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WORKING

CAPITAL

MANAGEMENT......

PART – 1

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WORKING CAPITAL MANAGEMENT

Part –1: WORKING CAPITAL

Definition of WC Why WC ....??? Objectives and Aspects of WC Purpose and Need of WC Components of WC Concepts of WC WC in case of Stable firm & Growing firm

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INTRODUCTION:

• Working Capital plays the crucial role in the business as the role of heart in the human body.

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DEFINITION: Working capital refers to funds required

to be invested in the business for a short period usually upto one year.

It is also known Short-term capital or Circulating capital

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

--- Acc.. to Shubin

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WHY WC...?? The firm has to maintain cash balance to pay

bills as they come due. In addition, the company must invest in

inventories to fill customer orders promptly. And finally, company invests in accounts

receivable to extend credit to customers.

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OBJECTIVES OF WC:→ To optimize investments in current assets.→ To see that company meets its current

liabilities obligation.→ Manage current assets to see that the return

on current assets is more than cost of capital.→ Proper balance between current assets &

current liabilities.

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Example:

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ASPECTS OF WC:There are many aspects of WCM which makes

it important function of financial management.

Time Investment Credibility Growth

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PURPOSE OF WC: To hold the stock of raw materials for such a

period To hold the stock of work in progress for

process period To hold the stock of finished goods for such

a period To grant credit to customers To hold cash balances to meet the expenses

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NEED FOR WC:֍ Operating Cycle.

֍ Operating cycle in a Trading firm is the length of time required.

Cash Inventory of FG

Receivables

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֍ Operating cycle in a Manufacturing firm is the length of time required

֍ Distinct Phases in Operating Cycle

Cash Inventory of FG

Inventory of WIP

Inventory of RM

Receivables

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Components of Operating Cycle: Gross Operating Cycle:

R W F DGOC

RM storage period

WIP holding period

FG storage period

Debtors Collection Period

Gross Operating Cycle

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Net Operating Cycle:

R W F D CNOC

Creditors Collection Period

Net Operating Cycle

RMSP WIPHP FGSP DCP

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How to Calculate Components of OC:Average RM Storage Period (in days)

Average stock of RMAverage Cost of RM Consumption per day

Average WIP Holding Period ( in days)

Average stock of WIP

Average Cost of WIP per dayAverage FG Storage Period (in days ) Average stock of FG

Average Cost of Goods Produced per dayAverage Debtors Collection Period ( in days) Average Trade Debtors

Average Cost of Credit Sales per dayAverage Creditors Payment Period (in days)

Average Trade CreditorsAverage Credit Purchases per day

Average Time-Lag in Payment of exp’s (in days)

Average Creditors for Expenses Average Expenses per day

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How to Calculate Number of Operating Cycles in a year:-The no. Of Operating Cycles in a year may

be calculated as follows: No.of days in a year No. of Operating Cycles in a year = Net Operating Cycle(in days)

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Illustration-1:1. RM Inventory Consumed during the year 60,00,0002. Average stock of RM 10,00,0003. Factory Cost of Goods Produced 1,05,00,0004. Average stock of WIP 4,37,5005. Office Cost of Goods Produced 1,14,00,0006. Average stock of FG 9,50,0007. Average trade debtors 11,25,0008. Cost of Credit Sales 90,00,0009. Average trade creditors 5,00,00010. Expenses for the year 30,00,00011. Average creditors for Expense 5,00,00012. No.of working days in a year (assume 360days)

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From the above following information of Company , Calculate ---

1. Gross Operating Cycle 2. Net Operating Cycle 3. No.of Operating Cycles

in a year

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Concepts Of WC:WC

On the basis of Concept Gross working capital

Net working capital

On the basis of TimePermanent working capital

Temporary working capital

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On the basis of Concept/Value:Gross W/C: It refers to the firm’s investment in

current assets. CA includes – stock of rawmaterial, WIP, FG’s, etc.In the form of Equation , Gross W/C can be shown

below:-

CASH

Inventoriesi. Raw-materialsii. Work-in-progress

iii. Finished Goods

Short term Marketable securities and other current assets

Gross Working Capital

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Net W/C: It refers to diff b/w current assets and current liabilities. CL includes – trade creditors , bills payable, o/s exp’s, etc.

Net Working Capital is a Qualitative Concept, which indicates:

i. Liquidity position of the firmii. Part of current assets which should be financed

with long-term funds

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In the form of an equation , Net Working Capital has been shown below:

Example: A company buys stocks of raw material for cash. It implies that company is financing raw material stock from its internal sources. Suppose, the company gets a two months credit for the same purchase. It implies the stock is financed by creditors.

Gross Working Capital (or) current Assets

Current Liabilities

LESSNet Working Capital

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Difference b/w Gross WC & Net WC :Gross working capital Net working capital1. Quantitative in nature

1. Qualitative in nature

2. It indicates total sum of current assets

2. It expressed as current assets minus current liabilities

3. It is suitable for companies

3. It is suitable for sole trading & partnership

4. It is a concept very popular in financial management

4. It is a concept very popular in accounting system

5. It cannot reveal the true financial position of company

5. It is very useful to find out true financial position of the company

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On the basis of Time:Time

Permanent / fixed WCRegular wc

Reserve wc

Temporary WCSeasonal wc

Special wc

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Permanent Working Capital:

It refers to a certain minimum level of current assets, which is essential for firm to carry on its business irrespective of the level of operations.

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Characteristics of PWC: Classified on the basis of Time factor Always remain in process Size increases according to the Growth of

enterprise suitable for business, which is the same

for all the year long Constantly changes from one asset to

another

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Temporary Working Capital:

It refers to the amount of working capital over and above the fixed minimum amount of WC, which is required to meet seasonal and other temporary requirements.

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Working Capital in case of a Stable firm

In case of a Stable firm , the Permanent working capital is stable over time and takes the shape of a Horizontal line. while temporary working capital is fluctuating – sometimes increasing and sometimes decreasing.

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Am

ount

of w

orki

ng c

apita

l

Level of temporary working capital

Level of permanent working capital

Time

Y

X

Temporary working capital line

Permanent working capital line

Working capital in case of Stable Firm Diagram

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In case of a Growing firm , the Permanent working capital may also keep on increasing over time to support a rising level of activity and hence PWC line may not always be Horizontal. while Temporary working capital is fluctuating – sometimes increasing and sometimes decreasing.

Working Capital in case of a Growing firm

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Working capital in case of a Growing Firm Diagram

Am

ount

of w

orki

ng c

apita

l

Level of temporary working capital

Level of permanent working capital

Time

Y

X

Temporary working capital line

Permanent working capital line

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Prepared by ...Sravan Kumar . D