Working Capital

Management
 WORKING CAPITAL
qCurrent assets – Current liabilities
qIt measures how much in liquid assets a
company has available to build its business.
qA short term loan which provides money to buy
earning assets.
qAllows to avail of unexpected opportunities.
qPositive working capital is required to ensure
that a firm is able to continue its operations and
that it has sufficient funds to satisfy both maturing
short-term debt and upcoming operational
expenses. The management of working capital
involves managing inventories, accounts
receivable and payable and cash.
 CONSTITUENTS OF WORKING
CAPITAL
CURRENT ASSETS
Inventory
Sundry Debtors
Cash and Bank Balances
Loans and advances
CURRENT LIABILITIES
Sundry creditors
Short term loans
Outstanding expenses

IMPORTANCE OF WORKING CAPITAL
 Arranging the sources of
working capital:
It depends mainly upon the availability of
funds and different application of this
working capital. Current assets or working
capital includes mainly three components
Inventories
Cash
Receivables
So, in short we can also say that the working
capital management means to manage all
these three components in the firm.
Types of Working Capital:
There are two broad classifications of the
working capital.
Gross Working Capital
Net Working Capital
There are two more classifications which are
also very important.
Permanent Working Capital
Temporary Working Capital
Gross Working Capital:
Total Current assets
Where Current assets are the assets that can
be converted into cash within an accounting
year & include cash , debtors etc.
Referred as “Economics Concept” since assets
are employed to derive a rate of return.

Net Working Capital:

CA – CL
Referred as ‘point of view of an Accountant’.
It indicates liquidity position of a firm &
suggests the extent to which working capital
needs may be financed by permanent sources
of funds.
Permanent Working Capital:
It refers to the amount of working capital which is
required by the firm every time. It shows the
minimum level of working capital which required
maintaining day to day operations of the firm.

Temporary Working Capital

It is required by the when while some changes in
production or sales volume or change in the price
level of any factors of production.


Approaches for determining the
Working Capital
There are following three types of
approaches to finance the working
capital
Matching Approach or Hedge
Approach
Conservative Approach
Aggressive Approach
 Matching Approach or
Hedge Approach:
In this approach of financing the
working capital the firm tries to finance
the permanent working capital through
the long term funds and temporary
working capital through short term
funds. The concept behind this is that
the maturity of source of funds should
match the nature of assets to be
financed.
 Conservative Approach:

According this approach the whole

amount of working capital should be
financed through the long term funds.
In this approach the firm does not want
to take any risk. It is a costly approach
in comparison to matching approach.


 Aggressive Approach:

Under this approach the firm uses the

short term funds to finance some part
of permanent working capital and the
whole of part of temporary working
capital. But this approach is more risky
for the firm, however this the cheapest
approach.

 Working Capital Operating Cycle

Cash Raw material

Work in progress Finished

Goods Sales
Debtors Bills receivables
Cash
 
 Demerits of Excessive
Working Capital
There may be following problems
It can accumulate unnecessary inventories. Thus
chance of mishandling, theft, wastage of
inventories may occur.
It also indicates poor collection of receivable
and very liberal credit policy regarding
sales. The bad debts will increase it such
situation continues for long time.
It allows to the management to inefficiently
Accumulation of excessive inventories also
leads to speculative profit. This may tend to
make dividend policy liberal, which may create
serious problems in future.
Excessive availability of cash tempts the
executive to spend more.
 Demerits of Inadequate
Working Capital :
There may be following problems-
It becomes difficult for the firms to undertake
profitable projects due to shortage of working
capital.
The firm may face problems in implementing the
operating plans and achieve the firm’s profit
target.
It also creates problem in meeting out day-to-day or
routine expenses.
Fixed assets can be utilized more effectively, thus
the overall return may go down.
Due to inadequate working capital firm may loose
some good credit opportunities
The firm may spoil its fame and reputation if it
fails to honour short-term obligations. As a
result, the firm faces tight credit terms.
It directly affects the liquidity positions of the
business firms.