Working

Capital Management

WORKING CAPITAL MANAGEMENT

INTRODUCTION TO FINANCE:
Finance is a field closely related to accounting that deals with the allocation of
assets and liabilities over time under conditions of certainty and uncertainty. Finance
also applies and uses the theories of economics at some level. Finance can also be
defined as the science of money management. A key point in finance is the time value
of money, which states that purchasing power of one unit of currency can vary over
time. Finance aims to price assets based on their risk level and their expected rate of
return. Finance can be broken into three different sub-categories: public finance,
corporate finance and personal finance.
Questions in personal finance revolve around

Protection against unforeseen personal events, as well as events in the wider

economy

Transference of family across generations bequests and inheritance

Effects of tax policies tax subsidies and/or penalties on management of personal

finances

Effects of credit on individual financial standing

Planning a secure financial future in an environment of economic instability

Personal finance may involve paying for education, financing durable goods such as
real estate and cars, buying insurance, e.g. health and property insurance, investing and
saving for retirement.
Personal finance may also involve paying for a loan, or debt obligations. The six key
areas of personal financial planning, as suggested by the Financial Planning Standards
Board, are:[1]
1. Financial position: is concerned with understanding the personal resources
available by examining net worth and household cash flow. Net worth is a
person's balance sheet, calculated by adding up all assets under that person's
control, minus all liabilities of the household, at one point in time. Household
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cash flow totals up all the expected sources of income within a year, minus all
expected expenses within the same year. From this analysis, the financial
planner can determine to what degree and in what time the personal goals can
be accomplished.
2. Adequate protection: the analysis of how to protect a household from
unforeseen risks. These risks can be divided into liability, property, death,
disability, health and long term care. Some of these risks may be self-insurable,
while most will require the purchase of an insurance contract. Determining how
much insurance to get, at the most cost effective terms requires knowledge of
the market for personal insurance. Business owners, professionals, athletes and
entertainers require specialized insurance professionals to adequately protect
themselves. Since insurance also enjoys some tax benefits, utilizing insurance
investment products may be a critical piece of the overall investment planning.
3. Tax planning: typically the income tax is the single largest expense in a
household. Managing taxes is not a question of if you will pay taxes, but when
and how much. Government gives many incentives in the form of tax
deductions and credits, which can be used to reduce the lifetime tax burden.
Most modern governments use a progressive tax. Typically, as one's income
grows, a higher marginal rate of tax must be paid. Understanding how to take
advantage of the myriad tax breaks when planning one's personal finances can
make a significant impact.
4. Investment and accumulation goals: planning how to accumulate
enough money - for large purchases and life events - is what most people
consider to be financial planning. Major reasons to accumulate assets include,
purchasing a house or car, starting a business, paying for education expenses,
and saving for retirement. Achieving these goals requires projecting what they
will cost, and when you need to withdraw funds. A major risk to the household
in achieving their accumulation goal is the rate of price increases over time, or
inflation. Using net present value calculators, the financial planner will suggest
a combination of asset earmarking and regular savings to be invested in a
variety of investments. In order to overcome the rate of inflation, the investment
portfolio has to get a higher rate of return, which typically will subject the
portfolio to a number of risks. Managing these portfolio risks is most often
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accomplished using asset allocation, which seeks to diversify investment risk

and opportunity. This asset allocation will prescribe a percentage allocation to
be invested in stocks, bonds, cash and alternative investments. The allocation
should also take into consideration the personal risk profile of every investor,
since risk attitudes vary from person to person.
5. Retirement planning is the process of understanding how much it costs to
live at retirement, and coming up with a plan to distribute assets to meet any
income shortfall. Methods for retirement plan include taking advantage of
government allowed structures to manage tax liability including: individual
(IRA) structures, or employer sponsored retirement plans.
6. Estate planning involves planning for the disposition of one's assets after
death. Typically, there is a tax due to the state or federal government at one's
death. Avoiding these taxes means that more of one's assets will be distributed
to one's heirs. One can leave one's assets to family, friends or charitable groups.

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INTRODUCTION TO WORKING CAPITAL

Working capital is the firms holding of current assets such as cash, receivables,
inventory and marketable securities. every firm required working capital for its day to
day transaction such as purchasing raw material , for meeting salaries , wages rents
rates ,advertising etc.., but there is much disagreement among various financial
authorities (financial manager , accountants ,businessmen and economists)as to the
exact meaning of the term working capital .
Defining Working Capital
1.Working capital is excess of current assets over current liabilities.
Guthmann&Dougall
2.Working capital refers to a firms investment in short term assets, cash, short term
securities, account receivables and inventories.

