introduction to working capital management

Introduction to Working Capital Management

By Jagannath Das

Eastern Institute Of Management

Working Capital Management

The goal of working Capital Management is to manage the firm’s current asset and current liabilities in such a way that a satisfactory level of working capital is maintained

Concept of Working CapitalThere are two concept of working capital:Gross and Net

Gross working Capital: it is the total current assets which represents the proportion of investment that circulates from one form to another in the ordinary conduct of business.

Net Working Capital

It is the difference between the current assets and current liabilities or alternatively the portion of current assets financed with long-term funds.Net Working Capital measures the liquidity of the firm.The three basic measures of a firms overall liquidity are – i) Current Ratio, ii) Liquidity test Ratio, iii) The Net Working Capital

Need for Working Capital

A) Operating cycle or Cash cycle- It implies the continuing flow from cash to suppliers, to inventory, to accounts receivables and back to cash.B)Permanent and temporary working capital- Permanent working capital-is a certain minimum level of working capital on a continuous and uninterrupted basis.Temporary working capital- is the working capital needed to meet seasonal as well as unforeseen requirements.

C)Changes in working capital-Changes in the level of working capital occurs due to, i)changes in the level of sales or operating expenses, ii)policy change, iii)changes in technology

Need for Working Capital

Computation of working capital

Estimation of current assets:i) Raw materials Inventory:

ii)Work-in-progress Inventory

iii)Finished goods inventory

iv)Debtors

v)Trade creditors:

Estimation of current liabilities:

vi)Direct wages

vii)Overheads other than Depreciation and Amortisation

Determination of Working capitalI)Estimation of current assets: Amount a)Minimum desired cash and bank balances *** b)Inventories: *** Raw materials *** Work-in-progress *** Finished goods *** c)Debtors *** Total Current Assets ****

II)Estimation of Current Liabilities a)Creditors *** b)Wages *** c)Overheads *** Total Current Liabilities ****

AmountIII)Net working capital (I-II) *** Add margin for contingencies ***IV)Net working capital required ***

Problem:X &Y ltd is desirous to purchase a business and has consulted you, and one point on which you are asked to advice them, is the average amount of working capital which will be required in the first years working.You are given the first years estimates and are instructed to add 10% to your computed figure to allow for contingencies.

Particulars Amount for the year

(i)Average amount backed up for stocks

Stocks of finished products Rs 5000 Stock of stores and materials Rs 8000

(ii)Average credit given: Inland sales,6weeks credit Rs312000 Export sales,1.5weeks credit Rs78000

(iii)Average time lag in payments of wages and other outgoings: Wages,1.5weeks Rs260000 Stocks and materials,1.5months Rs48000 Rent and royalties,6months Rs10000 Clerical staffs,0.5months Rs62400 Manager,0.5month Rs 4800 Miscellaneous expenses ,1.5months Rs48000

Particulars Amount for the year

(iv)Payment in advance: Sundry expenses(paid quarterly in advance) Rs8000 Undrawn profits on an average throughout the year. Rs11000

Set up your calculations for the average amount of working capital required.

Thank you