Working Capital

Management
U N D E R S TA N D I N G W O R K I N G C A P I TA L I N B U S I N E S S F I N A N C E

BY: C A N I D H I M U RA R K A
FOR BBA HONORS FIRST YEAR
M A N I PA L U N I V E R S I T Y
Brief Introduction about myself
Founder, Nidhi Murarka & Associates
Chartered Accountant | Company Secretary | Lawyer
With over a decade of experience in the field of taxation, GST audits, and financial
advisory, I have been practicing as a Chartered Accountant since 2012. I previously
worked with M.K. Mangal & Associates as a partner until 2022, where I specialized in
tax and GST audits for various firms. I hold a Bachelor of Commerce (B.Com), a
Company Secretary (CS) qualification, and a Bachelor of Laws (LLB).
Recently, I pursued an Executive Course in Capital Markets & Investment Banking
from IIM Calcutta (2024) to further deepen my expertise in finance and investment
banking.
Session Focus:
• Concept of Working Capital

• Components of Working Capital

• Determinants of Working Capital
• Need of Working Capital
• Computation of working Capital using Operating Cycle Method
 Finance
Manager

Sources of Application of
Funds Funds

Short Term
Long Term
Long Term Short Term (Current
(FA & Invt)
Assets)
Introduction to Working Capital
•Working capital is the capital required to fund a company's day-to-day
operations.
•It is the difference between current assets and current liabilities.
Working Capital=Current Assets−Current Liabilities
•A Positive Working Capital (CA > CL) means the company can pay off its short-
term liabilities with its short-term assets.
•A Negative Working Capital (CA < CL) means a company is under Financial
distress.
Components of Working
Capital
Current Assets Current Liabilities WC=CA-CL
• Inventory (RM, WIP & • Bills & Trade Payable • It enables an
FG) • ST Borrowings organisation to meet its
• Cash & Cash Equivalents • Current portion of Long day to day operating
(ST Marketable Term Debts expenses and its short
Securities) • ST Provisions (Provision term obligations.
• Trade and Bills for Taxes etc.)
Receivables • Outstanding Payments • It is the life blood of a
• Prepaid Expenses (Rent, (Wages, Salary, Rent, business.
Salary, Insurance, Taxes Utility Bills, Taxes, etc.)
etc.)
Balance Sheet
ASSETS Amount (Rs.)
CASH 1,00,000
ACCOUNTS RECEIVABLE 2,00,000
INVENTORY 3,00,000
CURRENT ASSETS 6,00,000
EQUIPMENT 20,00,000
BUILDINGS 50,00,000
FIXED ASSETS 70,00,000
TOTAL 76,00,000
LIABILITIES
ACCOUNTS PAYABLE 3,00,000
LINE OF CREDIT 50,000
CURRENT LIABILITIES 3,50,000
LONG-TERM DEBT 35,00,000
TOTAL DEBT 38,50,000
EQUITY 37,50,000
TOTAL LIABILITIES 76,00,000
Example:
CURRENT ASSETS
CASH 50,000
ACCOUNTS RECEIVABLES 60,000
INVENTORY 1,50,000
PREPAID RENT 45,000
TOTAL 3,05,000

CURRENT LIABILITIES
ACCOUNTS PAYABLES 40,000
SHORT TERM BORROWINGS 50,000
ACCURED LIABILITIES 40,000
TOTAL 1,30,000

WORKING CAPITAL 1,75,000

Types of Working Capital

On the basis of Value On the basis of Time

Permanent/ Core Current Assets
Gross W.C. = Current Asset (CA) W.C.
(Firms total investment in CA) Minimum level invested in Current
Assets

Net W.C. = Current Asset(CA) - Fluctuating/Temporary W.C. :

Current Liabilities (CL) Depends upon the sales
Optimum Working Capital
WC IS HIGH WC IS LOW WC IS OPTIMUM
CASH HIGH CASH LOW 3 E’S TO OPTIMISE WC
INVENTORY HIGH INVENTORY LOW ECONOMICAL – FINANCING
DECISION
DEBTORS HIGH DEBTORS LOW EFFICIENT- INVESTMENT
DECISION
(I) COST – HIGH (I) COST- LOW EFFECTIVE- STARTEGIC DECISION
(II) LIQUIDITY – HIGH (II) LIQUIDITY-LOW
(III) PROFITABILITY – LOW (III) PROFITABILITY- HIGH
(IV) RISK -LOW (IV) RISK - HIGH
Determinants of Working Capital
Some of the Factors which needs to be considered while planning for WC
requirement are:
•Nature of Business: Capital-intensive industries (e.g., manufacturing) typically
require more working capital than service-oriented businesses.
•Business Cycle: During periods of high sales or production, working capital
requirements increase, and during off-peak periods, they decrease.
•Operating Efficiency: Efficient operations (e.g., inventory management,
eliminating waste, improving coordination) reduce the need for working capital.
Contd:
•Credit Policy: A company’s credit policy (e.g., offering long credit periods to
customers) affects the amount of receivables and, consequently, working
capital.
•Seasonal Factors: Some businesses have seasonal peaks in sales, which increase
their working capital needs during peak seasons.
•Growth and Expansion: Expanding operations often lead to higher working
capital needs to support the increased volume of business.
•Liquidity Position: Companies with strong liquidity may require less working
capital, as they can rely on available cash to fund operations.
Contd:
•Short-term Financing Options
•Size of business and Scale of Production
•Length of production cycle
•Working capital cycle
•Rate of stock turnover
•Price level changes
•Technology and Manufacturing Policies
Need for Working Capital
Working capital is essential for:
Smooth Operations: Ensures that a company can meet its daily expenses such as wages, rent,
and utilities.
Growth and Expansion: A company requires working capital to finance its expansion, whether
it's buying raw materials or increasing production capacity.
Liquidity Management: Helps in ensuring the business can pay its short-term liabilities, avoiding
default.
Operational Efficiency: Adequate working capital allows for better inventory management,
timely payments, and handling customer payments.
Operating Cycle
Cash

