This chapter included, Meaning and concepts of working capital Management , Operational environment for working capital Management and Determinants of working capital

1. Working Capital Management
Mr. Sunil Tiwari

2. WORKING CAPITAL
 Current assets – Current liabilities
 It measures how much in liquid assets a company has
available to build its business.
 A short term loan which provides money to buy earning
assets.
 Allows to avail of unexpected opportunities.
 Positive working capital is required to ensure that a firm is
able to continue its operations and that it has sufficient funds
to satisfy both maturing short-term debt and upcoming
operational expenses. The management of working capital
involves managing inventories, accounts receivable and
payable and cash.

3. WORKING CAPITAL
 An increase in working capital indicates that the business has
either increased current assets (that is received cash, or other
current assets) or has decreased current liabilities, for
example has paid off some short-term creditors.

4. Working Capital Management
 Decisions relating to working capital and short term financing are
referred to as working capital management. Short term financial
management concerned with decisions regarding to CA and CL.
 Management of Working capital refers to management of CA as well as
CL.
 If current assets are less than current liabilities, an entity has a working
capital deficiency, also called a working capital deficit.
 These involve managing the relationship between a firm's short-term
assets and its short-term liabilities.

5. Working Capital Management
 The goal of working capital management is to ensure that the firm is able
to continue its operations and that it has sufficient cash flow to satisfy
both maturing short-term debt and upcoming operational expenses.
 Businesses face ever increasing pressure on costs and financing
requirements as a result of intensified competition on globalised markets.
When trying to attain greater efficiency, it is important not to focus
exclusively on income and expense items, but to also take into account
the capital structure, whose improvement can free up valuable financial
resources

6. WORKING CAPITAL MANAGEMENT
 Active working capital management is an extremely
effective way to increase enterprise value.
Optimising working capital results in a rapid release
of liquid resources and contributes to an
improvement in free cash flow and to a permanent
reduction in inventory and capital costs, thereby
increasing liquidity for strategic investment and debt
reduction. Process optimisation then helps increase
profitability.

7. WORKING CAPITAL MANAGEMENT
 The fundamental principles of working capital
management are reducing the capital
employed and improving efficiency in the
areas of receivables, inventories, and
payables.

8. Why working Capital is important?
 Investment in CA represents a substantial
portion of total investment.
 Investment in CA and level of CL have to be
geared quickly to changes in sales.

10. Concepts of Working Capital
 Gross Working Capital
 Net working Capital

11. Gross Working Capital
 Total Current assets
 Where Current assets are the assets that can
be converted into cash within an accounting
year & include cash , debtors etc.
 Referred as “Economics Concept” since
assets are employed to derive a rate of return.

12. Net Working Capital
 CA – CL
 Referred as ‘point of view of an Accountant’.
 It indicates liquidity position of a firm &
suggests the extent to which working capital
needs may be financed by permanent sources
of funds.

13. CONSTITUENTS OF WORKING
CAPITAL
 CURRENT ASSETS
 Inventory
 Sundry Debtors
 Cash and Bank Balances
 Loans and advances
 CURRENT LIABILITIES
 Sundry creditors
 Short term loans
 Provisions

14. Characteristics of Current Assets
 Short Life Span
I.e. cash balances may be held idle for a week or
two , thus a/c may have a life span of 30-60 days etc.
 Swift Transformation into other Asset forms
I.e.each CA is swiftly transformed into other asset
forms like cash is used for acquiring raw materials ,
raw materials are transformed into finished goods
and these sold on credit are convertible into A/R &
finlly into cash.

15. Matching Principle
 If a firm finances a long term asset(like machinery)
with a S-T Debt then it will have to be periodically
finance the asset which will be risky as well as
inconvenient.
 i.e. maturity of sources of financing should be
properly matched with maturity of assets being
financed.
 Thus Fixed Assets & permanent CA should be
supported with L-T sources of finance & fluctuating
CA by S-T sources.

