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Working capital management refers to the management of current assets

and current liabi1ities. Working capital is the excess of current assets over
current liabilities. Current assets are-- cash, marketable securities,
inventories and bills receivables. Current liabilities mainly include bills
payable, notes payable and miscellaneous accruals. Current assets are
those assets which are normally converted into cash within an accounting
year; and current liabilities are usually paid within an accounting year.
J. S. Mill, The sum of the current assets is the working capital of a
C. W. Gerstenberg, Working capital has ordinarily been defined as the
excess of current assets over current liabilities.
Mead, Molott and Fild, Working capital means current assets.
Classification of Working Capital It is based on the concepts of time and requirements. On the basis of
quantitative and qualitative concepts working capital can be classified into

two categories, e.g., (i) Gross Working Capital and (ii) Net Working
Capital. There are also two other types of working capital: (i) Permanent,
(ii) Temporary working capital.
(i) Gross Working Capital-- It refers to the companys total funds
required for maintaining current assets, such as--cash, marketable
securities, bills receivables, inventories, etc., which are normally
converted into cash within an accounting year.
(ii) Net Working Capital-- Net working capital is the excess of
current assets over current liabilities. In other words, it is that
portion of a firms current assets which is financed by long term
funds. It may be either positive or negative.
Permanent Working Capital-- It refers the irreducible
minimum amount which is permanently blocked in the business
and that cannot be converted into cash in the normal course of
business. It represents the current assets required on a continuing
basis over the entire year. Since it is permanently needed for the
business operations and financed by long-term funds.
(iv)Temporary Working Capital-- It is also called variable working
capital. Any amount over and above the permanent level of

working capital is temporary working capital. It represents

additional current assets needed at different times during the
operating year. Since it is required for carrying out seasonal or
special operations of short duration such as extensive marketing
campaigns and it should be financed by the short-term sources.
Need and Significance of Working Capital
A firm needs working capital for its daily operations. Raw materials
inventories are needed for manufacturing. During to the time lag between
manufacturing of finished goods and sales, a firm needs cash for financing
inventories, bills receivables and other routine business expenses. If right
amount of working capital is not available, the firm will not be in a
position to sustain its business operations. The time gap between the sales
and their actual realisation in cash is technically termed as operating
cycle of the business. Working capital needs of a company, therefore,
depend on the length of its operating cycle.
A company must have adequate working capital, i.e., as much as needed
by the company. It should neither be excessive nor inadequate. Excessive
working capital means idle funds laying with the firm and not earning any

profit for it while inadequate working capital means that the enterprise
does not have sufficient funds for financing it daily business activities,
which ultimately results in production interruptions and reduced
1. Increase in Goodwill and Debt Capacity Rapidity in payments
creates goodwill and increases the debt capacity of the firm. Regular
availability of adequate working capital creates confidence among
investors and lenders that they will get their due interest and principal in
time. Thus, a firm with adequate working capital can raise the requisite
funds from market, borrow short-term credit from banks and purchase
inventories of raw materials for the business.
2. Loans from Financia1 Institutions-- The presence of adequate
working capital and current assets help a company to raise unsecured and
secured loans from financial institutions and arrange loans from the banks
on easy and favourable terms.
3. Increased Efficiency-- If adequate working capital is maintained in
the business, the firm can successfully carry out its operations, research
and development programmes etc., which would lead to increased
production efficiency. Production efficiency, in turn, will increase the

efficiency of the employees and boost up their morale.

4. Exploitation of Favourable Opportunities-- In the presence of
adequate working capital, a company can avail the benefits of favourable
opportunities. For example, the company having adequate working capital
can avail the benefits of bulk supply order, bulk purchases of raw
materials, off season purchases, etc.
5. High administrative spirits An adequate working capital also
boosts up the morale of the executive in so far as they have an
environment of creativity, security and confidence, which is an important
psychological factor in improving the efficiency and morale of the
business executives.
6. Meeting Contingencies and Adverse Changes-- A Company, which
has an adequate working capital can easily face certain business and
economic crises. For example, the demand for goods decreases during the
depression period and the payment of credit sales is also made after a long
period. In this case, companies with adequate working capital can only
successfully meet this adverse situation.
7. Dividend to Shareholders-- To declare and distribute attractive
dividend to its shareholders an adequate working capital helps the firm. It

also increases the value of shares. In other hand, a company not having
adequate working capital cannot distribute attractive dividend in spite of
sufficient profits.
8. Confidence and Security -- Adequate working capital creates a
confidence and security not only among the business executives but also
among the customers, creditors.
9. Availing Cash Discount The firm can avail the advantage of cash
discount by making cash payments for to the suppliers of raw material and
merchandise. It will reduce the cost of production and increase the profits
of the firm.
Factors determining working capital
These are the factors which determine the proper amount of working
1. Nature of Business - An adequate amount of working capital
requirements of an enterprise are basically related to the nature of its
business. Trading concerns require large amount of working capital and
they also have to keep large amounts of cash. Conversely, the public utility

