Working Capital Management1

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Some basics

Business requires money to generate more money

Tasks of Entrepreneur to

envisage the process

accumulate resources

take risks

enjoy the return

Resources and their funding is primarily of two types:

BUSINESS

Short-term AssetsLong-term Assets

Long-term Funds Short-term Assets


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Working Capital

Centuries old concept

Necessity of every business

Needed for various purposes Requirement varies according to industry, size,

technology, creditability, etc.

Available from numerous sources


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Working capital typically means the firmsholding of current or short-term assets such ascash, receivables, inventory and marketable

securities. These items are also referred to as circulating

capital

Corporate executives devote a considerableamount of attention to the management ofworking capital.

Working Capital


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Definition of Working Capital

Working Capital refers to that part of the firms capital, which is

required for financing short-term or current assets such a cash

marketable securities, debtors and inventories


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WORKING CAPITAL

BASIS OFCONCEPT

BASIS OF TIME

Gross

Working

Capital

Net Working

Capital

Permanent /

Fixed WC

Temporary /

Variable WC

TYPES OF WORKING CAPITAL


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SOURCES OF WORKING CAPITAL

Sources of working capital are many. There are both external or internal sources. The

external sources are both short-term and long-term.

Some of external short-term sources are:

Trade credit,

commercial banks,finance companies,

indigenous bankers,

public deposits,

advances from customers,

accrual accounts,

loans and advances from directors and groupcompanies etc.


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Trade credit is a short term credit facility extended by suppliers of raw materials and

other suppliers. It is flexible; that is advance retirement or extension of credit period

can be negotiated.

Trade credit might be costlier as the supplier may inflate the price to account for the

loss of interest for delayed payment.

Commercial banks are the next important source of working capital finance.

Straight loans, cash credits, hypothecation loans, pledge loans, overdrafts and billpurchase and discounting are the principal forms of working capital finance provided

by commercial banks.


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Finance Companies provide need based loans and sometimes arrange loans from others

for customers.

Interest rate is higher. But timely assistance may be obtained.

Indigenous bankers provide financial assistance. to small business and trades. They

change exorbitant rates of interest by very much understanding.

Public deposits are unsecured deposits raised by businesses for periods exceeding a yearbut not more than 3 years by manufacturing concerns and not more than 5 years by non-

banking finance companies.

The RBI is regulating deposit taking by these companies in order to protect the depositors.


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Advances from customers are normally demanded by producers of costly goods at the

time of accepting orders for supply of goods. Contractors might also demand advance

from customers.

Accrual accounts are simply outstanding suppliers of overhead service requirements and

the like. taxes due, dividend provision, etc. are accrual accounts capital finance for short

period on a regular basis. dues to workers , outstanding wages.

Debentures and equity fund can be issued to finance working capital so that the

permanent working capital can be matchingly financed through long term funds.


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IMPORTANCE OF WORKING CAPITAL

MANAGEMENT

Because of its close relationship with day to day operations of a business, astudy of working capital and its management is of major importance.

It is being increasingly realised that inadequacy or mismanagement of working

capital is the leading cause of business failures.


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A firm may have to face the following adverse consequences from inadequate working

capital:

1 Growth may be stunted.

2. Implementation of operating plans may become difficult.

3. Operating inefficiencies may creep in due to difficulties in meeting even day to day

commitments.

4 Fixed assets may not be efficiently utilised due to lack of working funds.

5 Attractive credit opportunities may have to be lost due to paucity of working capital.

6 The firm loses its reputation when it is not in a position to honour its short-term.


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On the other hand, excessive working capital may pose the following dangers:

1.Excess of working capital may result in unnecessary accumulation of inventories.

2.Excessive working capital may make management complacent, leading eventually to

managerial inefficiency.

3.It may encourage the tendency to accumulate inventories for making speculative profits,

causing a liberal dividend policy.

An enlightened management, therefore, should maintain the right amount of working

capital on a continuous basis.


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Different Aspects of Working Capital

Management

Management of Inventory

Management of Cash

Management of Receivables/Debtors

Management of Payables/Creditor


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MANAGEMENT OF INVENTORY

Inventory means Tangible property which is held in:

In the process of Production (i.e. WIP) for Sale

OR For Consumption in the production of good & services

which will be used for sale in the ordinary course ofBusiness.

Inventory Includes Raw-Material, FG, WIP, Spares,Consumables etc.


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Inventory Management Means

An Optimum Investment in the Inventories.

Striking balance between Adequate Stock &Investment.

Maintain Adequate Stock and that too by keepingInvestment at Minimum Level. It is also known asOptimum Level of Inventory.

Maintaining Inventory at the Optimum Level is calledInventory Management.


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MANAGEMENT OF CASH

Cash means Liquid Assets that a Business Owns. It

includes Cheques, Money Orders & Bank Drafts.

Cash Management means efficient Collection &

Disbursement of cash and any Temporary Investment

of Cash.

(Maintaining Optimum Level of Cash in an

Organization is called Cash Management)


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Motives of Holding Cash

How much cash should a organization

keep on hand?

Transaction Motive

Speculative Motive

Precautionary Motive


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1.Transactions Motive: Enough cash to makepayments when needed.(Daily or Weekly Cash Budget helpful)

2.Speculative Motive: Situations where holdingmoney is perceived to be less riskythaninvesting it in some other asset.

3. Precautionary Motive: Additional cash maybe held for unexpected requirements. (Safetystock)

Working Capital Management1

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