Working Capital Management Notes

Working Capital: Working capital is that part of the firms total capital which is required for financing short term assets or current assets such as cash, debtors, inventories, marketable securities. It is also known as circulating capital.

Concept of working capital: Working capital is the amount of funds necessary to cover the cost of operating the enterprise. There are two concepts of working capital:

  • Gross working capital
  • Net working capital

Gross working capital: is the capital invested in total current assets of the enterprise. Net working capital is the excess of current assets over current liabilities.

Different types of working capital:

  • Permanent working capital
  • Temporary working capital
  • Gross working capital
  • Net working capital

Working capital management: Working capital management refers to the administration of all aspects of current assets namely cash, debtors, inventories and marketable securities and current liabilities. This basically determines the levels and compositions of current assets to ensure that right sources are tapped to finance current assets and current liabilities are paid in time.

Conservative approach to working capital financing: Conservative approach to working capital financing depends on long-term funds for financing needs. The firm finances the permanent current assets and a part of the temporary current assets with long-term funds. If the temporary assets are not needed then the long-term funds are invested in the marketable securities. A firm following this approach will face less risk but along with low returns.

Determinants of working capital:

  • Opersational efficiency
  • Growth and Expansion

Operating cycle: The term operating cycle or cash cycle refers to the time duration required to convert the cash to raw materials, raw materials to work-in-progress, work in progress to finished goods, finished goods to debtors and debtors back to cash.

Cash management: Cash management refers to the process of managing cash i.e. its inflow and outflow in an organisation for cash demanding activities and minimising funds committed to cash balances.

Cash cycle: It is the net time interval between cash collections from sale of the product and cash .payment for resources acquired by the firm. It also represents the time interval over which additional funds called working capital, should be obtained in order to carry out the firm’s operations.

Various floats which necessitates management of cash: Float refers to the amount of money tied up between the time a payment is initiated and cleared funds become available in the company’s bank account. The different types of float are:

Various Cash Management Techniques:

  • Budgeting
  • Investing
  • Credit
  • Generating income

Receivables: Receivables are also known as accounts receivables or Book debts. Receivables are the claims against its customers for the goods , sold to the customers in the ordinary.course of business on credit basis. The purpose of lending goods on credit basis is to attract more customers, meet competition and to increase sales and profits.

Receivable management: Receivables management is a decision making process which takes into account the creation of debtors turnover and minimising the cost of borrowing of working capital due to lacking of funds in receivables.

Ageing Schedule: Ageing schedule is a table that classifies accounts receivable and payables according to their dates. It helps in managing cash and analyzing payments.

Debtors Turnover Ratio: A concern may sell goods on cash as well as on credit. Credit is one of the important elements of’ sales promotion. The volume of sales can be increased by following a liberal credit policy.

Inventory Management: Inventory Management refers to the purchase of raw materials from the right source at the right time and at the right price and supplying the materials to the production department as and when required. The main objective of inventory, management is to reduce the order placing, receiving and inventory carrying cost

Objectives of inventory management:

  • Availability of materials
  • Best services to consumers.
  • Wastage minimisation
  • Optimum Investment.

EOQ: Economic Order Quantity is a point at which the; carrying cost and the ordering cost are equal. Economic order Quantity is that ‘ size of the lot to be purchased which is economically viable. This is the quantity of materials which can be purchased at minimum costs.

Benefits of holding inventories:

  • Avoiding Lost Sales
  • Gaining Quantity Discounts
  • Reducing Order Cost.

Techniques of inventory management:

  • Fixation of levels
  • ABC Analysis
  • VED analysis
  • FSN analysis
  • Economic order quantity
  • Perpetual inventory system.

ABC analysis OR Pareto analysis: ABC analysis is a method of material control, wherein the materials are divided into a number of categories. Materials are controlled giving importance to its value. Materials are graded as A, B & C where in materials with ‘A’ grade are costly in value but less in number where as materials with ‘C grade are cheap in value and more in number. Grade ‘B’ materials are moderate in value and moderate number of such items are maintained.

Just-In-Time Management: Just-In-Time (JIT) is a broad philosophy of seeking excellence and eliminatingwaste in the manufacturing process. A major objective of JIT is to have items . only at the right place at the right time i.e. to purchase and produce items only before they are needed so that work-in- rocess inventory is keet low. As a concept, JIT means that virtually no inventories are held at any stage of production and that exact number of units is brought to each successive stages of production at the right time.

Safety stock: The receipt of inventory from the suppliers may be delayed beyond the expected lead time. The delay may be because of strikes, floods, transportation and communication barriers, and also because of seasonal nature of the raw materials. This inturn would disrupt the production schedule. To prevent this situation the firm maintains additional inventory which is known as “safety stock”.

Different principles of Working Capital:

  • Principle of Risk Variation
  • Principle of Cost of Capital
  • Principle of Equity Position
  • Principle of Maturity of Payment.

Various types of working capital:

  • Permanent working capital.
  • Temporary working capital.
  • Gross working capital.
  • Net working capital.

Methods of estimating working capital requirements:

  • Conventional Method or Cash Cycle Method
  • Operating Cycle Method.

Objectives of cash management:

  • Transactionary motive.
  • Precautionary motive.
  • Speculative motive.

Factors influencing size of receivables:

  • Volume of credit sales.
  • New products.
  • Location.
  • Credit policy.
  • Credit worthiness of the customers.
  • Credit collection efforts.

Various Inventory Management Techniques:

  • Fixation of levels
  • ABC analysis
  • VED analysis
  • FSN analysis
  • Economic order quantity
  • Perpetual inventory system.

Determinants of working capital:

  • Operational efficiency.
  • Growth and Expansion.
  • Profit Appropriation.
  • Capital structure of the company.
  • Policies of RBI.
  • Changes in prices.
  • Profitability.
  • Nature and size of the firm.
  • Sales volume.
  • Business terms.

Different sources of finance for funding working capital:
1. Trade Credit:
Accrued Expenses and Deferred Income.

2. Bank Borrowing:

  • Loans
  • Cash Credit
  • Overdrafts
  • Purchasing and Discounting of bills.

Various Cash Management Techniques:

  • Cash Planning.
  • Cash Forecasts and Budgeting.
  • Investment of Surplus Funds.

Management of Accounts Receivable:
(1) Forming of Credit Policy.

(2) Credit Evaluation of Individual Accounts:

  • Credit Information.
  • Credit Investigation.
  • Credit Limit
  • Collection Procedure.

(3) Control of Receivables.