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    S Working Capital

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    Tapas Tiwari
    Working capital refers to the capital required to meet the day-to-day operating expenses of a business. It includes current assets like cash, inventory, and accounts receivable as well as current liabilities like accounts payable. There are different types of working capital like net, gross, permanent, and variable working capital. A company must manage its working capital needs carefully to ensure adequate but not excessive levels. Key factors that influence working capital requirements include the nature of the business, seasonality, production and market conditions. Companies should finance current assets with short-term sources like accounts payable and plan working capital needs using methods like the operating cycle approach. Both inadequate and excessive working capital can pose problems for a business.

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    S Working Capital

    Uploaded by

    Tapas Tiwari
    35 views23 pages
    Working capital refers to the capital required to meet the day-to-day operating expenses of a business. It includes current assets like cash, inventory, and accounts receivable as well as current liabilities like accounts payable. There are different types of working capital like net, gross, permanent, and variable working capital. A company must manage its working capital needs carefully to ensure adequate but not excessive levels. Key factors that influence working capital requirements include the nature of the business, seasonality, production and market conditions. Companies should finance current assets with short-term sources like accounts payable and plan working capital needs using methods like the operating cycle approach. Both inadequate and excessive working capital can pose problems for a business.

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    Working capital refers to the capital required to meet the day-to-day operating expenses of a business. It includes current assets like cash, inventory, and accounts receivable as well as current liabilities like accounts payable. There are different types of working capital like net, gross, permanent, and variable working capital. A company must manage its working capital needs carefully to ensure adequate but not excessive levels. Key factors that influence working capital requirements include the nature of the business, seasonality, production and market conditions. Companies should finance current assets with short-term sources like accounts payable and plan working capital needs using methods like the operating cycle approach. Both inadequate and excessive working capital can pose problems for a business.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    35 views23 pages

    S Working Capital

    Uploaded by

    Tapas Tiwari
    Working capital refers to the capital required to meet the day-to-day operating expenses of a business. It includes current assets like cash, inventory, and accounts receivable as well as current liabilities like accounts payable. There are different types of working capital like net, gross, permanent, and variable working capital. A company must manage its working capital needs carefully to ensure adequate but not excessive levels. Key factors that influence working capital requirements include the nature of the business, seasonality, production and market conditions. Companies should finance current assets with short-term sources like accounts payable and plan working capital needs using methods like the operating cycle approach. Both inadequate and excessive working capital can pose problems for a business.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 23

    WORKING CAPITAL

    MANAGEMENT

    1
    Concept of Working Capital

    Working Capital is a capital which is consumed during


    a fiscal period in creating current income. It is
    investment in current assets and there is cost involved
    Concept of Working Capital
    Gross working capital:
    Total current assets.
    Net working capital:
    Current assets - Current liabilities.
    Net operating working capital (NOWC):
    Operating CA – Operating CL =
    (Cash + Inv. + A/R) – (Accruals + A/P)
    Types of Working Capital
    1. Net Working Capital
    2. Gross Working Capital
    3. Permanent Working Capital
    4. Variable Working Capital
    5. Negative Working Capital
    Net Working Capital
    The net working capital is the difference
    between current assets and current liabilities.
    Gross Working Capital
    Gross Working capital is the amount of funds
    invested in the various components of current assets.

    This concept has the following advantages:


    (a) It enables a firm to realize the greatest return on its
    investment
    (d) It helps in the fixation of various areas of financial
    responsibility
    (e) It enables a firm to plan and control funds and to
    maximize the return on investment.
    Permanent Working Capital
    Permanent working capital is the minimum amount of
    current assets which is needed to conduct a business even
    during the dullest season of the year.

    • This amount varies from year to year, depending upon the


    growth of a company and the stage of the business cycle in
    which it operates.

    Permanent working capital has the following characteristics:


    (a) It is classified on the basis of the time factor
    (b) Its size increases with the growth of business operations.
    Temporary or Variable Working Capital

    It represents the additional assets which are


    required at different times during the
    operating year -additional inventory, extra
    cash etc.
    • It is not always gainfully employed. It is
    particularly suited to business of a seasonal or
    cyclical nature
    Negative Working Capital
    Negative working capital emerges when
    current liabilities exceed current assets. Such a
    situation is not absolutely theoretical, and
    occurs when a firm is nearing a crisis of some
    magnitude.
    •
    Characteristics of Working Capital
    • Short life span
    • Swift transformation into other asset forms

    Current Assets Cycle

    Finished
    goods

    Accounts Work-in-
    receivable process
    Wages, salaries,
    factory overheads
    Raw materials

    Cash Suppliers
    The Operating Cycle and the Cash Cycle
    Raw material
    Cash
    purchased Finished goods sold
    received
    Order Stock
    Placed Arrives

