Cash is the lifeline of a company.

If this lifeline deteriorates, so does the company's ability to

fund operations, reinvest and meet capital requirements and payments. Understanding a
company's cash flow health is essential to making investment decisions. A good way to judge
a company's cash flow prospects is to look at its working capital management (WCM).
Working capital refers to the cash a business requires for day-to-day operations or, more
specifically, for financing the conversion of raw materials into finished goods, which the
company sells for payment. Among the most important items of working capital are levels of
inventory, accounts receivable, and accounts payable. Analysts look at these items for signs
of a company's efficiency and financial strength.
The working capital is an important yardstick to measure the companys operational and
financial efficiency. Any company should have a right amount of cash and lines of credit for
its business needs at all times.
The working capital management precisely refers to management of current assets. A
firms working capital consists of its investment in current assets, which include shortterm assets such as:

Cash and bank balance,

Inventories,

Receivables (including debtors and bills),

Marketable securities.

Working capital is commonly defined as the difference between current assets and current
liabilities.

WORKING CAPITAL = CURRENT ASSETS-CURRENT LIABILITIES

There are two major concepts of working capital:

Gross working capital

Net working capital

Gross working capital:

It refers to firm's investment in current assets. Current assets are the assets, which can be
converted into cash with in a financial year. The gross working capital points to the need of
arranging funds to finance current assets.

Net working capital:

It refers to the difference between current assets and current liabilities. Net working capital
can be positive or negative. A positive net working capital will arise when current assets
exceed current liabilities. And vice-versa for negative net working capital. Net working
capital is a qualitative concept. It indicates the liquidity position of the firm and suggests
the extent to which working capital needs may be financed by permanent sources of funds.
Net working capital also covers the question of judicious mix of long-term and short-term
funds for financing current assets.

Significance Of Working Capital Management

The management of working capital is important for several reasons:

For one thing, the current assets of a typical manufacturing firm account for half of
its total assets. For a distribution company, they account for even more.

Working capital requires continuous day to day supervision. Working capital has the
effect on company's risk, return and share prices,

There is an inevitable relationship between sales growth and the level of current
assets. The target sales level can be achieved only if supported by adequate working
capital, inefficient working capital management may lead to insolvency of the firm if
it is not in a position to meet its liabilities and commitments.

CLASSIFICATION OF WORKING CAPITAL

Working capital can be classified as follows:

On the basis of time

On the basis of concept

GOTSRPNK
ORNEASGM
YOTNIRUET
ISHLNVAFWD
WSDWLROS
EKWOR
CBOOKRK
ARFKCI
SKTNW
NIGSO
GSCOR
COPAF
AFKTPC
PTNLTIO
TILANG
AMLC
LEC
A
PP
TT

E E PE
CE
N/
I

E
SR AI
L
V
E A
X B
O
I
ON
AI R
N
ALI
II

A
A

A
IA
I

MR

A
T

N
A

P
P

E L

/
R
RG
G

E
I

A
L

T
I

TYPES OF WORKING CAPITAL NEEDS

Another important aspect of working capital management is to analyze the total working capital
needs of the firm in order to find out the permanent and temporary working capital. Working
capital is required because of existence of operating cycle. The lengthier the operating cycle,
greater would be the need for working capital. The operating cycle is a continuous process and
therefore, the working capital is needed constantly and regularly. However, the magnitude and
quantum of working capital required will not be same all the times, rather it will fluctuate.

The need for current assets tends to shift over time. Some of these changes reflect permanent
changes in the firm as is the case when the inventory and receivables increases as the firm
grows and the sales become higher and higher. Other changes are seasonal, as is the case with
increased inventory required for a particular festival season. Still others are random reflecting
the uncertainty associated with growth in sales due to firm's specific or general economic
factors.

The working capital needs can be bifurcated as:

Permanent working capital

Temporary working capital

Permanent working capital:

There is always a minimum level of working capital, which is continuously required by a firm
in order to maintain its activities. Every firm must have a minimum of cash, stock and other
current assets, this minimum level of current assets, which must be maintained by any firm all
the times, is known as permanent working capital for that firm. This amount of working capital
is constantly and regularly required in the same way as fixed assets are required. So, it may also
be called fixed working capital.

