Introduction

What is working capital

The capital of a business which is used in its day-to-day trading operations, calculated
as the current assets minus the current liabilities.
Definition

Working capital is how much in liquid assets that a company has on hand. Working
capital is needed to pay for planned and unepected epenses, meet the short-term
obligations of the business, and to build the business.
What is the Accounting Formula to Determine a Business Working Capital?
The accounting formula used to calculate the a!ailable working capital of a business is"
Current Assets - Current Liabilities = Working Capital
Working capital can be reflected as a positi!e or negati!e number depending on how
much debt the business is carrying.
Where Does Working Capital Come From?
Working capital comes from"
#et income$
%ong-term loans &non-current liabilities'$
(ale of capital &non-current' assets$ and
)unds contributed by the owners and in!estors &stockholders'.
Working Capital is required to Start and Grow a Business:
When you first start a business you need start-up working capital since the business is
not yet making money to sustain itself. The number one reason most businesses fail
during their first two years of operation is due to a lack of working capital.
eed !or Working Capital
Working capital is the life blood and ner!e center of business. Working capital is !ery
essential to maintain smooth running of a business. #o business can run successfully
without an adequate amount of working capital. The main ad!antages or importance of
working capital are as follows"
1. Strengthen the Sol"enc#
Working capital helps to operate the business smoothly without any financial
problem for making the payment of short-term liabilities. *urchase of raw
materials and payment of salary, wages and o!erhead can be made without any
delay. +dequate working capital helps in maintaining sol!ency of the business by
pro!iding uninterrupted flow of production.
2. $nhance Goodwill
(ufficient working capital enables a business concern to make prompt payments
and hence helps in creating and maintaining goodwill. ,oodwill is enhanced
because all current liabilities and operating epenses are paid on time.
3. $as# %&taining 'oan
+ firm ha!ing adequate working capital, high sol!ency and good credit rating can
arrange loans from banks and financial institutions in easy and fa!orable terms.
4. (egular Suppl# %! (aw )aterial
-uick payment of credit purchase of raw materials ensures the regular supply of
raw materials for suppliers. (uppliers are satisfied by the payment on time. It
ensures regular supply of raw materials and continuous production.
5. Smooth Business %peration
Working capital is really a life blood of any business organi.ation which
maintains the firm in well condition. +ny day to day financial requirement can be
met without any shortage of fund. +ll epenses and current liabilities are paid on
time.
6. A&ilit# to Face Crisis
+dequate working capital enables a firm to face business crisis in emergencies
such as depression.
*he main components o! working capital are:
Cash+ /ash is one of the most liquid and important components of working
capital. 0olding cash in!ol!es cost because the worth of cash held, after a year will be
less than the !alue of cash as on today. 1cess of cash balance should not be kept in
business because cash is a non-earning asset.-0ence, a proper and 2udicious cash
management is of utmost importance in business.
)arketa&le Securities. These securities also don3t gi!e much yield to the
business because of two reasons, &i' 4arketable securities act as a substitute for cash,
&ii' These are used are temporary in!estments. These are held not for speculati!e
balances, but only as a guard against possible shortage of bank credit.
Accounts (ecei"a&le. Too many debtors always lock up the firm3s
resources especially during inflationary tendencies. This is a two step account. When
goods are sold, in!entories are reduced and accounts recei!ables are created. When
payment is made, debtors reduce and cash le!el increases. Thus, quantum of debtors
depends on two things, &i' !olume of /redit sales &ii' a!erage length of time between
sales and collections. The entrepreneur should determine the optimal credit standards.
+n optimal credit policy should be established and the firm3s operations should be
continuously monitored to achie!e higher sales and minimum bad debt losses.
,n"entor#+ In!entories represent a substantial amount of firm3s assets.
In!entories must be properly managed so that this in!estment doesn3t become too large,
as it would result in blocked capital which could be put to producti!e use elsewhere. 5n
the other hand, ha!ing too little or small in!entory could result in loss of sales or loss of
customer goodwill. +n optimum le!el of in!entory, therefore, should be maintained.