concerns like railways, electricity, insurance etc., need relatively much

less inventories and cash.
2. Production Policies - Production policies are the important factor to
determine the working capital
requirements of the firm. More working
capital is required by those industries which produce or sale goods in a
particular season. For example, sugar and woollen textile industries
require more working capital in winter season.
3. Size of Business - The size may be measured either in terms of scale of
operations or in assets or sales. Generally, large scale concerns require
more working capital as against the small concerns for carrying out
business operations.
4. Length of Manufacturing Cycle - The length of this period depends
on the nature of products and production technology used by a concern.
Longer the manufacturing process, the higher will be the requirements of
working capital and vice versa. The size of working capital is also
influenced by the length of the manufacturing cycle. A concern can
reduce its working capital needs by shortening the length of its
manufacturing cycle through technological improvements, and also by

efficient planning and control upon its operations.

5. Firms Credit Policy - It also influences the working capital.
Companies allowing liberal credit to their customers require more working
capital as against the companies which have efficient debt collection
machinery and observe strict credit terms. This is because in the former
case, a substantial amount of fund is tied up in bills receivable or sundry
6. Business Fluctuations - Cyclical changes also influences the level of
working capital. In a period of boom, there is need for larger amount of
working capital due to increase in sales and rise in prices of raw materials.
This creates demand for more capital. Similarly, during depression when
the prices and demand for manufactured goods constantly reduce, the
industrial and trading activities show a downward trend and the demand
for working capital is low.
7. Expand and Growth of Business - In starting, A company requires low
working capital. However, with the gradual growth and expansion, its
working capital needs also increase and it is necessary to expand the

8. Current Assets Policies - A company with conservative assets policy

may operate with a relatively high level of working capital than its sales
volume. It may carry larger volume of raw materials and finished goods
inventories, offer liberal terms of credit to its customers and carry a large
amount of cash to meet its current expenditure. The quantum of working
capital of a company is significantly determined by its current assets
9. Supply Fluctuations - For maintaining large reserves of raw material
due to their irregular sales and intermittent supply certain companies
requires large working capital. But, in other hand some require low
is particularly true in case of companies which require special kind of
materials available from limited sources.
10. Seasonal Variations - Some industries manufacture and sells goods
occur only in certain seasons. For example, sugar, oil and woollen textile
industries have either seasonal supplies of raw materials or make
sales in a particular season. Therefore, the requirement of working capital
of industries will be higher during a certain season than the others.
11. Dividend Policy - The amount of working capital also influences by

the dividend policy. If a company follows a conservative dividend policy

and retains larger portion of net profits in the business, the
capital position will be stronger.
12. Other Factors - There are a number of other factors which affect the
working capital of a business concern. Some of them are as follows:
(i) Effective co-ordination between production and distribution policies
will reduce the quantum of working capital in a business concern.
(ii) Less developed means of transportation and communication add to the
quantum of working capital of companies in such areas, because of
(iii) The magnitude of working capital is also determined by the extent of
hazards and contingenciesinherent in a particular type of business.
Estimating Working Capital Requirements
The most ticklish problem faced by the finance manager is to
determine the amount of working capital. To solve this problem, estimates
of future requirements and availability of cash for current assets are
ascertained. For this purpose, a working capital forecast is prepared

involving some calculations after taking into consideration the factors

affecting working capital (as discussed earlier). All the calculations are
made on cash basis. Following methods are generally used in estimating
working capital for the future period:
(i) Operating Cycle Method
(ii) Forecasting Net Current Assets Method
(iii) Projected Balance Sheet Method
(iv)Adjusted Profit and Lass Method
(v) Cash Flow Forecast Method
Debtors and bills


Finished goods




Operating Cycle
As explained earlier, this is the best technique for estimating future cash
working capital of a firm. Under this method, the computation of total
operating expenses, operating cycle period and number of operating
cycles in the year is essential for estimating the amount of working
Operating Expenses - It includes purchase of raw
materials, direct labour cost, fuel and power, administrative and selling
and distribution expenses for a specific period for which estimates can
be obtained from cost records. Depreciation, write off of intangible
assets are not included in these expenses because these are non-cash
items. Similarly, tax and dividend being appropriation of profits are also
excluded from these expenses.