Temporary working capital:

Any amount over and above the permanent level of working capital is temporary, fluctuating or
variable working capital. The position of the required working capital is needed to meet
fluctuations in demand consequent upon changes in production and sales as a result of seasonal
changes.

The permanent level is constant while the temporary working capital is fluctuating increasing
and decreasing in accordance with seasonal demands as shown in the figure.
In the case of an expanding firm, the permanent working capital line may not be horizontal.
This is because the demand for permanent current assets might be increasing (or decreasing) to
support a rising level of activity. In that case line would be rising.

FINANCING OF WORKING CAPITAL

There are two types of working capital requirements as discussed above. They are:

Permanent or Fixed Working Capital requirements

Temporary or Variable Working Capital requirements

Therefore, to finance either of these two working capital requirements, we have long-term as
well as short-term sources.

FACTORS DETERMINING WORKING CAPITAL REQUIREMENTS

There are many factors that determine working capital needs of an enterprise. Some of these
factors are explained below:

Nature or Character of Business.

The working capital requirement of a firm is closely related to the nature of its business.
A service firm, like an electricity undertaking or a transport corporation, which has a
short operating cycle and which sells predominantly on cash basis, has a modest
working capital requirement. Oh the other hand, a manufacturing concern like a
machine tools unit, which has a long operating cycle and which sells largely on credit,
has a very substantial working capital requirement.
HCL Infosystems carry on activities related to computer systems. Though they are
primarily an assembling firm they also have manufacturing facilities in Chennai and
Pondicherry. This requires them to keep a very sizeable amount in working capital.

Size of Business/Scale of Operations.

HCL is the leader in its segment in both consumer as well as commercial market share.
They have increased their share in the consumer segment notably in the last four years.
This they have achieved through retail expansion. The scale of operations and the size it
holds in the Indian IT market makes it a must for them to hold their
inventory and current asset at a huge level.

Price Level Changes.

8

Changes in the price level also affect the working capital requirements. It was the
reduced margins in the price of the raw materials that had prompted them to go for bulk
purchases thus making on additions to their net current assets. They might have gone for
this large-scale procurement for availing discounts and anticipating a rise in prices,
which would have meant that more funds are required to maintain the same current
assets.

WORKING CAPITAL CYCLE

The upper portion of the diagram above shows in a simplified form the chain of events in a
manufacturing firm. Each of the boxes in the upper part of the diagram can be seen as a tank
through which funds flow. These tanks, which are concerned with day-to-day activities, have
funds constantly flowing into and out of them.

The chain starts with the firm buying raw materials on credit.

In due course this stock will be used in production, work will be carried out on the stock,
and it will become part of the firms work-in-progress.

Work will continue on the WIP until it eventually emerges as the finished product.

As production progresses, labor costs and overheads need have to be met.

Of course at some stage trade creditors will need to be paid.

When the finished goods are sold on credit, debtors are increased.

They will eventually pay, so that cash will be injected into the firm.

Each of the areas- Stock (raw materials, WIP, and finished goods), trade debtors, cash
(positive or negative) and trade creditors can be viewed as tanks into and from which funds
flow.
Working capital is clearly not the only aspect of a business that affects the amount of cash.

The business will have to make payments to government for taxation.

Fixed assets will be purchased and sold

Lessors of fixed assets will be paid their rent

Shareholders (existing or new) may provide new funds in the form of cash

Some shares may be redeemed for cash

Dividends may be paid

Long-term loan creditors (existing or new) may provide loan finance, loans will need to
be repaid from time-to-time, and

10

Interest obligations will have to be met by the business

Unlike, movements in the working capital items, most of these non-working capital cash
transactions are not every day events. Some of them are annual events (e.g. tax payments, lease
payments, dividends, interest and, possibly, fixed asset purchases and sales). Others (e.g. new
equity and loan finance and redemption of old equity and loan finance) would typically be rarer
events.

11