WORKING CAPITAL MANAGEMENT

This PPT is an explanation of basic WCM

1. Working
Capital
Management

2. Definition of Working Capital
Working Capital refers to that part of the
firm’s capital, which is required for
financing short-term or current assets such a
cash marketable securities, debtors and
inventories. Funds thus, invested in current
assets keep revolving fast and are constantly
converted into cash and this cash flow out
again in exchange for other current assets.
Working Capital is also known as revolving
or circulating capital or short-term
capital.

3. KINDS OF WORKING CAPITAL
WORKINGCAPITAL
BASIS OF
CONCEPT
BASIS OF
TIME
Gross
Working
Capital
Net
Working
Capital
Permanent
/ Fixed
WC
Temporary
/ Variable
WC
Regular
WC
Reserve
WC
Special
WC
Seasonal
WC

4. Significance of Gross WC
Optimum investment in CA
Investment in CA must be adequate CA investment should not
be inadequate or excessive inadequate WC can disturb
production and can also threaten the solvency of firm , if it fails
to meet its current obligation excessive investment in CA
should be avoided , since it impairs firms profitability
Financing of CA
Need for WC arises due to increasing level of business activity
& it is to provided quickly some time surplus fund may arises
which should be invested in Short term securities , they should
not be kept idle

5. Significance of Net Working Capital
Maintaining Liquidity position
For maintaining liquidity position there is a
need to maintain CA sufficiently in excess of
CL
Judge Financial Soundness of a firm
The Net working capital helps creditors and
investors to judge financial soundness of a
firm

6. BALANCE SHEET OF ABC COMPANY AS ON 31 -3-2000
Liabilities R’s Assets R’s
Equity Shares 200000 Goodwill 20000
8% Debentures 100000 Land and Building150000
Reserve & Surplus 50000Plant and Machinery100000
Sundry Creditors 150000 Inventories
Bills Payable 30000 Finished Goods 60000
Outstanding Expenses20000 Work in process 40000
Bank Overdraft 50000 Prepaid Expenses 20000
Provision for Taxation20000Marketable Securities60000
Proposed Dividend 30000 Sundry Debtors 90000
Bills Receivables20000
Cash & Bank Balance90000
TOTAL 650000 TOTAL 650000

7. Difference between permanent & temporary working
capital
Amount Variable Working Capital
of
Working
Capital
Permanent Working Capital
Time
Permanent and temporary working capital for Stable firm

8. Variable Working Capital
Amount
of
Working
Capital
Permanent Working Capital
Time
Permanent and temporary working capital for Growing firm

9. Operatingcycleconcept
Maximizationofshareholder’swealthofafirmispossibleonly
whentherearesufficientreturnfromtheoperations
Successfulsalesactivityisnecessaryforearningprofitsalesdonot
convertintocashimmediately
Thereisinvisibletimelapbetweenthesaleofgoodandreceiptof
cash
Thetimetakentoconvertrawmaterialintocashisknownas
operatingcycle
Conversionofcashintorawmaterial
Conversionofrawmaterialintoworkinprogress
ConversionofWorkinprogressintofinishedgoods
ConversionoffinishedgoodintoSales(Debtorsandcash)

10. Operating Cycle in
Manufacturing firm
Cash
Raw
Materials
W I P
Finished
Goods
Debtors
SALES

11. Operating cycle of Non
Manufacturing Firm
cash
Receivables
Stock of finished goods

12. Formula for calculating Operating
cycle for Manufacturing firm
OC = ICP+ARP
OC = Operating cycle
ICP = Inventory Conversion period
ARP = Account Receivable Period
ICP = Average Inventory
Cost of good sold /365
ARP = Average Account Receivable
Sales/365

13. ABC Company Provide the
following information , Compute
the operating cycle
Sales 3000 Lakhs
Inventory Opening R’s 610 Lakhs ;
closing R’s 475 Lakhs
Receivable opening R’s 915 Lakhs;
Closing R’s 975 Lakhs
Cost of Goods Sold R’s 2675 Lakhs

14. CASH CONVERSION CYCLE
The amount of time a firm’s resources are tied
up calculated by subtracting the average
payment period from the operating cycle the
time period between the date a firm pays its
supplier and the date it receives cash from its
customer
CCC = OC –APP
AAI = Average Inventory
Cost of good sold /365
ARP = Average Account Receivable
Annual Sales/365
APP = Account Payable Period
Cost of good sold /365

