to sales.
O Simple to understand and easy to
calculate, but it cannot be applied in all
cases because the direct relationship
between sales and working capital may
not be established.
2. Regression analysis method
O Regression analysis: predicting the unknown
value of a dependent variable from the known
value of an independent variable.
O Relationships between sales and working
capital is represented by the eqn,
Where y=Working capital(dependent variable)
a=intercept of the least square
b=slope of the regression line
x=sales (independent variable)
3. Cash Forecasting Method
O It involves forecasting of cash receipts
and disbursements during a future period
O It include all possible sources from which
cash will be received and the channels in
which payments are to be made so that a
consolidated cash position is determined.
O This method is similar to the preparation
of a cash budget.
5. Projected Balance Sheet
O Projected balance sheet for future date is
prepared by forecasting current assets
and current liabilities.
O Estimated amount of working capital
required = Forecasted Current Assets –
Forecasted Current Liability
Financing of working capital
O Working Capital Requirements can be
1. Permanent or Fixed Working Capital
2. Temporary or variable working capital
The main sources of short-
term funds are as follows:
O Indigenous Bankers
O Trade Credit
O Installment Credit
O Accounts Receivable Credit or Factoring
O Accrued Expenses
O Deffered Incomes
O Commercial Paper
O Commercial Banks
O Public Deposits
The main sources of long-term
funds are as follows:
O Public Deposits
O Ploughing back of profits
O Loans from financial institutions
O Private money lenders or country bankers
O Very High rates of interest
O Trade credit refers to the credit extended by the
suppliers of goods in normal course of business.
O This type of finance is widely used because:
O It is easy and convenient method of finance.
O No interest charge is made by the lender;
O It is flexible as the credit increases with the growth of
O It is informal and spontaneous source of finance
O The normal terms of trade credit are ‘net 30 days’, or in other
words, the invoice must be paid in full within thirty days.
O Sometimes a discount is offered to customers for early
O One method of extending trade credit is known as
‘stretching’. This is the practice of postponing
payments to creditors beyond the originally agreed
period of time. This may be accepted by the supplier
especially if the business is a regular customer.
1) Supplier is charging higher prices
2) loss of cash discount
O It is used as a source of short-term working capital.
O Goods purchased and the payment is made in installments
over a pre-determined period of time.
O Interest is charged on the unpaid price or it may be adjusted
in the price.
O Some business houses collect advances from
their customers and agents against orders.
O It is a cheap source of finance in order to
minimize their investment in working capital.
O Firms manufacturing industrial products prefer
to take advance from their customers.
credit sales for which money has not been paid yet can be
sold to a debt factoring company for an immediate cash
payment (normally 80% of the amount owing). When
the debt becomes due, the debt factoring company will
then collect it and make a final payment to the
business, keeping a commission (usually around 5%)
O Factoring has three main drawbacks.
- High cost of factoring as compared to other
- Because it is expensive, it is often regarded as
being a last-resort method of financing and thus
may affect the reputation of a company if it is
known that it is using factoring.
- Adverse impact of tough stance taken by factor,
against a defaulting buyer resulting in reduced
O Expenses which have been incurred but not
yet due and hence not yet paid also.
O The longer the payment-period, the greater is
the amount liability towards employees or the
funds provided by them.
O The most important items of accruals are
wages & salaries, interest and taxes.
O No interest is payable on accrued expenses.
O Incomes received in advance before supplying goods and
O Usually no interest is charged for such amount if they make
the supply on time.
O Firms having good reputation in the market can demand
O These are short term unsecured promissory
notes with fixed maturity period.
O Only a company which is listed on the stock
exchange, has a net worth of at least Rs.
10crores and a maximum permissible bank
finance of Rs. 25 crores can issue C.P not
exceeding 30 % of its working capital.
O The maturity period of C.P. in India, mostly
ranges from 91 to 180 days.
O Commercial banks are the most important
source of short-term capital. They provides:-
O Cash credits
O Purchasing and Discounting of bills
O Acceptance of fixed deposits from the public by all type of
manufacturing and non-bank financial companies in the
O They are unsecured , more risky, less liquid and without any
O Permanent current assets or working
are supposed to be financed by
long-term source of finance.
O Most important source for raising the
permanent or long-term capital.
O Can issue equity shares and preference
O It is an instrument issued by the company
acknowledging its debt to its holder.
O Debenture holders are creditors of the
O Fixed interest is paid to debenture
O Are the fixed deposits accepted by a
business enterprise directly from the
Ploughing Back of Profits
O It means the reinvestments by the
concern of its surplus earnings in its
O Internal source of finance.
Loans from Financial
O FIs such as Commercial banks, LIC,
Industrial Finance Corporation Of India,
State Financial Corporations, State
Industrial Development Corporations etc
provide short term, medium term and long
Analysis and control of
1. Ratio Analysis
2. Funds flow Analysis
O Ratio is simple arithmetical expression of
relationship of one number to another.
i. Current Ratio
ii. Acid test Ratio
iii. Absolute Liquid Ratio
iv. Inventory Turnover Ratio
v. Receivables Turnover Ratio
vi. Payables Turnover Ratio
vii. Working Capital Turnover Ratio
viii. Working Capital Leverage
Funds Flow Analysis
O Technical devise to study the sources
from which additional funds are derived
and uses of these funds.
O It consists of 1) Preparing schedule of
changes in working capital 2) Statement
of application of funds
Working Capital Budget
O A budget is a financial / quantitative
expression of business plans and policies
to be pursued in the future period of time.
Approaches for financing
Approaches for Financing Working Capital
O It is the process of matching
maturing of debt with the matching
of financial needs.
O Permanent current asset is financed
by long term sources and temporary
working capital is financed by short
Permanent current assets
Temporary current Assets
O According to this approach, a firm
depends more on long-term funds for
O The firm finances its regular or permanent
current assets and a part of temporary or
variable current assets with long term
source of funds.
Temporary Current Assets
Features of conservative
i. Liquidity is higher
ii. Risk is minimized
iii. The cost of financing is relatively more
as interest has to be paid even on
seasonal requirements for the entire
O A firm is said to be aggressive, when it
uses more sort-term funds than warranted
by the hedging approach or matching
O A firm’s finances are a part of its regular or
permanent current assets with short-term
sources of funds.
O Under this more risk but it will prove to
have more returns.
Temporary CA Short-term
i. More risky
ii. Less costly
iii. More profitable
Profitability, Risk and Liquidity
The Liquidity Versus Profitability
O There is a trade off between liquidity and
profitability, gaining more of one ordinarily
means giving up some of the other.
O Having enough money in the form of
cash, or near-cash assets, to meet your
O Assets can be converted into cash
O A measure of the amount by which a
company’s revenues exceed its relevant
O ‘Liquidity’ as being on one end of a
straight line and ‘Profitability’ on the other
end of the line.
O There is a trade-off between liquidity and
O The items on the asset side of a
company's balance sheet are listed in
order of liquidity (easily converted in to
cash) eg. Cash, marketable Security,
Accounts Receivable, Inventory, Fixed
O We go from the top of the list to the
bottom, the liquidity decreases. But from
the top to bottom, the profitability
O In other words the most profitable
investment for company is normally in its
O The least profitable investment is cash.
O National Credit council constituted
committee under the leadership of Shri
V.T. Dehejia in 1968.
O To determine the extend to which credit
needs of industry and trade are likely to
be inflated and how much trends could be