Weston & Beigham

3.Working capital is the amount of funds necessary to cover the cost of operating the
enterprise.

Shubin

Objectives of Working capital Management:

The Objectives of Working capital Management are two fold:
1. Maintenance of Working capital and
2. Ability of ample funds at the time of need.
The basic goal of Working capital management is to manage each of the funds
current assets and current liabilities in such a way that an acceptable level of
networking capital is always maintained in the business.

Scope of Financial Management:

The Scope of Financial Manager is divided into two broad categories.

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(A). Traditional Approach: The Scope of Finance function was treated by the
traditional approach in the narrow sense of procurement of finds by corporate to
meet their financing needs.
(B).Modern Approach: The modern approach views financial management in a
broad sense and provide a conceptual and analytical frame work for finance
function covers both acquisitions of funds as well as their allocation.

Significance of working capital:

The world in which real firms function is not perfect. It is characterizes by the
firms considerable uncertainty regarding the demand, markets price, quality
circumstances introduce problems to the firm must deal. While the firm has many
strategies available to address these circumstances, strategies that utilize investment or
financing with working capital accounts often offer a substantial advantage over the
other techniques. The importance of working capital management is reflected in the
fact that financial managers spend a great deal of time in managing current assets and
current liabilities like

Arranging short term financing:

Negotiating favorable credit terms
Controlling the movement of cash
Administering accounts receivables
Monitoring investment in receivables
Decisions concerning the above areas ply an important role in maximizing
overall value of the firm. Once decisions concerning these areas are reached, the level
of working capital is also determined in active decision sense, but falls out as residual
from the decision just made.
The management of working capital plays an important role in maintaining the
financial health during the normal course of business. This critical role can be
enunciated by examining the flow of resources thorough the firm. By far the major flow
is the working capital cycle. Working capital.
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Financial Management Process:

FINANCIAL DECISIONS: Financial decision is three types

Market Price of the Share: Share Holder Wealth (WO=Npo)

1.Investment Decisions:
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It is broadly concerned with the investment of assets.

The main idea is

maximization of owners wealth. Decision is taken to maximize the benefits of equity

shareholders.
2. Financial decision
The major second decision of the firm is the financing decision. Here, the financial
manager is concerned with determining the best financing mix or capital structure for
his firm. The management will decide how many funds should be provided from
outside public and financial institutions.

3. Dividend decision:
The top management decides how much is retained and distributed to equity share
holders. These earnings are called earnings available to equity shareholders.

Determinants of working capital:

A large number of factors influence the net working needs of the firm. These
factors affect different enterprises differently. They vary from time to time. In general
the following factors are involved in a proper assessment of working capital required.

1. Nature and Size of Business:

Working capital requirements of a firm are basically influenced by the nature of
its business. Trading and financial firms have a very less investment in fixed assets but
require a large sum of money to be invested in working capital. In contrast public
utilities have a very limited need for working capital and have to invest abundantly in
fixed assets. The working capital needs most manufacturing concerns fall between two
extreme requirements of trading and public utilities.
The size of business also has an impact on its working capital needs. Size may
be measured in terms of the scale of operation. A firm with larger scale of operation
will need more working capital than a small firm.

2. Manufacturing Cycle:

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The manufacturing cycle starts with the purchase of raw materials and
completes with production of finished goods. Longer the manufacturing cycle, larger is
the tied up of funds in inventories. Thus if there are alternative ways of larger is the tied
up of funds in inventories. Thus if there are alternative ways of manufacturing product,
The Process with the shortest manufacturing cycle must be chosen.
3. Business Fluctuation:
Business variations effect especially the temporary working capital requirement.
When there is an upward swing in the economy sales wills increase correspondingly the
firms investment in inventories and book debts will also increase. On the other hand
when there is a decline in the economy, sales will fall and consequently levels of
inventories and book debt will also fall.
4. Production Policy:
A strategy of constant production may be maintained in order to resolve the
working capital problems arising due to seasonal changes in the demand for the firms
capital. A steady production policy will cause inventories to accumulating during the
off-season periods and the firm will be exposed to greater inventory costs and risks.
The firm may then adopt the policy of varying its production schedules in accordance
with changing demand.
5. Firms Credit Policy:
The credit policy of the firm affects working capital by influencing the level of
book debts. The credit terms to be granted to customers may depend upon norms of the
industry to which the firms belong. A high collection period will mean tie up of funds
in book debts.
6. Availability of Credit:
The credit terms granted by the firms creditors also effect the working capital
requirements of a firm, which creditors also effect the working capital requirements of
a firm. A firm which can get bank credit easily on favorable conditions will operate
with less working capital than a firm with out such a facility.
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7. Growth and Expansion Activities:

A growing firm may need to invest funds in fixed assets in order to sustain its
growing production and sales. This will in turn increase investment in current assets to
support enlarged scale of operations. It should therefore make proper planning to
finance the increasing needs for working capital.
8. Price Level Changes In Raw Material And Finished Goods:
Rising price levels require a firm to maintain higher working capital; same level
of current assets will require products prices with rising price levels so that they do not
face a serve working capital problem.
9. Profit Margin And Appropriation:
A high net profit is a source of working capital to the extent; it has been earned
cash. The cash profit is found by adjusting non-cash items such as depreciation
outstanding expenses, accumulated expenses and losses written off in the net profit. It
contribution working capital would be affected by the way in which profit are
appropriated .Higher the amount of dividends less will be the contribution towards
working capital funds, the availability of cash generated from operation thus depends
upon taxation, dividend and retention policy and depreciation policy.
10. Operating Efficiency:
The operating efficiency of the firm relates to the optimum utilization resources
costs. The firm will be effectively contributing to its working capital if it is efficient in
controlling operating costs. The use of working is improved and pace of cash cycle is
accelerated with operating efficiency.

SOURCES OF WORKING CAPITAL:

After determining the level of working capital on the basis of various determinants
the next step is to consider how it will be financed. A large manufacturing concern may
procure funds from various sources to meet its working capital requirement s from time
to time. For the convenience of study the sources of working capital may be classified
under twos heads.
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a) Sources of long term or regular working capital

b) Sources of short term or seasonal working capital

Sources of long term working capital:

The long-term working capital requirements can be met from the following
sources.

1. Issue of Shares:
It is the safest way of producing permanent and regular working capital with out
any fixed charges.
2. Issue of Debentures:
Regular and long term working capital may be obtained at lower cost of trade
on equity.
3. Retained profits:
Accumulated large profits are also considered to be good sources of financing
long-term working capital requirements. It is the best and the cheapest source of
finance. It creates no change in future profits.

4. Sale of fixed assets:

If there is any idle fixed assets in the firm can be sold out and the proceeds may
be utilized for financing the working capital requirements.

5. Term loans:
Mid term and long-term loans for a period above 3 years provide import sources
of working capital such term loans can be borrowed from the special financial
institutions such as IDBI, IFSI, and LIC etc.

Sources of short term working capital:

The sources of short term working capital may be classified in two heads
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1. Internal sources
2. External sources

Internal sources:
Under this category the sources of working capital are tapped from within the
internal sources are depreciation funds, provision for taxation and accrued expenses.

1. Depreciation fund:
Depreciation funds created out of profits provided they are invested in or
represented by assets

2. Provision for taxation:

There remains a time lag between making the provision for and payment of
taxation. A company may utilize such provision during the intermittent period
temporarily.

3. Bank credit:
The greater part of the working capital is supplied by commercial banks to their
customers through direct advances in the shape of loans, cash credit or over draft and
thorough discounting the credit, papers, e.g. billpayable and promissory

4. Customer credit:
Advance may also be obtained form customers against the contracts entered into
by the enterprise such advances are generally asked for, by the Companies
manufacturing large plants and machinery involving longer time in completing the
process of manufacturing e.g., ship building industries. The amount can be used for
purchasing raw materials, paying wages and so on.

5. Public deposits:

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Most of the companies in recent years depend on this source to meet their
working capital requirements. Under the companies Act 1956 a company is authorized
to raise funds equal to 25% paid up capital and free reserves by this source.

6. Government assistance:
Central and state Governments of the country provide short-term finance to
industries or business by allowing tax concessions, sanctioning direct loans or grants to
industries or a class of industries to assist their production programs etc.

Standards of working capital management:

I.

There is no one single criteria for judging the efficient

arrangement of working capital.