15. Calculate CCC
(CASH CONVERSION CYCLE)
Average use of Inventory 80 days
Account receivable collection period 50 days
Account payable period is 40 days
CCC= OC-APP
OC = AAI+ARP
80+50=130
CCC =130-40 =90 days

16. Purchase of Sale of Goods Collection of
Raw Material on Credit Account Receivables
On credit
Average age of Account receivable
Inventory (AII) period (ARP)
Account Payable
Period (APP)
Payment to
suppliers
Receipt of Invoice Operating Cycle (OC)
Cash Conversion cycle

17. Resource flows for a manufacturing firm
Fixed
Assets
Production
Process
Generates
Inventory
Via Sales Generator
Accounts
receivable
Used in
Accrued Direct
Labour and
materials
Accrued Fixed
Operating
expenses
Cash and
Marketable
Securities
Suppliers
Of Capital
External Financing
Return on Capital
Collection
process
Used to
purchase
Used to
purchase
Used in
Working
Capital
cycle

18. Calculate cash conversion cycle
Sales R’s 1587.95
Cost of Good sold R’s 1406.27
Inventory opening 195.82, closing 202.29
Account receivables opening 423.03 closing
449.46
Account payable opening 140.40, closing
168.33
CCC = OC –APP
OC = AAI + ARP

19. FORECASTING / ESTIMATION OF
WORKING CAPITAL REQUIREMENTS
Factorstobeconsidered
Totalcostsincurredonmaterials,wagesandoverheads
Thelengthoftimeforwhichrawmaterialsremaininstores
beforetheyareissuedtoproduction.
ThelengthoftheproductioncycleorWIP,i.e.,thetimetaken
forconversionofRMintoFG.
ThelengthoftheSalesCycleduringwhichFGaretobekept
waitingforsales.
Theaverageperiodofcreditallowedtocustomers.
Theamountofcashrequiredtopayday-to-dayexpensesofthe
business.
Theamountofcashrequiredforadvancepaymentsifany.
Theaverageperiodofcredittobeallowedbysuppliers.
Time–laginthepaymentofwagesandotheroverheads

20. PROFORMA -WORKING CAPTIAL ESTIMATES
1.TRADING CONCERN
STATEMENT OF WORKING CAPITAL REQUIREMENTS
Amount (Rs.)
Current Assets
(i) Cash ----
(ii) Receivables ( For…..Month’s Sales)---- ----
(iii) Stocks ( For……Month’s Sales)----- ----
(iv)Advance Payments if any ----
Less : Current Liabilities
(i) Creditors (For….. Month’s Purchases)- ----
(ii) Lag in payment of expenses -----_
WORKING CAPITAL ( CA –CL ) xxx
Add : Provision / Margin for Contingencies -----
NET WORKING CAPITAL REQUIRED XXX

21. 1. MANUFACTURING CONCERN
STATEMENT OF WORKING CAPITAL REQUIREMENTS
Amount (Rs.)
Current Assets
(i) Stock of R M( for ….month’s consumption) -----
(ii)Work-in-progress (for…months)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(iii) Stock of Finished Goods ( for …month’s sales)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(iv) Sundry Debtors ( for …month’s sales)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(v) Payments in Advance (if any) -----
(iv) Balance of Cash for daily expenses -----
(vii)Any other item -----
Less : Current Liabilities
(i) Creditors (For….. Month’s Purchases) -----
(ii) Lag in payment of expenses -----
(iii) Any other -----
WORKING CAPITAL ( CA –CL )xxxx
Add : Provision / Margin for Contingencies -----
NET WORKING CAPITAL REQUIRED XXX

22. Prepare an estimate of Working capital requirement
from the following information of a trading concern:
Projected annual sales 100000 units
Selling price R’s 8 per unit
% age of Net profit on sales 25%
Average Credit Period allowed to
customer 8 weeks
Average Credit Period allowed by
supplier 4 weeks
Average stock holding in terma of sales
requirement 12 weeks
contingencies 10%

23. Points to be remembered while
estimating WC
(1)Profitsshouldbeignoredwhilecalculatingworkingcapital
requirementsforthefollowingreasons.
(a)Profitsmayormaynotbeusedasworkingcapital
(b)Evenifitisused,itmaybereducedbytheamountofIncometax,
Drawings,Dividendpaidetc.
(2)CalculationofWIPdependsonthedegreeofcompletionasregards
tomaterials,labourandoverheads.However,ifnothingismentioned
intheproblem,take100%ofthevalueasWIP.Becauseinsuchacase,
theaverageperiodofWIPmusthavebeencalculatedasequivalent
periodofcompletedunits.
(3)CalculationofStocksofFinishedGoodsandDebtorsshouldbe
madeatcostunlessotherwiseaskedinthequestion.

