T.Y. B.

Com (Sem-V)
Business Administration
Asst. Prof. Dr. Richu Juneja
1. MEANING OF WORKING CAPITAL
There are two different opinions about the meaning of the term Working
Capital.
According to one school of thought, Working Capital represents all current
assets of a company. This view is supported by such authorities as Field and
Baker, Malott and Mead. They believe that working capital represents those
assets which change their form during the process of production.

Working Capital = Total Current Assets

According to other school of thought, Working Capital is excess of current
assets over current liabilities. This concept is advocated by such authorities
as Lincoln, Stevens and Sailers.

Working Capital = Current Assets – Current Liabilities

To avoid the confusion involved in the interpretation of working capital, it

is suggested that total current assets should be described as Gross
Working Capital, while excess of total current assets over total current
liabilities should be designated as Net Working Capital.

Gross Working Capital = Total Current Assets

Net Working Capital = Current Assets – Current Liabilities
1.1 DEFINITION OF WORKING CAPITAL
Gerstenberg holds that, “Circulating or Working capital means current
assets of a company that are changed in the ordinary course of business
from one form to another, as for example, from cash to inventories,
inventories to receivables, receivables into cash.”

Hoagland, views “Working Capital as the excess of current assets over

current liabilities.”
 1.3 WORKING CAPITAL CYCLE
The working capital cycle (WCC) is the amount of time it takes to turn the
net current assets and current liabilities into cash. The longer the cycle is, the
longer a business is tying up capital in its working capital without earning a
return on it. Therefore, companies strive to reduce its working capital cycle
by collecting receivables quicker or sometimes stretching accounts payable.
2. TYPES OF WORKING CAPITAL

OR
Initial Working Capital
1) PERMANENT / FIXED WORKING CAPITAL
It is that part of working capital which is permanently locked up in current
assets. Some cash is required to maintain stocks of raw materials and finished
goods at their normal level, and also for paying wages and salaries regularly.
Permanent working capital is of two kinds:
i. Initial working capital: In the initial period of its operation, a company
must have enough money to pay certain expenses before the business
yields a cash receipts. In the initial years, banks may not grant loans or
overdrafts, sales may have to be made on credit and it may be necessary to
make payments to the creditors immediately. Hence, the necessary funds
will have to be supplied by the owners themselves in the initial years.

ii. Regular working capital: It is the working capital required to continue

the regular business operations. It is required to maintain regular stocks of
raw materials and work in progress and also of the finished goods which
must be maintained permanently at a definite level. Regular working
capital is the excess of current assets over current liabilities. It ensures a
smooth operation of the business.
2) VARIABLE WORKING CAPITAL
It is that part of working capital which is required to meet the seasonal
needs as well as special needs of the business.
It is therefore subdivided into two parts:
i. Seasonal working capital: Some business enterprises require
additional working capital during a particular season. For example,
the sugar mills have to purchase sugarcane in particular season and
have to employ additional labor to process it.

ii. Special working capital: In all enterprises, some unforeseen events

do occur when extra funds are needed to tide over such situation.
Some of these events are: sudden increase in demand for the final
product, downward movement of prices and sales during depression
necessitating extra working funds, considerable rise in prices of raw
materials so that more funds will be needed to maintain their stock at
the normal level; and strikes or natural calamities which also force the
management to provide for additional funds, etc.
In long term trend if working capital is to more up, then both the curves
will be upward sloping.
3. CHARACTERISTICS OF WORKING CAPITAL

1. Short-term needs

2. Circular movement

3. An element of permanency

4. An element of fluctuation

5. Liquidity

6. Less risky

7. Special accounting system not needed

4. FACTORS DETERMINING WORKING
CAPITAL REQUIREMENTS
1. Nature and Volume of 6. Availability of Credit
Business

2. Length of 7. Growth and

Manufacturing Cycle Expansion

8. Profit and its

3. Business Fluctuations Distribution

9. Price Level
4. Production Policy Fluctuations

5. Credit Policy of the 10. Operating Efficiency

Unit
5. MAIN PROBLEMS OF MANAGEMENT OF
WORKING CAPITAL
1) To determine a proper amount of working capital to be held in the
business.
2) To take decision on the sources of working capital.
3) To ensure that working capital is efficiently utilized.
REASONS WHY THE PROBLEMS OF WORKING
CAPITAL MANAGEMENT ARE SO IMPORTANT:
1) The need for working capital is directly linked to the growth of sales. The
requirement of working capital grows rapidly with the growth of sales,
because the investment in inventories and receivables. A financial manager
has to take steps immediately to meet this additional requirement.
2) The experience shows that much of the financial manager’s time is used in
the management of working capital. The problems of current assets and
current liabilities crop up every now and then.
3) Working capital constitutes a large portion of total investment in assets.
This underlines the importance of working capital management.
4) Working capital management is more important for the small firm.
Generally, in the small units, investment in such current assets as cash,
inventories and receivables tends to be larger than investment in fixed
assets.
 6. COMPONENTS OF WORKING
CAPITAL
COMPONENTS OF WORKING
CAPITAL

2. Debtors or
1. Cash / Bank 3. Inventory
Receivables
 6.1 MANAGEMENT OF CASH
Cash management involves the following four factors:

i. Ascertainment of the minimum cash balance and controlling the

levels of cash.
ii. Controlling cash inflows.
iii. Controlling cash outflows.
iv. Optimum investment of surplus cash.

