Working Capital Management

WORKING CAPITAL
• Working Capital is the amount of funds
necessary for the day to day operation of the
organization.
• Working capital is the difference between the
book value of the current assets and the current
liabilities.
• Working capital is the excess of current assets
over current liabilities.
• It is also called as revolving or circulating or
short term capital.
CONCEPTS OF WORKING CAPITAL
Gross working capital (GWC)
 GWC refers to the firm’s total
investment in current assets.
 Current assets are the assets which
can be converted into cash within an
accounting year.
 It includes Cash, Short-term
securities, Accounts Receivables (Debtors
and Bills Receivable and Stock (inventory).
 Contd…
Net working capital (NWC)
 NWC refers to the difference between current
assets and current liabilities.
 Current liabilities (CL) are those claims of
outsiders which are expected to mature for
payment within an accounting year and
include Accounts Payables (Creditors and
Bills Payable) and Outstanding Expenses.
 NWC can be positive or negative.
– Positive NWC = CA > CL
– Negative NWC = CA < CL
 Contd…
Gross Working Capital focuses on
Optimization of investment in current Assets
Financing of current assets
Net Working Capital focuses on
Liquidity position of the firm
Mix of short-term and long-tern financing
Zero Working Capital focuses on
Forces the corporates to produce and deliver faster, helps
in gaining new business.
ZWC = Inventories plus receivables minus payables
TRADE-OFF BETWEEN PROFITABILITY AND RISK
Profitability
The relationship between revenues and costs generated
by using the firm’s assets—both current and fixed in
productive activities. Firm can increase its profits by
increasing revenues or decreasing costs.
Risk (of insolvency)
The probability that a firm will be unable to pay its bills
as they come due.
Insolvent
Describes a firm that is unable to pay its bills as they
come due.
Changes in Current Assets
Changing the level of the firm’s current assets
affects its profitability–risk trade-off by using the
ratio of current assets to total assets. This ratio
indicates the percentage of total assets that has been
financed with current assets.
Changes in Current Liabilities
Changing the level of the firm’s current liabilities
affects its profitability–risk trade-off by using the
ratio of current liabilities to total assets. This ratio
indicates the percentage of total assets that has been
financed with current liabilities.
Working Capital Operating Cycle
CASH CONVERSION CYCLE OR OPERATING CYCLE

Operating cycle is the time duration required to convert

sales, after the conversion of resources into inventories,
into cash. The operating cycle of a manufacturing
company involves three phases:
– Acquisition of resources such as raw material,
labour, power and fuel etc.
– Manufacture of the product which includes
conversion of raw material into work-in-progress
into finished goods.
– Sale of the product either for cash or on credit.
Credit sales create account receivable for
collection.
 Cash Conversion Cycle
Gross Cash Conversion Cycle
It is a sum of Inventory conversion period (ICP) and
Debtors Conversion/Collection period (DCP).
GOC = ICP (R+W+F)+DCP (or)
OC = AAI + ACP
Average Age of Inventory (AAI) & Average Collection Period
(ACP)
Net Cash Conversion Cycle
The difference between the Gross Cash Conversion Cycle and
Creditors Payment period (CPP)
NOC = GOC – CPP (or)
CCC = OC – APP
Operating Cycle (OC) & Average Payment Period (APP).
 CASH CONVERSION CYCLE

CCC = AAI (R + W + F) + ACP – APP

CCC = Cash Conversion Cycle
R = Raw materials average storage period
W = Work-in-progress average process period
F = Finished goods average storage period
ACP = Average Collection period
APP = Average Payment period
(or)
CCC = AAI + ACP - APP
R = Average stock of raw materials
Average cost of production/consumption per
day
W = Average work-in-progress inventory
Average cost of production per day
F = Average Finished stock inventory
Average cost of goods sold per day
D = Average book debts (debtors)
Average credit sales per day
C = Average trade creditors
Average credit purchase per day
 From the following particulars, compute Net operating cycle
period, Number of operating cycles in a year and the Amount
of working capital.
Period cover 360 days
Average period allowed by suppliers 30 days
Average period allowed to debtors 45 days
Raw materials consumed during the year Rs.600000
Average stock of raw material Rs.50000
Work-in-progress inventory Rs.500000
Average work-in-progress inventory Rs.30000
Finished goods inventory Rs.800000
Average finished goods stock held Rs.40000
Total cost of sales Rs.840000
 COMPUTATION OF NET OPERATING CYCLE
Raw materials held in stock: 30 days
Avg. stock of materials / Avg. Cost of production per day
Avg. Consumption per day = 600000 / 360 = 1667
= 50000 / 1667