24. Prepare statement of working
capital requirement, Profit &Loss
A/C, Balance Sheet Assuming
Share Capital 150000
8% Debentures 200000
Fixed asset 130000
Material 40%
Direct lab our 20%
Overheads 20%

25. The following further particular are available
It is proposed to maintain a level of activity
of 2,00,000 units
Selling price is R’s 12/-per unit
Raw Material are expected to remain in
stores for an average period of one month
Material will be in process , on average
half a month
Finished goods are required to be in stock
for an average period of one month
Credit allow to debtors is two month
Credit allow by supplier is one month

26. Working Capital Financing Mix
Approaches to Financing
Mix
The Hedging or
Matching Approach
The Conservative
Approach
The Aggressive
Approach

27. Hedging approach to asset financing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-term
Debt
Long-term
Debt +
Equity
Capital

28. The Hedging approach
Hedging approach refers to a process of
matching maturities of debt with the maturities of
financial need . In this approach maturity of
source of fund should match the nature of asset
to be financed
This approach is also known as matching
approach.
The hedging approach suggests that the
permanent working capital requirement should be
financed with fund from long term sources while
the temporary working capital requirement
should be financed with short term funds.

29. Estimated Total Investment in Current Asset of company X for
the year 2000
Month
Investment
in Current Asset
(R's )
Permanent or
Fixed
Investments
(R's)
Temporary
or seasonal Invest
(R's)
January 50400 45000 5400
February 50000 45000 5000
March 48700 45000 3700
April 48000 45000 3000
May 46000 45000 1000
June 45000 45000 -
July 47500 45000 2500
August 48000 45000 3000
September 49500 45000 4500
October 50700 45000 5700
November 52000 45000 7000
December 48500 45000 3500
TOTAL 44300

30. Conservative Approach
This approach suggested that the entire
estimated investments in current asset should be
finance from long term source and short term
should be use only for emergency requirement
Distinct features of this approach
Liquidity is greater
Risk is minimized
The cost of financing is relatively more as
interest has to be paid even on seasonal
requirement for the entire period

31. Conservative approach to asset financing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-term
Debt
Long-term
Debt +
Equity
capital

32. Trade off between Hedging and
conservative approaches
The hedging approaches implies low cost , high
profit and high risk while the conservative
approach leads to high cost , low profit , low
risk Both the approaches are the two extreme
and neither of them serve the purpose of
efficient working capital management
A trade off between the two will then be an
acceptable approach , One way of determining
the trade off is by finding the AVG of maximum
and minimum requirement of current asset or
working capital

33. Aggressive approach to asset financing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-term
Debt
Long-term
Debt +
Equity
capital

34. Aggressive approach
The aggressive approach suggests that the entire
estimated requirement of current asset should be
financed from short-term sources and even a
part of fixed asset investment be financed from
short -term sources
This approach make the finance mix :
More Risky
Less costly
More Profitable

35. Prepare a projected balance
sheet , profit and loss a/c and
then an estimation of working
capital .
Issued Share Capital 300000
6% Debentures 200000
Fixed asset 200000
Raw Material 50%
Lab our 20%
Overheads 20%
Profit 10%
There is a regular production and
sales cycle

36. Raw Material are kept in stores for an
average period of two month
Finished goods remain in stock for an
average period of three month
Production during the previous year was
180000 units and it is planned to maintain
the same in the current year also
Each unit of production is expected to be
in process for half a month
Credit allow to customer is three month
and given by supplier is two month
Selling price is Rs 4 per unit
Calculation of debtors may be made at
selling price

37. Management of Working Capital
Working capital in general practice refer to the
excess of CA over CL.
Management of working capital therefore is
concerned with the problems that arise in
attempting to manage the CA, the CL and the
inter-relationship that exists between them.
The basic goal of WCM is to manage the CA & CL
of a firm in such a way that a satisfactory level of
WC is maintained.
Working Capital Management Policies of a firm
have a great effect on its profitability, liquidity and
structural health of the organization