-ow to calculate working capital:
Working capital = current assets current liabilities
Working /apital )ocus
*./$S %F W%(0,G
CA/,*A'
*#pes o! working capital:
Working capital
Basis of concept
Basis of time
Net working
capital
Permanent /Fixed
Working capital
Temporary /
variable
working capital
Seasonal working
capital
Special
working capital
Reglar working
capital
Reserve working capital
!ross
working
capital
*#pes o! Working Capital:
Working capital is classified into different types and the classification is based on the
following !iews"
6. 7alance (heet 8iew
9. 5perating /ycle 8iew
Gross Working Capital 1GWC2: /urrent assets in the balance sheet of a company are
known as gross working capital. /urrent assets are those short term assets which can
be con!erted into cash within a period of one year. The grey area in the management of
current assets or gross working capital is its unpredictability i.e. it is !ery difficult to
ascertain the eact time of con!ersion of such assets. Why such a nature is
problematic: It is because the liabilities occur at their time and do not wait for our
current asset to reali.e. This mismatch or the gap creates a need for arranging working
capital financing.
et Working Capital 1WC2: #et working capital is a !ery frequently used term. There
are two ways to understand net working capital. )irst one says it is simply the difference
of current assets and the current liabilities in the balance sheet of a business. The other
understanding discloses little deeper or hidden meaning of the term. +s per that, #W/ is
that part of current assets which are indirectly financed by long term assets. /ompared
to gross working capital, net working capital is considered more rele!ant for effecti!e
working capital financing and management.
Di!!erence &etween net working capital and Gross working capital
et working capital Gross working capital
#et working capital is the concept of
qualitati!e nature
It is indicating the firm;s ability to meet
its operating epense and current.
It epressed as current assets minus
current liability.
It is a concept !ery popular in
accounting system
#et concept suitable for sole trader and
partnership firms
Its is useful to find out the true financial
position of a company
Increase in bank loan cannot increase
working capital..<etained profits sale of
fied assets will increase net working
capital.
,ross concept of working capital
quantitati!e nature
It is pointing out the total amount
a!ailable for financing the current
assets
Its indicates the total sum of current
assests
It is a concept !ery popular in financial
management circles.
,ross concept suitable for companies
It cannot re!eal the true financial
position of a company
1!ery increase in borrowing will
increase the gross working capital.
=nder net concept no change in
working capital
On te basis o! Operating C"cle #ie$% t"pes o! $orking capital are as belo$&
o /ermanent 3 Fi4ed Working Capital: Dealing with current asset and fied
assets is totally different. Determining the financing requirement in case of fied
assets is simply the cost of the asset. (ame is not true for current assets because
!alue of current assets is constantly changing and it is difficult to accurately forecast
that !alue at any point of time. To simplify the compleity to some etent, on the
basis of past trend and eperience, we can find a le!el below which current asset
has ne!er gone. The current assets below this le!el are called permanent or fied
working capital.
/haracteristics of permanent working capital
&6' /ontinue to eist for a longer period of time is the business acti!ites.
&9' /onstantly changes in the business from one asset to another.
&>' <equired to meet peramanent obligations along with other fied assets.
&?' ,rows the si.e or !olume of business operations.
&@' /lassifiesd on the basis of the time factor.
&A' 4inimum le!el of working capitl always required to be maintained.
&B' Depends on the nature of opreting cycle of the firm.
1ample 5f Different Types 5f working capital.
*#pes o! Working Capital
et Working
Capital
/ermanent 3
Fi4ed Working
Capital
*emporar# 3 5aria&le
Working Capital
(equirement
>CCC 9@CC @CC
9@CC 9@CC C
9DCC 9@CC >CC
>9CC 9@CC BCC
In the eample, 9@CC is the permanent working capital below which the net working
capital has not gone.
o Regular Working Capital: It is the permanent working capital which is normally
required in the normal course of business for the working capital cycle to flow
smoothly.
o Reserve Working Capital: It is the working capital a!ailable o!er and abo!e
regular working capital. It is kept for contingencies which may arise due to
unepected situations.
*emporar# 3 5aria&le WC: Temporary working capital is easy to understand after
getting hold o!er permanent working capital. In simple terms, it is the difference between
net working capital and permanent working capital. The main characteristic which can
be made out from the eample is fluctuationE. The temporary working capital therefore
cannot be forecasted. In the interest of measurability, this can be further bifurcated as
below which can create at least some base to forecast.
/haracteristics of *emporar# working capital
6 It is an etra working capital needed to changing production and sales acti!ities.
9 It is created to meet liquidity requirements.
> Temporary working capital is fluctuating during the operating period.
? It fluctuates according to the le!el of operating.
@ It is needed for shorter period.
