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WORKING CAPITAL MANAGEMENT

Dr. P. S. Vohra
Ph.D (Accounting & Finance), M.Com, MBA, LLB

Dr. Vohra

Introduction

Working capital is as important in a business as Blood in Human body,


it is also considered as controlling nerve centre of a business.

Because it is only the source of day to day expenses in any organization. Working Capital refers to that part of businesss capital, which requires or fulfill the financing for short term or current assets such as Cash, Marketable securities, Debtors and Inventories. Funds which invest in current assets through W.C. keeps revolving fast and constantly convert into cash-inflow and same again exchanges for other current assets.

Dr. Vohra

Working Capital ..?

Working Capital is the difference between resources in Cash or readily convertible into Cash (Current Assets) and organizational commitments for which Cash will soon be required (Current Liabilities).

It refers to the amount of Current Assets that exceeds Current Liabilities (i.e. CA - CL).

So the funds ties up in the Current Assets known as Working Capital Funds.

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Different Dictionary of Working Capital

1.

Circulating Capital
Revolving Capital Short term Capital Liquid Capital

2.

3.

4.

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Concept of Working Capital


To understand the concept of working capital properly, it is necessary to understand the meaning of the words Working and Capital separately. The word Working with reference to capital means circulating capital, means changing of capital from one form to another form during day-to-day activities of the business. The term capital means the fund invested in the business.

Therefore working capital means that part of capital which is invested in the current assets which in tern changes from one from to another from in the ordinary course of business.
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Interpretation of Working Capital


In case of interpretation of working capital there is a different opinion among accountants, financial managers, entrepreneurs and economists. So to understand its, real meaning let us understand and analyses its following concept:1.

Quantitative concept

2.

Qualitative concept

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Quantitative Concept

It is also known as Gross Working Capital concept.

This concept of working capital emphasis on Quantity of Capital rather than Quality of capital.

W.C. = Total of C.A.

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Analysis of Quantitative Concept

This concept focuses on two aspects -

(a) How to optimize investment in current assets?


(b) How should current assets be financed?

Therefore this concept is called as quantitative, because emphasis is on quantity. This concept provides the figure of total funds required for current assets not the current liabilities, therefore it does not show the true picture of the firm.

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Qualitative Concept
This concept is also known as Net working capital concept. According to this concept Working Capital is the Excess of Current Assets over Current Liabilities. If the amount of current assets and current liabilities is equal, it means there is no working capital. The net working may either be positive or negative.

When current assets exceed current liabilities, its working capital is positive or vice versa.

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Analysis of Qualitative Concept


1.

This concept is more suitable in ascertaining the true financial position of the firm. Only the current assets do not portray better financial position unless they are compared with current liabilities. 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 the funds. In this case current assets should be sufficiently in excess of current liabilities to constitute a margin for maturing obligations within the ordinary operating cycle of business.
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2.

3.

Analysis Continues
4.

The excess of current assets over current liabilities provides better, margin of protection to short-term creditors and investors. Net working capital concept also covers the questions of judicious mix of long tem and short term funds for financing current assets. Thus the qualitative concept measures the firms Liquidity Position. This concept is useful for accountants, investors, creditors or for those persons who have interest in the liquidity and financial soundless of the form

5.

6.

7.

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Types of Working Capital


Working capital can be classified in two ways:

On the basis of Concept On the basis of Nature

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On the Basis of Concept


Under this category further working capital can be classified in the following two ways:

Gross working capital: It means the total of current assets. Net working capital: It means the difference between current assets and current liabilities. If the current assets are more than working capital will be positive and it will be negative vice-versa
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On the Basis of Nature


Under this category the working capital can be further divided in following two types:
1.

Fixed or Permanent Working Capital: There is always a need for current assets because of the operating cycle of the business. The operating cycle is a continuous process, and therefore, the need for current assets is required constantly. But the level of current assets needed is not always the same, it increases and decreased over time.
However there is always a minimum level of current assets which is continuously required by the firm to carry on its business operations. This minimum level of current assets is referred to as fixed or regular working capital. Example, minimum stock of raw material, minimum finished stock, minimum cash or bank balances.
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2. Variable or Temporary Working Capital: It is the part of working capital which is needed over and above the permanent working capital. The requirement of this part may be for a short time period. It keeps on fluctuating as per the change in the production and sales activities. This variable working capital may be further classified into: Seasonal Working Capital: - The part of working capital which is required to meet the seasonal demand is called as seasonal working capital. Seasonal working capital is also required for effective business operations. For example at the time of festival sale may increase and some extra stock would be needed. Speculative Working Capital: - This part of working capital is held for speculative purpose. For example, purchase of goods during the recession period or in expectation of increase in prices. Precautionary Working Capital: - This working capital is required for unforeseen contingencies like strike, flood, war etc.

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Management of Working Capital for

PROFITABILITY V/S LIQUIDITY


Management of working capital is necessary to maintain both Liquidity and Profitability. Liquidity is a necessity for the survival of the firm. While comparing liquidity with profitability, liquidity gets higher priority. No firm can survive if it has No Liquidity. A firm having no profit may be treated as sick but not having liquidity may die over a period of time. In this way working capital management involves to decide the amount and composition of current assets and how to finance these assets.
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WORKING CAPITAL CYCLE


Operating cycle is the Time Duration which requires to convert inventories into sales or resources.

Cash

RM

W.I.P

F.G.

Operating Cycle is the key of W.C.

Debtors

Sales
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How the Length of Operating Cycle determined?