38. Working capital management is 3 dimensional in
Nature
Dimension I
Profitability,
Risk, & Liquidity

39. Working Capital Issues
Assumptions
50,000 maximum units
of production
Continuous production
Three different policies
for current asset levels
are possible
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSET LEVEL Current Assets
Policy C
Policy A
Policy B

40. Impact on Liquidity
Liquidity Analysis
Policy Liquidity
A High
B Average
C Low
Greater current asset levels
generate more liquidity; all
other factors held constant.
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSET LEVEL Current Assets
Policy C
Policy A
Policy B

41. Impact on
Expected Profitability
Return on Investment =
Net Profit
Total Assets
Let Current Assets = (Cash +
Rec. + Inv.)
Return on Investment =
Net Profit
Current + Fixed Assets
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSET LEVEL
Current Assets
Policy C
Policy A
Policy B

42. Impact on
Expected Profitability
Profitability Analysis
PolicyProfitability
A Low
B Average
C High
As current asset levels decline,
total assets will decline and
the ROI will rise.
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSET LEVEL Current Assets
Policy C
Policy A
Policy B

43. Impact on Risk
Decreasing cash reduces the
firm’s ability to meet its
financial obligations. More
risk!
Stricter credit policies reduce
receivablesand possibly lose
sales and customers. More
risk!
Lower inventory levels
increase stockouts and lost
sales. More risk!
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSET LEVEL Current Assets
Policy C
Policy A
Policy B

44. Impact on Risk
Risk Analysis
Policy Risk
A Low
B Average
C High
Risk increases as the level of
current assets are reduced.
Optimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSET LEVEL Current Assets
Policy C
Policy A
Policy B

45. Summary of the Optimal
Amount of Current Assets
SUMMARYOFOPTIMALCURRENTASSETANALYSIS
Policy LiquidityProfitabilityRisk
A HighLow Low
B Average Average Average
C Low High High
1. Profitability varies inversely with liquidity.
2. Profitability moves together with risk.
(risk and return go hand in hand!)

46. Techniques of analysis of working
capital
The analysis of working capital can be conducted
through a number of devices such as
Ratio analysis
Fund flow analysis
Working capital Budgeting
Ratio analysis : A ratio is a simple arithmetical
expression of the relationship of one number to
another , this technique can be employed for
measuring short term liquidity or working capital
position of a firm.

47. The following ratios may be
calculated for this purpose
Liquidity Ratio
a)Current Ratio
b)Acid test ratio/quick ratio/liquid ratio
c)Cash Position ratio/absolute liquid ratio
Inventory turnover ratio
Receivable turnover ratio
Payable turnover ratio
Working capital turnover ratio

48. Current ratio may be define as the
relationship between CA and CL
This ratio is also known as WCR.
(Working capital ration).
It is helpful to measure short –term
financial position or liquidity of a firm
Current ratio: Current asset
Current liabilities

49. CURRENT ASSETS CURRENT LIABILITIES
Cash in hand
Bills Payable
Cash at bank Sundry Creditors
Sundry Debtors
Accrued or Outstanding
Expenses
Marketable securities
(Short term)
Short term loan and
advances
Bills Receivable Dividend payable
Inventories of Stock Bank Overdraft
Work in progress
Finished goods
Prepaid Expenses

50. Quick or Acid test or Liquid
Ratio
An asset is said to be liquid if it can be convert
into cash with in a short period with out loss of
value
Inventory cannot be termed to be liquid asset
because they cannot be convert into cash
immediately
The quick ratio can be calculated
Quick ratio: liquid asset
Current liabilities

51. Quick or liquid Current Liabilities
Cash in hand Bills Payable
Cash at bank Sundry Creditors
Sundry Debtors
Accrued or Outstanding
Expenses
Marketable securities
Short term advances
Temporary Investments Dividend payable
Bank Overdraft
Income tax payable
Convection quick ratio of 1:1 is consider satisfactory

52. Cash Position ratio/absolute liquid ratio
Absolute Liquid assets include cash in hand and
cash at bank and marketable securities or
temporary investments
The acceptable norms for this ratio is 50% or
.05%
Cash ratio: Cash & bank + Short –term securities
Current liabilities

53. Calculate all the three ratio
Liabilities Rs Assets Rs
9% preference
share 500000Goodwill 100000
Equity share
capital 1000000Land and building 650000
8% debentures 200000Plant 800000
Long term loan 100000
Furniture and
fixtures 150000
Bills payable 60000Bills receivable 70000
Sundry creditors 70000Sundry debtors 90000
Bank over draft 30000Bank balance 45000
Outstanding
expenses 5000
short term
investments 25000
Prepaid expenses 5000
Stock 30000
1965000 1965000

