UNIT-4

WORKING CAPITAL MANAGEMENT

I.

Introduction :
Concepts of working capital : The term working capital means either Gross Working
Capital or Net working capital.
Net working capital means current assets less current
liabilities.
Gross Working capital means current assets.
Unless otherwise specified,Working capital means Net working
capital.
Working capital Management refers to proper management
of current assets and current liabilities.

II.

Why is Working capital necessary?

Generally,it will not be possible for any organization to operate
without the working capital.
Let us assume that,a manufacturing organization commences
its business with a certain amount of cash.
This cash will be invested to buy raw materials.
This raw material purchased will be processed with the help of
various infrastructural facilities like labour,machinery etc., to
form finished goods.
These are sold in the market on credit basis where receivables
by debtors are generated.
These receivables generate cash which forms a cycle called
Working capital cycle.
CASH

DEBTORS

RAW MATERIALS

FINISHED GOODS

 In between each of these cycles,there is sometime gap

involved,and it is during this gap that the need for working
capital arises.
As this time gap is unavoidable, the requriment for working
capital is also unavoidable.
The finance professional is interested in reducing this time
gap,so as to manage the working capital properly.

III.

Factors influencing working capital:

1) Nature of business :-

In some businesses,the need for fixed capital will be more than

working capital.
For example:
Public utility services like Railways, Electricity boards,
Infrastructure oriented project etc., require lesser working
capital.
Whereas Trading organizations require more working capital
due to the involvement of current assets, stocks and
receivables.
2) Size of the Organization : Small scale organizations require high Working capital because
of high overheads,high buying and selling costs.
As such, Medium sized organizations have an edge over the
small scale organizations.
3) Phase of trade cycles : During Inflatory conditions,the Working capital requirement will
be higher as more raw materials,more production and more
receivables are desired.
During depreciation,Working capital requirement will be lower
due to reduced operations.

4) Trading terms : If purchases are made on cash basis and sales are made on
credit basis to meet market competition, the Working capital
requirement will be higher and viceversa.
5) Length of Production cycle : The term Production cycle refers to the duration from the stage
raw materials is aquired till the stage finished product is
manufactured.
Longer the duration of the production cycle,Higher will be the
Working Capital requirement.
6) Profitability : High profitability reduses the strain on the WC as profit earned
can be used for financing the requirement of WC.

IV.

Types of Working capital :

There are 2 types of Working Capital :i.

Fixed or Permanent Working capital :

This is the minimum working capital required to be

maintained in the business on permanent or un-interrupted
basis.The requirement for FWC is unaffected by changeas in
the level of activity.

ii.

Variable Working capital :

This is the WC required over and above the FWC and
changes with the fluctuations in the level of activity as a
result of changes in productio and sales.

Temporary

Amount of
WC

Permanent
Time
Sources of Working capital :
1.
2.
3.
4.

Spontaneous sources.
Inter-corporate deposits.
Commercial papers.
Banks.

PROBLEMS :
1. ABC Ltd. Plans to sell 36000 units next year.Expected cost of goods
is as follows : Raw material = Rs.100/unit.
Manufacturing expenses= Rs.30/unit.
Average monthly production and sales = 3000units.
Selling price/unit = Rs.200/unit.
Duration of various stages of operating cycle is expected to be :
Raw materials stage = 2 months (60 days).
Debtors stage = 2 months.
Finished goods stage = 1 month.
WIP stage = month.
Compute the investment in various assets.
Solution :Let 1 year =360 days.
1) Investment in inventory =
(raw material stage)

36000*100*60

= Rs.6,00,000/-

360
2) Work In process = 36000*15*(100+30)

Rs.1,95,000/-

360
3) Finished goods stage =

36000*130*30

Rs.3,90,000/-

Rs.7,80,000/-

360
4) Investment in debtors =

36000*130*60
360

Therefore, Total current Assets = Rs.19,65,000/-

OPERATING CYCLE and CASH CYCLE

Formulas:
Operating cycle= Inventory period + Accounts receivable period
Cash cycle= Operating cycle- Accounts payable period
Inventory period = (Average inventory)/ (Annual cost of goods sold/365)
Accounts Receivable period= (Average accounts receivable)/ (Annual
sales/365)
Accounts payable period = (Average accounts payable)/ (Annual cost of
goods sold/365)
Question 1. The table below provides information for a company. Calculate
Operating cycle and Cash cycle.
Particulars
Sales
Cost of goods
sold

Profit and
Loss data
800
720

Balance
sheet data
Inventory
Accounts
receivable
Accounts
payable

Beginning of
time period
96
86

Ending of
time period
102
90

56

60

Inventory period = (Average inventory)/ (Annual cost of goods sold/365)

Inventory period= (99)/(720/365)
Inventory period= 50.18 days
Accounts Receivable period= (Average accounts receivable)/ (Annual
sales/365)
Accounts Receivable period= (88)/(800/365)
Accounts Receivable period=40.15 days

Accounts payable period = (Average accounts payable)/ (Annual cost of

goods sold/365)
Accounts payable period = (58)/(720/365)
Accounts payable period = 29.40 days
Operating cycle= Inventory period + Accounts receivable period
Opening cycle= 50.18+40.15=90.33 days
Cash cycle= Operating cycle- Accounts payable period
Cash cycle= 90.33-29.1=60.9 days
Question 2. The recent information for a company called Xavier for year
ended 20-1 is given. Calculate Operating cycle and Cash cycle.
Particulars

