Working Capital

Management
Working Capital
Management
 Working Capital management is concerned
with
 The problems that arise in managing Current
assets and current liabilities
 And the interrelationship between them
 The goal is to manage CA and CL in such a
way that a satisfactory level of net working
capital is maintained.
Working Capital
Management
 Gross Working Capital means the total
Current Assets
 Net Working capital is the difference between
CA and CL.
 Net Working capital is necessary due to non-
synchronous nature of expected cash inflows
and required cash outflows.
◦ The more predictable the cash inflows are, the less
NWC will be required and vice versa
◦ The NWC represents liquidity of the firm
Working Capital
Management
 NWC affect liquidity, profitability and the risk
of becoming insolvent
 The higher the NWC
◦ the higher the liquidity
◦ The lower the risk
◦ The lower the profitability
◦ And vice versa
 So trade-off between profitability and risk is
important
Working Capital
Management
 The need for working capital arise from the
cash operating cycle (Working Capital Cycle)
 Cash operating cycle refers to the length of
time required to complete the following cycle
of events
3. Conversion of cash into inventory
4. Conversion of inventory into receivables
5. Conversion of receivables into cash
 The operating cycle and its time for
completion
◦ creates the need for working capital
Working Capital
Management
Permanent working Temporary Working
capital Capital
 Needed for a certain  Needed to meet
irreducible level of CA seasonal and other
on a continuous and temporary
uninterrupted basis requirements
 Should be financed  Should be financed
from long term sources from short term
sources
Factors Determining NWC
Factors:
2. Nature of Business
Manufacturing and trading enterprises require
fairly large amount of working capital to
maintain sufficient amount of cash,
inventories and book debts to support their
production (purchase) and sale activities
Service enterprises and hotels and
restaurants need to carry less Working
capital
Factors Determining NWC
2. Production Cycle
The longer the production cycle, the larger the
WC needed and vice versa
5. Business cycle
During boom conditions the need for WC is
likely to grow to cater for the increased
level of activity
During recessionary conditions the need for
WC is low due to low volume of sales and
production
Factors Determining NWC
4. Credit Policy
Liberal credit policy to customers increase the
need for WC
Tight credit policy reduce WC requirement
The credit policy of creditors/suppliers of
materials will be an offsetting factor.
9. Growth and Expansion
Growth industries and firms require more WC
12.Uncertainties in Availability of raw
materials
A firm require adequate level of inventory of
raw materials, which increase the need for
WC
Factors Determining NWC
7. Dividend Policy:
Dividend payment consumes cash resources,
and therefore decreases WC of a firm.
Conversely non payment of dividend
increases WC.
10.Depreciation:
Higher depreciation (enhanced rates of
depreciations) has a positive impact on the
WC
◦ Lower tax liability, and so more cash
◦ Lower disposable profits, and smaller dividend
payment
Factors Determining NWC
9. Efficiency of Operations
Efficiency accelerates the pace of cash cycle
and improves the WC turnover resulting in
reduced requirement of WC
Computation of Working
Capital
The Optimum Level of NWC
 A firm should have adequate WC to support its
budgeted level of activity in terms of
production/sales
◦ Neither more nor less WC than required.
 Excessive WC affects profit adversely
 Inadequate WC interrupts the smooth operations
of the company. So Correct computation is
required.
Computation of Working
Capital
Each Component: CA and CL has to be
separately estimated.
Estimation of Current Assets:
3. Raw Material Inventory

6. Work in Process inventory

8. Finished Goods Inventory

Computation of Working
Capital
4. Debtors
The WC tied up in debtors should be estimated
in total cost (excluding depreciation)
Debtors=

10.Cash and Bank Balances

Computation of Working
Capital
Estimation of Current Liabilities
2. Trade creditors

4. Direct Wages

The average credit period for payment of

wages is approximately half a month in the
case of monthly wage payment
Computation of Working
Capital
3. Overheads (other than depreciation and
amortization)