    Inventory period Accounts receivable period

    Time
    Accounts payable period

    Firm receives invoice Cash paid for materials

    Operating cycle

    Cash cycle
    The Operating Cycle and the Cash Cycle
    Accounts
    Cash cycle = Operating cycle – payable
    period
    FACTORS INFLUENCING WORKING CAPITAL
    REQUIREMENTS
    • Nature of Business

    • Seasonality of Operations

    • Production Policy

    • Market Conditions

    • Conditions of Supply
    WC Policy

    Flexible/Relaxed Restrictive
    (Conservative) (Aggressive)
    Policy Policy
    Liquidity High Low
    Inventories Large Small
    Debtors High Low
    CURRENT ASSETS FINANCING POLICY

    According to the matching principle, fixed assets and

    permanent current assets should be supported by long-term

    sources of finance whereas fluctuating current assets must

    be supported by short-term sources of finance.


    METHODS OF ESTIMATING WORKING CAPITAL

    1. Conventional Method: According to the


    conventional method, cash inflows and
    outflows are matched with each other.
    2. Operating Cycle Method
    • Operating cycle of an enterprise is the length of
    time which is required to convert cash into
    resources, resources into final product, the final
    product into receivables and receivables back into
    cash.
    Operating Cycle Method
    O =R+W+F+A-P
    R= Av Stock of RM/ Per day Consumption
    of RM
    W= Av Stock of WIP/ Per day Production
    F = Av Stock of FG / Per day Sales
    A= Av book debts / Av. credit sales per day
    P = Av trade creditors / credit sales per day
    ADEQUACY OF WORKING CAPITAL

    • It protects a business from the adverse effects of shrinkage in the


    values of current assets.
    • It is possible to pay all the current obligations promptly and to take
    advantage of cash discounts.
    • It ensures to a greater extent the maintenance of a company's credit
    standing and provides for such emergencies as strikes, floods etc.
    • It permits the carrying of inventories at a level that would enable a
    business to serve satisfactorily the needs of its customers.
    • It enables a company to extend favourable credit terms to customers.
    • It enables a company to operate its business more efficiently because
    there is no delay in obtaining materials.
    • It enables a business to withstand periods of depression smoothly.
    Contd..
    • There may be operating losses or decreased retained earnings.
    • There may be excessive non-operating or extraordinary losses.
    • The management may fail to obtain funds from other sources
    for purposes of expansion.
    • There may be an unwise dividend policy.
    • Current funds may be invested in non-current assets.
    • The management may fail to accumulate funds necessary for
    meeting debentures on maturity.
    • There may be increasing price necessitating bigger
    investments in inventories and fixed assets.
    When working capital is inadequate, a
    company faces the following problems

    • It is not possible for it to utilise production facilities fully for want of working
    capital.
    • A company may not be able to take advantage of cash discount facilities.
    • The credit-worthiness of the company is likely to be jeopardised because of
    lack of liquidity,
    • A company may not be able take advantage of profitable business
    opportunities.
    • The modernisation of equipment and even routine repairs and maintenance
    facilities may be difficult to administer.
    • A company will not be able to pay its dividends because of the non­availability
    of funds.
    • A company may have to borrow funds at exorbitant rates of interest.
    • Its low liquidity may lead to low profitability in the same way as low
    profitability results in low liquidity.
    DANGERS OF EXCESSIVE WORKING CAPITAL

    • A company may keep very big inventories and tie up its


    funds unnecessarily.
    • There may be an imbalance between liquidity and
    profitability . A company may enjoy high liquidity and, at
    the same time, suffer from low profitability.
    • High liquidity may induce a company to undertake greater
    production which may not have a matching demand.
    • A company may invest heavily in its fixed equipment which
    may not be justified by actual sales or production. This
    may provide a fertile ground for later over-capitalisation.
    Four test of working capital policy:
    There are four test of working capital policy:
    • Level of Working Capital: This should be maintained by a careful study of the
    movements of working capital in successive periods. If a management can develop a
    pattern in these movements, this pattern would serve as guide to its changing
    requirements in relation to certain decisions which are made from time to time.
    • Structural Health: The relative health of the various components of the working
    capital should be considered from the point of view of liquidity. It is necessary to draw
    structural relationships in respect of each component constituting the current assets.
    • Circulation: This is an important feature of the liquid position and involves the natural
    activity cycle of an enterprise. Ratios may be calculated to show the average period
    required for the conversion of raw materials into finished goods, finished goods into
    sales, and sales into cash.
    • Liquidity: A more comprehensive test to measure liquidity may be adopted by using
    following three ratios, each expressed as a percentage of:
    (a) Working capital to current assets;
    (b) Stocks to current assets;
    (c) Liquid resources to current assets

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