54. CONCLUSION:
Current ratio of the company is not
satisfactory because the ratio 1:6 is much
below then the expected Standards .
Acid test ratio on the other hand is more
than the normal standard of 1:1
Absolute ratio is slightly low because it is
0.42 where as the accepted standard is 0.5
In this company need to improve its short
term financial position

55. Inventory turnover ratio
Inventory turn over ratio = Cost of good sold
Average Inventory at cost
Generally , the cost of good sold may not be known
from the published financials , in such
circumstances
Inventory turn over ratio = Net Sales
Average Inventory at cost
Inventory turn over ratio = Cost of good sold
Average Inventory at selling price

56. Inventory conversion period
Inventory conversion period = Days in a year
Inventory Turnover Ratio
M/s Rakesh& Co supplies you the following
information for the year ending 31
st
Dec 1999
Credit Sales Rs 150000
Cash SalesRs 250000
Return Inward Rs 25000
Opening Stock Rs 25000
Closing Stock Rs 35000

57. Debtor/Receivable turnover ratio
/Debtor velocity
Debtor(Receivable) = Net credit Annual sales
Average Trade debtors
Trade debtors = Sundry debtor + Bill Receivable and
account receivable s
Average Trade Debtors = Opening Trade debtor +
Closing Trade Debtor /2
Note : Debtor should always be taken at gross value , No
provision for doubtful debt be deducted from them but when
the information about opening and closing balance of trade
debtor and credit sales is not available , then the debtors
turnover ratio calculated by dividing the total sales by the
balance of debtors(inclusive of Bills receivables) given
Debtors turn over Ratio = Total sales
Debtors

58. Average Collection Period
The average collection period represent the
average number of days for which a firm has to
wait before its receivable are converted into cash
Average Collection period =
Average Trade Debtors (Drs + B/R)
Sales per day
Sales Per day= Net Sales
No of working days

59. Or
Average collection period =Average trade debtors
Net Sales
No of working days
If the period is in months:
Average collection period =No of working days
Debtors turnover ratio
The two basis component of the ratio are debtors
and sales per day

60. Creditor/Payable turnover ratio
The analysis for credit turnover is basically the same
as of debtors turnover ratio except that in place of
trade debtor, the trade creditor are taken and in
place of sales , average daily purchase are taken as
the other component of the ratio.
Creditors turnover ratio
= Net credit annual purchase
Average Trade creditors

61. Average Payment period Ratio
= Average Trade Creditors( Creditors+ Bills
payable)/Average Daily purchases.
Average daily purchase = Annual Purchase /No of
working days in a year.
Average Payment Period = Trade creditor * No of
working days / Net annual purchase.
Average Payment Period = No of working days /
Credit turnover Ratio.

62. Working capital turnover ratio
Working capital of a concern is directly related to
sales and current asset like debtors , bills
receivable , cash , stock etc .
Working capital turnover ratio = Cost of Sales /
Average working capital
Average working capital = Opening working
capital + Closing Working capital/2
** If cost of sales is not given , then the figure of
sale can be used . O n the other hand if opening
working capital is not disclosed then working
capital at the end of the year will be used.
Cost of sale /Net working capital

63. The following information is given about M/s S.P
Ltd for the year ending Dec 31 2000
Stock turnover ratio = 6times
Gross Profit ratio = 20% on sales
Sales for 2000 = Rs 300000
Closing stock is Rs 10000 more than the
opening stock
Opening Creditors = Rs 20000
Closing Creditors = Rs 30000
Trade debtor at the end = Rs 60000
Net Working Capital = Rs 50000

64. FIND OUT
Average Stock
Purchases
Credit turnover ratio
Average Payment Period
Average Collection Period
Working Capital turnover ratio

65. Fund flow analysis: Fund flow analysis is a
technical device designated to study the sources
from which additional fund were derived and
the use to which these sources were put . It is an
effective management tool to study change in
the financial position of business
The fund flow analysis consists of
Preparing schedule of change in working capital
Statement of sources and application of funds

66. Working capital Budgeting : Working
capital budget as a part of total
budgeting process of a business , is
prepared estimating future long term
and short term working capital need
and the sources of finance them .
The objective of a working capital
budget is to ensure availability of fund
as and when needed and to ensure
effective utilization of these resources .