Work-in-process: 22 days
Average WIP / Avg. Cost of production per day
Avg. Cost of production = 500000 / 360 = 1388
= 30000 / 1388

Finished goods held in stock: 18 days

Avg. finished goods / Avg. cost of goods sold per day
Avg. cost of goods sold per day = 800000 / 360 = 2222
= 40000 / 2222

Credit period allowed to debtors: 45 days

Gross operating cycle period 115 days
Less: Credit period allowed by creditors 30 days
Net operating cycle period 85 days
2. No. of operating cycles in a year = 360 / 85
= 4.2

3. Working capital required

Total cost of sales
No. of operating cycles in a year

= 840000 / 4.2

= Rs.2,00,000
 OC = AAI + ACP
Average Age of Inventory (AAI) + Average Collection Period
(ACP)
CCC = OC – APP
Cash Conversion Cycle (CCC) = Operating Cycle (OC) - Average
Payment Period (APP).

A company is concerned about managing cash efficiently. Average

Inventories are held for 90 days, Account receivable collected in 60
days and Accounts payable are paid in 30 days.
OC = AAI + ACP
= 90 days + 60 days = 150 days
CCC = OC – APP
= 150 days − 30 days = 120 days
STRATEGIES FOR MANAGING THE
CASH CONVERSION CYCLE
Turn over inventory quickly.
Collect accounts receivable as quickly
as possible without losing sales from
high-pressure collection techniques.
Pay accounts payable as slowly as possible
without damaging the firm’s credit rating or
its relationships with suppliers.
PERMANENT AND VARIABLE
WORKING CAPITAL

Permanent or Fixed working capital

A minimum level of current assets,
which is continuously required by a firm to
carry on its business operations,
Variable or Fluctuating working capital
The extra working capital needed to
support the changing production and sales
activities of the firm.
Determining Financing Mix
Sources of funds for raising current asset financing
Short term sources (Current Liabilities)
•Long term sources (Share Capital, Long term
borrowings, Retained earnings etc.)
Permanent funding requirement
A constant investment in operating assets resulting from
constant sales over time.
Seasonal funding requirement
An investment in operating assets that varies over time
as a result of cyclic sales.
Aggressive funding strategy
A funding strategy under which the firm
funds its seasonal requirements with
short-term debt and permanent requirements
with long-term debt.
Conservative funding strategy
A funding strategy under which the firm
funds both its seasonal and permanent
requirements with long-term debt.
 ESTIMATING WORKING CAPITAL
Current assets holding period
To estimate working capital requirements on the basis of
average holding period of current assets and relating
them to costs based on the company’s experience in
the previous years and it is based on the operating
cycle concept.
Ratio of sales
To estimate working capital requirements as a ratio of
sales on the assumption that current assets will change
with change in sales.
Ratio of fixed investment
To estimate working capital requirements as a percentage
of fixed investment.
Estimation of Current Assets :
Raw material inventory
= Budgeted Production (in units) × Cost of raw material ×
Average inventory holding per unit period (months/days/weeks)
/12 months / 365 days / 52 weeks
Work-in-process inventory
= Budgeted Production (in units) × Estimated WIP × Average
inventory holding cost per unit
/ 12 months / 365 days / 52 weeks
Finished goods inventory
= Budgeted Production (in units) × Cost of goods
(excluding Depreciation) × Finished Goods holding period
(months/days/weeks)
/ 12 months / 365 days / 52 weeks
Debtors
= Budgeted credit sales (in units) × Cost of sales
per unit (excluding Depreciation) × Average debt
collection period (months/days/weeks)
/ 12 months / 365 days / 52 weeks
Cash and bank balances
Should have minimum balances of cash in hand
and at bank and this will be added in current assets.
This will be based on the motives for holding cash
balances.
Estimation of Current Liabilities :
Trade Creditors
= Budgeted yearly Production (in units) × Raw material
cost per unit × Credit period allowed by creditors
(months/days/weeks)
/ 12 months / 365 days / 52 weeks
Direct Wages
= Budgeted yearly Production (in units) × Direct labour
× Average time-lag in payment of wages
(months/days/weeks)
/ 12 months / 365 days / 52 weeks
Overheads
(Other than Depreciation & Amortization)
= Budgeted yearly Production (in units) × Overhead
cost per unit × Average time-lag in payment of
overheads (months/days/weeks)
/ 12 months / 365 days / 52 weeks
Goods and Services Tax (GST)
= Budgeted yearly Sales (in units) × GST per unit ×
Average time-lag in payment of GST
(months/days/weeks)
/ 12 months / 365 days / 52 weeks
Format of Determination of Working Capital :
(I)Estimation of Current Assets
a)Inventories - Raw materials
b)Work-in-process
c)Finished goods
d)Debtors
e)Minimum desired cash and bank balances
Total Current Assets (I)
(II) Estimation of Current Liabilities
a)Creditors
b)Wages
c)Overheads
d)Goods and Services Tax
Total Current Liabilities (II)
(III) Net Working Capital ( I – II )
Add : Contingencies
(IV) Net Working Capital required
 ESTIMATING WORKING CAPITAL
From the following estimates, calculate the estimated amount
of working capital required.
per annum
1. Average amount locked up in stock: Rs.
Stock of finished goods and work-in-progress 10000
Stock of stores, material etc. 8000
2. Average credit given:
Local sales 2 weeks 104000
Outside the state 6 weeks 312000
3. Time available for payments:
For purchases 4 weeks 78000
For wages 2 weeks 260000
Add 10% to allow for contingencies.
 STATEMENT OF WORKING CAPITAL
REQUIREMENTS
Current Assets: Rs. Rs.
Stock of Finished goods and WIP 10000
Stock of stores, material etc 8000
Debtors-Local Sales (2 weeks) 104000 X 2/52 4000
Outside the state (6 weeks)
312000 X 6/52 36000
58000
Less : Current Liabilities:
Creditors (4 Weeks) 78000 X 4 / 52 6000
Outstanding wages (2 weeks) 260000 X 2 /52 10000 16000
Working Capital (CA – CL) 42000
Add: 10% for contingencies 4200
Estimated working capital required 46200
P Ltd. is engaged in customer retailing. You are
required to forecast their working capital requirements
from the following information.

