WORKING CAPITAL MANAGEMENT

1)WHAT IS WORKING CAPITAL ? (3 Times Repeated)

Working capital is the part of total capital. It is used for carrying out regular business In
other words, it is the amount of funds used for financing the day today operations or
activities.
2)DEFINE WORKING CAPITAL ? (2 Times Repeated )
Shubin defines, working capital is the amount of funds necessary to cover the cost of
operating the enterprise.
Hoagland defines, working capital is descriptive of that capital which is not fixed.
But the more common use of the working capital is to consider it as the difference
between the book value of current assets and the current liabilities.
3)EXPLAIN VARIOUS SHORT TERM SORCE OF FINANCE WORKING
CAPITAL ? EXPLAIN WITH THEIR FEATURES? (4 Times Repeated)

Trade credit
Bank credit

Overdraft
Cash credit
Purchase/Discounting of bills
Letter of credit
Working capital loan

TRADE CREDIT :
Trade credit refers to the credit that a customer gets from suppliers of goods in the normal
course of business. In practice, the buying firms do not have to pay cash immediately for
the purchases made. This deferral of payments is a short term financing called trade
credit.
OVER DRAFT :
Under overdraft facility, the borrower allowed to withdraw the funds in excess of the
balance in his current account up to a certain specified limit during a stipulated period.
Interest is charged on the daily balances-on the amount actually withdrawn subject to
some minimum charges

CASH CREDIT :
Under this cash credit facility, a borrower is allowed to withdraw the funds from the bank
up to sanctioned limit. The interest is payable on the amount actually utilized by the
borrower.
Purchase Or Discounting Of Bills :
The banks purchases or discounts the borrowers bills. The amount provided under this
agreement covered within the overall cash credit or overdraft limit. Before purchasing or
discounting the bills, the bank satisfies itself as to the credit worthiness of the drawer.
Letter Of Credit :
Suppliers, particularly foreign suppliers insist that the buyer should ensure that his bank
will make the payments if he fails to honor its obligations. This arrangement passes the
risk of the supplier to the bank.
Working Capital Loan :
A borrower may sometimes require ad hoc or temporary accommodation in excess of
sanctioned credit limit to meet unforeseen contingencies. Banks provide such
accommodation through a demand loan A/c or a non-operable cash credit A/c.
FEATURES :

Short term sources can be further divided into internal and external sources of

working capital finance.

The short term internal sources includes tax provision, dividend provision etc.
Short term external sources include short term working capital financing from
banks such as bank overdraft , cash credits, trade deposits and commercial papers.

4)WHAT DO YOU MEAN BY NEGATIVE WORKING CAPITAL ? (3 Times

Repeated)
Negative Working capital is when a company current liabilities exceed its Current Asset .
This means that Liabilities that need to be paid within one year exceed the current assets
that are magnetisable over the same period.
5) EXPLAIN THE 3 ALTERNATIVE APPROACHES FOR FINANCING
WORKING CAPITAL ? (5 Times Repeated)
Depending on the mix of short and long term financing there are 3 basic approaches for
determining working capital.

Matching approach
Conservative approach
Aggressive approach

MATCHING / HEDGING APPROACH :

The firm can adopt a financial plan which matches the expected life of assets with the
expected life of the source of funds raised to finance assets.
Example:
A ten- year loan may be raised to finance a plant with an expected life of ten years;
stock of goods to be sold in thirty days may be financed with a thirty-day commercial
paper or a bank loan.
The justification for the exact matching is that the purpose of financing is to pay for
assets the source of financing and the asset should be relinquished simultaneously.
This process is called as matching or hedging

Fixed & permanent current assets are financed with -- Long term finance.
if the level of these assets increases, the Long-term financing level also increases.
Temporary/ variable CA are financed with Short-term funds.
If the level of these assets increases, the level of short-term finance also increases.
LiquidityAverage; Profitabilityaverage; Riskaverage.
NOTE: Short-term financing will not be used --- if the firm has a fixed CA need
only.

Conservative approach :

Depend more on long term funds.

Fixed, permanent assets & a part of temporary CA are financed with -- Long term

finance.
when the firm has no need for temporary CA, the idle LTF can be:
Invested in the tradable (marketable) securities to conserve liquidity.
This plan relies heavily on LTF & therefore firm has less risk of facing the

problem of shortage of funds.

LiquidityHigh; ProfitabilityLow; RiskLow.
Aggressive approach :
When firm uses more STF than warranted by the matching plan - aggressive

approach
The firm finances Temporary & a part of its permanent current assets with --- STF.
Some extremely aggressive firms may even finance a part of their fixed assets

withSTF.
Relatively more use of short-term financing makes the firm more risky.
Liquiditylow; ProfitabilityHigh; RiskHigh.

6)WHAT DO YOU MEAN BY COST LIQUIDITY AND COST OF ILLIQUIDITY?