16. MATCHING PRINCIPLE

17. Need for Working Capital
 As profits earned depend upon magnitude of sales
and they donot convert into cash instantly, thus there
is a need for working capital in the form of CA so as
to deal with the problem arising from lack of
immediate realisation of cash against goods sold.
 This is referred to as “Operating or Cash Cycle” .
 It is defined as “The continuing flow from cash to
suppliers, to inventory , to accounts receivable &
back into cash “.

18. Need for Working Capital
 Thus needs for working capital arises from cash or
operating cycle of a firm.
 Which refers to length of time required to complete
the sequence of events.
 Thus operating cycle creates the need for working
capital & its length in terms of time span required to
complete the cycle is the major determinant of the
firm’s working capital needs.

19. Operating or Cash Cycle
1. Conversion of cash into inventory
2. Conversion of inventory into Receivables
3. Conversion of Receivables into Cash

20. OPERATING CYCLE
Receivables
Cash
Inventory
Phase 1
Phase 2
Phase 3

21. TYPES OF WORKING CAPITAL
 PERMANENT WORKING CAPITAL
 VARIABLE WORKING CAPITAL

22. PERMANENT WORKING CAPITAL
 THERE IS ALWAYS A MINIMUM LEVEL OF
CA WHICH IS CONTINOUSLY REQUIRED BY
A FIRM TO CARRY ON ITS BUSINESS
OPERATIONS.
 THUS , THE MINIMUM LEVEL OF
INVESTMENT IN CURRENT ASSETS THAT IS
REQUIRED TO CONTINUE THE BUSINESS
WITHOUT INTERRUPTION IS REFERRED AS
PERMANENT WORKING CAPITAL.

23. VARIABLE WORKING CAPITAL
 THIS IS THE AMOUNT OF INVESTMENT REQUIRED
TO TAKE CARE OF FLUCTUATIONS IN BUSINESS
ACTIVITY OR NEEDED TO MEET FLUCTUATIONS IN
DEMAND CONSEQUENT UPON CHANGES IN
PRODUCTION & SALES AS A RESULT OF SEASONAL
CHANGES.

24. DISTINCTION
 PERMANENT IS STABLE OVER TIME WHEREAS
VARIABLE IS FLUCTUATING ACCORDING TO
SEASONAL DEMANDS.
 INVESTMENT IN PERMANENT PORTION CAN BE
PREDICTED WITH SOME PROFITABILITY WHEREAS
INVESTMENT IN VARIABLE CANNOT BE PREDICTED
EASILY.
 WHILE PERMANENT IS MINIMUM INVESTMENT IN
VARIOUS CA , VARIABLE IS EXPECTED TO TAKE
CARE FOR PEAK IN BUSINESS ACTIVITY.

25. DISTINCTION
 WHILE PERMANENT COMPONENT REFLECTS THE
NEED FOR A CERTAIN IRREDUCIBLE LEVEL OF
CURRENT ASSETS ON A CONTINOUS AND
UNINTERRUPTED BASIS , THE TEMPORARY
PORTION IS NEEDED TO MEET SEASONAL & OTHER
TEMPORARY REQUIREMENTS.
 ALSO PERMANENT CAPITAL REQUIREMENTS
SHOULD BE FINANCED FROM L-T SOURCES , S-
TFUNDS SHOULD BE USED TO FINANCE
TEMPORARY WORKING CAPITAL NEEDS OF A FIRM,

26. OPERATING
ENVIRONMENT OF
WORKING CAPITAL

27. Monetary and Credit Policies
 Monetary policy is the process by which the govt.,central bank, or
monetary authority of a country controls (i) the supply of money, (ii)
availability of money, and (iii) cost of money or rate of interest, in order
to attain a set of objectives oriented towards the growth and stability of
the economy.
 Monetary policy is the process by which the government, central bank, or
monetary authority of a country controls (i) the supply of money, (ii)
availability of money, and (iii) cost of money or rate of interest, in order
to attain a set of objectives oriented towards the growth and stability of
the economy.Monetary theory provides insight into how to craft optimal
monetary policy.
 Monetary policy involves variations in money supply , interest rates ,
lending by commercial banks etc.

