WORKING CAPITAL

Working capital is a financial metric which represents operating liquidity available to a

business, organization, or other entity, including governmental entities. Along with fixed
assets such as plant and equipment, working capital is considered a part of operating capital.
Working capital = current assets- current liabilities
Concepts of working capital
1. Gross working capital
Gross working capital is the sum total of company’s investment in current assets. Current
assets are those assets which can be converted into cash within a period of one year. It is the
total of components of current assets like cash and bank balance, short term investments,
sundry debtors, bills receivables, stock (raw materials, work-in-progress and finished goods),
prepaid expenses and consumable stores.
2. Net working capital
Net working capital is the excess of current assets over current liabilities. Current liabilities
are those claims of outsiders which are expected to mature for payment within a period of one
year. The principal objective here is to learn the composition and magnitude of current asset
required to meet current liabilities.
The components of current liabilities are: short term borrowings, advances received from
customers, bank over draft, sundry creditors and bills payable, outstanding expenses etc.
a. Positive working capital
A positive working capital is one where the current assets exceeds current liabilities. This
concept lays emphasis on qualitative aspects which indicates the liquidity position of the
concern and suggest the extent to which working capital needs may be financed by permanent
sources of fund. Current assets should be sufficiently in excess of current liabilities to
constitute a safe margin for maturing obligations within the ordinary operating cycle of a
business. -
b. Negative working capital
Negative working capital is a position where the current assets are less than current liabilities.
A negative working capital indicates a negative liquidity position. A weak or negative
liquidity position poses a threat to the solvency of the company and makes it unsafe and
unsound.
3. Zero Working Capital
Zero working capital refers to the financial position where the current asset equated to current
liabilities. It is a modern concept developed in working capital management.
Zero working capital= inventories +receivables -payables

