Unit 5
Working Capital Management
Introduction
The term working capital management’ primarily refers to the efforts of the management towards
effective management of current assets and current liabilities. Working capital is nothing but the
difference between the current assets and current liabilities. In other words, an efficient working capital
management means ensuring sufficient liquidity in the business to be able to satisfy short-term expenses
and debts.
In a broader view, ‘working capital management’ includes working capital financing apart from
managing the current assets and liabilities. That adds the responsibility for arranging the working capital
at the lowest possible cost and utilizing the capital cost-effectively.
Concept of Working Capital Management
Working capital management is a procedure that ensures the effective operation of the company with the
best utilization of business current assets and liabilities. The main aim of managing your working
capital is to monitor the assets and liabilities of the organization so that adequate cash flow can be
maintained and the short-term goals of the business can be met. It assists in managing the planned and
unplanned expenses and determines the efficiency of the business by maintaining liquidity.
Proper working capital management facilitates the business to operate smoothly and improves its
earnings. It includes the proper management of inventory, account receivables and account payables so
that enough cash is available for routine operations. It is an accounting strategy that not only helps
businesses to meet their financial obligations but also enhances its earnings. It also helps in identifying
the areas of the business that requires attention to maintain profitability and liquidity.
Objectives of Working Capital Management
The primary objectives of working capital management include the following:
a. Smooth Operating Cycle: The key objective of working capital management is to ensure a
smooth operating cycle. It means the cycle should never stop for the lack of liquidity whether it
is for buying raw material, salaries, tax payments etc.
b. Lowest Working Capital: For achieving the smooth operating cycle, it is also important to
keep the requirement of working capital at the lowest. This may be achieved by favorable credit
terms with accounts payable and receivables both, faster production cycle, effective inventory
management etc.
c. Minimize Rate of Interest or Cost of Capital: It is important to understand that the interest
cost of capital is one of the major costs in any firm. The management of the firm should
negotiate well with the financial institutions, select the right mode of finance, maintain
optimal capital structure etc.
d. Optimal Return on Current Asset Investment: In many businesses, you have a liquidity
crunch at one point of time and excess liquidity at another. This happens mostly with seasonal
industries. At the time of excess liquidity, the management should have good short-term
investment avenues to take benefit of the idle funds.
, Importance of Effective Working Capital Management
Although, importance of working capital is unquestionable in any type of business. Working capital
management is a day-to-day activity, unlike capital budgeting decisions. Most importantly,
inefficiencies at any levels of management have an impact on the working capital and its management.
Following are the main points that signify why it is important to take the management of working capital
seriously.
a. Ensures Higher Return on Capital
b. Improvement in Credit Profile & Solvency
c. Increased Profitability
d. Better Liquidity
e. Business Value Appreciation
f. Most Suitable Financing Terms
g. Interruption Free Production
h. Readiness for Shocks and Peak Demand
i. Advantage over Competitors
Concept of Working Capital:
In an ordinary sense, working capital denotes the amount of funds needed for meeting day-to-day
operations of a concern.
This is related to short-term assets and short-term sources of financing. Hence it deals with both, assets
and liabilities—in the sense of managing working capital it is the excess of current assets over current
liabilities.
The funds invested in current assets are termed as working capital. It is the fund that is needed to run the
day-to-day operations. It circulates in the business like the blood circulates in a living body. Generally,
working capital refers to the current assets of a company that are changed from one form to another in
the ordinary course of business, i.e. from cash to inventory, inventory to work in progress (WIP), WIP to
finished goods, finished goods to receivables and from receivables to cash.
There are two concepts in respect of working capital:
(i) Gross working capital and
(ii) Networking capital.
(i) 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.It is also called simply
‘working capital’. It refers to the total of all the current assets of the firm. Current assets are the assets
which are meant to be converted into cash within a year or an operating cycle. Stock of raw materials,
stock of semi-finished goods, stock of finished goods, trade debtors, bills receivable, prepaid expenses,
cash at bank and cash in hand are examples of current assets.
The sum total of all current assets of a business concern is termed as gross working capital. So,
Gross working capital = Stock + Debtors + Receivables + Cash.