Factors to be taken into account for organizing on efficient lines:

Ability to meet short term commitments in time, make payment of bills on
due dates.
Ability to find adequate cash at the right time to present forecast levels of
business.
Ability to maximize sales turnover with minimum possible cash.
Minimum possible inventory Turnover Turnover norms are fixed.
Whether reasonable credit is extended to customers as a sales and monitoring
strategy.
Financing plans are prepared in anticipation of future need so that funds
become available at the right time and at least cost.
Policies for credit to present and new customers are prepared and forecast of
collections of receivables are hole along with forecast of sales.
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Norms are laid down for average age of receivables, collection period.
Proportion of goods in process and finished goods to new orders and
dispatches.
Proportion of raw materials, goods in process, and finished goods to total
inventories are established and operated.
Ratio to measure the efficiency of working capital.
Current Ratio: Current assets/Current liabilities
Quick Ratio : (Current assets-inventories)/current liabilities
Sales to Cash: Sales during a period / Average cash balance
Average collection period: Debtors divided by annual credit sales and
the resulting figure multiplied by 365. This ratio indicates how many
days of credit are being obtained from the suppliers.

Average payment period: Creditors divided by annual credit purchase

and the resultant figure is multiplied by 365. This ratio indicates how
many days of credit are being obtained from the suppliers.

Inventory turnover ratio: Sales/Average Inventory.

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Working capital cycle

Accrued direct
labour and material

Inventory

Production process
generates

Cash & marketable

securities

Via sales
generates

Collection process
external
functioning

Accounts
receivables

Supplies of
capital

Accrued fixed
operating expenses

Return
to
capital

Used to
purchase

Fixed assets

This is the loop which starts at the cash and the marketable securities account,
goes trough the current account as direct labour and materials which are purchased and
use to produce inventory, which in turn is sold and generates accounts receivables,
which are finally collected to replenish cash. The major point to notice about this cycle
is that the turnover or velocity of resources through this loop is very high related to the
other inflow s and outflows of the cash account.

Concept of working capital:

There are two concepts of working capital
Gross Working Capital
Net Working Capital

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Gross Working Capital:

Gross working capital, simply called as working capital refers to the firms
investment in current assets, which in ordinary course of business can be converted into
cash within an accounting year.
Examples of Current Assets are:
Cash and bank balances
Short term loans and advances
Bills Receivables
Sundry Debtors
Inventory
Prepaid Expenses
Accrued Incomes
Money Receivable in 12 months
Gross working capital focuses attention of two aspects of current assets management.
a) Optimum investment in current assets and
b) Financing of current assets.
The Consideration of the level of investment in current assets should avoid two
danger points excessive and inadequate investment in current arranging funds to
finance arises due to the increasing level of business activity or for any other reason
arrangement should be made quickly.

Net Working Capital:

Net working capital refers to the difference between the current assets and
current liabilities. Current liabilities are those claims of outsiders, which are accepted,
to mature for payment with an accounting year and include creditors, bills payable and
outstanding expenses.
Net Working Capital = Current Assets-Current Liabilities
Net working capital can be positive or negative. A positive net working capital
will arise when current assets exceeds current liabilities. It is a quantitative concept. I
a) Indicate the liquidity position of the firm and
b) Suggests the extent to which working capital needs may be

financed by permanent

sources of funds.

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Types of Working Capital:

Working capital can be classified into two categories i.e.
1. Permanent working capital
2. Temporary or variable working capital

Permanent Working Capital:

It is the minimum amount of investment in all current assets which is required
at all times to carry out minimum level of business activities. Tendon Committee has
reserved to this type of working capital as Core Current Assets.

Characteristics of permanent working capital:

Amount of permanent working capital remains in the business in one form or
another.
It also grows the size of the business. It should be financed out of long term
funds.

Variable working capital:

The amount of working capital over permanent working capital is known as
variable working capital. The amount of such working capital keeps on fluctuating
form time to time on the business activities. It may again be subdivided into seasonal
working capital and special working capital. Seasonal working capital is required to
meet the seasonal demands of busy periods occurring at started intervals on the other
hand, special working capital is required to meet extraordinary need for contingencies.
Even like strikes, fire unexpected competition; rising price tendencies or initiating a big
advertisement campaign require such capital.

The Need for Working Capital:

Every business needs some amount of working capital. The need for working
capital arises due to the gap between production and realization of cash from sales.
The following are the needs of working capital:

To pay wages and salaries

To incur day to-day expenses and over heads.
To meet the selling costs.
To provide credit facilities to the customers.

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Some of the Important Terms

1. Gross Working Capital =Total Current Assets.
2. Net Working Capital = Current Assets Current Liabilities.

Operating cycle
There is an Operating Cycle involve in the conversion of sales into cash. Operating
cycle is the time duration required to convert sales, after the conversion of resources
into cash. The duration of time required to complete the following sequence of events is
the operating cycle for a manufacturing firm is as follows.

ASSEMENT:
In order to find out the total working capital requirements of a firm, the needs at each
of the following 4 stages have to be calculated.
STAGE ITEM
1.RAW MATERIAL

TIME
Lead time

VALUE
consumption Value of consumed raw

storage period.

material, The valuations

to be down at a cost or

2.STOCK IN PROCESS

price whichever is lower.