Seasonal Working Capital: (easonal working capital is that temporary
increase in working capital which is caused due to some rele!ant season for the
business. It is applicable to businesses ha!ing impact of seasons for eample,
manufacturer of sweaters for whom rele!ant season is the winters. #ormally, their
working capital requirement would increase in that season due to higher sales in
that period and then go down as collection from debtors is more than sales.
Special Working Capital: (pecial working capital is that rise in temporary
working capital which occurs due to a special e!ent which otherwise normally
does not take place. It has no basis to forecast and has rare occurrence
normally. )or eample, country where 5lympic ,ames are held, all the
business require etra working capital due to sudden rise in business acti!ity.
"
m
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t

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f

w
o
r
k
i
n
g

c
a
p
i
t
a
l
Time
Temporary working
capital
Temporary or variable working
capital line
Permanent or fixed
working capital
Fixed working
capital line
Balance sheet working capital:
The balance sheet working capital is one which is calculated from the items appreaing in
the balance sheet. ,ross working capital, which is represented by current assets which
ha!e to be ensure continuity of production. #et working capital, which is represented by
the ecess of current assets o!er current liabilities. 7oth gross working capital and net
working capital are the eamples of the balance sheet working capital.
Cash working capital:
The narrow concept of cash refers to working capital. + firm;s cash working capital is
required to make payment to its supplies, to incur day to day epenses and to pay
salaries, wages, interest and di!idends. The items of cash working capital appearing in
the profit and loss account. /ash working capital shows the impacts of !arious
transactions on cash position of firm.
<easons for change in working capital"
orking capital is comprised of all current assets minus all current liabilities. Thus, a
positi!e working capital position represents an incremental in!estment in a business,
while a negati!e working capital position represents a source of funds for a business. In
summary"
Working capital assets, such as accounts recei!able and in!entory, consume
cash
Working capital liabilities, such as accounts payable, are a source of cash
In nearly all companies, there is a positi!e amount of working capital on the books.
4anagers should constantly be looking for ways to reduce their in!estment in a
business, so you need to know what is causing a change in working capital.
*he cange in $orking capital is considered to be the difference in the net working
capital amount from one accounting period to the net. Thus, if net working capital at the
end of )ebruary is F6@C,CCC and it is F9CC,CCC at the end of 4arch, then the change in
working capital was an increase of F@C,CCC. The business would ha!e to find a way to
fund that increase in its working capital asset, perhaps through one of the following
financing options"
(elling shares
Increasing profits
(elling assets
Incurring new debt
-ere are a num&er o! actions that can cause changes in working
capital:
Credit polic#+ + company tightens its credit policy, which reduces the amount of
accounts recei!able outstanding, and therefore frees up cash. 0owe!er, there may be
an offsetting decline in net sales. + looser credit policy has the re!erse effect.
Collection polic#+ + more aggressi!e collection policy should result in more rapid
collections, which shrinks the total amount of accounts recei!able. This is a source of
cash. + less aggressi!e collection policy has the re!erse effect.
,n"entor# planning+ + company may elect to increase its in!entory le!els in order to
impro!e its order fulfillment rate. This will increase the in!entory in!estment, and so
uses cash. <educing in!entory le!els has the re!erse effect.
/urchasing practices+ The purchasing department may decide to reduce its unit costs
by purchasing in larger !olumes. The larger !olumes increase the in!estment in
in!entory, which is a use of cash. 7uying in smaller quantities has the re!erse effect.
Accounts pa#a&le pa#ment period+ + company negotiates with its suppliers for longer
payment periods. This is a source of cash, though suppliers may increase prices in
response. <educing the accounts payable payment terms has the re!erse effect.
Growth rate+ If a company is growing quickly, this calls for large changes in working
capital from month to month, as the business must in!est in more and more accounts
recei!able and in!entory. This is a ma2or use of cash. The problem can be reduced with
a corresponding reduction in the rate of growth.
-edging strateg#+ If a company acti!ely uses hedging techniques to generate offsetting
cash flow, there are less likely to be unepected changes in working capital, though
there will be a transactional cost associated with the hedging transactions themsel!es.
4onitoring changes in working capital is one of the key tasks of the chief financial
officer, who can alter company practices to fine-tune working capital le!els. It is also
important to understand changes in working capital from the perspecti!e of cash flow
forecasting, so that a business does not eperience an unepected demand for cash.
