• Working capital typically means the firm’s holding of current or short-term
assets such as cash, receivables, inventory and marketable securities.
• These items are also referred to as circulating capital.
• Corporate executives devote a considerable amount of attention to the
management of working capital.
• Working Capital refers to that part of the firm’s capital, which is required for
financing short-term or current assets such a cash marketable securities,
debtors and inventories. Funds thus, invested in current assets keep
revolving fast and are constantly converted into cash and this cash flow out
again in exchange for other current assets. Working Capital is also known
as revolving or circulating capital or short-term capital.
• There are two concepts of working capital:
• Gross working capital: total of all current assets
• Net working capital: excess of current assets over current liabilities /
difference between current assets and current liabilities
• Working capital, also known as net working capital or NWC, is a financial
metric which represents operating liquidity available to a business.
• Working capital is really what a part of long term finance is locked in and
used for supporting current activities.
• circulating 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, receivable to cash.
• Along with fixed assets such as plant and equipment, working capital is
considered a part of operating capital.
• If current assets are less than current liabilities, an entity has a working
capital deficiency, also called a working capital deficit.
• When firms speak of shortage of working capital they in fact possibly imply
scarcity of cash resources.
• The firm has to maintain cash balance to pay the bills as they come due.
• In addition, the company must invest in inventories to fill customer orders
• And finally, the company invests in accounts receivable to extend credit to
• Operating cycle is equal to the length of inventory and receivable
• The size and nature of investment in current assets is a function of different
factors such as type of products manufactured, the length of operating
cycle, the sales level, inventory policies, unexpected demand and
unanticipated delays in obtaining new inventories, credit policies and current
• Working capital management involves the relationship between a firm's short-term
assets and its short-term liabilities.
• Working capital management/short-term financial management is concerned with
decisions relating to current assets and current liabilities.
• The key difference between long-term financial management and working capital
management is in terms of the timing of cash. While long term financial decisions
like buying capital equipment or issuing debentures involve cash flows over an
extended period of time, short term financial decisions typically involve cash flows
within a year or within the operating cycle of the firm.
• The goal of working capital management is to ensure that a firm is able to continue
its operations and that it has sufficient ability to satisfy both maturing short-term debt
and upcoming operational expenses.
• The management of working capital involves managing inventories, accounts
receivable and payable, and cash.
• Characteristics of current assets:
• Short life span
• Swift transformation into other assets forms
TYPES OF WORKING CAPITAL
BASIS OF BASIS OF
Gross Net Permanent Temporary
Working Working / Fixed / Variable
Capital Capital WC WC
Operating cycle of a typical company
• Importance of working capital
– Risk and uncertainty involved in managing the cash flows
– Uncertainty in demand and supply of goods, escalation in cost both
operating and financing costs.
• Strategies to overcome the problem
– Manage working capital investment or financing such as
– Holding additional cash balances beyond expected needs
– Holding a reserve of short term marketable securities
– Arrange for availability of additional short-term borrowing capacity
– One of the ways to address the problem of fixed set-up cost may be to
– One or combination of the above strategies will target the problem
• Working capital cycle is the life-blood of the firm
Difference between permanent & temporary working
Amount Variable Working Capital
Permanent Working Capital
Variable Working Capital
Permanent Working Capital
FACTORS DETERMINING WORKING CAPITAL
• Nature of the Industry
• Demand of Industry
• Cash requirements
• Nature of the Business
• Manufacturing time
• Volume of Sales
• Terms of Purchase and Sales
• Inventory Turnover
• Business Turnover
• Business Cycle
• Current Assets requirements
• Production Cycle
• Credit control
• Inflation or Price level changes
• Profit planning and control
• Repayment ability
• Cash reserves
• Operation efficiency
• Change in Technology
• Firm’s finance and dividend policy
• Attitude towards Risk
• EXCESS OR INADEQUATE WORKING CAPITAL
• Every business concern should have adequate working capital to run its
business operations. It should have neither redundant or excess working
capital nor inadequate or shortage of working capital.
• Both excess as well as shortage of working capital situations are bad for
any business. However, out of the two, inadequacy or shortage of working
capital is more dangerous from the point of view of the firm.
Disadvantages of Redundant or Excess Working Capital
õ Idle funds, non-profitable for business, poor ROI
õ Unnecessary purchasing & accumulation of inventories over required
õ Excessive debtors and defective credit policy, higher incidence of B/D.
õ Overall inefficiency in the organization.
õ When there is excessive working capital, Credit worthiness suffers
õ Due to low rate of return on investments, the market value of shares
Disadvantages or Dangers of Inadequate or Short Working Capital
õ Can’t pay off its short-term liabilities in time.
õ Economies of scale are not possible.
õ Difficult for the firm to exploit favourable market situations
õ Day-to-day liquidity worsens
õ Improper utilization the fixed assets and ROA/ROI falls sharply
Working capital financing
• The short term sources of finance are as follows:
• Trade credit
• Working capital advance by commercial banks
• Public deposits
• Inter-corporate deposits
• Short term loans from financial institutions
• Cash credit
• Hypothecation and pledge
• Bank overdraft
• Commercial paper
• Letter of credit