(ii) Net Working Capital:
Net working capital refers to the excess of current assets over current liabilities. The net working capital
is an accounting concept which represents the excess of current assets over current liabilities. Current
Working Capital Management
Introduction
The term working capital management’ primarily refers to the efforts of the management towards
effective management of current assets and current liabilities. Working capital is nothing but the
difference between the current assets and current liabilities. In other words, an efficient working capital
management means ensuring sufficient liquidity in the business to be able to satisfy short-term expenses
and debts.
In a broader view, ‘working capital management’ includes working capital financing apart from
managing the current assets and liabilities. That adds the responsibility for arranging the working capital
at the lowest possible cost and utilizing the capital cost-effectively.
Concept of Working Capital Management
Working capital management is a procedure that ensures the effective operation of the company with the
best utilization of business current assets and liabilities. The main aim of managing your working
capital is to monitor the assets and liabilities of the organization so that adequate cash flow can be
maintained and the short-term goals of the business can be met. It assists in managing the planned and
unplanned expenses and determines the efficiency of the business by maintaining liquidity.
Proper working capital management facilitates the business to operate smoothly and improves its
earnings. It includes the proper management of inventory, account receivables and account payables so
that enough cash is available for routine operations. It is an accounting strategy that not only helps
businesses to meet their financial obligations but also enhances its earnings. It also helps in identifying
the areas of the business that requires attention to maintain profitability and liquidity.
Objectives of Working Capital Management
The primary objectives of working capital management include the following:
a. Smooth Operating Cycle: The key objective of working capital management is to ensure a
smooth operating cycle. It means the cycle should never stop for the lack of liquidity whether it
is for buying raw material, salaries, tax payments etc.
b. Lowest Working Capital: For achieving the smooth operating cycle, it is also important to
keep the requirement of working capital at the lowest. This may be achieved by favorable credit
terms with accounts payable and receivables both, faster production cycle, effective inventory
management etc.
c. Minimize Rate of Interest or Cost of Capital: It is important to understand that the interest
cost of capital is one of the major costs in any firm. The management of the firm should
negotiate well with the financial institutions, select the right mode of finance, maintain
optimal capital structure etc.
d. Optimal Return on Current Asset Investment: In many businesses, you have a liquidity
crunch at one point of time and excess liquidity at another. This happens mostly with seasonal
industries. At the time of excess liquidity, the management should have good short-term
investment avenues to take benefit of the idle funds.
, Importance of Effective Working Capital Management
Although, importance of working capital is unquestionable in any type of business. Working capital
management is a day-to-day activity, unlike capital budgeting decisions. Most importantly,
inefficiencies at any levels of management have an impact on the working capital and its management.
Following are the main points that signify why it is important to take the management of working capital
seriously.
a. Ensures Higher Return on Capital
b. Improvement in Credit Profile & Solvency
c. Increased Profitability
d. Better Liquidity
e. Business Value Appreciation
f. Most Suitable Financing Terms
g. Interruption Free Production
h. Readiness for Shocks and Peak Demand
i. Advantage over Competitors
Concept of Working Capital:
In an ordinary sense, working capital denotes the amount of funds needed for meeting day-to-day
operations of a concern.
This is related to short-term assets and short-term sources of financing. Hence it deals with both, assets
and liabilities—in the sense of managing working capital it is the excess of current assets over current
liabilities.
The funds invested in current assets are termed as working capital. It is the fund that is needed to run the
day-to-day operations. It circulates in the business like the blood circulates in a living body. Generally,
working capital refers to the current assets of a company that are changed from one form to another in
the ordinary course of business, i.e. from cash to inventory, inventory to work in progress (WIP), WIP to
finished goods, finished goods to receivables and from receivables to cash.
There are two concepts in respect of working capital:
(i) Gross working capital and
(ii) Networking capital.
(i) 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.It is also called simply
‘working capital’. It refers to the total of all the current assets of the firm. Current assets are the assets
which are meant to be converted into cash within a year or an operating cycle. Stock of raw materials,
stock of semi-finished goods, stock of finished goods, trade debtors, bills receivable, prepaid expenses,
cash at bank and cash in hand are examples of current assets.
The sum total of all current assets of a business concern is termed as gross working capital. So,
Gross working capital = Stock + Debtors + Receivables + Cash.
(ii) Net Working Capital:
Net working capital refers to the excess of current assets over current liabilities. The net working capital
is an accounting concept which represents the excess of current assets over current liabilities. Current