Sales
Cost of goods
sold

Profit and
Loss data ( in
million)
80
56

Balance
sheet data

Beginning of
20-1

Ending of 201

Inventory
Accounts
receivable
Accounts
payable

9
12

12
16

10

Inventory period = (Average inventory)/ (Annual cost of goods sold/365)

Inventory period= (10.5)/(56/365)
Inventory period= 68.437 days
Accounts Receivable period= (Average accounts receivable)/ (Annual
sales/365)
Accounts Receivable period= (14)/(80/365)
Accounts Receivable period=63.87 days
Accounts payable period = (Average accounts payable)/ (Annual cost of
goods sold/365)
Accounts payable period = (8.5)/(56/365)
Accounts payable period = 55.40 days

Operating cycle= Inventory period + Accounts receivable period

Opening cycle= 68.43+63.87=132.74 days
Cash cycle= Operating cycle- Accounts payable period
Cash cycle= 132.74-55.4=77.34 days
Question 3. The table below provides information for a company. Calculate
Operating cycle and Cash cycle for year ending 20-0
Particulars
Sales
Cost of goods
sold

Profit and
Loss data
500
360

Balance
sheet data
Inventory
Accounts
receivable
Accounts
payable

Beginning of
20-0
60
80

Ending of 200
64
88

50

56

Inventory period = (Average inventory)/ (Annual cost of goods sold/365)

Inventory period= (62)/(360/365)
Inventory period= 62.86 days
Accounts Receivable period= (Average accounts receivable)/ (Annual
sales/365)
Accounts Receivable period= (84)/(500/365)
Accounts Receivable period=61.32 days

Accounts payable period = (Average accounts payable)/ (Annual cost of

goods sold/365)
Accounts payable period = (53)/(360/365)
Accounts payable period = 53.73 days
Operating cycle= Inventory period + Accounts receivable period
Opening cycle= 62.86+61.32=124.18 days

Cash cycle= Operating cycle- Accounts payable period

Cash cycle= 124.18-53.73=70.45 days
Question 4. The table below shows relevent information for a company.
Calculate Operating cycle and Cash cycle.
Particulars

Profit and
Loss data
1000
750

Balance
Beginning of
sheet data
time period
Sales
Inventory
110
Cost of goods
Accounts
140
sold
receivable
Accounts
60
payable
Inventory period = (Average inventory)/ (Annual cost of goods

Ending of
time period
120
150
66
sold/365)

Inventory period= (115)/(750/365)

Inventory period= 55.96 days
Accounts Receivable period= (Average accounts receivable)/ (Annual
sales/365)
Accounts Receivable period= (145)/(1000/365)
Accounts Receivable period=52.92 days

Accounts payable period = (Average accounts payable)/ (Annual cost of

goods sold/365)
Accounts payable period = (63)/(750/365)
Accounts payable period = 30.66 days
Operating cycle= Inventory period + Accounts receivable period
Opening cycle= 55.96+52.92=108.88 days
Cash cycle= Operating cycle- Accounts payable period
Cash cycle= 108.88-30.66=78.22 days
Question 5. The following annual figures relate to company XYZ company.

Particulars
Amount ( rupees)
1. Sales( at 2 months credit)
36,00,000
2. Material consumed ( suppliers
9,00,000
extend 2 months)
3. Wages paid (monthly in
7,20,000
arrears)
4. Manufacturing expenses
80000
outstanding at end of year
( cash expenses are paid 1
month in arrears)
5. Total administrative expenses
2,40,000
paid as above
6. Sales promotion expenses, paid 1,20,000
quarterly in advance
The company sells 75 products on gross profit of 25% counting depreciation
as part of its cost of production. It keeps one month stock, each of raw
materials and finished goods and a cash balance of Rs. 1, 00,000. Assuming
20% safety margin, work out working capital of company on cash-cost basis.
Ignore working process.

Particulars
1. Manufacturing expenses
Sales
Less gross profit of 25%

Total Manufacturing cost

Less material consumed
Wages

Manufacturing expenses

Amount ( rupees)
36,00,000
9,00,000

27,00,000
9,00,000
7,20,000

10,80,000

2. Cash
manufacturing
expenses(80,000,
1 month
9,60,000
in advance)
3. Depreciation
(Depreciation = Manufacturing 1,20,000
expenses-cash manufacturing
expenses)

4. Total cash cost

Total manufacturing cost
Less depreciation

Cash manufacturing cost

27,00,000
1,20,000

25,80,000
Add
total
expenses
Add
sales
expenses

administrative
promotional 2,40,000
1,20,000

Total cash cost

29,40,000

Current Assets
Item
Debtors

Raw material cost

Finished goods cost

Prepaid sales promotion

expenses (paid
quarterly)

Formula
((Total cast cost)/12)*2
((29,40,000)/12)*2
((Material cost)/12)*1
((9,00,000)/12)*1

Amount
4,90,000

75,000

((cash Manufacturing
cost)/12)*1
((25,80,000)/12)*1

2,15,000

1,20,000/4

30,000

Predetermined Amount

1,00,000

Current Assets

9,10,000

Cash balance

Current liabilities

Item
Creditors

Formula
((Material cost )/12)*2
((9,00,000)/12)*2

Amount

Manufacturing expenses
outstanding

1 month expenses

80,000

Wages outstanding

1 month wages

60,000

Total administrative
expenses outstanding

1 month admin
expense

20,000

1,50,000

3,10,000
Current liabilities

Working capital = Current assets current liabilities

Working capital= 9,10,000-3,10,000 = 6,00,000
Total working capital = working capital + 20% of working capital
Total working capital = 6,00,000 + 20% of 6,00,000 = 7,20,000
Total working capital for the given problem is 7,20,000