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Working Capital Management

Businesses require adequate capital to succeed in business environment. There are two types of
capital required by business; fixed capital and working capital. Businesses require investment in
asset, which has to be utilized over a longer period of times. These long-term investments are
considered as fixed capital, e.g. plant, machinery, etc.

Another type of finance required is short term in nature. This short term finance or capital is required
to undertake day to day operation. Such short capital is called current capital or working capital.

Working capital refers to company’s investment in short term asset such as cash, inventory,
short term marketable securities and account receivable.

Information technology is playing a big part in today’s working capital management. Several aspects
of working capital management like the cash management, inventory management, account
receivables/payable management, etc. are managed through enterprise resource planning modules.

Cash Management System

The cash management module within the working capital management system should be fully
integrated with other modules like account receivable/payable, payroll and general ledger. The main
features of cash management tools are as follows:

 The module tracks complete audit trails of all transactions and adjustment for controls.
 It highlights current and future balances for all cash accounts.
 The module has the capability for complete drill down to the source of all transactions.
 The module provides full bank reconciliation.
 It allows export of information for analysis, forecasting, presentation, reports, etc.

Inventory Management System

Inventory management and control module is utilized by companies to avoid product overstock and
outages. There are several components of an inventory management tool such as order
management, asset tracking, product identification, etc. The main purpose within the inventory
management system is to reduce the overall costs of carrying. An inventory management tool helps

 Sustain a balance between too less and too much inventory.

 Track inventory between locations.
 Track inventory been received at warehouse.
 Track product sales and finished goods inventory.

The main advantage of an inventory management tool is cost savings, increased efficiency,
warehouse management, etc.

Account Receivable Management

An account receivable management tool helps solve critical question like when payment is due, how
much payment is due, etc. The main features of account receivable tool are as follows:

 Permits transfer of account receivable information for analysis, forecasting, presentation,

reports, etc.
 Maintain complete customer information, including sales history, current balance, open
deposit, last payment, etc.
 Minimize data entry errors and permit print invoice, credit memos, debit memos, etc.

Appropriate credit policy is essential to maintain the cash flow cycle and return on capital.

Short Term Financing

Another important aspect of working capital management is short term financing. The short term
financing tool based on cash flow cycle, inventory position and requirement helps in deciding the
quantity of capital required. It also helps identify the term of financing and track payment.

Working capital management decision directly affects day to day business operations. One of the
such factors is the cash conversion cycle which immediately affects the liquidity of the organization.

Working Capital Financing

Techniques for Finding Optimal Level of Working

Working capital management techniques such as the intersection of carrying cost and
shortage cost, working capital financing policy, cash budgeting, EOQ and JIT are
applied to manage different components of working capital like cash, inventories,
debtors, financing of working capital etc. These effective techniques mainly manage
different components of current assets.
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Working capital management techniques are very effective tools in achieving
the Objective of Working Capital Management. Working capital is the difference
current assets and current liabilities of a business. A major focus is on current assets
because current liabilities arise due to current assets only. Therefore, controlling the
current assets can automatically control the current liabilities. Now, current assets
include Inventories, Sundry Debtors or Receivables, Loans and Advances, Cash and
Bank Balance.
All working capital management techniques attempt to find the optimum level of
working capital because both excess and shortage of working capital involves a cost
to the business. Excess working capital carries the ‘carrying cost’ or ‘interest cost’ on
the capital lying unutilized. Shortage of working capital carries ‘shortage cost’ which
include disturbance in production plan, loss in revenue etc. Finding the optimum
level of working capital is the main goal or winning situation for any business
There are certain techniques used for finding the optimum level of working capital or
management of different items of working capital.
One of the important methods of finding the optimum level of working capital is the
point of intersection of carrying cost and shortage cost in a graphical representation.
The total of carrying and shortage cost is minimum at this point.
Here, the levels of current assets are optimum at the point where the shortage and
carrying costs are meeting or intersecting. At this point, the total cost, as we can see,
is minimum and this is why that level of current assets is considered to be optimal.


Working capital can be divided into two viz. Permanent and Temporary. Permanent
working capital is the level of working capital which is always required and
maintained. Temporary working capital is the part of working capital which keeps on
fluctuating. It is high in good seasons and low in bad seasons. There are two types
of financing available. They are long-term financing and short-term financing. Three
strategies are possible with respect to the financing of working capital. Efficient
financing of working capital reduces carrying a cost of capital.
1. Long term financing is used for both permanent and temporary WC.
2. Long term financing is used for permanent and some part of temporary WC.
Remaining part of temporary WC is financed through short-term financing as
and when required.
3. Long term financing is used for permanent and short-term financing for
temporary WC.
These strategies should be chosen so as to match the maturity of the source of
finance with the maturity of the asset.

Cash budgeting is another important technique for working capital
management which helps to keep an optimum level of cash in the business. Cash
budgeting involves estimating the requirements of cash by estimating all the fore
coming receipts and payments. For effective management, a balance is needed
between both excess and shortage of cash. It is because both ends are costly.
Speeding up of collection and getting relaxed credit terms from the creditors can
reduce the cash requirements.
Inventory is an important component of working capital or current assets. An
optimum level of inventory can save on costs heavily.

Economic Order Quantity (EOQ) model is a famous model for managing the
inventories. It helps the inventory manager know how to find the right quantity that
should be ordered considering other factors like cost of ordering, carrying costs,
purchase price and annual sales. The formula used for finding EOQ is as follows:

EOQ = ?{ (2 * A * O) / (P * C)}

A – Annual Sales
O – Cost per Order

P – Purchase price per unit

C – Carrying Cost

Just-in-time is another very important technique which brought about the paradigm
shift in the management of inventories. It did not reduce the cost of inventory but it
abolished it completely. Just-in-time means acquiring raw material or manufacturing
product at the time when it is required by the customer. This strategy is very difficult
to implement but if implemented can bring down inventory cost to minimum levels.
These are some important techniques discussed here. They are very effective in
managing working capital. Managing working capital means managing current
assets. Current assets like cash can be managed using cash budgeting; inventory
can manage using inventory techniques like EOQ and JIT. Debtors and financing of
working capital can be managed using appropriate sources of finance.