AD$67A*$ W%(0,G CA/,*A'" The firm should maintain a sound working
capitalposition. It should ha!e adequate working capital to run its business operations.
7oth ecessi!e as well as inadequate working capital positions are dangerous from
firm3s point of !iew. 1cessi!e working capital means holding costs and idle funds which
earn no profit for the firm. *aucity of working capital not only impairs the firm3s
profitability but also results in production interruptions and inefficiencies and sales
disruption
A"aila&ilit# o! (aw )aterials (egularl#"- +dequacy of working capital makes
itpossible for a firm to pay the suppliers of raw materials on time. +s a result it
willcontinue to recei!e regular supplies of raw materials and thus there will be no
disruption in production process
Ad"antage o! Adequate Working Capital:
+!ailability of <aw 4aterials <egularly"- +dequacy of working capital makes itpossible
for a firm to pay the suppliers of raw materials on time. +s a result it willcontinue to
recei!e regular supplies of raw materials and thus there will be no disruption in
production process.
Full 7tili8ation o! Fi4ed Assets:9 +dequacy of working capital makes it possible for
afirm to utili.e its fied assets fully and continuously. )or eample, if there is
inadequatestock of raw material, the machines will not be utili.ed in full and their
producti!ity willbe reduced.
Full 7tili8ation o! Fi4ed Assets"- +dequacy of working capital makes it possible for a
firm to utili.e its fied assets fully and continuously. )or eample, if there is inadequate
stock of raw material, the machines will not be utili.ed in full and their producti!ity will
be reduced.
Cash Discount "- + firm ha!ing the adequate working capital can a!ail the cash
discount by purchasing the goods for cash or by making the payment before the due
date.
,ncrease in Credit (ating "- *aying its short-term obligations in time leads to a strong
credit rating which enables the firm to purchase goods on credit on fa!ourable terms
and to maintain its line of credit with banks etc. it facilities the taking of loan in case of
need.
Ad"antages o! Fa"oura&le Business %pportunities"- Whene!er there are
chances of increase in prices of raw materials, the firm can purchase sufficient
quantity if it has adequate of working capital. (imilarly, if a firm recei!es a bulk order for
the supply of goods it can take ad!antage of such opportunity if it has sufficient
workng capital.
Facilit# in %&taining Bank 'oans"- 7anks do not hesitate to ad!ance e!en the
unsecured loan to a firm which has the sufficient working capital. This is because the
ecess of current assets o!er current liabilities itself is a good security.
Facilit# in %&taining Bank 'oans"- 7anks do not hesitate to ad!ance e!en the
unsecured loan to a firm which has the sufficient working capital. This is because the
ecess of current assets o!er current liabilities itself is a good security.
,ncrease in $!!icienc# o! )anagement"- +dequacy of working capital has a
fa!ourable psychological effect on the managers. This is because no obstacle arises
in the day-to-day business operations. /reditors, wages and all other epenses are
paid on time and hence it keeps the morale of managers high.
)eeting 7nseen Contingencies" - +dequacy of working capital enables a company
to meet the unseen contingencies successfully.
Disad"antage o! e4cessi"e and inadequate working capital
$:C$SS,5$ AD ,AD$67A*$ W%(0,G CA/,*A'" + business enterprise
should maintain adequate working capital according to the needs of its business
operations.
The amount of working capital should neither be ecessi!e nor inadequate. If the
working
capital is in ecess if its requirements it means idle funds adding to the cost of capital
but
which earn nom profits for the firm. 5n the contrary, if the working capital is short of its
requirements, it will result in production interruptions and reduction of sales and, in turn,
will
affect the profitability of the business ad!ersely.
Disad"antage o! $4cessi"e Working Capital:9
$4cessi"e ,n"entor#"- 1cessi!e working capital results in unnecessary
accumulation of large in!entory. It increases the chances of misuse, waste, theft etc.
$4cessi"e De&tors"-1cessi!e working capital will results in liberal credit policy
which, in turn, will results in higher amount tied up in debtors and higher incidence of
bad debts.
Ad"erse $!!ect on /ro!ita&ilit#"-1cessi!e working capital means idle funds in the
business which adds to the cost of capital but earns no profits for the firm. 0ence it has
a bad effect on profitability of the firm.
,ne!!icienc# o! )anagement"-4anagement becomes careless due to ecessi!e
resources at their command. It results in laity of control on epenses and cash
resources.
