INTRODUCTION TO WORKING CAPITAL

Capital required for day to day working in the business concern, for
purchasing raw material, for meeting day to day expenditure on salaries,
wages, rent, rates, advertisement, etc. is called as working capital.
It represents the portion of the business concern total financial resource,
which is put to variable operative purpose .these are two concept of
working capital

 Gross working capital.

 Net working capital.

Gross working capital refers to firm total current assets .It can also
called as circulating capital.

Gross working capital =Total current assets

Net working capital =current assets –current liabilities

Current assets are those assets which have short life span and are
converted into cash in accounting year the major current assets are cash
bank balance, marketable securities, accounts receivable and inventories.

Current liabilities are those liabilities which are intended to be paid

in the ordinary course of business within a year. The basic current
liabilities account payable, bank overdraft, outstanding expenses.
 FRAME WORK OF WORKING CAPITAL MANAGEMENT

Working capital refers to the investment by a company in short-term

assets such as cash, marketable securities, accounts receivables and
inventories. A study of working capital is of major importance to internal
and external analysis because of its close relationship with the current
day to day operations of business.

Business needs funds for the purpose of its establishment and to carry
out its day-to-day operations. Long-term funds are required to create
production facilities through purchase fixed assets such as plant &
machinery, land & buildings, furniture etc. investment in these assets
represents the part of firm's capital, which is blocked on a permanent or
fixed and is called fixed capital, Funds are also needed for short-term
purpose for the purchase of raw materials, payments of wages and other day-
to-day expenses etc., these funds are known as working capital.

Working capital is one of the most important requirements of any

business concern. Working capital can be compared with the -blood of
human beings. As human cannot survive without blood, in the same way on
business cannot survive without working capital.

Working capital management deals with maintaining the levels of

working capital to optimum, because if a concern has inadequate
opportunities if the working capital is more than required the concern will
loose money in form of interest on the block funds. Therefore working
capital management plays a very vital role in profitability of a company.

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DEFINITION AND MEANING:

Working capital is defined as excess of current assets over current

liabilities. Management of working capital includes management of all
current-assets and current liabilities. The interaction between current
assets and current liabilities is the main theme of the theory of working capital
management.

Working capital is commonly used for the capital required for day to day
working in a business concern, such as purchasing raw material for
meeting day to day expenditure on salaries, wages, rent rates, advertising
etc.

Working capital management may be said to include in its definitions,

needs, optimum level of current assets, the trade off between profitability
and risk associations with a firm's level of current assets and liabilities
financing mix strategies and so on.

Current Working capital measures how much in assets a company

has available to build its business. The number can be positive or
negative, depending on how much debt the company is carrying. In
general, companies that have a lot of working capital will be more
successful since they can expand and improve their operations.
Companies with negative working capital may lack the necessary for also
called net current assets or current capital.

Cash is the lifeline of a company. If this lifeline deteriorates, so does

the company's ability to fund operations, reinvest and meet capital
requirements and payments. Understanding a company's health is
essential to making investment decisions. A good way to judge a
company's cash flow prospects is to look at its Working Capital
Management (WCM).

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NEED FOR WORKING CAPITAL:

The basic objective of financial management is to minimize the

shareholder wealth. This is possible only when company earns sufficient
profits. The amount of such profits largely depends upon the magnitude of
sales. However sales convert into cash instantaneously. There is always
time gap between sale for goods and their actual realization working
capital required in order to sustain the sales activities in this period.

In case adequate working capital is not available for this period the
company will not be in a position to purchase raw material, pay wages and
other expenses required for, manufacturing the goods. Therefore sufficient
amount of working capital is to be maintained at nay point time.

ADEQUACY OF WORKING CAPITAL:

A firm must have -adequate working capital is as much as needed by the

firm. It should neither be excessive nor in adequate. Both the situation is
harmful to the concern. Excessive working capital is the firm as ideal funds which
earns no profits for the firm inadequate working capital means the firm does
not have funds to perform operations which means ultimately results in
production interruptions and lowering down of the profitability.

It will be interesting to understand the relationship between working

capital, risk return in manufacturing concern it is generally accepted that
higher levels of working capital decrees the risk and have the potential of
increasing the profitability also.