Types of working capital

Permanent working capital
Permanent working capital is the minimum amount of investment in all current assets which
must be kept in order to carry on the business.it is the investment in current assets which is
permanently locked up in the business. Therefore, permanent working capital is also known
as fixed or regular working capital. Though the fixed working capital constantly changes its
form from one asset to another, it always remains in the firm. However, its size increases
with the growth of business. It is generally financed from long term sources.
Variable working capital
Variable working capital is the working capital which is needed over and above the fixed
working capital. Variable working capital can also have called as fluctuating working
capital.it is the extra working capital need to support the changing production and sales
activities.
Depending on the changes in the volume of activity the need for working capital over
and above the fixed working capital may also vary on account of seasonal changes or
abnormal conditions. Therefore, variable working capital is also called seasonal working
capital.
WORKING CAPITAL MANAGEMENT
Working capital management is a business strategy designed to ensure that a company
operates efficiently by monitoring and using its current assets and liabilities to the best effect.
The primary purpose of working capital management is to enable the company to maintain
sufficient cash flow to meet its short term operating costs and short term debt obligations.
Working capital management is an integral part of the financial management of a company
because many short term activities have effects on long term financial decisions.
Determinants of working capital
The determinants of working capital are items that have a direct impact on the amount
invested in current asset and current liabilities. Managers like to keep a close watch over
these factors, since working capital can absorb a large part of the funding that an organization
has at its disposal. Accordingly, managers are always trying to adjust the manner in which
operations are run in order to pare back on the working capital investment. There are a
number of determinants of working capital, which includes the following:
1. Nature of business
Nature and size of business influence the magnitude of working capital. Small companies
have smallest proportion of cash receivables and inventory than large investment in
inventories, cash balance, etc., and very low investment in fixed assets. On the other hand ,
public utility concerns have a limited need for working capital and have to invest heavily in
fixed assets.
2. Business cycle
Business expands during period of prosperity and declines during the period of depression.
Consequently, more working capital is required during periods of prosperity and less during
periods of depression. During the recover and prosperity phases of business cycle, prices of
raw materials and wages tend to rise and the business will need additional funds to carry on
the business. In the depression and recession period collection difficulties and declining sales
results in dwindling cash balance.
3. Operational efficiency
Operational efficiency is the capability to deliver products or services to its customers in the
most effective manner. The operating efficiency of a firm also affects the firm’s need of
working capital and optimum utilization of assets. In turn it results in more fund release for
working capital.
4. Storage time or processing period
Time needed for keeping the stock in store is called storage period. The amount of working
capital is influenced by the storage period. If storage period is high, a firm should keep more
quantity of goods in store and hence requires more working capital. Similarly, if the
processing time is more, then more stock of goods must be held in store as work-inprogress.
5. Volume of Sale
The volume of sales and size of working capital is maintained to support operational
activities which results in sales. Thus, higher the volume of the sales larger will be the size of
working capital and vice versa.
6. Terms of purchase and sales
If a firm has allowed very liberal credit terms to its customers more fund will be tied in book
debts and working capital needs will be high. Where supplies have granted liberal credit
terms to the firm, there will be less need of working capital
7. Inventory turnover
If the inventory turnover is high, the working capital requirement will be low. With a better
inventory control, firm is able to reduce its working capital requirements.
8. Receivables turnover
A prompt collection of receivables and good facilities for settling payables result into low
working capital requirements
9. Value of current assets
A decrease in real value of current assets as compared to their book value reduces the size of
working capital. examples are decline in the market value of stock to below its cost price, bad
debts on debtors, etc.
10. Production cycle The time taken to convert raw materials into finished products referred
to as production cycle. The longer the production cycle, the greater the requirement of
working capital 11. Credit control Credit control includes such factors as the volume of credit
sales, collection policy, etc. A firm can improve its cash position with a sound credit policy
12. Liquidity and profitability If a firm gives more importance to liquidity it is interested in
maintaining a larger amount of working capital. On the other if it is interested in profitable
employment of funds. It reduces size of its working capital. 13. Inflation As a result of
inflation there may be a better inflow of cash and consequently the working capital is
increased. 14. Seasonal fluctuations For seasonal firms the size of working capital fluctuates
with seasonal variations. The size of working capital is large during busy seasons than slack
seasons. 15. Changes in technology Technological development related to the production
process have a impact on working capital. technological changes which reduces manual labor
may reduce the volume of working capital while application of technology which increases
production and sales may increase the volume of working capital. 16. Other factors The other
factors which determine working capital are firm’s credit policy, production policy, attitude
towards risk, activities of the firms, etc.

Areas of working capital management

Working capital management involves management of different components of working
capital:
 Cash management  Receivables management  Inventory management 1. Cash
management
Cash is the most liquid asset that a business owns. It includes many and such instruments
equivalent to cash namely cheque, money orders or bank drafts which banks normally accepts
for deposits and immediately credit to the depositors account. Cash management is concerned
with management of cash and cash equivalents so as to maintain an optimum cash balance
and at the same time avoid idle cash balance. It aims at maintaining an equilibrium between
liquidity and profitability for maximizing the profit of the enterprise.
Motives for holding cash
Cash is held by a firm due to the following motives
a. Transaction motive
A firm always keeps at cash balance with the motive of meeting routine business payments
like purchase of raw materials, payment of wages, operating expenses, interests, taxes,
dividends and so on.
b. Precautionary motives
A firm keeps cash balance to meet unexpected cash needs arising out of unexpected
contingencies such as strikes, flood, unexpected cancellation of the orders by customers, etc.
c. speculative motive
A firm also keeps cash balance to take advantage of investing in profit making opportunities
typically outside the course of business. This motive is purely defensive in nature.
d. Compensation motive
Banks usually require their clients to keep a maximum cash balance with them to provide
certain services as a compensation for providing certain services free of charge.
2. Receivables management (debtor’s management)
Receivable are assets which are created as a result of sale of goods or services in the ordinary
course of business. Receivable management is concerned with all the process adopted for
maintaining the amount of receivables at the optimum level considering the requirements of
the customers at one end and the credit sanctioning capacity of the firm at the other.
The following are the objectives of receivables management.
 To increase the volume of sale.  To ensure adequate flow of cash from trade debtors to
meet current obligations.  To facilitate liberal credit transactions.  To settle Trade debts
without loss.  To achieve the target return on investment.  To minimize the cost and risk
involved in the trade credit.  To maintain adequate liquid capital of the firm.  To ensure
credit worthiness of the concern.  To take the maximum advantage of trade discount and
cash discount facilities.  To achieve target return in investment.

