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AN INTRODUCTION
TO WORKING
CAPITAL
MANAGEMENT
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Meaning of working capital
Working capital is that capital which is
involved in the current assets of the
business. Basically, it is the capital which
is required to meet the day to day
expenses of the business.
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Types/Kinds of working capital
On the basis of
concept

Gross working
capital
Net working capital
On the basis of
need

Permanent working
capital
Temporary working
capital
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On the basis of concepts
Gross working capital = Total current assets

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Net working capital = current assets current
liabilities





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On the basis of Need
Permanent working capital
The sum up of the funds required to
finance the minimum level of current
assets of the business is known as the
permanent working capital. This capital
is required everytime to put the
business into working condition.

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Temporary working capital
It is required to explore the short term
opportunities of the market. The
requirement of temporary working capital
varies with time period.
Seasonal working capital
Special working capital
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Working Capital Needs of Different Firms
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Concepts of working capital
1. Balance Sheet concept
Gross working capital
Net working capital
2. Operating cycle concept
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OPERATING CYCLE CONCEPT
Operating cycle may be defined as the time
duration starting from the procurement of raw
materials or goods and ending with sales realisation.
Operating cycle of a firm consists of the time
required for the completition of the following activities.
Procurement of raw materials
Conversion of raw into W-I-P
Conversion of W-I-P into finished goods
Sale of goods(cash or credit)
Conversion of recievables into cash.
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Calculation of duration of Op.cycle
Duration of raw materials storage stage
+
Duration of Work in Process stage
+
Duration of finished goods stage
+
Duration of receivables collection stage
-
Duration of the credit period allowed by suppliers

O = R + W + F + D - C
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Estimation of working capital requirements
1. Calculate no. of operating cycles in a
year i.e. 365
no. of days in a op. cycle

2. Total operating exp. of the year
No. of the op.cycle in the year

The resulted amount plus additional
amount for contingencies will be the
avg. requirement of working capital.

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The Operating Cycle Concept
Product is
converted into
cash, which is
transformed into
more product,
creating the cash
conversion cycle.
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Cash Conversion Cycle
Purchase
Inventory
Pay for
Inventory

Sell Inventory
on Credit

Collect
Receivables
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LIQUIDITY
VS.
PROFITABILITY
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Financing of working capital
Long Term financing
Short Term financing
Spontaneous financing
Approaches regarding financing

Hedging Approach
Conservative Approach
Aggressive Approach
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Working Capital Financing Policies
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Working Capital Financing Policies
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Short-Term vs. Long-Term Financing

Short-term financing
Cheap but risky
Cheapshort-term rates generally lower
than long-term rates

Riskybecause you are continually entering
marketplace to borrow
Borrower will face changing conditions (ex;
higher interest rates and tight money)
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Short-Term vs. Long-Term Financing

Long-term financing
Safe but expensive

Safeyou can secure the required
capital

Expensivelong-term rates generally
higher than short-term rates
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Determinants of working capital
Nature of Business
Size of Business
Growth and expansion
Production cycle
Business fluctuations
Production policy
Sale policy
Availability of raw material
Availability of credit
Volume of profit
Dividend policy
Efficiency of management
Price level changes
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Working capital management
WCM is the process of planning and
controlling the level and mix of the
current assets of the firm as well as
financing these assets. Specially wcm
requires financial manager to decide that
what quantities of cash,accounts
recievables and inventories etc. the firm
must hold at any point of time. The goal
of wcm is to manage the current assets
and current liabilities of the firm in such a
way that satisfactory level of working
capital is maintained.
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Importance of working capital
Maximising shareholders wealth
Profit maximisation
Agency problem
Ethical issues
Social responsibilities
Behavioural objectives
Diversent objectives
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While preparing a project report on behalf of a client you have collected the following
facts. Estimate the net working capital required for that project. Add 10 per cent to your
computed figure to allow contingencies:
Particulars Amount per unit
Estimated cost per unit of production:
Raw material
Direct labour
Overheads (exclusive of depreciation, Rs 10 per unit)
Total cash cost
Rs 80
30
60
170
Additional information:
Selling price, Rs 200 per unit
Level of activity, 1,04,000 units of production per annum
Raw materials in stock, average 4 weeks
Work in progress (assume 50 per cent completion stage in respect of conversion costs
and 100 per cent completion in respect of materials), average 2 weeks
Finished goods in stock, average 4 weeks
Credit allowed by suppliers, average 4 weeks
Credit allowed to debtors, average 8 weeks
Lag in payment of wages, average 1.5 weeks
Cash at bank is expected to be, Rs 25,000.
You may assume that production is carried on evenly throughout the year (52 weeks) and
wages and overheads accrue similarly. All sales are on credit basis only.
Solution
Net working capital estimate of a project
(A) Current assets:
(i) Raw materials in stock, (1,04,000 Rs 80 4/52) Rs 6,40,000
(ii) Work-in-progress
(a) Raw material (1,04,000 Rs 80 2/52) 3,20,000
(b) Direct Labour (1,04,000 Rs 15 2/52) 60,000
(c) Overheads (1,04,000 Rs 30 2/52) 1,20,000
(iii) Finished goods stock: (1,04,000 Rs 170 4/52) 13,60,000
(iv) Debtors: (1,04,000 Rs 170 8/52) 27,20,000
(v) Cash at bank 25,000
Total investment in current assets 52,45,000
(B) Current liabilities:
(i) Creditors, average 4 weeks: (1,04,000 Rs 80 4/52) 6,40,000
(ii) Lag in payment of wages (1,04,000 Rs 30 1.5/52) 90,000
Total current liabilities 7,30,000
(C) Net working capital: Current assets Current liabilities 45,15,000
Add: 10 per cent contingencies 4,51,500
Net working capital required 49,66,500
Working Notes
A full unit of raw material is required at the beginning of the
manufacturing process and, therefore, total cost of the material, that is,
Rs 80 per unit has been taken into consideration, while in the case of
expenses, viz. direct labour and overheads, the unit has been finished
only to the extent of 50 per cent. Accordingly, Rs 15 and Rs 30 have
been charged for direct labour and overheads respectively in valuing
work-in-process.