WORKING CAPITAL

MANAGEMENT

Submitted to Submitted by:

Ms. Rashmi Uchil Sahil Pasrija
Lecturer 10HM25
HSM Dept
NITK
 MEANING OF WORKING
CAPITAL

Funds required for short term purposes or day to day expenses are working
capital. Working Capital refers to part of firm’s capital required for financing
short term or current assets also known as revolving or short term capital or
circulating capital.

Concept of Working Capital:

There are two concepts of working capital- gross and net

 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) and include cash, short-term securities,
and debtors, bills receivable and stock.

 Net working capital refers to the difference between current assets and
current liabilities. Current liabilities are those claims of outsiders which are
expected to mature for payment within an accounting year and include
creditors, bills payable and outstanding expenses. Net working capital can be
positive or negative. A negative working capital occurs when current
liabilities are in excess of current assets.
 TYPES OF WORKING
CAPITAL

1. Gross working capital:

Total or gross working capital is that working capital which is used for all the
current assets. Total value of current assets will equal to gross working capital. In
simple words, it is total cash and cash equivalent on hand. But remember, we do
not account of current liabilities in gross working capital.

2. Net Working Capital:

Net working capital is the excess of current assets over current liabilities.
Net Working Capital = Total Current Assets – Total Current Liabilities
This amount shows that if we deduct total current liabilities from total current
assets, then balance amount can be used for repayment of long term debts at any
time. It also measure of both a company's efficiency and its short-term financial
health.

3. Permanent Working Capital:

Permanent working capital is that amount of capital which must be in cash or
current assets for continuing the activities of business. It also shows the minimum
amount of all current assets that is required at all times to ensure a minimum level
of uninterrupted business operations.

4. Temporary Working Capital:

Sometime, it may possible that we have to pay fixed liabilities, at that time we
need working capital which is more than permanent working capital, then this
excess amount will be temporary working capital. In normal working of business,
we don’t need such capital
 OPTIMUM LEVEL OF
WORKING CAPITAL

Optimal level of working capital is that level where company is capable to pay day
to day expenses and company has enough cash to buy the stocks in case if it does
not receive money from debtors on the time. This level is achieved by thinking and
using the techniques of working capital management. Both low level and over level
of working capital is harmful for development of business.

If company has not enough cash to repay its liability, it will create the risk of
solvency and liquidity  and company may go for liquidation. In case, company has
over working capital, it will be misuse of money because that money is not gaining
any earning and its opportunity cost will suffer by shareholders and ultimately it
will decrease the value of share in share market. So, as finance manager, one
should try to create equilibrium or optimal or optimum level of working capital
 IMPORTANCE

 Maintains solvency of business.

 Helps in arranging loans from banks & others on easy and favorable terms.

 Enables a concern to avail cash discount and hence reduce cost.

 Ensures regular supply of raw materials.

 Ensures regular payment of salaries and wages and other day to day
commitment.

 Exploitation of favorable market condition.

 Enables a concern to face business crises.

 It is a qualitative concept which indicates firm’s ability to meet its operating

expenses and short time liabilities.

 It indicates the margin of protection available to the short term creditors.

 Working capital is the indicator of financial soundness of a company.

FACTORS DETERMINING
NEEDS OF WORKING
CAPITAL OF A COMPANY:

The following is the description of factors which generally influence the working
capital requirements of a firm:

 Nature of business:
Working capital requirements of a firm are basically influenced by the
nature of its business. Trading and financial firms have a very small
investment in fixed assets, but require a large sum of money to be invested
in working capital. Some manufacturing companies also have to invest
substantially in working capital. In contrast, public utilities have a very
limited need for working capital, because they may have only cash sales and
supply services, not products.

 Sales and Demand Conditions:

The working capital needs of a firm are related to its sales. It is difficult to
precisely determine the relationship between volume of sales and working
capital needs. In practice, current assets will have to be employed before
growth takes place. It is, therefore, necessary to make an advance planning
of working capital for a growing firm on a continuous basis.
 Technology and Manufacturing Policy:
The manufacturing cycle (or the inventory conversion cycle) comprises of
the purchase and se of raw material and the production of finished goods.
Longer the manufacturing cycle, larger will be the firm’s working capital
requirements.

 Credit Policy:
The credit policy of the firm affects the working capital by influencing the
level of debtors. The credit terms to be granted may depend on the norms of
the industry to which the firm belongs. But a firm has the flexibility of
shaping its credit policy within the constraint of industry norms and
practices.

 Availability of Credit:
The working capital requirements of a firm are also affected by credit terms
granted by its creditors. A firm will need less working capital if liberal credit
terms are available to it.

 Operating Efficiency:
The operating efficiency refers to the optimum utilization of resources at
minimum costs. The firm will be effectively contributing in reducing the
working capital investment if it is efficient in controlling operating costs and
utilizing current assets.

 Price level Changes:

The increasing shifts in price level make functions of a financial manager
difficult. He should anticipate the effect of price level changes on working
capital requirements of the firm. Generally, rising price levels will require a
firm to maintain higher amount of working capital.
 ISSUES IN WORKING
CAPITAL:
 Time:
Empirical observations show that the financial managers have to spend
much of their time to the daily internal operations, relating to current assets
and current liabilities of the firm. As the largest portion of the financial
manager’s valuable time is devoted to working capital problems, it is
necessary to manage working capital in the best possible way to get
maximum benefit.

 Investment:
Investment in current assets represents a very significant portion of the total
investment in assets. For example, in the case of the large and medium
public limited companies in India, current assets constitute about 60% of
total net assets or total capital employed. This clearly indicates that the
financial manager should pay special attention to the management of current
assets on a continuing basis. Actions should be taken to curtail unnecessary
investment in current assets.

 Criticality:
Working capital management is critical for all firms, but particularly for
small firms. A small firm may not have much investment in fixed assets, but
it has to invest in current assets. Further, the role of current liabilities in
financing current assets is far more significant in case of small firms, as,
unlike large firms, they face difficulties in raising long term funds.
 Growth:
There is a direct relationship between a firm’s growth and its working
capital needs. As sales grow, the firm needs to invest more in inventories
and debtors. These needs become very frequent and fast when sales grow
continuously. The financial manager should be aware of such needs and
finance them quickly. Continuous growth in sales may also require
additional investment in fixed assets.

Reference:
www.scibd.com
www.ajolinfo.com
www.svtution.org
IM PANDEY- Book on Financial Management