3. INVENTORY MANAGEMENT
Inventory management means that part of financial management where optimum level of raw
material, work in progress, finished goods, consumables, spares, and supplies are maintained
so that regular supply of material is assured for continues flow of production and other
activities.
Inventory is an important constituent of working capital in most of the industrial
undertakings. The organization was take at most care for the proper control and management
of inventories. The main objective of inventory management is to assure adequate supply of
materials required by the production departments and also minimize the investment in
inventories.

Tools and techniques used for inventory are ABC analysis, FSN analysis, VED analysis, Just
–InTime Inventory system, Economic Order Quantity etc.
Sources of Working Capital
Identification and mobilization of funds are much crucial to a business. The various sources
enable raising adequate funds for the operation of MDPL are as follows:
Long term sources
1. Issue of shares
Shares are the main source of long term finance of any company. It is the owners fund.
Shares are of two types i.e., equity and preference shares.
Equity shares are also known as ordinary shares. Equity shares are those shares which are not
preference share
Preference shares are those shares which enjoy preferential rights as to the payment of
dividend at a fixed rate during the life of the company and as to the return of capital on
winding up of the company over the equity shares.
2. Retained earnings
Generally, the entire profits of the company are not distributed amongst the shareholders as
dividend; some portion of profits are retained by the company for their future expansion. It is
also known as ploughing back of profits. A part of the profits is re-invested into the business
operation and it is treated as an ideal source of financing for modernization of the company.
3. Institutional finance
Commercial banks and specialized financial institutions provide long term funds to
corporations. The banks which provide financial assistance to the industry for the economic
development of the country are known as development banks. It seeks to mobilize scarce
resources such as capital, technical knowhow, entrepreneurial and managerial talents and
channelize them into industrial
4. Lease financing
Leasing is an agreement between the owner of the property and the user of the property. It
provides a firm with use and control over the assets without buying and owning the same. It
is one of the ways of renting assets.
Short Term Sources
 Trade credit Trade credit is the loan extended by one trader to another when the goods and
services bought on credit. The credit facilitates the purchase of supplies without immediate
payment. Trade credit is commonly used by business organizations as a source of short term
financing.  Bank credit The term bank credit refers to the amount of credit available to a
business or individual from a banking institution in the form of loans. Banks provides short
term finance in the form of over draft, cash credit, discounting of trade bills and letters of
credit to its customers.  Public deposit Public deposits refer to the unsecured deposits
invited by companies from the public mainly to finance working capital needs. The company
has only to advertise and inform the public that it is authorized by the Companies Act 1956,
to accept public deposit. Public deposits can be invited by offering a higher rate of interest
allowed on bank deposits. However, the companies can raise funds through public deposits
subject to a maximum of 25% of their paid up capital and free reserves.  Inter Corporate
Deposits An Inter Corporate Deposits(ICD) is an unsecured borrowing by corporates and FIs
from other corporate entities registered under the Companies Act 1956. The corporate having
surplus funds would lend to another corporate in need of funds. This lending would
 Advance from customers Many times sellers or producers receive whole or part of the
amount of goods in advance and such advance remains with them till the supply of goods.
Normally no interests are paid on this amount.  Factoring Factoring is a business activity in
which a financial intermediary called factor takes the responsibility of collecting the debtors
or receivables of a manufacturing or trading concern.in other words instead of discounting the
bills from bankers the debtors and bills are sold to a special financial institution engaged in
factoring. The factor collects amount on due dates, effects payment to the concern on these
dates irrespective of whether customers have paid or not and also assumes credit risk
associated with collection of accounts. The main advantages of factoring are:

a. Reduces the operating cycle by providing liquidity

b. Credit risk is transferred from seller of goods to the factor
c. Cash flow from credit sales is assured
d. Sales administration is taken over by factors.