Working Capital Management

Working capital management refers to a company's managerial

accounting strategy designed to monitor and utilize the two
components of working capital, current assets and current liabilities,
to ensure the most financially efficient operation of the company.
Proper management of working capital is essential to a company's
fundamental financial health and operational success as a business.
A hallmark of good business management is the ability to utilize
working capital management to maintain a solid balance between
growth, profitability and liquidity.
Working capital management commonly involves monitoring cash
flow, assets, and liabilities through the ratio analysis of key elements
of operating expenses, including the working capital ratio, collection
ratio, and the inventory turnover ratio.
1. Gross Working Capital:
• The concept of gross working capital refers to the total value of
current assets.
• In other words, gross working capital is the total amount available
for financing of current assets.
• However, it does not reveal the true financial position of an
enterprise. How? A borrowing will increase current assets and, thus,
will increase gross working capital but, at the same time, it will
increase current liabilities also.
• As a result, the net working capital will remain the same.
• This concept is usually supported by the business community as it
raises their assets (current) and is in their advantage to borrow the
funds from external sources such as banks and the financial
institutions.

In this sense, the working capital is a financial concept. As per this

concept:
Gross Working Capital = Total Current Assets
2. Net Working Capital:
• The net working capital is an accounting concept which represents
the excess of current assets over current liabilities.
• Current assets consist of items such as cash, bank balance, stock,
debtors, bills receivables, etc. and current liabilities include items
such as bills payables, creditors, etc.
• Excess of current assets over current liabilities, thus, indicates the
liquid position of an enterprise.
• The ratio of 2:1 between current assets and current liabilities is
considered as optimum or sound.
• What this ratio implies is that the firm/ enterprise have sufficient
liquidity to meet operating expenses and current liabilities.
• It is important to mention that net working capital will not increase
with every increase in gross working capital. Importantly, net
working capital will increase only when there is increase in current
assets without corresponding increase in current liabilities.
Thus, in the form of a simple formula:
Net Working Capital = Current Assets-Current Liabilities
3. Permanent working capital:
• Permanent working capital is the minimum investment required
in working capital irrespective of any fluctuation in business activity.
• Also known as fixed working capital, it is that level of net working
capital below which it has never gone on any day in the financial
year.
• Net working capital (NWC) means current assets less current
liabilities.
• This term is important to be calculated for decisions relating
financing mix of working capital and save the interest cost of the
firm.
• For satisfying the customer needs, we need to maintain a minimum
level of inventory and to generate revenue and improve customer
relations, we have to extend credit and thereby maintain accounts
receivables.
• Therefore, it is clear from the above explanation, irrespective of the
activity levels of the business, a minimum investment in the current
asset is always required.
• This investment requirement is called permanent working capital.
4. Temporary Working Capital:
• Temporary working capital (TWC) is the temporary fluctuation of
networking capital over and above the permanent working capital.
• It is the additional working capital requirement arising out of
seasonal demand of the product or any special event which
otherwise are not predictable.
• In other words, it is the difference between net working capital and
the permanent working capital.
Business earnings are not like the salary earnings of an employee.
In business, businessmen get an opportunity to earn good money at
a particular time and all businessmen try to grab such opportunities.
This requires additional working capital for him to take that
advantage. Such a requirement of working capital is temporary
working capital.
Temporary Working Capital = Net Working Capital – Permanent
Working Capital.
5. Seasonal Working Capital:
• Some products have seasonal demand. Seasonal demand arises due
to festival.
• In this way, seasonal working capital means an amount of working
capital maintained to meet the seasonal demand of the product.
6.Regular Working Capital:
The minimum amount of working capital to be maintained in normal
condition is called Regular Working Capital.
7.Special Working Capital:
Special programs may be conducted for business development. The
programs may be advertisement campaign, sales promotion
activities, product development activities, marketing
research activities, launching of new products, expansion of markets
and the like.
Therefore, special working capital means an amount of working
capital maintained to meet the expenses of special programs of the
company.
• 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
 Conservative Approach
Conservative approach is a risk-free strategy of working capital
financing. A company adopting this strategy to maintain a higher
level of current assets and therefore higher working capital also.
The major part of the working capital is financed by the long-term
sources of funds such as equity, debentures, term loans etc.
So, the risk associated with short-term financing is abolished to a
great extent.
In the conservative approach, fixed assets, permanent working
capital and a part of temporary working capital is financed by long-
term financing sources and the remaining part only is financed by
short-term financing sources.
Thus, the primary objective of working capital management is
ensured.
EQUATION
Long Term Funds will Finance = Fixed Assets + Permanent Working
Capital + Part of Temporary Working Capital

Short Term Funds will Finance = Remaining Part of Temporary

Working Capital
 Aggressive Approach
The aggressive approach is a high-risk strategy of working capital
financing wherein short-term finances are utilized not only to
finance the temporary working capital but also a reasonable part of
the permanent working capital.
In this approach of financing, the levels of inventory, accounts
receivables and bank balances are just sufficient with no cushion for
uncertainty. There is a reasonable dependence on the trade credit.
Fixed assets and a part of permanent working capital are financed by
long-term financing sources and the remaining part of permanent
working capital and total temporary working capital is only is
financed by short-term financing sources

Long Term Funds will Finance = Fixed Assets + Part of Permanent

Working Capital

Short Term Funds will Finance = Remaining Part of Permanent

Working Capital + Temporary Working Capital
 Hedging Approach
Maturity matching or hedging approach is a strategy of working
capital financing wherein short term requirements are met with
short-term debts and long-term requirements with long-term debts.
The underlying principal is that each asset should be compensated
with a debt instrument having almost the same maturity.