28. Credit Policy
 Credit gives the customer the opportunity to buy goods and services, and
pay for them at a later date.
 Clear, written guidelines that set
(1) the terms and conditions for supplying goods on credit ,
(2) customer qualification criteria
(3) procedure for making collections , and
(4) steps to be taken in case of customer delinquency . Also called collection
policy.
 Where delinquency means Failure to repay an obligation when due or as
agreed. Thus in consumer installment loans, missing two successive
payments will normally make the account delinquent

29. Advantages of credit trade
 Usually results in more customers than cash trade.
 Can charge more for goods to cover the risk of bad debt.
 Gain goodwill and loyalty of customers.
 People can buy goods and pay for them at a later date.
 Farmers can buy seeds and implements, and pay for them only
after the harvest.
 Stimulates agricultural and industrial production and commerce.
 Can be used as a promotional tool.
 Increase the sales.

30. Disadvantages of credit trade
 Risk of bad debt.
 High administration expenses.
 People can buy more than they can afford.
 More working capital needed.
 Risk of Bankruptcy.

31. Instruments of Monetary Policy in
India
 Money Supply
 Bank Rate
 Reserve Ratios
 Interest Rates
 Selective Credit Controls
 Flow of Credit

32. Money Supply
 This is the sum total of money public funds and can be used
for settling transactions to buy and sell things and make other
payments constitutes the money supply of a nation.
 Money supply = Notes and coins with public + Demand
deposits with Commercial papers

33. Bank Rate
 Standard rate at which bank is prepared to buy or rediscount bills of
exchange or other commercial papers eligible for purchase under Reserve
bank of India Act,1934.
 The rate of interest charged by central bank on their loans to commercial
banks is called bank rate(Discount rate).
 An increase in bank rate makes it more expensive for commercial banks
to borrow . This exerts pressure to bring about the rise in interest rates
(lending rates) charged by commercial banks on their lending to public.
This leads to a general tightening in economy.
 Whereas decrease in bank rate has the opposite effect and leads to general
easing of credit in the economy.

34. RESERVE REQUIREMENTS
 The reserve requirement (or required reserve ratio) is a bank
regulation that sets the minimum reserves each bank must hold to
customer deposits and notes. These reserves are designed to satisfy
withdrawal demands, and would normally be in the form of fiat
currency stored in a bank vault(vault cash), or with a central bank.
 The reserve ratio is sometimes used as a tool in the monetary policy,
influencing the country's economy, borrowing, and interest rates
.Western central banks rarely alter the reserve requirements because it
would cause immediate liquidity problems for banks with low excess
reserves; they prefer to use open market operations to implement their
monetary policy

35. RESERVE REQUIREMENTS
 Thus central bank makes it legally obligatory
for commercial banks to keep a certain
minimum percentage of deposits in reserve.
 These are of 2 types:-
1. Cash reserves
2. Liquidity reserves

36. CRR
 CASH RESERVE RATIO
 THIS IS DEFINED AS A cash reserve ratio
(or CRR) is the percentage of bank reserves to
deposits and notes. The cash reserve ratio is
also known as the cash asset ratio or liquidity
ratio.

37. STATUTORY LIQUIDITY
RATIO
 Statutory Liquidity Ratio (SLR) is a term used in
the regulation of banking in India. It is the amount
which a bank has to maintain in the form:
 Cash
 Gold valued at a price not exceeding the current
market price,
 Unencumbered approved securities (G Secs or Gilts
come under this) valued at a price as specified by the
RBI from time to time.

