Management of Working Capital

Working capital management working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability to

satisfy both maturing short-term debt and upcoming

operational expenses. The management of working capital involves managing inventories, accounts receivable, accounts payable and cash

Need for working capital management

Ensuring that enough cash exists to pay bills; Ensuring that enough inventory exists to make and sell products; Ensuring that any excess cash is invested in interestbearing securities; Ensuring that accounts receivable are at a level that maximizes earnings,

Ensuring that short-term borrowings such as salaries

payable and trade credit are used efficiently and at the lowest cost possible

Concepts of working capital Gross working capital It refers to the firms investment in current assets. Current assets are the assets, which can be converted into cash within an accounting year or within an operating cycle. You can include here cash, short-term securities, debtors (accounts receivable & book debts), bills receivable and stock.

GWC= Firms total investment in current assets

Net working capital

Net working capital refers to the difference between

current assets and current liabilities. Current liabilities are those claims of outsider, which are

expected to mature for payment within an accounting

year & include creditors, bills payable & the outstanding expenses. NWC = CA - CL

CURRENT ASSETS constitute the following: 1 Inventories 2 Trade Debtors 3 Prepaid Expenses 4 Loan and Advances

5 Short Term Investment

6 Cash and Bank Balance CURRENT LIABILITIES comprise the following:

I. Sundry Creditors
II. Bank Overdrafts III. Short-term Loans

IV. Provisions: provisions for taxation, proposed dividends and contingencies.

Danger points to be kept in mind while planning Excessive investment (Profitability)

a. It results in unnecessary accumulation of inventories. Thus,

chances of inventory mishandling, waste, theft & losses increase.

b. It is an indication of defective credit policy & slack collection

period. c. Excessive WC makes management complacent, which

degenerates into managerial inefficiency.

d. Tendencies of accumulating inventories tend to make speculative profits grow.

Inadequate investment (Liquidity)

a. It stagnates growth. b. It become difficult to implement operating plans and achieve the

firms operating profit target.

c. Operating inefficiencies creep in when it becomes difficult even to meet day-to-day commitments

d. Fixed assets are not efficiently utilized for the lack of working
capital funds. Thus, the firms profitability would deteriorate. e. Paucity of WC funds render the firm unable to avail attractive

credit opportunities.
f. The firm loses its reputation when it is not in a position to honour its short-term obligations.

Kinds of Working Capital Permanent working capital: Permanent working capital is the minimum amount of current assets, which is needed to conduct a business even during the dull season of the year. The minimum level of current assets is called permanent or fixed working capital

as this part is permanently blocked in current assets.

It represents the current assets, which are required on a continuing basis over the entire year. It is maintained as the medium as to

continue the operations at any time.

Characteristics of Permanent working capital It is classified on the basis of the time period

It constantly changes from one asset to another and continues to

remain in the business process. Its size increase with the growth of business operations.

Temporary working capital: Temporary working capital represents a certain amount of fluctuations in the total current assets during a short period Additional current assets are required at different times during the operating year.

Variable working capital is the amount of additional current asset that

are required to meet the seasonal needs of a firm, so is also called as the seasonal working capital.

Characteristics of Temporary working capital

It is not always gainfully employed, though it may change from one asset to another asset, as permanent working capital does.

It is particularly suited to business of a seasonal or cyclical nature.

Determinants of WC Nature of business

Terms of sales and purchases

Manufacturing cycle Rapidity of turnover

Business cycle
Changes in technology Seasonal variation Market condition Dividend policy Working capital cycle

Approaches of WCM

Mix of short-term & long-term sources of finance

1. Matching/ Hedging approach

2. Conservative approach
3. Aggressive approach

Compute the duration of the operating cycle for each of the two years. (360 days) )

Particulars

Year 1 20,000 14,000 21,000 96,000 1,40,000 1,60,000 32,000 16,000

Year 2 27,000 18,000 24,000 1,35,000 1,80,000 2,00,000 50,000 18,000

Stocks Raw materials WIP Finished goods

Purchase of raw materials Cost of goods sold Sales Debtors Creditors