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CONCEPT OF WORKING CAPITAL :

There are two concepts of working capital. They are:

 Gross Working Capital

 Net working Capita

GROSS WORKING CAPITAL:

It is the total of all the current assets, which include inventories,

sundry debtors, and cash in hand, and bank, advances, investments, short
term deposits etc.,

NET WORKING CAPITAL:

It is the excess of current assets over current liabilities; this is as
a matter of fact the most commonly accepted definition. In other words
it can also be defined as difference between current assets and
current assets and current liabilities.
It is that portion of a firm's current assets, which is financed with
long -term funds.
TYPE OF WORKING CAPITAL:
The working capital may also be classified into permanent and
temporary working capital .permanent working capital refers to the
minimum amount of investment in all current assets which is requires all
the time to carry out minimum level of business activities . It represent
the current assets are called as core current assets .the amount of
permanent working capital remains in the business in one form or another
form of assets .the suppliers of such working capital are not paid during
the life of the firm i.e. the assets concerned are financed by funds raised
from long term sources . Permanent working capital of the firm increase
with the volume of business as illustrated in figure 1

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Amount of
working
capital Permanent

FIG1:
It represent that permanent capital is fixed over a period of time while
temporary working capital is fluctuating Permanent.

Amount of Permanent
working
capital

fig2

It represents that: permanent working capital increasing over a

period of time which increases the level of business activity. And
temporary working capital is fluctuating.

The amount of working capital that fluctuates from time to time on

the basis of business activity is called temporary working capital.

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 It represents additional current assets required at different times
during the accounting year. Temporary working capital requirement are
met by fund raising from short term sources of finance. Suppliers are paid
generally during off range season.

Working capital management is aimed to manage the firm’s current

assets and current liabilities. So that a satisfactory level of working capital
is maintained. If a firm is unable of maintain adequate working capital
.The firm may become insolvent and even be forced into bankruptcy.

A firm must have adequate working capital it should not be

excessive working capital results in idle funds, which yield no profits for
the business. Inadequate working capital results into insufficient of funds
for running the operations of the business smoothly. Sometimes it result
into production interruption and there by reduces the profitability of the
business. Working capital management is concerned with all decision and
acts the influence the size and effectiveness of working capital efficient.
Working capital management requires that the firm should operate with
some amount of working capital. The size of net working capital varies
from firm to firm and depends upon the nature of Business. The use of net
working capital is to measure a firm’s liquidity requirement cash flow and
cash flow out of business does concede. Cash out flow results forms
payment of current liabilities are predictable, whereas cash inflow are
difficult to predict, the more the accuracy of prediction of cash inflow the
lower will be the net working capital requirement.

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Working capital is required for a business because of the time gap
between the sales and their actual realization in cash. The time gap is
technically called an operating cycle of the Business fig -3 illustrates the
operating cycle of a firm working capital management involves
management of different components of working capital such as account
receivable and i9nventories for determining the size and method of
financing.

Cash Raw material

Work in
progress
Account
receivable

Finished
goods
Sales

OPERATING CYCLE FIG3

A brief description of various issues involved in the management of

each of the component of working capital is here below. Adequate cash
balance have to maintained so that no fund are blocked in idle cash which
involves costs in terms if interest. Adequate cash is required to meet
business obligation as and when they raise. Cash requirement also arise
to meet unforced contingencies such as stake, increase in the price of raw
material, and fall in the collocation of the account receivable. The grater is
the possibilities of contingencies. The greater amount of fund required to
maintain by the firm.

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 Adequate cash is also required to take the advantages of
unexpected Business opportunities. The management of cash is aimed to
meet the obligation as per the payment schedule and to minimize the
amount of idle cash balance. Inventories include raw material, work in
progress and finished good inventories. The maintenance of these levels
of inventories depend upon the nature of business.

Adequate inventories protect the firm from the losses on account of

shortage or delay in production price variations and defer ratio of stock.
Accounts receivable constitute a significant portion of the hotel current
assets of a business. Accounts receivable are the results of goods or credit
intended increase the scale volume and thereby increase in the profits of
the business. Management of accounts receivable is aimed to ensure
liquidity. Higher level of accounts receivable to be bad debt and inverse
the collection cost.

