WORKING-CAPITAL MANAGEMENT

Meaning:Funds which are needed for shortterm purposes for the purchase of raw materials, payment of wages and other day to day expenses, etc. These funds are known as working capital.

Definition:
Working Capital is the amount of funds necessary to cover the cost of operating the enterprise Shubin

Concepts of Working Capital:

A. Balance Sheet Concept
B. Operating Cycle or Circular Flow Concept

Balance Sheet Concept:

a) Gross Working Capital b) Net Working Capital

Contd
i) Gross Working Capital: is the capital invested in total current assets of the enterprise. ii) Net Working Capital: is the excess of current assets over current liabilities

Merits of Gross Concept:

Provide correct amount of working capital. Management is more interested in total current assets. It considers the fact that every increase in funds would increase its working capital. More useful in determining ROI.

Merits of Net Working Capital

It is a qualitative concept which indicates firms ability. It indicates the margin of protection available to the short-term creditors. It is an indicator of the financial soundness of the enterprise. It suggests need of working capital requirement out of permanent sources of funds.

Operating Cycle Concept:

Cash
Raw Materials

Debtors

Work in Progress

Sales

Finished Goods

1) Gross Operating Cycle = RMCP+WIPCP+FGCP+RCP RMCP - Raw Material Conversion Period WIPCP - Work-in-Process Conversion Period FGCP - Finished Goods Conversion Period RCP - Receivables Conversion Period

2) Net Operating Cycle Period = Gross operating Cycle Period - Payable Deferal period

CLASSIFICATION/KINDS:
Kinds of Working Capital
On the Basis Of Time Permanent Working Capital Temporary Working Capital Special Working Capital

On the Basis of Concept

Gross Working Capital

Net Working Capital

Regular Working Reserve Working Capital Capital

Seasonal Working Capital

Importance of Adequate Working Capital:

1. Solvency of the business 2. Goodwill 3. Easy Loans 4. Cash Discounts 5. Regular supply of raw materials 6. Regular Payments of expenses 7. Exploitation of favorable market conditions 8. Ability to face crisis 9. Quick and Regular return on investment 10.High Morale

Disadvantages of Excess Working Capital:

1. Idle Funds which earn no profits 2. Unnecessary purchasing and accumulation of inventories 3. Excessive debtors & defective credit policy 4. Inefficiency in the organization 5. Problems in maintaining relations 6. Low rate of return on investment 7. Rise in speculative transactions

Disadvantages of Shortage of Working Capital

1. Unable to pay short-term liabilities 2. Unable to buy in bulk and avail discounts 3. Unable to exploit favorable market conditions 4. Unable to pay day-to-day expenses 5. Underutilization of Fixed Assets 6. Fall in return on investment

Objectives of Working Capital

For purchase of raw materials, components and spares. To pay wages & salaries. To incur day-to-day expenses. To meet the selling costs as packing, advertising etc. To provide credit facilities. To maintain the inventories.

Factors determining Working Capital:

1. Nature of Business
2. Size of Business 3. Production Policy 4. Length of Production Cycle 5. Seasonal Variations 6. Working Capital Cycle

Contd
7. Rate of Stock Turnover 8. Credit Policy 9. Business Cycles 10.Rate of Growth of Business 11.Earning Capacity and Dividend Policy 12.Price Level Changes

Management of Working Capital

It refers to all aspects of administration of both current assets and current liabilities. It has three dimensions:

Formulation of policies with regard to liquidity,

risk and profitability.

Decisions about the composition & level of C.A.

Decisions about the composition & level of C.L.

Principles of Working Capital Management:

1. Principal of Risk Variation
2. Principal of Cost of Capital

3. Principal of Equity Position

4. Principal of Maturity of Payment

Main activities in WCM :1. Estimating the working capital requirement 2. Financing of working capital needs
3. Analysis & Control of working capital

Estimating Working capital :Current Assets : i. Cash ii. Debtors (For months sales) iii. Stocks (For months sales) iv. Advance Payments v. Others Less : Current Liabilities :i. Creditors (For months sales) ii. Lag in payment of expenses Working Capital ( C.A-C.L) Add:- Provision for contingencies Net Working Capital Required

Statement of Working Capital Requirement

Methods to Forecast/Estimate of Working Capital Requirement: Percentage of Sales Method Regression Analysis Method
b/w Sales & Working Capital).

(Avg. relationship

Cash Forecasting Method Operating Cycle Method Projected Balance Sheet Method

Sources of Working Capital

SOURCES

Permanent or Fixed 1.Shares 2.Debentures 3.Public Deposits 4.Ploughing Back of Profits 5.Loans from Financial Institutions

Temporary or Variable 1.Commercial Banks 2.Indigenous Bankers 3.Trade Creditors 4.Installment Credit 5.Advances 6.Accounts ReceivablesCredit/Factoring 7.Accrued Expenses 8.Commercial Paper

Determining the Working Capital Financing Mix:

Approaches to Financing Mix

The Hedging or Matching Approach

The Conservative Approach

The Aggressive Approach

Working Capital Analysis :1)

Ratio Analysis
i) Current Ratio
ii) Acid Test Ratio iii) Inventory Turnover Ratio iv) Receivable Turnover Ratio v) Working Capital Turnover

2) Fund Flow Analysis 3) Working Capital Budget

Thank-You