Disad"antage o! ,nadequate Working Capital:
Di!!icult# in A"aila&ilit# o! (aw9)aterial"- +dequacy of working capital results in
non-payment of creditors on time. +s a result the credit purchase of goods on
fa!ourable terms becomes increasingly difficult. +lso, the firm cannot a!ail the cash
discount.
Full 7tili8ation o! Fi4ed Assets not /ossi&le" Due to the frequent interruption in the
supply of raw materials and paucity of stock, the firm cannot make full utili.ation of its
mahines etc.
Di!!icult# in the )aintenance o! )achiner#" Due to the inadequacy of working
capital, machines are not cared and maintained properly which results in the closure of
production on many occasions.
Decrease in Credit (ating" 7ecause of inadequacy of working capital, firm is unable
to pay its short-term obligations on time. It decays the firm3s relations with its bankers
and it becomes difficult for the firm to borrow in case of need.
on 7tili8ation o! Fa"oura&le %pportunities" )or eample, a firm cannot purchase
sufficient quantity of raw materials in case of sudden decrease in the prices. (imilarly,
if the firm recei!es a big order, it cannot eecute it due to shortage of working capital.
Decrease in Sales" Due to the shortage of working capital, the firm cannot keep
sufficient stock of finished goods. It results in the decrease in sales. +lso, the firm will
be forced to restrict its credit sales. This will further reduce the sales.
Di!!icult# in the Distri&ution o! Di"idends" 7ecause of paucity of cash resources,
firm will not be able to pay the di!idend to its shareholders.
Decrease in the $!!icienc# o! )anagement: It will become increasingly difficult for
the management to pay its creditors on time and pay its day-to-day epenses. It will
also be difficult to pay the wages regularly which will ha!e an ad!erse effect on the
morale of managers.
Determination o! working capital
The factors determining working capital needs of a business firm are as follows:
;+ Si8e o! the !irm:
+ large firm needs more working capital than a small firm. In order to sustain the high
!olume of production and sales, a large firm has to maintain greater current assets.
<+ ature o! Business:
+ trading concern has to maintain more in!entory than a manufacturing concern.
Therefore, more working capital is required by a trading concern. *ublic utility concerns
such as railways, electricity supply concerns, gas agencies require less working capital
because most of their transactions are on cash basis. (imilarly, hotels and restaurants
need little working capital as stock and debtors are not high.
=+ *#pe o! /roduction /rocess:
+ firm using labour intensi!e technique needs more working capital to pay wages and
salaries. + highly automatic plant will need less working capital and more fied capital.
Working capital requirements are higher when raw materials account for a ma2or
proportion of the total cost.
>+ 'ength o! %perating C#cle:
%onger is the time gap between purchase of raw materials and receipt of cash from
debtors, greater is the need for working capital. That is why firms ha!ing a lengthy and
roundabout manufacturing process require more working capital. )or eample, a hea!y
engineering firm has a longer operating cycle than a rice mill.
?+ ,n"entor# *urno"er:
Where the in!entory is large and its turno!er is slow, working capital required is more.
In!entory turno!er means the speed with which sales are made. )or eample, a 2eweller
has to maintain a high in!entory of different types of 2ewellery and the mo!ement of
in!entory is slow. Therefore, the working capital requirements of a 2eweller are more
than those of a grocer.
@+ *erms o! Credit:
+n enterprise with a liberal credit policy require more working capital. (uch a firm allows
credit to all its customers, the period of credit is comparati!ely long and debts are hot
collected strictly within the credit period. (imilarly, a concern en2oying liberal credit from
the suppliers need less working capital.
A+ Banking !acilities:
Where good, quick and dependable credit is a!ailable from commercial banks, a
concern can manage its operations with relati!ely less working capital. In such a case,
cash requirements are small.
B+ Seasonal "ariations:
(ome enterprises need greater working capital during particular seasons. )or eample,
a sugar mill requires more working capital during December to +pril when production
takes place. It requires much less working capital in other months.
C+ Contingencies:
If the demand for and prices of products of a small enterprise are sub2ect to wide and
unepected fluctuations, pro!ision has to be made for arranging higher amounts of
working. capital. Trade cycles may affect the amount of working capital required in an
enterprise.
;D+ *erms o! purchase and sale:
If the firm purchases raw materials and other needs on credit and sells on cash basis, it
requires less working capital. If it buys on cash basis and sells its product on credit, it
will need a large amount of working capital because of instant payments and slow
collections.