Working capital can be divided into categories on the basis of time.

 Permanent working capital / fixed working capital

 Temporary working capital / variable working capita

PERMANENT WORKING CAPITAL:

This refers to that minimum amount of investment in all current

assets, which is required at all times to carry out minimum levels of
business activities. Permanents working capital represent the current
assets required on a continuing basis over the entire year. Amount of
permanent working capital remains in the business in one form or other.
This is particulars important form the point of view of financing. The
suppliers of such working capital should not expect its return during the
lifetime of the firm.

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TEMPORARY WORKING CAPITAL:

The amount of such working capital keeps on fluctuating from time to

time on the basis of business activities. Working capital represents
additional current assets required at different times during the operating year.

ESTIMATION OF WORKING CAPITAL :

Since working capital is excess of current assets over current

liabilities, the forecast for working capital requirements can be made only
after estimating the amount of different constituent's working capital.
I. Inventories

 Stock of raw materials

 Work - in – process
 Finished goods
II. Sundry debtors
III. Cash and bank balances
IV. Sundry creditors
V. Outstanding expenses

I. INVENTORIES:

The terms inventories include stock of raw materials, work - in -

process and finished goods. The estimation of each of them will be made
as follows:

 STOCK OF RAW MATERIALS: The average amount of raw materials to

be kept in stock will depends upon the quantity of raw material required
for production during a particular period and the average time taken in
obtaining a fresh delivery.

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  WORK- IN-PROCESS: The cost of work - in - process includes raw
materials, wages and overheads. In determining the amount of work in
process, the time period for which the good will be in the course of
production process, is most important.

 FINISHED GOODS: The finished goods are kept in warehouse and according to
the orders of the customers, goods will be delivered.

II.SUNDRY DEBTORS: Debtors are those persons who will be purchase goods on
credit basis. The sundry' debtors will-be calculated on the basis of credit
sales.

III.CASH AND BANK BALANCES: The amount of money to be kept as cash in hand or
cash at bank can be estimated on the basis of past experience.

IV.SUNDRY CREDITORS: The lag in payment to suppliers of raw materials, goods,

etc., and likely credit purchase to be made during the period will be help in
estimating the amount of creditors.

V.OUTSTANDING EXPENSES: The time lag in payment of wages and other

expenses will be help in estimation of outstanding expenses.

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SOURCES OF WORKING CAPITAL

There are mainly two types of sources of working capital, they

are as follows:

PERMANENT OR FIXED OR LONG-TERM WOKI N G CAPITAL:

 SHARES: Issue of shares is the most important share for raising the
permanent or long-term capital. A company can issue various types of
shares, preference share and deferred share.

 DEBENTURES: A debenture is an instrument issued by the company

acknowledging its debts to its holder it is also an important method of
raising long term permanent working capital

 PUBLIC DEPOSITS: Public deposits are the fixed deposits accepted by a

business enterprise directly popular in the absence of banking
facilities.

 LOANS FROM FINANCIAL INSTITUTION : Financial Institutions such as

commercial Banks, industrial finance corporations of India, state
financial corporations.

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TEMPORARY OR VARIABLE FOR SHORT -TERM WORKING CAPITAL :

 TRADE CREDIT : Trade credit refers to the credit extended by

the suppliers of goods in the normal coerce of business. As present
day commerce is built upon credit, the trade credit arrangement of a
firm with its suppliers is an important source of short-term finance.

 I NDIGENOUS BUSINESS: Private money-lenders and other is

country banks used to be the only sources of finance prior to the
establishment of commercial banks. They used to change very
higher rates of interest and exploited the customers to the
largest extent possible.

 DEFERRED INCOMES: Deferred incomes are incomes received

advances before supplying goods or services. They represent funds
received by a firm for which it has to supply goods or services in
future.

