Liquidity Decisions:

Working Capital Management

INTRODUCTION
• Working capital is described as the capital which is
not fixed but the more common uses of the
working capital is to consider it as the difference
between the book value of current assets and
current liabilities.
• It is concerned with short-term finance of the
business concern which is a closely related trade
between profitability and liquidity.
• Efficient working capital management leads to
improve the operating performance of the
business concern and it helps to meet the short-
term liquidity
MEANING OF WORKING CAPITAL
• Working Capital is another part of the capital
which is needed for meeting day to day
requirement of the business concern.
• For example, payment to creditors, salary paid to
workers, purchase of raw materials etc., normally
it consists of recurring in nature.
• It can be easily converted into cash. Hence, it is
also known as short-term capital.
Definitions
• According to the definition of Weston and
Brigham, “Working Capital refers to a firm’s
investment in short-term assets, cash, short-term
securities, accounts receivables and inventories”
• According to the definition of Genestenberg,
“Circulating capital means current assets of a
company that are changed in the ordinary course
of business from one form to another, for example,
from cash to inventories, inventories to
receivables, receivables to cash”.
CONCEPT OF WORKING CAPITAL
Gross Working Capital
• Gross Working Capital is the general concept which
determines the working capital concept.
• Thus, the gross working capital is the capital
invested in total current assets of the business
concern.
• Gross Working Capital is simply called as the total
current assets of the concern.
• GWC = CA
Net Working Capital
• Net Working Capital is the specific concept, which,
considers both current assets and current liability
of the concern.
• Net Working Capital is the excess of current assets
over the current liability of the concern during a
particular period.
• If the current assets exceed the current liabilities it
is said to be positive working capital; it is reverse,
it is said to be Negative working capital.
• NWC = C A – CL
Component of Working Capital
• Working capital constitutes various current assets
and current liabilities.
• This can be illustrated by the following chart.
NEEDS OF WORKING CAPITAL
• 1. Purchase of raw materials and spares: The
basic part of manufacturing process is, raw
materials.
• It should purchase frequently according to the
needs of the business concern.
• Hence, every business concern maintains certain
amount as Working Capital to purchase raw
materials, components, spares, etc.
NEEDS OF WORKING CAPITAL
• 2. Payment of wages and salary: The next part of
Working Capital is payment of wages and salaries
to labour and employees.
• Periodical payment facilities make employees
perfect in their work.
• So a business concern maintains adequate the
amount of working capital to make the payment of
wages and salaries.
NEEDS OF WORKING CAPITAL
• 3. Day-to-day expenses: A business concern has
to meet various expenditures regarding the
operations at daily basis like fuel, power, office
expenses, etc.
• 4. Provide credit obligations: A business concern
responsible to provide credit facilities to the
customer and meet the short-term obligation.
• So the concern must provide adequate Working
Capital.
TYPES OF WORKING CAPITAL
Permanent Working Capital
• It is also known as Fixed Working Capital.
• It is the capital; the business concern must
maintain certain amount of capital at minimum
level at all times.
• The level of Permanent Capital depends upon the
nature of the business.
• Permanent or Fixed Working Capital will not
change irrespective of time or volume of sales.
Temporary Working Capital
• It is also known as variable working capital.
• It is the amount of capital which is required to meet
the Seasonal demands and some special purposes.
• It can be further classified into Seasonal Working
Capital and Special Working Capital.
• The capital required to meet the seasonal needs of the
business concern is called as Seasonal Working Capital.
• The capital required to meet the special exigencies
such as launching of extensive marketing campaigns
for conducting research, etc.
Semi Variable Working Capital
• Certain amount of Working Capital is in the field
level up to a certain stage and after that it will
increase depending upon the change of sales or
time.
Working Capital Position/ Balanced
Working Capital Position.
• A business concern must maintain a sound
Working Capital position to improve the efficiency
of business operation and efficient management of
finance.
• Both excessive and inadequate Working Capital
lead to some problems in the business concern.
A. Causes and effects of excessive
working capital.
• (i) Excessive Working Capital leads to unnecessary
accumulation of raw materials, components and
spares.
• (ii) Excessive Working Capital results in locking up
of excess Working Capital.
• (iii) It creates bad debts, reduces collection
periods, etc.
• (iv) It leads to reduce the profits.
B. Causes and effects of inadequate
working capital
• (i) Inadequate working capital cannot buy its
requirements in bulk order.
• (ii) It becomes difficult to implement operating
plans and activate the firm’s profit target.
• (iii) It becomes impossible to utilize efficiently the
fixed assets.
• (iv) The rate of return on investments also falls
with the shortage of Working Capital.
• (v) It reduces the overall operation of the business.
FACTORS DETERMINING WORKING
CAPITAL REQUIREMENTS
• Working Capital requirements depends upon
various factors.
• There are no set of rules or formula to determine
the Working Capital needs of the business
concern.
• The following are the major factors which are
determining the Working Capital requirements.
Factors Determining Working
Capital Requirements……………
• 1. Nature of business: Working Capital of the
business concerns largely depend upon the nature
of the business.
• If the business concerns follow rigid credit policy
and sell goods only for cash, they can maintain
lesser amount of Working Capital.
• A transport company maintains lesser amount of
Working Capital while a construction company
maintains larger amount of Working Capital.
Factors Determining Working
Capital Requirements……………2
• 2. Production cycle: Amount of Working Capital
depends upon the length of the production cycle.
• If the production cycle length is small, they need to
maintain lesser amount of Working Capital.
• If it is not, they have to maintain large amount of
Working Capital.
Factors Determining Working
Capital Requirements……………3
• 3. Business cycle: Business fluctuations lead to
cyclical and seasonal changes in the business
condition and it will affect the requirements of the
Working Capital.
• In the booming conditions, the Working Capital
requirement is larger and in the depression
condition, requirement of Working Capital will
reduce.
• Better business results lead to increase the Working
Capital requirements.
Factors Determining Working
Capital Requirements……………4
• 4. Production policy: It is also one of the factors
which affects the Working Capital requirement of
the business concern.
• If the company maintains the continues
production policy, there is a need of regular
Working Capital.
• If the production policy of the company depends
upon the situation or conditions, Working Capital
requirement will depend upon the conditions laid
down by the company.
Factors Determining Working
Capital Requirements……………5
• 5. Credit policy: Credit policy of sales and purchase
also affect the Working Capital requirements of
the business concern.
• If the company maintains liberal credit policy to
collect the payments from its customers, they have
to maintain more Working Capital.
• If the company pays the dues on the last date it
will create the cash maintenance in hand and
bank.
Factors Determining Working
Capital Requirements……
• 6. Growth and expansion: During the growth and
expansion of the business concern, Working
Capital requirements are higher, because it needs
some additional Working Capital and incurs some
extra expenses at the initial stages.
Factors Determining Working
Capital Requirements……
• 7. Availability of raw materials: Major part of the
Working Capital requirements are largely depend
on the availability of raw materials.
• Raw materials are the basic components of the
production process.
• If the raw material is not readily available, it leads
to production stoppage.
• So, the concern must maintain adequate raw
material; for that purpose, they have to spend
some amount of Working Capital.
Factors Determining Working
Capital Requirements……
• 8. Earning capacity: If the business concern
consists of high level of earning capacity, they can
generate more Working Capital, with the help of
cash from operation.
• Earning capacity is also one of the factors which
determines the Working Capital requirements of
the business concern.
Q&A