38. STATUTORY LIQUIDITY RATIO
 The quantum is specified as some percentage of the total demand and time
liabilities ( i.e. the liabilities of the bank which are payable on demand anytime,
and those liabilities which are accruing in one months time due to maturity) of a
bank. This percentage is fixed by the Reserve Bank of India. The maximum and
minimum limits for the SLR are 40% and 25% respectively.
 Following the amendment of the Banking regulation Act(1949) in January 2007,
the floor rate of 25% for SLR was removed. Presently the SLR is 24% with effect
from 8 November, 2008.
 The objectives of SLR are:
 To restrict the expansion of bank credit.
 To augment the investment of the banks in Government securities.
 To ensure solvency of banks. A reduction of SLR rates looks eminent to support
the credit growth in India.

39. INTEREST RATES
 This is generally done by stipulating min. rates of interest for
extending credit against commodities covetred under
selective credit control.
 Also, concessive or ceiling rates of interest are made
applicable to advances for certain purposes ao to certain
sectors to reduce the interest burden and thus facilitate their
development.
 Further obj. behind fixing rates on deposits are to avoid
unhealthy competition amongst the banks for deposits and
keep the level of deposit rates in alignment with lending rates
of banks for deposits.

40. Selective Credit Controls
 These are Qualitative instruments which are
aimed at affecting changes in the availability
of credit with respect to particular sectors of
the economy.
 Thus selective controls are called selective
because they are aimed at movement of credit
towards selective sectors of the economy.

41. Selective Credit Controls
 The general instruments such as Reserve ratios,
Bank rate and open market operations.
 They are called so because they influence the
nation’s money supply and general availability of
credit.
 Quantitative instruments are called quantitative
because they affect the total volume(quantity) of
money supply and credit in the country.

42. Selective Credit Controls
 The most widely used qualitative techniques are
selective control and moral suasion.
 While the general credit controls operate on the cost
and total volume of credit , selective credit controls
relate to tools available with the monetary authority
for regulating the distrubution or direction of bank
resources to particular sectors of economyin
accordance with broad national priorities considered
necessary for achieving the set.

43. MORAL SUASION
 IT IMPLIES THE CENTRAL BANK
EXERTING PRESSURE ON BANKS BY
USING ORAL AND WRITTEN APPEALS
TO EXPAND OR RESTRICT CREDIT IN
LINE WITH ITS CREDIT POLICY.

44. DETERMINATION OF
WORKING CAPITAL NEEDS

45. Different approaches in determination of
working capital
 Industry norm approach
 Economic modeling approach
 Strategic choice approach

46. INDUSTRY NORM APPROACH
 THIS APPROACH IS BASED ON THE
PREMISE THAT EVERY COMPANY IS
GUIDED BY THE INDUSTRY PRACTICE.
 LIKE IF MAJORITY OF FIRMS HAVE
BEEN GRANTING 3 MONTHS CREDIT
TO A CUSTOMER THEN OTHERS WILL
HAVE TO ALSO FOLLOW THE
MAJORITY DUE TO FEAR OF LOSING
CUSTOMERS.

47. ECONOMIC MODELLING
APPROACH
 TO ESTIMATE OPTIMUM INVENTORY
IS DECIDED WITH THE HELP OF EOQ
MODEL.

48. STRATEGIC CHOICE
APPROACH
 THIS APPROACH RECOGNISES THE
VARIATIONS IN BUSINESS PRACTICE
AND ADVOCATES USE OF
STRATEGYIN TAKING WORKING
CAPITAL DECISIONS.
 THE PURPOSE BEHIND THIS
APPROACH IS TO PREPARE THE UNIT
TO FACE CHALLENGES OF
COMPETITION & TAKE A STRATEGIC
POSITION IN THE MARKET PLACE.

49. STRATEGIC CHOICE
APPROACH
 THE EMPHASIS IS ON STRATEGIC
BEHAVIOUR OF BUSINESS UNIT.THUS
THE FIRM IS INDEPENDENT IN
CHOOSING ITS OWN COURSE OF
ACTION WHICH IS NOT GUIDED BY
THE RULES OF INDUSTRY,

50. Determinants of working capital
 General nature of business
 Production cycle
 Business cycle
 Credit policy
 Production policy
 Growth and expansion
 Profit level
 Operating efficiency