Operating Cycle Period - It means the total
number of days involved in the different stages of operation
commencing from the purchase of raw materials and ending with
collection of sale proceeds from debtors after adjusting the number of
days credit allowed by suppliers. Thus, the operating cycle is the total
period involved in different stages of operations which may be
calculated by using the following formula-OC = M + W + F + D - C
Here; OC = Operating Cycle Period
M = Material Storage Period
W = Work-in-Process or Conversion Period
F = Finished Goods Storage Period
D = Debtors Collection Period
C = Creditors Payment Period
Material Storage Period (M) =

Average Stock of Raw Materials

Daily Aver age Consumptio n


(Opening Stock Closing Stock)/2

Material consumed for the year /365

WIP or Conversion Period (W) =

Average Stock of work - in - progress

Daily Aver age Production Cost


Opening WIP Closing WIP)/2

= Total Production Cost/365

Finished Goods Storage Period (F) =
Opening Stock Closing Stock)/2
Total Cost of Goods Sold / 365

Average Stock of Finished Goods

Daily Aver age Cost of Goods Sold

Average Debtors B/R

Credit Sales per day

Debtors Collection Period (D) =

(Opening Drs. Closing Drs.)/2
= Total Credit Sales / 365


Average Creditors B/P

Credit Purchases per day

Creditors Payment Period (C) =

(Opening Crs. Closing Crs.)/2
= Total Credit Purchases / 365
Note: In respect of the above formulae the following points are worth
(a) The figure 365 represents number of days in a year. However, there is
no hard and fast rule and sometimes even 360 days are considered.
(b) In absence of any information, total purchases and total sales be treated
a credit.
(3) Number of Operating Cycles-- The number of operating cycles in a
period is determined by dividing the number of days in a year i.e. 365 by
the length of net operating cycle.

(4) Provision for Contingencies-- After ascertaining the amount of

Working capital as above, a certain amount say 5% or 10% may be added
to cover contingencies. It is to be noted that facts based on estimates may
not to be cent percent accurate. Therefore, this provision is made to cover
the probable error in these calculations.
(B) Forecasting net current assets method In this the finance manager prepares a working capital forecast. In
preparing this forecast, he estimate of all the current assets is made on
monthly basis. Thus, estimate of stock of raw materials, amount of raw
material that will remain in process (WIP), stock of finished goods and
outstanding amount from debtors and other receipts will have to be made.
This should be followed by estimate of current liabilities comprising
outstanding payments for material, wages, rent, administrative and other
expenses. Difference of the forecasted amount of current assets and
current liabilities shows net working capital requirements. To this amount,
a flat percentage would be added by way of provisions for contingencies.
The resulting figure will be the amount of total estimated working capital

required. From this, bank finance is to be subtracted, if available. The

remaining balance will be the amount of working capital that is to be
managed by the firm.
Accordingly, quantum of working capital for different current assets is
calculated based on monthly requirements. The different current assets and
liabilities are stock of raw materials, work-in-progress, finished goods,
debtors, creditors of 15 industries. In India, business firms have to present
computation of working capital to banks while applying for loans. Some
banks use printed forms for this purpose.
Statement Showing Working Capital Requirements

Current Assets


(i) Stock of Raw Materials (for months consumption

(ii) Work-in-process (formonths)

(a) Raw Material
(b) Direct Labour

(c) Overheads

(iii) Stock of Finished Goods (formonths sales)

(a) Raw Material
(b) Labour

(c) Overheads
(iv) Sundry debtors or Receivables (formonths sales)
(a) Raw Material


(c) Overheads







(vi) Balance of Cash (required to meet day-to-day


(B) Current Liabilities
(i) Creditors (formonths purchase of raw material) *
(ii) Lag in payment of expenses (outstanding expenses) *
(iii) Others (if any)

Net Working Capital (A) (B)
Add: Provision for Contingencies
Total Working Capital Required


(C) Projected Balance Sheet Method In this method, a balance sheet

is prepared based on these forecasted assets and liabilities known as
projected balance sheet. The difference of assets and liabilities of this
balance sheet is treated as working capital of that period. If the total of

liabilities side is more than the total of assets side, it represents excess
cash which is not required by the firm. But, if the total of assets side is
more than the total of liabilities side, then it indicates the deficiency of
working capital.
(D) Adjusted Profit and Loss Method In this method, estimated profit
is calculated on the basis on transactions of the ensuing period. Thereafter,
increase or decrease in working capital is computed adjusting the
estimated profit by cash inflows and cash outflows. A few banks in India
use the forms for computing working capital under this method.
Computation of Working Capital
Net Income
Add: Non-cash items
Working Capital provided by Operations
Add: Cash Inflow items


Less: Cash Outflow Items

Net Changes in Working Capital

(E) Cash Forecasting Method In this method, estimate is made of cash

receipts and payments in the ensuing period. The difference of these
receipts and payments indicates deficiency or surplus of cash. The
management formulates plans to procure the amount of deficit. This
method, in a way is a form of Cash Budget. (i.e., in the way of receipt
and payment method).