Working Capital Management

INTRODUCTION TO WORKING CAPITAL

Sakshi Karn 1
LEARNING OBJECTIVE :-

 The major objective of this course is to understand and apply

the principles and techniques of managing working capital or

short-term finance of business firms.

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  CONCEPTS OF WORKING CAPITAL

 Working capital (WC) is a financial metric which

represents operating liquidity available to a business,
organization or other entity, including governmental entities.
 Along with fixed assets such as plant and equipment, working
capital is considered a part of operating capital.
 Gross working capital is equal to current assets.
 Working capital is calculated as current assets minus current
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liabilities.
 If current assets are less than current liabilities, an entity has a
working capital deficiency, also called a working capital deficit.

 A company can be endowed with assets and profitability but may fall
short of liquidity if its assets cannot be readily converted into cash.

 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,

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accounts receivable and payable, and cash.

 Calculation of working Capital:-

 Working capital is the difference between current assets and

current liabilities. It is not to be confused with trade working
capital (the latter excluding cash).

 The basic calculation of working capital is based on the entity’s

gross current assets.

 Working Capital= {CURRENT ASSETS}-{CURRENT

LIABILITIES} 5
 WORKING CAPITAL CYCLE
 Working capital is computed as the sum of: Inventories (+) Trade
receivables (+) Cash (-) Trade payables.
 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.
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 Companies strive to reduce their working capital cycle by
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 trade or
production inputs.
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 What is a Working Capital Cycle?

 The Working Capital Cycle for a business is the length of time it

takes to convert the total net working capital (=current
assets less current liabilities) into cash.
 Businesses typically try to manage this cycle by selling
inventory quickly, collecting revenue from customers quickly,
and paying bills slowly, to optimize cashflow.

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WORKING CAPITAL CYCLE

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 WORKING CAPITAL MANAGEMENT
Decisions relating to working capital and short-term financing are
referred to as working capital management. These involve
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. 10
 A managerial accounting strategy focusing on maintaining efficient
levels of both components of working capital, current assets, and
current liabilities, in respect to each other.
 Working capital management ensures a company has sufficient
cash flow in order to meet its short-term debt obligations and
operating expenses.

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 ADVANTAGES OF WORKING CAPITAL

 Fuels short-term needs: Working capital loans are easy to secure

and help you meet short-term requirements. They have flexible
repayment tenors to help you plan your payments better too.
 Eliminates collateral: The biggest advantage of working capital
loans is that they are unsecured. For most loans, pledging collateral
is essential as it acts as an assurance of repayment. However, this
isn’t ideal as it puts your business assets and personal valuables12at
risk. Working capital loans save you from this hassle.
 ADVANTAGES OF WORKING CAPITAL

 Makes it easier to get financing: You can easily apply for a

working capital loan online and will have to submit only a few
documents. As a result, the process is easier for you and funds are
disbursed faster.
 Maintains cash flow: Irrespective of your requirement and
monthly revenue, working capital financing helps maintain good
cash flow for your business. This means that your business gains
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stability and financial strength for urgent or unexpected needs.
 ADVANTAGES OF WORKING CAPITAL

 Provides a line of credit facility: Another benefit is that these

loans provide you with the facility of line of credit wherein you
can withdraw the amount according to your needs via a credit
line. On a monthly basis, you only have to pay the interest in the
form of EMIs and the principal amount has to be repaid only at
the end of your tenor.
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 ADVANTAGES OF WORKING CAPITAL

 Preserves ownership: If you have venture capital backing your

business, you have to share your ownership privileges with
someone else. You cannot take all decisions and there is a
constant risk of losing the funders and investors if anything goes
wrong. But with working capital loans, you remain the sole owner
of your business. The decisions you make and the strategies you
draw up are entirely in your control. 15
 DISADVANTAGES OF WORKING CAPITAL

 No return on Capital:- The biggest disadvantage of this capital is

that all the excess working capital lying with the company earns no
interest and therefore it can be termed as zero return capital. Capital
has an opportunity cost and if the company has locked too much
capital into working capital than it is not a prudent financial
decision on the part of the company. Hence in simple words a
company has to maintain fine balance when it comes to managing
this capital as more working capital than required also is not a good
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sign as far as the company is concerned.

 DISADVANTAGES OF WORKING CAPITAL

 Chances of Overspending:- Another drawback of this capital is

that if the company has excess capital than chances are that the
company will end up spending or purchasing those things which
are not necessary for the business. Hence in simple words
purchasing unnecessary things due to excess capital is one of the
limitations of having working capital with the company.
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 DISADVANTAGES OF WORKING CAPITAL

 No Bifurcation:- Another risk associated with working capital

is that companies tend to use the working capital for financing
long-term projects and thus there is no bifurcation between short
term and long term method of financing.
In simple words just like one antibiotic cannot be used to treat all
diseases in the same way working capital cannot be used to fund
all types of expenses which some companies tend to do and
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jeopardize the short-term financial position of the company.

LEARNING OUTCOMES:-
 Evaluate comparative working capital management Policy
 Formulation of optimum inventory and receivables management plan.
 Showing the impact of working capital policy on firm’s operations, etc.

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