WORKING

CAPITAL
MANAGEMENT

WORKING CAPITAL
Every business needs investment to procure fixed assets, which remain in use for a longer period.
Money invested in these assets is called ‘long term funds’ or ‘fixed capital’.

Business also needs funds for short-term purposes to finance current operations. Investment in
short term assets like cash, inventories debtors etc. is called ‘short term funds’ or ‘working
capital’.

The working capital is categorized as fund needed for carrying out day-to-day operations of the
business smoothly. The management of the working capital is equally important as the
management of long term financial investment.

Every running business needs working capital. Even a business which is fully equipped with all
types of fixed assets required is bound to collapse without-

1. Adequate supply of raw materials for processing.

2. Cash to pay for wages, power and other costs.
3. Creating a stock of finished goods to feed the market demand regularly.
4. The ability to grant credit to its customers.

All these require working capital.

“Working capital is like the lifeblood of a business”

The business will not be able to carry on day-to-day activities without the availability of
adequate working capital.

Working capital, also known as net working capital, is a financial metric which represents
operating liquidity available to a business.

Along with fixed assets such as plant and equipment, working capital is considered a part of
operating capital. It is calculated as current assets minus current liabilities. if current assets are
less than current liabilities, an entity has a working capital deficiency, also called as working
capital deficit.

A company can be endowed with assets and profitability but short of liquidity if its assets
cannot readily be 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, accounts receivables and payable and cash.

CALCULATIONS
Current assets and current liabilities include three accounts which are of special importance.
These accounts represent the areas of business where the managers have the most direct impact-

 Accounts receivable (current assets)

 Inventory (current assets), and
 Accounts payable (current liabilities)

The current portion of debt (payable within 12 months) is critical, because it represent a short
term claim to current assets and is often secured by long term assets. Common types of short-
term debts are bank loans and lines of credit.

An increase in working capital indicates that the business has either increased current assets (that
is received cash, or other current assets) or has increased current liabilities, for example paid off
some short-term creditors.

 CURRENT ASSETS- this is any cash or assets that can be quickly turned into cash.
This includes prepaid expenses, accounts receivables, most securities and your inventory.

Constituents of current assets-

 Cash in hand and bank balances

 Bill receivables
 Sundry debtors (less provision for bad debts)
 Short term loans and advances
 Inventories of stock:

 Raw material
 Work in process
  Stores and spares
 Finished goods
 Coal and fuel
 Temporary investments of surplus funds
 Prepaid expenses
 Accrued expenses

 CURRENT LIABILITIES-this is a liability in the immediate future. This includes

wages, taxes and accounts payable.

Constituents of current liabilities-

 Bills payable
 Sundry creditors or accounts payable
 Short term loans, advances & deposits.
 Dividend payable
 Bank overdraft
 Provision for taxation, if it does not amount to appropriation of profits

IMPLICATION ON M & A-
The common commercial definition of working capital for the purpose of a working capital
adjustment in an M & A transaction (i.e. For a working capital adjustment mechanism is a sale
and purchase agreement) is equal to-

Current assets – current liabilities (excluding deferred tax assets/liabilities, excess cash,
surplus assets and/or deposit balances)