Projected annual sales

Rs.650000
% of N.P. To cost of sales 25%
Avg. Credit allowed to debtors 10 weeks
Avg. Credit allowed by creditors 4 weeks
Avg. Stock carrying
(in terms of sales requirement) 8 weeks

Add 20% to allow for contingencies.

 Per annum
Rs.
Projected sales 650000
Less: Net profit 25% on cost, i.e.,
20% on sales 130000
Cost of sales 520000
 STATEMENT OF WORKING CAPITAL
REQUIREMENTS

Current Assets: Rs. Rs.

Stock (8 weeks) 520000 X 8/52 80000
Debtors (10 weeks) 520000 X 10 / 52 100000 180000
Less : Current Liabilities:
Creditors (4 Weeks) 520000 X 4 / 52 40000 40000
140000
Add: 20% for contingencies 28000
Average working capital required 168000
ABC ltd., desires to purchase a business and has consulted you,
and one point on which you are asked to advise them in the
average amount of working capital which will be required in
the first year’s working.
You are given the following estimates and are instructed to add
10% to your computed figure to allow for contingencies.
Figures for the
year
1. Average amount locked up in stock: Rs.
Stock of finished product 5000
Stock of stores, materials etc. 8000
2. Avg. Credit given:
Inland sales 6 weeks credit 312000
Export sales 1 ½ weeks credit 78000
3. Lag in payment of wages and other outstanding:
Wages - 1 ½ weeks 260000
Stores, materials etc – 1 ½ months 48000
Rent, royalties etc – 6 months 10000
Clerical staff – ½ month 62400
Manager – ½ month 4800
Miscellaneous expenses – 1½ months 48000
4. Payments in advance:
Sundry expenses (paid quarterly in advance) 8000
5. Undrawn profits on an average throughout the year 11000

Calculate the estimated amount of working capital required.

 STATEMENT OF WORKING CAPITAL REQUIREMENTS
Current Assets: Rs. Rs.
Stock of finished goods 5000
Stock of stores, materials etc. 8000 13000
Inland sales (6 weeks) 312000 x 6/52 36000
Export sales (1 ½ weeks) 78000 x 1.5 / 52 2250 38250
Debtors: Advance payment of expenses (Quarterly) 8000 x 3/ 12 2000
53250
Less: Current Liabilities
Lag in payments: Wages (1 ½ weeks) 260000 x 1.5 /52 7500
Stores, materials etc (1 ½ months) 4800 x 1.5 /52 6000
Rent, Royalties etc (6 months) 10000 x 6/12 5000
Manager ( ½ month) 4800 x 0.5/12 200
Clerical staff ( ½ month) 62400 x 0.5 / 12 2600
Miscellaneous expenses (1 ½ months) 48000 x 1.5/12 6000 27300
Net working Capital (Current Assets – Current Liabilities) 25950
Add: 10% for contingencies 2595
Estimated Working Capital Required 28545