Working Capital

Management
WORKING CAPITAL
• The capital of a business which is used in its day-by-day trading
operations, calculated as the current assets minus the current
liabilities.
• Working capital is also called operating assets or net current assets.
• WC= CA-CL
WORKING CAPITAL MANAGEMENT
• Working capital management refers to a company’s managerial
accounting strategy designed to monitor and utilize the two
components of working capital, current assets and current liabilities,
to ensure the most financially efficient operation of the company.
NEED OF WORKING CAPITAL
MANAGEMENT
• Inventory Management
• Receivables Management
• Cash Management
FACTORS AFFECTING WORKING CAPITAL

1. Nature of business
2. Production policy
3. Credit policy
4. Inventory policy
5. Abnormal factor
6. Market conditions
7. Conditions of supply
8. Business cycle
9. Taxation policy
10. dividend policy
11. Operating efficiency
12. Price level changes
13. Depreciation policy
14. Availability of raw material
BUSINESS CYCLE
IMPORTANCE OF ADEQUATE /
OPTIMUM WC
1. Smooth running of business
2. Profitability with manage risk
3. Growth and development possibility
4. Smooth payment
5. Increase in goodwill
6. Trade relationship better
WORKING CAPITAL CYCLE

• The determination of WC helps in forecast, control & management of

WC. The duration of WC may vary depending upon the nature of
business.
• The duration of operating cycle (WC cycle) for the purpose of
estimating WC is equal to the sum of duration of each of above events
less the credit period allowed by the supplier
• For ex.- A co. holds raw material on an average for 60 days, it gets
credit firm supplier for 15 days, production process needs 15 days,
finished products are held 30 days & 30 days is the total WC cycle. So,
60+15+30+30-15=120 days.
VARIOUS COMPONENTS OF
OPERATING CYCLE
A) Raw material shortage period = Average stock of raw material
Avg cost of RM consumed per day
B) WIP holding period = Average WIP inventory
Average cost of production per day
C) FG storage period = Estimated prodn (in units) * direct lab permit
12 months / 360 days
D) Debtors collection period = Average goods debtors
Average credit sale per day
E) Credit period available to suppliers = Average rate credit
Average credit purchase per day