The length of operating cycle of a manufacturing firm is : -

(Inventory Conversion Period + Receivable Conversion Period) Payables deferral period

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Techniques adopted to Cut down length of Operating cycle

Profit Margin
Assets Efficiency (Turnover)

(Techniques like balanced inventory, reduction in collection, technological up gradation can be used to cut down the length of operating cycle)

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Components of the Working Capital


There are mainly two components of working capital:
1. Current

Assets liabilities

2. Current

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Importance of Working Capital


1.

Working capital plays a vital in day-today operation of a business. It is not sufficient to run the business only arranging the fixed assets, even it is also required to utilize the fixed assets in an efficient manner. To utilize these fixed assets in a efficient manner working capital is needed.

2.

3.

In day-to-day activated a business needs working capital for purchasing of raw material, expenses for converting them into finished goods like salary, wages and overhead etc. and for arrangement of credit sales.
Working capital works flow of blood in a human body. Therefore proper management of working capital is necessary for smooth functioning of the business.

4.

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Importance of Working Capital Continues


4.

The working capital fulfills the following needs of the business:

Funds for purchasing the raw materials.


Funds for payment of expenses like wages, salaries, which are necessary for converting raw material into finished goods. Arrangement for selling the goods. Like for sales and promotions expenses. Funds for selling the goods on credit.
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Level of Working Capital: There are generally three types of level are in working capital:1.

Adequate / Optimum level of working capital Excessive level of working capital Inadequate level of working capital

2.

3.

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Adequate level of Working Capital:

To run a business efficiently an optimum level of working capital is always required. In the absence of this amount fixed assets cannot be gainfully utilized. Working capital is considered the life blood and the controlling nerve centre of a business. The adequacy of the working capital determines the survival or the death of an enterprise.

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Adequate level of Working Capital Why?


Quick payment to suppliers. Increase in debt / landing capacity and increase in goodwill. Cash discount. Easy availability of bank loans. In Cash of favorable opportunities. Distribution of adequate dividends. Improvement in efficiency. Increase in the productivity of fixed assets. Meeting unseen contingencies.

1. 2. 3. 4. 5. 6. 7. 8.

9.

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Disadvantages of Excessive Working Capital

1.

2.
3. 4. 5. 6. 7.

Unnecessary accumulation of inventories. Speculative profit tendency. Liberal credit policy. Managerial inefficiency. Adverse impact on profitability. Dissatisfaction among the shareholders. Liberal dividend policy.

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Disadvantages of Inadequate Working Capital: The firm cannot undertake profitable projects due to lack of availability of liquidity. The firm finds it difficult to implement operating plans and achieve the profit target.

1.

2.

3.

It becomes difficult to cope with even the day-today commitments.


Fixed assets are not gainfully utilized for lack of funds thus the rate of return on investment in fixed assets is adversely affected. It makes the firm unable to avail attractive opportunities
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4.

5.

Sources of Working Capital Finance


Trade Credit Accruals

Sources for Short Term Working Capital

Deferred Income Commercial Paper Public Deposit Inter Corporate Deposit Commercial Banks Factoring
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Equity Share Capital

P.S. Capital

Sources for Long Term Working Capital

Debentures

Long Term Public Deposits

Retained Earnings

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Factors which Effect the volume of Working Capital


As already discussed adequate working capital is required for smooth running of a business, but the problem is finding the answer of the following questions:

What should be the amount of working capital When it is needed For how long it is needed In which current assets it should be invested.

The finance manager has to solve all these questions. But there is no a criterion or formula to determine the amount of working capital needs that may be applied to all the firms.

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Factors continues
The amount of working capital required depends upon a large number of factors and each factor has its own importance. They also vary from time to time.
1.

Nature of Business: The working capital requirements are highly influenced by the nature of business. Like some retail store they need a large working capital because they have to maintain large stocks of a variety of goods to satisfy the varied and continuous demand of their customers.

2.

Size of Business
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Factors continues
3. Production process: Another factor which has a bearing on the quantum of working capital is the production cycle. The term production or manufacturing cycle refers to the time involved in the manufacturing of goods. 4. 5. 6. 7. 8. 9. 10. 11. Availability of raw material Operating efficiency Price level changes Taxation policy Profit margin Business cycle fluctuations Banking relations Credit policy

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Approaches for Financing Current Assets

Approaches for Financing Current Assets

Matching or Hedging

Conservative

Aggressive

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In case of Matching / Hedging approach Long term finance will be used to finance permanent current assets. Short term financing should be used to finance temporary or variable current assets.
In Case of Conservative approach Firms finances both permanent and short term working capital through long term sources. And when permanent capital is not requires same will be invested in marketable securities.

In Case of Aggressive approach Firm finances his permanent working capital though Short term sources.
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Current Assets to Fixed Assets Ratio

The level of current assets can be measured by relating current assets to fixed assets. Dividing current assets by fixed assets gives CA / FA ratio.

A Higher Ratio indicates Conservative policy and a Lower Ratio means Aggressive policy.
A Conservative policy indicates Greater Liquidity and Lower Risk. An Aggressive policy indicates Higher Risk and Poor liquidity.

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Conclusion
Any change in the working capital will have an effect on a business's cash flows. A positive change in working capital indicates that the business has paid out cash, for example in purchasing or converting inventory, paying creditors etc. Hence, an increase in working capital will have a negative effect on the business's cash holding. However, a negative change in working capital indicates lower funds to pay off short term liabilities (current liabilities), which may have bad repercussions to the future of the company.

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THANK YOU VERY MUCH

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