Conceptual Framework 1

CONCEPTUAL FRAMEWORK
2.1. WORKING CAPITAL MANAGEMENT – A THEORETICAL DISCUSSION

The term working capital is commonly used for the capital required for day-to-day
working in a business concern, such as for purchasing raw material, for meeting day-
to-day expenditure on salaries, wages, rents rates, advertising etc. But there is much
disagreement among various financial authorities (Financiers, accountants,
businessmen and economists) as to the exact meaning of the term working
capital.Working capital management involves managing the relationship between a
firm's short-term assets and its short-term liabilities. 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.
Working capital is defined as, ―the excess of current assets over current
liabilities and provisions.
In the Annual Survey of Industries (1961), working capital is defined to include,
― Stocks of materials, fuels, semi-finished goods including work-in- progress and

finished goods and by-products; cash in hand and bank and the algebraic sum of
sundry creditors as represented by,
(a) outstanding factory payments e.g., rent, wages, interest and dividend;
(b) purchase of goods and services;
(c) short-term loans and advances and sundry debtors comprising amounts due to
thefactory on account of sale of goods and services and advances towards tax
payments.
CALCULATION OF WORKING CAPITAL
The net working capital formula is calculated by subtracting the current liabilities from
the current assets. Here is what the basic equation looks like:
Typical current assets that are included in the net working capital calculation are
cash,accounts receivable, inventory, and short-term investments. The current liabilities
section typically includes accounts payable, accrued expenses and taxes, customer
deposits, and other trade debt.
A positive net working capital is better than a negative one. A positive calculation shows
creditors and investors that the company is able to generate enough from operations to pay
for its current obligations with current assets.
A negative net working capital, on the other hand, shows creditors and investors that the operations of
the business aren’t producing enough to support the business’s current debts.
CLASSIFICATION OF WORKING CAPITAL

Working Capital may be classified in two ways,
a) Concept based working capital
b) Time based working capital

➢ On the basis of concept:
1. Gross Working Capital: It refers to the firm’s investment in total current or
circulating assets.
2. Net Working Capital: The term ―Net Working Capital has been defined in two
different ways:
1) It is the excess of current assets over current liabilities. This is, as a matter of fact,
the most commonly accepted definition. Some people define it as only the
difference between current assets and current liabilities.
2) Alternate definition of net working capital is that portion of a firm’s current

assets which is financed by long-term funds .
➢ On the basis of time:

1.Permanent/Fixed Working Capital:
Permanent or fixed working capital represents that part of capital which It increases
within the crease in size of the business. Fixed working capital can be classified into:
Regular working capital:
It is the minimum amount of liquid capital required to keep the circulation of
capital from cash to inventories, receivable and again to cash. A sufficient
amount of bank balance is a good source of regular working capital.
Reverse working capital:
It is the excess of capital over the needs of regular working capital which should
be kept to meet the contingencies that may arise any time. These contingencies
include rising in prices, business depression, strikes, special operations such
as experiment with new products etc.
2.Temporary/Variable Working Capital:
It represents that part of the working capital which is required over and above the
permanent working capital. It is the additional assets required of the time during the
year. This type of working capital is not needed throughout the year. It is needed to
meet the seasonal fluctuation and for any other special purpose. They can be divided
in the following ways:
Seasonal Variable Working Capital:

It is the part of the working capital required to meet the seasonal demand of the
business is regarded as Seasonal Variable Working Capital. In peak seasons more raw
materials are required to be purchased, more expenses need to be incurred etc. This
short-term requirement of working capital would be financed from short term
sources of capital.
Special Variable Working Capital:
It is that part of working capital which is required for financing special operations
such as extensive marketing campaign, experiments with products or methods of
production, carrying of special jobs, etc. This is also to be financed from short term
debt financing.
2.1.i. IMPORTANCE OR ADVANTAGES OF ADEQUATE WORKING CAPITAL
Working capital is the life blood of a business. Just as circulation of blood is essentialin the
human body for maintaining life, working capital is very essential to maintain the smooth
running of a business. No business can run successfully without an adequate amount of
working capital. The main advantages of maintaining adequate amount of working capital are
as follows:
1. Solvency of the business:
Adequate working capital helps in maintaining solvency of the business by

providing uninterrupted flowof production.
2. Goodwill:
Sufficient working capital enables a business concern to make prompt payments and
hence helps in creating and maintaining goodwill.
3. Easy loans:
Adequate working capital enables a concern to face business crisis in

emergencies such as depression because during such periods,
generally, there is much pressure on working capital.
4. Cash Discounts:
Adequate working capital also enables a concern to avail cash discounts on the
purchases and hence it reduces costs.
5. Regular supply of raw materials:

Sufficient working capital ensures regular supply of raw materials and
continuous production.
6. Ability to face Crisis:
Adequate working capital enables a concern to face business crisis in emergencies such
as depression because during such periods, generally, there is much pressure on
working capital.
2.1.ii DISADVANTAGES OF INADEQUATE (EXCESS) WORKING CAPITAL
2. It cannot buy its requirements in bulk and cannot avail of discounts, etc.
3. It becomes difficult for the firm to exploit favorable market conditions and
undertake profitable projects due to lack of working capital.
4. The firm cannot pay day-to-day expenses of its operations and it creates
inefficiencies, increases costs and reduces the profits of the business.
5. It becomes impossible to utilize efficiently the fixed assets due to non -
availability of liquid funds.
6. The rate of return on investments also falls with the shortage of working capital.
The working capital cycle (WCC), also known as the cash conversion cycle, is the
amount of time it takes to turn the net current assets and current liabilities into
cash. The longer this cycle, the longer a business is tying up capital in its working
capital without earning a return on it. Companies strive to reduce their working
capital cycleby collecting receivables quicker or sometimes stretching accounts
payable. Under certain conditions, minimizing working capital might adversely
affect the company's ability to realize profitability, e.g., when unforeseen hikes in
demand exceed inventories, or when a shortfall in cash restricts the company's
ability to acquire tradeor production inputs.
The operating cycle is useful for estimating the amount of working capital that
a company will need in order to maintain or growits business. A company with
an extremely short operating cycle requires less cash to maintain its operations,
and socan still growwhile selling at relatively small margins.Conversely, a
business mayhave fat margins and yet still require additional financing to growat
even a modest pace, if its operating cycle is unusually long. In case of a
manufacturing company, the operating cycle is the length of time necessary to
complete the following cycle of events
•
•
•
•
2 . 3 NATIONAL & INTERNATIONAL SCENARIO:

Working capital management (WCM) is of particular importance to the small business.
With limited access to the long-term capital markets, these firms tend to rely more heavily
on owner financing, trade credit and short-term bank loans to finance their needed
investment in cash, accounts receivable and inventory. However, the failure rate among
small businesses is very high compared to that of large businesses. In 2012 UK and the US
have shown weak financial management - particularly poor working capital management
and inadequate long-term financing - is a primary cause of failure among small businesses.
The success factors or impediments that contribute to success or failure are categorized as
internal and external factors. The factors categorized as external include financing (such as
the availability of attractive financing), economic conditions, competition, government
regulations, technology and environmental factors. While the internal factors are managerial
skills, workforce, accounting systems and financial management practices. Some research
studies have been undertaken on the working capital management practices of both large
and small firms in India using either a survey-based approach to identify the push factors for
firms to adopt good working capital practices or econometric analysis to investigate the
association between WCM and profitability.
REGIONAL AND COUNTRY PERFORMANCE REVIEW:
India’s weak WC performance in 2012 was due to poor results in receivables and
inventories (DSO and DIO up 2% each), partly offset by a better showing in
payables(DPO up 1%). The deterioration in WC performance also arose from poor results
in receivables and inventories (DSO and DIO up 4% and 3%, respectively), partly
offsetby a better showing in payables (DPO up 2%).posted a deterioration in WC
performance compared with 2011.
Greece, Italy, Portugal, Spain and France saw a drop of 6% in C2C, driven by a
combined decrease in both DSO and DIO. Cyclical and oil industries and electric utilities
all made progress in reducing C2C, with the drop reported by cyclical companies
exacerbated by the fall in general retailers scored poorly, still affected by the regulatory
decision to cap corporate payment terms, although some exceptions areallowed. (C2C
down 4%), after a slight deterioration the year before. But performance between and
within industries was varied: for example, it was mixed for electric utilities, chemical and
suppliers and consumer products companies. Benelux posted a further reduction of 6% in
C2C, with a strong showing from oil companies and consumer products. For the Nordic
countries, WC performance remains heavily skewed toward the performance of certain
industries.

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CONCEPTUAL FRAMEWORK

2.1. WORKING CAPITAL MANAGEMENT – A THEORETICAL DISCUSSION

In the Annual Survey of Industries (1961), working capital is defined to include,

― Stocks of materials, fuels, semi-finished goods including work-in- progress and

CLASSIFICATION OF WORKING CAPITAL

a) Concept based working capital

b) Time based working capital

2) Alternate definition of net working capital is that portion of a firm’s current

➢ On the basis of time:

Seasonal Variable Working Capital:

1. Solvency of the business:

Adequate working capital helps in maintaining solvency of the business by

Adequate working capital enables a concern to face business crisis in

5. Regular supply of raw materials:

2 . 3 NATIONAL & INTERNATIONAL SCENARIO:

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