WORKING CAPITAL Management

A firm must have adequate Working Capital

neither excess nor shortage. Maintaining
adequate Working Capital at the
satisfactory level is crucial for maintaining
the competitiveness of a firm.

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Gross Working Capital: Gross Working Capital
refers to the amounts invested in the various
components of current assets.
Net Working Capital: Net Working Capital is the
excess of current assets over current liabilities
and provisions.
Permanent Working Capital: Permanent Working
Capital is the minimum amount of investment
required to be made in current assets at all
times to carry on the day to day operation of
firm’s business.
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Objective of working capital management is
achieving a trade-off between liquidity and
profitability of operations for the smooth
conduct of normal business operations of the
firm.
Firms should neither go for CONSERVATIVE
policy nor for AGGRESSIVE policy.
Firms must balance between the two.
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Need for Working Capital
The need for working capital arises on account
of two reasons:
a. To finance operations during the time gap
between sale of goods on credit and
realization of money from customers of the
firm.
b. To finance investments in current assets for
achieving the growth target in sales.
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The time gap between acquisition of resources
and collection of cash from customers is
known as the OPERATING CYCLE.
Operating cycle of a firm has the following
elements:
Acquisition of resources from suppliers.
Making payments to suppliers.
Conversion of raw materials into finished goods.
Sale of finished products to customers.
Collection of cash from customers for the goods
sold.
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Operating cycle = IC period + RC

period

IC period = Inventory conversion

period

RC period = Receivables conversion

period
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Inventory Conversion period =
( Average Inventory x 365 ) / Annual
Cost of goods sold

Receivables conversion period =

( Average Accounts Receivables x
365 ) / Annual Credit Sales
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Accounts Payables period =

Average Creditors / Purchases per
day

Purchases per day =

Total Credit Purchases for a year /
365
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Cash Conversion Cycle: It is the length of time
between the firm’s actual cash expenditure
and its own cash receipt. The cash conversion
cycle is the average length of time a rupee is
tied up in current assets.
Cash Conversion Cycle (CCC ) is
CCC = ICP + RCP – PDP
ICP = Inventory Conversion Period
RCP = Receivables Conversion Period
PDP = Payables deferral period
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Determinants of Working Capital
The following factors determine a firm’s working
capital requirements:
Nature of business
Size of Business Operation
Manufacturing Cycle
Products Policy
Volume of sales
Term of Purchase and Sales
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Operating efficiency
Price level changes
Business Cycle
Processing technology
Fluctuations in the supply of raw materials
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Estimation of Working Capital
Estimation of Current Assets:
1.Raw materials inventory: Average investment
in raw material is estimated
2.Average investment in work-in-progress
inventory is estimated
3.Average investment in finished goods
inventory is estimated
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4.Average investment in receivables
5.Based on the firm’s attitude towards risk,
access to borrowing sources, past experience
and nature of business, firms decide on the
policy of maintaining the minimum cash
balances.
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Estimation of Current Liabilities:

1.Trade Creditors
2.Direct wages
3.Overheads
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Example
The following details are available for XYZ Ltd for the
year ended 31.03.10
Sales Rs.8,00,000
Cost of goods Rs.5,60,000
Inventory :(31.03.09)Rs.90,000 (31.03.10)Rs.1,20,000
Accounts Receivables:(31.03.09) Rs.1,20,000
(31.03.10) Rs.1,60,000
Accounts Payable: (31.03.09) Rs.70,000
(31.03.10) Rs.1,00,000
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Find out
What is the length of the operating cycle?
What is the cash cycle?
Assume 365 days in the year.
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• Example: A Proforma cost sheet of a company
provides the following data
• Costs per Unit:
• Raw Material Rs.52.00
• Direct Labour Rs.19.50
• Overheads Rs.39.00
• Total Cost Rs.110.50
• Profit Rs.19.50
• Selling Price Rs.130.00
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• The following additional information is
available:
• a. Average raw material in stock: One month
• b. Average materials in process: Half a month
• c. Credit allowed by Suppliers: One month
• d. Credit allowed to debtors: Two months
• e. Time lag in payment of wages: one and a
half weeks
• f. Time lag in payment of overheads one
month
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g. One-fourth of sales on cash basis
h. Cash balance expected to be maintained is
Rs.1,20,000
You are required to prepare a statement
showing the working capital required to
finance a level of activity of 70,000 units of
output. You may assume that production is
carried on evenly through out the year and
wages and overheads occur similarly. Assume
360 days (52 weeks) in a year.
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Example: A company has prepared its annual
budget, relevant details of which are
reproduced below:
Sales Rs. 46.80 lakhs (25% cash sales) 78,000
units
Raw material cost 60% of sales value
Labour cost Rs.6 per unit
Variable overheads Re.1 per unit
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Fixed overheads: Rs. 5 lakhs(including
Rs.1,10,000 as depreciation)
Budgeted stock levels:
Raw materials: 3 weeks
Work-in-progress: 2 weeks(Materials 100%,
Labour & Overheads 50%)
Finished goods: 3 weeks
Debtors are allowed credit for 4 weeks
Creditors allow 3 weeks credit
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Wages due: 1 week
Lag in payment of overheads: 2 weeks
Cash required: Rs.80,000.
Prepare working capital budget requirement for
the company, making whatever assumptions
that you may find necessary.

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