 COMMERCIAL PAPER: Commercial paper represents unsecured

promissory notes issued by firms to raise short-terms funds. It is an
important money market instrument in advanced countries like U.S.A.
In India, the reserve bank of India introduced commercial paper in the
Indian Money Market on the recommendations of the working capital
upon money market (Vague - Committee)

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DETERMINANTS OF WORKING CAPITAL:

Some of the important determinants of working capital are given below:

 NATURE OF WORKING CAPITAL: The working capital requirements of

enterprises are basically related to conduct of the business.
Public utility undertaking need very limited working capital as
they offer cash sales only and supply services but not product and
as such no funds are tied up in inventories and receivables, but at
the same time trading firms require large amounts in current assets
like inventories, receivable, cash etc. and has to invest less
amount in fixed assets.

 SIZE OF BUSINESS: The working capital requirements of a concern are

directly influenced by the size of its business, which may be
measured in terms of scale of operations. Greater the size of a
business unit, larger will be the requirements of working capital.

 TERMS OF SALES AND PURCHASE: Credit terms granted by the concern

to its customers as well as credit terms granted by its suppliers
also affected the working capital.

 MANUFACTURING CYCLE: The length of manufacturing cycle

influences the quantum of working capital needed.
Manufacturing process always involves a time or lag between
the time when raw materials are fed into production line and
finished products are finally turned out by it.

 RAPIDITY OF TURNOVER: If the inventory turnover is high, the working

capital requirements will be low, with a better inventory control,
a firm is able to reduce its working capital requirement, firms
should determine, the minimum level stock, which it will be have
to maintain throughout the period of its operation.

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 SEASONAL VARIATION: The inventory of raw materials, spares and
stores depends on the conditions of supply. If the supply is
prompt and adequate the firm can manage with small inventory.
However if the supply is unpredictable and scant then the firm, to
ensure continuity of production, would have to acquire stocks
and when they are available larger inventory should be carried.

 DIVIDEND POLICY: Dividend policy has a dominant influence on the

working capital position of an enterprise. If the management
follows a conservative dividend policy, consequently drains off
large amounts from the pool of working capital.

 SEASONALITY OF OPERATING: Firms, which have marked seasonality in

their operations usually, have higher fluctuating working capital
requirement. On the other side firms which manufacture products,
which have sales round the year, tend to have stable working capital
needs.

 CREDIT POLICY: The credit policy of a concern in its dealings with

debtors and creditors influence considerably the requirements
of working capital. A concern that purchases it requirements on
credit and sells its product/services on cash requires lesser
amount of working capital.

 BUSINESS: Business cycle refers to alternate expansion and

contraction in general business activity. In a period of boom i.e.,
when the business is prosperous there is a need for larger
amount of working capital due to increase in sales rise in prices,
optimistic expansion of business etc.

 PRICE LEVEL CHANGES: Changes in the price level also affect the
working capital requirements. Generally the rising prices will
require the firm to maintain larger amount of working capital as

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 more fund will be requirement to maintain the same current
assets.

 OPERATING CYCLE: Working capital is required because of the time gap

between the sales and their actual realization of cash. This time
gap is technically termed as "Operating Cycle" of the business. In
the case of manufacturing company, the operating cycle is the
length of time necessary to complete the following cycle of
events:

 Conversion of cash into raw materials

 Conversion of raw material into working in process

 Conversion of work in process into finished goods

 Conversion of finished goods into accounts receivable

 Conversion of accounts receivables into cash

The cycle will be repeated again and again. In case of a "trading firm' the
operating cycle will include the length of time required.

TO CONVERT:

 Conversion of inventories.

 Inventories into accounts receivables.

 Accounts receivable into cash.

 In case of financing firms the operating cycle includes the length of

the time taken for conversion of cash into debtors and debtors into
cash.

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OBJECTIVE OF CASH MANAGEMENT:

There are two basic objectives of cash management.

 To minimize the mount locked up as cash balances

 To meet the cash disbursement needs as per the payment

schedule.

ADVANTAGES OF SIMPLE CASH FUNDS:

 Maintain a good bank relation.

 Maintain of goodwill.

 Exploration of business opportunities.

 Encourage new investment.

 Helps to overcome abnormal financial situations.

CASH MANAGEMENT – BASIC PROBLEM:

Cash management involves the following four .basic problems

 Controlling level of cash.

 Controlling inflows of cash.

 Controlling outflows of cash.

 Optimum investment of surplus.

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