Working Capital Management Working capital management ensures a company has sufficient cash flow in order to meet its

short-term debt obligations and operating expenses. Meaning of Working Capital: 1 - Working Capital is the amount of Capital that a Business has available to meet the day-today cash requirements of its operations 2 - Working Capital is the difference between resources in cash or readily convertible into cash (Current Assets) and organizational commitments for which cash will soon be required (Current Liabilities) 3 - It refers to the amount of Current Assets that exceeds Current Liabilities (i.e. CA - CL) 4 - Working Capital refers to that part of the firms Capital, which is required for Financing Short-Term or Current Assets such as Cash, Marketable Securities, Debtors and Inventories. Working Capital is also known as Revolving or Circulating Capital or Short-Term Capital Working Capital Concepts: 1 - Gross Concept: It means Current Assets. 2 - Net Concept: It means difference between Currents Assets & Current Liabilities. CA-CL Factors Determining Working Capital Requirements

1. Nature of business: The amount of working capital depends on the nature of business.
For instance, public utilities such as railways, transport companies, etc. require less working capital as their operations are mostly on cash payment basis and they do not require any stock of raw materials. Trading companies have to maintain sufficient amount of cash, inventory, and book debts. Manufacturing enterprises also require large amounts of capital, depending on their asset structure.

2. Length of manufacturing cycle: Manufacturing cycle refers to the time-span between

procurement of raw material and completion of production of finished goods. The longer the time-span of the manufacturing cycle, the larger is the amount of working capital required to carry on hand stocks of materials and to maintain personnel etc. during the process.

3. Volume of business: The greater to volume of business, more will be the amount of
working capital required. As the wage bill, stocks of raw material, etc. are higher in this case.

4. Terms of purchase and sale: If a firm is able to purchase raw materials, etc. on credit but

sells it finished goods on cash basis, it requires less working capital. On the other hand, if cash purchases are made against credit sales, the firm would require more amount of capital.

5. Collection policy / Credit policy: The credit policy influences the working capital in two
ways. A) Through credit terms granted to the customers / buyer of goods. B) Credit terms available to the firm from its creditors. A company with regular income from sales needs relatively less capital, while if collection from credit sales is not regular, more funds are required. Thus, the need for working capital is linked with the efficiency as well as credit and collection of the company.

6. Stock turnover: Stock turnover is the ratio of sales to average stock held in business. The
greater the turnover, larger the volume of business that can be conducted with a given working capital. If the turnover is high, fewer funds are required.

7. Business fluctuations: When business is prospering and prices are rising management
prefers to maintain larger stocks to reap the benefits of higher prices. The credit policy is also liberalized and more funds are blocked in book debts. This requires larger amounts of working capital. During depression, sales, revenue, and profits are low. Hence, funds are locked up in inventories and collections are also slow. This necessitates more working capital.

8. Possibility of reduction in value of current assets: Companys working capital gets

reduced with there is a decline in the market prices of its current assets such as investments and stocks. This requires more working capital and the company will have to keep large amounts of cash funds to meet such eventualities.

9. Seasonal demand: In some business finished goods in demand throughout the year, thus

requiring less working capital. When the demand is seasonal, more working capital is required.

Dangers of Excessive W.C.: The dangers of excessive W.C. are as follows: 1 Excess funds may promote accumulation of inventories. The management is tempted to make unnecessary or excessive purchases of raw materials, resulting into losses like wastage, theft, mishandling losses and loss of interest on capital blocked. It also indicates defective credit policies like slack collection of book-debts, very liberal credit policy. This leads to excessive bad-debts affecting the profitability. Due to excessive funds, decisions of unnecessary expansion may be taken without analyzing its long-term effects on profits and growth. It leads to liberal dividend policies which would reduce the necessary reserves to be utilized in future for future contingencies, affecting the market price of shares adversely. The management may not remain as careful and vigilant as they ought to be with respect to day-to-day operations due to availability of ample funds. This leads to decrease in efficiency. Return on investment declines as excess funds are not properly utilized which reduces the profitability of the business.

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Dangers of Inadequate W.C.: Shortage of W.C. has contributed to business failures. The Dangers of inadequate W.C. are as follows: 1 The growth of the company is hampered as the management is forced to function with insufficient funds and they are not able to think of growth or expansion.

Due to shortage of funds, the firm is cannot take advantage of opportunities coming its way, eg there may be an opportunity to buy a profitable business at attractive price or there may be an opportunity to buy raw materials in bulk at low prices. The firm loses its credit-worthiness as it is not able to make regular payments to its trade and loan creditors. Moreover, they would not get goods on a favourable credit terms. The firm is not able to achieve its profit targets, as it is difficult for the firm to implement its operating plans due to inadequacy of W.C. The firm is not able to use the fixed assets efficiently or maintain them is proper condition due to insufficient funds. This leads to inefficiency in production and reduces profitability. Adequate dividend is not paid due to insufficient funds inspite of having good profits. This creates dissatisfaction among the shareholders and affects the market price of the shares.

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Types of W.C.:

Permanent W.C.: Permanent W.C. refers to that part of the working capital which is necessary for maintaining stock of raw materials and finished goods at their normal level and for paying wages and salaries and other expenses regularly. It is the minimum amount of current assets which is needed for the smooth functioning of the business. It is that capital which is permanently locked up in current assets. Permanent W.C. is of two types:

(a)

Initial W.C.: During the initial stage of its operation, a company must have enough funds to pay for certain expenses. This amount will be funded by the owners themselves as during the initial period, credit facilities , loans, overdrafts etc. are not easily available and sales have to be made on credit. (b) Regular W.C.: This is the working capital required for the regular and smooth functioning of business operations, maintaining regular stock of finished goods, raw materials and to make payments for regular business expenses etc. In other words, it is the excess of current assets over current liabilities.

Variable W.C.: It is that part of working capital which is required to meet seasonal demands and special needs. It is called variable working capital because its amount varies according to the extent of extra demand. Variable W.C. is of two types:

(a)

Seasonal W.C: Some business units require more amount of current assets during a particular season. Eg sugar mills have to purchase sugarcane and employ more people for its processing during a particular season. (b) Special W.C.: Such capital is required to meet any unforeseen event taking place requiring extra funds. eg unforeseen contingencies like strike, fire, lockouts etc. force the management to provide for extra funds. During depression, prices and sales decline considerably, which necessitates extra working funds. Sources of Finance for Working Capital Retained Earnings Trade Credit (creditors) Factoring

Cash credit Hypothecation of inventory Medium term loans from Banks/FI Bank O/D Inter-corporate deposits Bill Discounting