;;+ ,mportance o! la&our:
If pro2ect is labour intensi!e, large amount of working capital is required.
%&Eecti"es o! working capital
*rocurement of required amount of working capital and its effect utilisation is the
important functions of working capital management. To ensure that the working capital
financial plain ser!es as a guide to the future course of action of the financial
department, the financial manager will keep in mind the following ob2ecti!es while
preparing the working capital financial plan.
6 +!ailability of adequate funds.
9 4inimum cost
> 4atching &balance' between profitability and liquidity
? )leibility
@ 5ptimum use of funds
; A"aila&ilit# o! Adequate Funds: + sound working capital financial plan must
ensure the supply of adequate amount of working capital needed by the business
enterprises, both for current and future needs.
< )inimum Cost: the fund required by the firm should be made a!ailable at the
lowest cost. It is made possible through planning-considering in ad!ance !arious cost
factors and trends of capital market and suggesting the best course of action.
= )atching 1Balance2 &etween /ro!ita&ilit# and 'iquidit#: + 2udicious
balance between profitability and liquidity is one of the fundamental principles of
successful finance planning. *rofitability and liquidity are in!ersely related. The working
capital financial plan must ensure sufficient amount of in!estment in those assets which
are liquid cash and near G cash assets.
> Fle4i&ilit#: The working capital financial plan should be dynamic in nature. In other
words, it should pro!ide sufficient scope for change and re-ad2ustment in the financial
structure. (uch changes become necessary due to changes in business conditions in
future.
? %ptimum 7se o! Funds: +n important focal point of a financial working capital
plan is the best of the funds raised through !arious sources. +ll the possible efforts
should be made that funds do not remain idle.
Working /apital
#eeds of Different )irms

Discuss the methods o! anal#sis o! working capital?
Working capital position of an enterprise is analysed by !arious internal and eternal
parties. 1ternal parties include bankers, creditors, financial institutions etc. The
ob2ecti!e of
these parties in analy.ing the working capital is to assess the liquidity of the business,
i.e. to
know whether the firm will ha!e sufficient current assets and cash to pay their debts
when
they fall due. 4ethod to analyse the working capital are"-
Schedule o! Changes in Working Capital: With the help of this schedule
increase or
decrease in !arious current assets and current liabilities can be ascertained. This
schedule considers only current assets and current liabilities, at the beginning and at
the end of the year. This schedule shows either increase or decrease in working
capital. )ollowing rules are followed while preparing a schedule of changes in working
capital.
(atio Anal#sis " + ratio is simply one number epressed in terms of another. It found
by di!iding one number into the other. Working capital can be analysed with the help of
!arious ratios mentioned below"
'iquidit# (atios"-
Current (atio"- This ratio eplains the relationship between current and current
liabilities of a business. The formula for calculating the ratio is"
/urrent +ssets
/urrent <atio H ---------------------------------
/urrent %iabilities
(atio"- %iquid ratio eplains the relationship between liquid assets and%iquid
current liabilities of a business. The formula for calculating the ratio is"
%iquid <atio H %iquid +ssets
-----------------------------
/urrent %iabilities
+bsolute liquid ratio
/ash I 7ank I 4arketable (ecurities
A&solute 'iquid (atio H -------------------------------------------------------
/urrent %iabilities
&7' +cti!ity <atios"-
/ost of ,oods (old
In!entory Turno!er <atio H --------------------------------------------
+!erage (tock
De&tors *urno"er (atio"- This ratio indicates the relationship between credit sales
and a!erage debtors during the year. The formula for calculating the ratio"
Debtors Turno!er <atio H #et /redit (ales
-----------------------------------------
+!erage Debtors I +!erage 7J<
Creditors *urno"er (atio"- This ratio indicates the relationship between credit
purchases and a!erage creditors during the year. The formula for calculating the ratio
is"
#et /redit *urchases
/reditors Turno!er <atio H -----------------------------------------------------
+!erage /reditors I +!erage 7J*
Working Capital *urno"er (atio"- This ratio indicates the relationship between cost
of goods sold and working capital. The formula for calculating the ratio is "
/ost of ,oods (old
Working /apital Turno!er <atio H ------------------------------------------
Working /apital
)und )low (tatement"- This statement re!eals the sources from which funds were
obtained and the uses to which funds were applied. In other words, this statement
discloses what the main sources of funds were and how these funds were utili.ed
during the year. With the help of this statement the basic reasons for increase or
decrease in working capital can be analysed. The term 3fund3 does not mean 3cash3. It
is generally used to denote the difference between current assets and current liabilities.