(2 Times Repeated)
cost of liquidity ;
If the firms level of CA is very high, it has excessive liquidity.
Its return on assets will be low, as funds tied up in idle cash & stocks and high level of
debtors --- reduces profitability.
cost of illiquidity:
Cost of holding insufficient current assets.
It forces the firm to borrow @ high rates of interest.
Adversely affect the credit-worthiness of the firm & its difficult to raise funds in future.
This force the firm into insolvency.
The low level of stocks will result in loss of sales & customers may shift to competitors.
7)WHAT DO YOU MEAN BY NEGATIVE WORKING CAPITAL ? (2 Times
Repeated)

WORKING CAPITAL LEVERAGE One of the new models of leverage is working

capital leverage which is used to locate the investment in working capital or current assets
in the company. Working capital leverage measures the sensitivity of return in investment
of charges in the level of current assets
WCL = Percentage Change in ROI /Percentage Change is WC.
8)

EXPLIAN

HOW

FACTORING

USEFUL

IN

WORKING

CAPITAL

FINANCING? (3 Times Repeated)

Size of firm :
The size of the firm in terms of its scale of operation is an important factor
affecting the requirements of the working capital.For example, small scale
organization requires less amount

of working capital where as large scale

organization requires more amount of working capital.

Nature of business:
Trading and financial firms have a very small investment in fixed assets, but
require large sum of money to be invested in working capital. On the contrary,
public undertakings like electricity, water supply, railways, etc., require huge
amount of working capital, because services are provided only on cash basis.
Production cycle:
The time taken for converting raw materials into finished product is known as
production cycle or manufacturing cycle.
Longer periods requires more amount of working capital
Shorter periods requires less amount of working capital
Seasonality of operations:
firms which have marked seasonality in their operations usually have highly
fluctuating working capital requirements.
Rate of turn over :

High rate of turn over require less amount of working capital. Whereas low rate
of turn over requires huge amount of working capital.
9) DISTINGUISH BETWEEN
1 )GROSS WORKING CAPITAL AND NET WORKING CAPITAL
2)PRODUCTION CYCLE AND OPERATING CYCLE (3 Times Repeated)
Gross working capital refers to the firms investment in current assets. Current assets are
the assets which can be converted into cash within an accounting year and include cash,
short term securities, debtors, B/R, stock
Net working capital refers to the difference between currents assets and current
liabilities.
Working capital=current assets-current liabilities
Current asset which are converted into cash within a period not exceeding one year
normally, such assets are called current assets.
Examples : cash in hand, cash at bank ,B/R, S drs, etc.,
Current liabilities are those liabilities- paid within a period of one year
Examples : creditors, bills payable and outstanding expenses.
PRODUCTION CYCLE :
It Is the cycle through which every product goes through from introduction to withdrawal
or eventual demise.
Operating cycle :
The time duration required between the purchase of raw materials and the collection of
cash for sales is referred as operating cycle.
10) WHAT ARE GOAL OF WORKING CAPITAL MANAGEMENT ?
The Goal of working capital Management is to achieve balance between having sufficient
working capital to ensure that business is liquid but not too much that the level of
working capital reduced profitability.

11)

EXPLAIN

THE

COMMITTEE

OF

THE

WORKING

CAPITAL

MANAGEMENT ?
The Dehejia committee:

The bank credit is treated as the first source of finance & not as supplementary to

other source of finance

It is the borrower who decide how much he would borrow the banker does not
decide how much he would lend7 & is therefore, not in a position to do credit

planning.
The amount of credit extended is based on the amount of security available, not on

the level of operations of borrower

Security does not by itself ensure safely of banks funds since all bad & sticky
advances are secured advances; safely essentially lies in the efficient follow-up
industrial operations of the borrower.

The Tandon Committee Recommendations :

To suggest guidelines for commercial banks to follow up & supervision credit.

To make suggestions for prescribing inventory norms for the different industries.
To make recommendations as to whether the existing pattern of financing working

capital requirements by cash/ overdraft system.

Operating plan
Production based financing
Partial bank financing
THE CHORE COMMITTEE RECOMMENDATIONS :

The banks should obtain quarterly statements in the prescribed format from all

borrowers having working capital credit limit of Rs. 50 lacs & above.
The banks should undertake a periodical review of limits of Rs.10 lacs & above.
The banks should fix separate credit limits for peak level & non peak level.
If a borrower does not submit the quarterly returns in time the banks may charge

the penal interest of 1% on the total amount outstanding for the period of default.
Banks should take steps to convert cash credit limits into bill limits for financing

sales.
The banks should discourage sanction of temporary limits by charging additional
1% interest over the normal rate on these limits.

12) EXPLAIN THE VARIOUS SOURCES OF WORKING CAPITAL ? (3 Times

Repeated)

Short term financing of working capital ?

