WORKING CAPITAL

MANAGEMENT
Topics To Be Covered
 Concept
 Definitions
 Types
 Factors Affecting WK Requirements
 Operating Cycle Approach
 Dangers of Excessive and Inadequate WK
 Practical Exercises
Nature of Working Capital
 Managing the current assets, current liabilities
and their inter-relationships
 Current Assets:
 Assets that can be converted into cash within 1
year ( marketable securities, cash, inventory,
accounts receivables)
 Current Liabilities:
 Obligations to be paid within a year from current
assets or earnings (accounts payable, bills, Bank
OD, O/s Expenses)
Contd..
 Goal of WK management: to manage
the current assets and liabilities so that
a satisfactory level of WK is maintained
 WHY?
 To avoid insolvency
 To avoid bankruptcy
 Efficient business operations
 Right mix of current assets and liabliites
“The interaction between current
assets and liabilities is the main
theme of WK management”
Concepts and Definitions
 Gross Working Capital
 Net Working Capital
Gross Working Capital
 The current assets which represent the
proportion of investment that circulates
from one form to another in ordinary
course of business
 TOTAL CURRENT ASSETS
Net Working Capital
 NWK = CA – CL

 Tool to measure the liquidity (like CR,

Acid Test Ratio)
 Non-synchronous cash flows
 CA > CL
 More ability to meet obligations
Net Working Capital (contd.)
 That portion of current assets which is
financed with long term funds
 CL represents short term sources of
finance
 If CA > CL then the excess is financed by
long term sources
 TRADE OFF BETWEEN
PROFITABILITY AND RISK

 Profits measured by revenues and

costs
 Risk of technical insolvency
 Probability that a firm will be unable to
meet its obligation as they become due
Effect of level of CA and CL
on Profitability-Risk Trade Off
 Assumptions:
 We are dealing with a manufacturing
concern
 CA are less profitable than fixed assets
 Short term funds are less expensive than
long term funds
 PROFITS RISK of
insolvency
CA + _ _

CA _ + +

CL + + +

CL - _ _
NEED FOR WORKING CAPITAL
 Goal of FM : Share-holder Wealth
Maximization

 Profits Sales
 Time lag involved need for WK
OPERATING CYCLE/ CASH
CYCLE
 The continuing flow from cash to
suppliers, to inventory, to accounts
receivable and back into cash
Operating cycle

RECEIVABLES
CASH

INVENTORY
Cash Cycle
 The length of time necessary to
complete the cycle of events
TYPES OF WK
 Permanent / Fixed WK
 Temporary / Fluctuating / Variable WK
CHANGES IN WK
 Changes in Sales and Operating
Expenses
 Policy Changes
 Technological Changes
DETERMINANTS OF WK
 General Nature of Business
 Production Cycle
 Business Cycle
 Production Policy
 Credit Policy
 Growth and Expansion
 Vagaries in availability of raw materials
 Profit Level
 Level of taxes
 Dividend policy
 Depreciation policy
 Price level changes
 Operating efficiency
DANGERS OF EXCESSIVE WK
 Accumulation of inventory – waste,
theft, loss
 Defective credit policy and slack
collection period – bad debts
 Complacency and inefficiency
 Affects dividend policy – speculative
profits in inventory tends to liberal
dividend policy- future?
INADEQUATE WK -
PROBLEMS
 Stagnates growth
 Difficult to achieve target profit levels and
operational plans
 Operating inefficiency
 Inefficient utilization of fixed assets
 Inability to avail attractive opportunities
 Buy raw materials at low rates
 Sell on credit to a big buyer
 Loss of reputation- inability to meet
obligations- tight credit terms