Raw Material/
Receivables Labour/Overh
ead

Stock WIP
 Computation of Working
Capital (Operating Cycle
Method)
• The operating cycle method for working capital calculation focuses on the time taken to convert raw
materials into cash.
• Operating Cycle: The operating cycle is the time taken between the purchase of raw materials and the
collection of cash from the sale of finished goods. It consists of:
• Inventory Conversion Period: The time it takes to turn raw materials into finished goods.
• Receivables Collection Period: The time it takes to collect payments from customers after the goods are
sold.
• Payables Deferral Period: The time a company takes to pay its suppliers after purchasing goods or
services.
• It is determined by adding the number of days required for each stage in the cycle.
• Operating Cycle = Inventory Conversion Period + Receivables Collection Period – Payables Deferral Period
Or
Operating Cycle = R+W+F +D-C
 30 C CREDITORS
PAYMENT

OPERATING CYCLE CREFITORS PERIOD

R
D 45
DEBTORS CASH RM
DEBT RM
COLLECTION STORES STORAGE
PERIOD PERIOD
45

WIP
CONVERSI
F
FG WAREHOUSE WIP FACTORY ON
PERIOD
60 20 W
FG STORAGE PERIOD
 Formula for Working Capital
Using Operating Cycle
• It is determined by adding the number of days required for each stage in the cycle.
• Operating Cycle = R+W+F +D-C

• Operating Cycle = 45+20+60+45-30

=140 days

Annual Operating Cost (Cost of Sales) = 540000

• Desired Cash Balance = 10000
• W.C. = Operating Cost / 360*Operating Cycle + Desired Cash Balance
• =540000/360*140 + 10000
• = 210000 +10000
• = 220000
Steps to Calculate WC
Requirement
Step1: Calculate all the components of Net OC:
o R- RM Conversion or Holding Period
o W-WIP Conversion or Holding Period
o F- FG Conversion or Holding Period
o D- Debtors Collection Period
o C- Creditors Payment Period
Step 2: Calculation of Value of Operating Activities
Step 3: Calculate NOC
Step 4: No. of OC in a year
Step 5: WC Forecast
STEP 1: CALCULATION OF ALL THE COMPONENTS OF NET OC
AVERAGE RM STOCK
R- RM CONVERSION OR HOLDING PERIOD AVERAGE RM CONSUMPTION PER DAY

AVERAGE WIP STOCK

W-WIP CONVERSION OR HOLDING PERIOD AVERAGE COST OF PRODUCTION PER DAY

AVERAGE FG STOCK
F-FG CONVERSION OR HOLDING PERIOD AVERAGE COGS PER DAY

D-DEBTORS COLLECTION PERIOD AVERAGE DEBTORS

AVERAGE CREDIT SALES PER DAY

C-CREDITORS PAYMENT PERIOD AVERAGE CREDITORS

AVERAGE CREDIT PURCHASES PER DAY
Inventory Turnover Ratio
Inventory Turnover Ratio = COGS OR SALES
Average Inventory
= 1400000/200000
=7
Indicates how many times a business sells and replenishes its inventory.

Inventory is of 3 Types: RM, WIP, & FG

FG CONVERSION PERIOD = 365/360 DAYS
INVENTORY TO RATIO
= 365/7
= 52.14 days
It indicates the average time period for which the Finished Goods are held in inventory.
Example:
Debtors Turnover Ratio = Credit Sales
Average Account Receivables
=2000000/400000
=5
Indicating how many times a company collects its average accounts receivable in a year.

Debtors Collection Period = 360 or 365 days

Debtors Turnover Ratio
= 360/5
= 72 days
Payable Turnover Ratio:
Payable Turnover Ratio = Average Net Credit Purchases
Average Account Payables
=1200000/200000
=6
Indicating how many times a company pays its average accounts payable in a year.

Creditors Payable Period = 360 or 365 days

Creditors Turnover Ratio
= 360/6
= 60 days
STEP 2: CALCULATION OF VALUE OF OPERATING ACTIVITIES

OPENING STOCK OF RAW MATERIAL ***

+ PURCAHSES ***
-CLOSING STOCK OF RAW MATERIAL ***
RAW MATERIAL CONSUMED ***
+ WAGES & PRODUCTION OVERHEADS ***
+ OPENING WIP ***
- CLOSING WIP ***
COST OF PRODUCTION ***
+OPENING FINISHED GOODS ***
- CLOSING FINISHED GOODS ***
COST OF GOODS SOLD ***
+ ADMINISTRATIVE OVERHEADS ***
- SELLING EXPENSES ***
COST OF SALES ***
+ PROFIT ***
SALES ***
Step 3: Calculate NOC

Net Operating Cycle = R+W+F+D-C

Step 4: No. of OC in a Year

No. of Operating Cycles = 365 or 360 days/NOC

Step 5: WC Requirement or Forecast

WC Requirement = Annual Operating (Cash) Cost
No. of OCs in a Year
Summary
•Working Capital is essential for the smooth running of daily operations and
meeting short-term financial obligations
•It is determined by the difference between current assets and current liabilities.
Components include cash, receivables, inventory, and payables
•Factors influencing working capital include the nature of business, credit
policies, and seasonality.
•The Operating Cycle Method computes working capital based on the time it
takes to convert inventory to cash, adjusting for the payment deferral period.