Operating Cycle = R+W+F+D-C

WORKING CAPITAL POLICY /
APPROACHES
• Conservative approach: A firm financing its common permanent
assets & also with long term financing & less risky so far as insolvency
is concerned. However funds may be invested in such investment
which fetches small returns to build up liquidity.
• Aggressive approach: The firm uses only short term financing. In this
approach, the firm finances a part of the permanent assets with short
term financing. This approach refers to more risky but may at returns
to the assets.
• Moderate Approach: this approach is in between conservative and
aggressive approach which ensures both risk and return to the firm
Negative working capital
• Negative working capital occurs when a company's current liabilities exceed
its current assets.
• In other words, it means that the company has more short-term obligations
to meet in the near future than it has available liquid assets to cover those
obligations.
• While negative working capital may seem problematic at first glance, it's not
always a sign of financial distress, and there can be various reasons for it.
• Companies may deliberately maintain a negative working capital position
under specific circumstances or as part of their strategic financial
management. This approach is often employed by businesses with efficient
operating models and well-thought-out strategies.
Key points about negative working capital:
1. Risk and Management: While negative working capital isn't inherently bad, it does come with
some risks. Companies with consistently negative working capital may face challenges meeting
short-term obligations, which can lead to liquidity issues, credit problems, and difficulties
securing financing. Effective cash flow management is crucial to mitigate these risks.
2. Liquidity Planning: Companies with negative working capital should have a clear plan for
managing their cash flow. This includes closely monitoring cash flow, optimizing receivables and
payables, and having access to short-term financing options when needed.
3. Industry Norms: It's essential to consider industry norms when evaluating negative working
capital. Some industries, like retail or technology, may commonly operate with negative working
capital due to their business models, while others, like manufacturing, may typically have positive
working capital.
4. Investor Perception: Investors and creditors may view negative working capital differently
depending on the company's circumstances. A company with a history of successfully managing
negative working capital may be seen as efficient, while others may raise concerns about
financial stability.
5. Long-Term Considerations: Negative working capital can be sustainable in the short term, but it's
important for companies to have a plan for achieving positive working capital if necessary. This
may involve improving cash flow, renegotiating supplier terms, or securing additional financing.
Reasons for maintaining negative wc:
1. Efficient Cash Conversion Cycle: The company has a short cash conversion cycle, meaning it
can quickly turn inventory into accounts receivable and, subsequently, into cash. This rapid
cycle allows them to generate cash to cover short-term obligations even if current liabilities
exceed current assets.
2. Supplier Payment Terms: The company has favorable supplier payment terms, such as
extended credit periods. They can delay payments to suppliers while using their goods or
services, effectively using supplier financing to support operations.
3. Seasonal Business: Seasonal businesses, like retail or agriculture, may experience
fluctuations in working capital throughout the year. They may have negative working capital
during slow seasons but positive working capital during peak sales periods.
4. Business Model: Certain industries and business models naturally lend themselves to
negative working capital. For example:
• Subscription-based businesses often receive cash upfront for services to be delivered later, resulting in
deferred revenue.
• Online marketplaces may collect payments from buyers before disbursing funds to sellers, creating a float.
5. Growth Strategy: Rapidly growing companies may intentionally have negative working
capital as they invest in expanding operations, inventory, and accounts receivable to
support increased sales. This strategy assumes that growth will continue and eventually
lead to positive working capital.
6. Access to Low-Cost Financing: The company has access to low-cost short-term financing
options, such as lines of credit or trade credit, to cover any temporary cash flow gaps.
These financing options can be used strategically to bridge working capital shortfalls.
7. Efficient Receivables Management: The company has efficient accounts receivable
management practices, ensuring that customers pay promptly. This can help maintain
cash flow even when accounts receivable are high.
8. Competitive Advantage: Maintaining negative working capital can provide a competitive
advantage by allowing the company to allocate cash to more productive uses, such as
growth initiatives, investments, or debt reduction.
9. Cost Savings: By delaying payments to suppliers, the company can potentially earn
interest or invest the cash elsewhere, realizing cost savings.
10. Operational Efficiency: The company's operations are highly efficient, minimizing the
need for excess working capital to support day-to-day activities.
FINANCING OF WORKING CAPITAL
Financing of working capital can be done in two ways:
• Long term sources
• Short term sources
A. Long term sources
1. Share capital
a. Equity share capital
b. Preference share capital
2. Debentures
a. Convertible debentures
b. Non-convertible debentures
c. Redeemable debentures
d. Non-Redeemable debentures
3. Bonds
4. Loans from banks & financial institutions
5. Retained earnings
6. Venture capital fund for innovative projects
B. Short term sources
1. Bank credit
2. Transaction credit
3. Advances from customers
4. Bank advances
5. Loans
6. Overdraft
7. Bills purchase and discounted
8. Advance against documents of title of goods
9. Term loans by bank
10. Commercial paper
11. Bank deposits
Types of Working Capital
• Gross Working Capital: Gross Working Capital refers to the firm’s
investment in Current Assets. Current assets are the assets,
which can be converted into cash within an accounting year or
operating cycle. It includes cash, short-term securities, debtors
(account receivables or book debts), bills receivables and stock
(inventory).
• Net Working Capital: Net Working Capital refers to the difference
between Current Assets and Current Liabilities are those claims of
outsiders, which are expected to mature for payment within an
accounting year. It includes creditors or accounts payables, bills
payables and outstanding expenses. Net Working Capital can be
positive or negative.
PRINCIPLES OF WORKING CAPITAL:
1. Principle of Optimization
2. Principle of Risk Variation
3. Principle of Cost of Capital
4. Principle of Maturity of Payment
5. Principle of Equity Position
1. Principle of Optimization:
• Working capital should be invested in each component of working
capital as long as the equity position of firm increases
• The level of working capital must be so kept that the rate of return on
investment is optimized.
• This is the point at which the increase in cost due to decline in
working capital is equal to the increase in the gain associated with it.
2. Principle of Risk Variation:
• This principle is based on the assumption that the rate of return on
investment is linked with degree of risk in the business. Risk here
refers to the inability of firm to maintain sufficient current assets to
pay its obligations.
• When the degree of risk increases, the opportunity for gain and loss
also increases. Thus, if the level of working capital goes up, amount of
risk goes down, and vice-versa, the opportunity for gain is like-wise
adversely affected.
3. Principle of Cost of Capital:
• Each source of working capital has different cost of capital. The
degree of risk also differs from one source to another.
• A firm should raise capital in such a manner that a balance is
maintained between risk and profit.
4.Principle of Maturity of Payment:
• This principle states that the working capital should be so raised from
different sources that the firm is able to repay them on maturity out
of its inflows of funds.
• Otherwise the firm would fail to repay on maturity and ultimately, it
would find itself into liquidation though it is earning profits.
• This implies that the firm’s ability to repay its short-term debts
depends not on its earnings but on the flow of cash into it.
5.Principle of Equity Position:
• According to this principle, the amount of working capital invested in
each component should be adequately justified by a firm’s equity
position.
• Capital invested in the working capital should contribute to the net
worth of the firm.
Thank You