Trade credit
Bank credit
Overdraft
Cash credit
Purchase/Discounting of bills
Letter of credit
Working capital loan

TRADE CREDIT :
Trade credit refers to the credit that a customer gets from suppliers of goods in the normal
course of business. In practice, the buying firms do not have to pay cash immediately for
the purchases made. This deferral of payments is a short term financing called trade
credit.
OVER DRAFT :
Under overdraft facility, the borrower allowed to withdraw the funds in excess of the
balance in his current account up to a certain specified limit during a stipulated period.
Interest is charged on the daily balances-on the amount actually withdrawn subject to
some minimum charges
CASH CREDIT :
Under this cash credit facility, a borrower is allowed to withdraw the funds from the bank
up to sanctioned limit. The interest is payable on the amount actually utilized by the
borrower.
Purchase Or Discounting Of Bills :
The banks purchases or discounts the borrowers bills. The amount provided under this
agreement covered within the overall cash credit or overdraft limit. Before purchasing or
discounting the bills, the bank satisfies itself as to the credit worthiness of the drawer.
Letter Of Credit :
Suppliers, particularly foreign suppliers insist that the buyer should ensure that his bank
will make the payments if he fails to honour its obligations. This arrangement passes the
risk of the supplier to the bank.

Working Capital Loan :

A borrower may sometimes require ad hoc or temporary accommodation in excess of
sanctioned credit limit to meet unforeseen contingencies. Banks provide such
accommodation through a demand loan A/c or a non-operable cash credit A/c.
Long term financing of working capital :

Retained Earnings
Share Capital
o Equity Shares (also referred as Ordinary
o Preference Shares
Debentures
Term Loans

Shares)

1.Retained Earnings :
A major portion of net income, after payment of dividend, is retained (ploughed back) in
the business, year-after-year, whereby the shareholders wealth increasingly grows and
goes-up.
2.Share Capital
There are two types of shares:
Equity Shares
Preference Shares
Equity Shares:
The equity shareholders of the company are considered to be the owners of the company
they are entitled to all the gains and benefits accruing to the company. But, at the same
time, they also share the losses and liabilities of the company. The liabilities for the
shareholders of all the limited liability companies remain confined and restricted only to
the extent of their share capital contributed in such companies. In the case of unlimited
liability company, the liabilities of the shareholders remain unlimited.
Preference Share Capital
Preference share capital is the combination of both equity shares and debentures.

It is similar to ordinary share in that:

The non-payment of dividends does not force the company to insolvency

Preference shareholders have claims on income and assets prior to ordinary

shareholders
Dividends are not deductible for tax purposes
In some cases, it has no fixed maturity date
It is similar to debenture in that:
Dividend rate is fixed
Preference shareholders do not share in the residual earnings
They usually do not have voting rights.

Debentures
The debenture holders are considered as the creditors to the company, as against the
shareholders, who are deemed to be the owners of the company. The company has the
legal obligation to pay the amount of interest at the specified rate and on the specified
time and redeem the debentures on due date.
Term Loans
Term Loans are granted for a period ranging from over one year but maximum up to 10
years . Term Loans are usually granted for the purpose of capital expenditure like for
acquiring fixed assets and are made repayable in stipulated installments, at the stipulated
periodical intervals. As these loans are not repayable on demand, these are not treated as
short term loans (like working capital finance provided by the banks), but as long term
loans, and accordingly, long term sources of finance.
13 )EXPLAIN OPERATION CYCLE AND CASH CYCLE ? (2 Times Repeated)
Operating cycle : The time duration required between the purchase of raw materials and
the collection of cash for sales is referred as operating cycle.
OC = Days of Sales outstanding + Days of Inventory
Cash cycle : The time length between the payment for raw material purchases and the
collection of cash for the sales is referred as cash cycle.
CC = Days of sales outstanding + Days of inventory outstanding -days of payable
outstanding.

14) WHAT IS THE DIFFERENCE BETWEEN NET WORKING CAPITAL AND

SPONTANEOUS WORKING CAPITAL ? (2 Times Repeated)
Net working capital refers to the difference between currents assets and current
liabilities.
Working capital=current assets-current liabilities
Current asset which are converted into cash within a period not exceeding one year
normally, such assets are called current assets.
Examples : cash in hand, cash at bank ,B/R, S drs, etc.,
Current liabilities are those liabilities- paid within a period of one year
Examples : creditors, bills payable and outstanding expenses.
Spontaneous financing :
spontaneous financing refers to the automatic sources of short term funds arising in the
normal course of business.
trade (suppliers) credit and outstanding expenses.
15) DISTINGUISH BETWEEN PERMANENT AND TEMPORARY WORKING
CAPITAL ? (2 Times Repeated)
Permanent or fixed working capital
A minimum level of current assets, which is continuously required by a firm to carry on
its business operations, is referred to as permanent or fixed working capital.
Temporary working capital :
The extra working capital needed to support the changing production and sales activities
of the firm is referred to as fluctuating or variable working capital.