Time taken to convert the Raw Material to all
raw

3.FINISHED GOODS

material,

finished expenses at cost price.

goods.
Average period for which

-do-

finished goods are kept

storage
4.RECEIVABLES

before

they

are

actual sold.
Credit period allowed by the Receivables at cost.
unit of buyers.

OTHER FACTORS:
Non- coordination of production and distribution cycle.
Menace of transport and communication not all developed enhances cost.
Impact of government policies etc.

WORKING CAPITAL FORECAST:

There are number of methods to determine the Working capital needs.

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1.

By determining the amount of current assets and current

liabilities:
The assessment of Working capital requirements can be made on the
basis of the current assets required for the business and the credit facilities
available for the acquisition of such current assets from the current liabilities.

2. Cash forecasting methods:

In this method the position of cash at the end of the period is shown after
considering the receipts and payments to be made during the period. Its form
assumes more or less a summary of cashbook. This shows the deficiency or
surplus of cash as the definite point time.

3. The Balance sheet Method:

The balance sheet method of forecast is made up of the various assets and
liabilities of the business. Afterwards, the difference between the two is taken
which will indicate cash surplus or deficiency.

4. Profit and Loss adjustment method:

Under this method the forecast profits are adjusted after adding the cash
inflows and deducting the cash outflows. The basic idea under this method is to
adjust the estimated profit on cash basis.

5. Working capital as a percent of sales:

Under this method the Working capital is to be related to sales and calculated
as a percentage of sales.

6. Working capital as percentages of fixed assets:

In this method Working capital is related to fixed capital investment.
Therefore, it is projected as a percentage of fixed capital investment.

Advantages of adequate working capital:

A business firm maintains an adequate level of working capital in order to run its
business smoothly. It is worth y to note that both excessive and inadequate working
capital positions are harmful .out of two, inadequacy of working capital is more
dangerous for a firm .excessive working capital result in idle funds on which no profit
is earned .similarly insufficiency of working capital result in interruptions of
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production. This will lead to inefficiencies, increase in costs and reduction in profits
.working capital is just like the lifeblood of business. If it becomes weak, the business
can hardly prosper and survive .no business can run successfully without an adequate
amount of working capital. The following are few advantages of adequate working
capital in the business.

Cash discount :
Adequate working capital enables a firm to avail cash discount facilities are
offered to it by the suppliers. The amount of cash discount reduces the cost of
purchase.
Goodwill :
Adequate working capital enables a firm to make prompt payment. Making
prompt payment is a base to create and maintain good will.

Ability to face crisis:

The provision of adequate working capital facilities to meet situations of crisis
and emergencies. It enables a business to withstand periods to depression
smoothly.
Credit-worthiness:
It enables a firm to operate its business more efficiently because there is no
delay in getting loans from banks and others on easy and favorable terms.
Regular supply of raw materials :
It permits the carrying of inventories at a level that would enable a business to
satisfactory the needs of its customers. That is it ensures supply of raw material
and continuous production.

Expansion of markets :
A firm, which has adequate working capital, can create favorable market
condition. That is purchasing its requirements in bulk when prices are lower and
holding its inventories for higher. Productivity increased Profits are increased.

Productivity increased
Research programs

Problems of inadequate working capital:

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It may not able to take advantage of profitable business opportunities.

Production facilities cannot be utilized fully
Short-term liabilities cannot be paid because of lack of working capital
It may fail to pay its dividend because of non-availability of funds
Its low liquidity may lead to low profitability .in the same way ,low profitability
results in low liquidity
It may not be able to take advantages of cash discounts
Credit worthless of the firm may be damaged because of lack of liquidity .thus
it may lose reputation; thereafter a firm may not be able to get credit facilities.

Danger of excessive working capital:

A firm may tempted to over trade and lose heavily
Unable to extract benefits of customer credit
The situation may lead to unnecessary purchases and accumulation of
inventories. This cause more chances of theft, waste, losses etc.
There arises an imbalance between liquidity and profitability.
Excessive working capital means funds are idle.
The situation leads to greater production, which may not be having
matching demand
The excess of working capital leads to carelessness about cost of
production.

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CONCLUSION:
In my point of view working capital with cash from operations and short-term
borrowings when necessary. Various assets and liabilities, including short-term debt,
can fluctuate significantly from month to month depending on short-term liquidity
needs. As a result, working capital is a prime focus of management attention.

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