In other words, the term 3fund3 stands for 3net working capital3. Thus, a fund
flow statement indicates the causes of changes in the working capital of a company
during the year.
Cash Flow Statement:- + cash-flow statement is a statement showing and outflows
of cash during a particular period. In other words, it is a summary of sources and
applications of cash during a particular span of time. It analyses the reason for
changes in balance of cash between the two balance sheet dates. The term 3cash3
here stands for cash and cash equi!alents. + cash-flow statement can be for the past
or can be pro2ected for a future period.
/ase (tudy on %KT %iquidity <atio
/alculation
%KT 9C66 K 9C69 7alance (heet
%KT 9C66 K 9C69 Income (tatement
)anagement o! WC
The main ob2ecti!e of W/ management is to manage the firms current assets and
liabilities in such a way that a satisfactory le!el of working capital is maintained.
/urrent assets should be sufficient enough to co!er current liabilities.
Different components of W/ should be properly balanced.
W/ 4anagement policies ha!e a great effect on a firm3s profitability, liquidity and its
structural health. The finance manager should therefore, chalk out appropriate W/
4anagement *olicies in respect of each of the components of W/ so as to ensure
higher profitability, proper liquidity, and sound structural strength.
In order to achie!e this ob2ecti!e the )inance 4anager has to perform two functions"
1stimating the amount of Working /apital &#eed to take into account !arious
factors that determine the working capital requirement'
(ources from which these funds ha!e to be raised &#eed to know type of W/
required'
Co'ponents o! Working Capital (anage'ent
/ash 4anagement
<ecei!ables 4anagement
In!entory 4anagement
)anagement o! Cash
/ash, the most liquid asset, is of !ital importance to the daily operations of business
firms. Though the companies hold the assets in the form of cash less than >L, its
efficient management is crucial to the sol!ency of the business.
)oti"es !or holding cash
Mohn 4aynard Neynes has put forth > possible moti!es for holding cash"
Transaction 4oti!e
*recautionary 4oti!e
(peculati!e 4oti!e
[Compensation Motive: Banks provide certain basic services to their clients free
of charge. The clients are asked to keep a minimum balance with them which
helps them to earn interest and thus compensate them for the free services so
provided
%&Eecti"es o! Cash )anagement
Two basic ob2ecti!es"
To make cash payments
To minimi.e the amount locked up as cash balances
Basic /ro&lems o! Cash )anagement
/ash *lanning
4anaging the cash flows
4aintenance of optimal le!el of cash
In!estment of surplus cash
Float
The cash balance shown by a firm in its books is called the book balance or ledger
balance. The balance shown in its bank account is called the a!ailable balance or
collected balance. The difference between the a!ailable balance and book balance is
referred to as the float.
There are two kinds of float"
+O Disbursement float
7O /ollection float
/heques issued by a firm create disbursement float. /heques recei!ed by a firm lead to
collection float.
The #et )loat is the sum of disbursement float and collection float. It is simply the
difference between the firm3s a!ailable balance and its book balance. If the net float is
positi!e, it means that the a!ailable balance is greater than the book balance. If the net
float is negati!e, the a!ailable balance is lesser than the book balance.
(ince what matters is the a!ailable balance, the finance manager should try to maimi.e
the net float. This means that the manager should stri!e to speed up collections and
delay disbursements.
In!entories
In!entories
Danger of ecess working capital"
It may result in unnecessary accumulation of in!entory which may lead to
increase in wastage due to mishandling, theft etc.
It is an indication of defecti!e credit policy. There is the possibility of higher
incidence of bad debts.
It may lead to complacency in managing day-to-day epenses of the firm.
1ecuti!es may be tempted to spend more.
Inadequate working capital is a situation where in the firm does not ha!e sufficient funds
to meet day to day running epenses. This ultimately results in interruption in the
production process.
Danger of inadequate working capital
5perating inefficiencies creep in when it becomes difficult of meet day-to-day
commitments.
It becomes difficult to implement operating plans and achie!e firms targets.
It directly affects firms liquidity position and the firm may find it difficult to honour
short-term obligations.
WCF (isk and (eturn
0igher le!el of W/ decreases the risk as well as profitability. %ower le!el of W/
increases the risk as well as the possibility of profitability