6.1.1 CONTROLLING THE LEVELS OF CASH

i. Preparing cash budget
ii. Providing for contingencies
iii. Consideration of cost of shortage of cash
iv. Availability of other sources of funds
6.1.2 MOTIVES FOR HOLDING CASH

1. Transaction
Motive

4. Motives for 2.
Compensation Holding Precautionary
Motive Cash Motive

3. Speculative
Motive
 6.2 MANAGEMENT OF RECEIVABLES
When goods are sold on credit in business, the price of the goods
becomes receivable. This amount is known as “Trade Debtors” or
“Debtors” or “Receivables” or “Account Receivables”. These
receivables are assets of the business.

There are three important features of this asset:

1) It involves an element of risk. There is no risk in cash sales, but in

credit sales, there is a risk of bad debts.
2) It is based on economic value. When sale is made, the economic value
immediately passes to the buyer, while it will pass to the seller in
future.
3) It implies futurity in the sense that the money is receivable in future.
 6.2.1 MEANING OF RECEIVABLES
When a firm sells goods or services on credit, payments are received only at a
future date and receivables are created. Account receivable constitute a
significant portion of the total current assets of the business after inventories.

O.M. Joy defines, “Receivables as a debt owed to the firm by customers

arising from sale of goods or services in the ordinary course of business”.

6.2.2 OBJECTIVES OF MAINTAINING OF

RECEIVABLES
OBJECTIVES OF
MAINTAINING RECEIVABLES

1. Achieve 2. Increase 3. Meet

Growth in Sales Profits Competition
6.3 MANAGEMENT OF INVENTORY
Inventory means tangible property held
i. For sale in the ordinary course of business or
ii. In the process of production for such sale or
iii. For consumption in the production of goods or services for sale.

Inventory refers to the stocks, not only of materials, but of finished and semi-
finished goods, spare parts, tools and equipment and general stores like oil,
grease, belt, etc.
To the finance manager, inventory connotes the value of raw materials,
consumables, spares, work-in-progress, finished goods and scrap in which a
company’s funds have been invested. He considers the inventory as blockage
of money. That is why he justify limited stock levels because money blocked
in inventory does not earn interest.
MEANING OF INVENTORY CONTROL
Inventory control refers to a planned method to determine which items to
purchase, how much to purchase and how much to keep in stock, so that the
costs of purchase and storage both are minimized without adversely
affecting either production or sales.

Different departments of the same organization have different levels of

holding inventory. The production manager favors relatively higher levels
of inventory so that production process runs smoothly. The marketing
manager prefers to have reserves of finished goods so as to ensure timely
availability of product in the market.
6.3.1 TYPES OF INVENTORY
1. Raw Materials

2. Work-in-Progress

3. Semi-finished Goods

4. Finished Goods

5. Supplies

6. Component Parts

7. Scrap

8. Defective Work
6.3.2 MOTIVES FOR HOLDING INVENTORY
 6.3.2 FUNCTIONS OF
INVENTORY CONTROL

Functions of Inventory Control

1. Protection 2. Continuous
3. Getting Quantity
Against Production for
Discounts
Uncertainties Seasonal Goods
 7. SOURCES OF WORKING CAPITAL

Debentures Retained
Shares
Earnings

NRI Fund Commercial

Banks
Urban Co-
operative SOURCES Loans
Banks OF
WORKING
Money CAPITAL Commercial
Lenders Paper

Public Certificate of
Deposits Deposits

Trade Commercial
Creditors Factoring Bills Market
 7.1 FACTORING
Factoring is a financial transaction and a type of debtor finance in which a
business sells its accounts receivable (i.e., invoices) to a third party (called
a factor) at a discount. In this purchase, accounts receivable are discounted in
order to allow the buyer to make a profit upon the settlement of the debt. A
business will sometimes factor its receivable assets to meet its present and
immediate cash needs. Essentially factoring transfers the ownership of
accounts to another party that then chases up the debt.

Forfaiting is a factoring arrangement used in international trade

finance by exporters who wish to sell their receivables to a
forfaiter. Factoring is commonly referred to as accounts receivable factoring,
invoice factoring, and sometimes accounts receivable financing. Accounts
receivable financing is a term more accurately used to describe a form
of asset based lending against accounts receivable.
 7.1.1 FUNCTIONS OF A FACTOR
i. Financing of trade debts.
ii. Collection of accounts receivables
iii. Assumption of risk in some cases.
iv. Advisory role for its clients.

7.1.2 PROCESS / MECHANISM OF

FACTORING