Working Capital Management Notes PDF

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Definition of Working Capital " Working capital is an excess of current assets over current liabilities. In other words, The amount of current assets which is more than current liabilities is known as Working Capital. If current liabilities are nil then, working capital will equal to current assets. Working capital shows strength of business in short period of time. If a company have some amount in the form of working capital , it means Company have liquid assets, with this money company can face every crises position in market. "

Formula of Calculating Working Capital Working Capital = Current Assets - Current Liabilities Current Assets Current assets are those assets which can be converted into cash within One year or less then one year . In current assets, we includes cash, bank, debtors, bill receivables, prepaid expenses, outstanding incomes . Current Liabilities Current Liabilities are those liabilities which can be paid to respective parties within one year or less than one year at their maturity. In current liabilities, we includes creditors, outstanding bills, bank overdraft, bills payable and short term loans, outstanding expenses, advance incomes .

Other names of Working Capital Some Professional accountants know working capital as operating capital, operating liquidity, positive working capital.

Important things about Working Capital 1. Working Capital can be negative. At that time, We add one word " deficiency" in the back of working capital . It means if Current Liabilities are more than current assets, it is known as working capital deficiency or inverse working capital or negative working capital. 2. Working capital can be easily adjusted, if Accounts manager knows different techniques of managing working capital . He can try to get short term loan or he can increase working capital by proper management of inventory and outstanding incomes and debtors . 3. Working capital can also change by Changing in Cash Conversion period. Cash conversion period is a period in which company changes current assets into cash or bank. 4. Working capital can also positive by increasing growth rate of company. If company does not invest more money and increase profit, the same amount will increase in the cash position of company and with cash company can increase their working capital position.

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Importance of Working Capital Some time, If creditors demands their money from company, at this time company's high working capital saves company from this situation . You know that selling of current assets are easy in small period of time but Company can not sell their fixed assets with in small period of time. So, If Company have sufficient working capital , Company can easily pay off the creditors and create his reputation in market . But If a company have zero working capital and then company can not pay creditors in emergency time and either company becomes bankrupt or takes loan at higher rate of Interest . In both condition , it is very dangerous and always Company's Account Manager tries to keep some amount of working capital for creating goodwill in market . Positive working capital enables also to pay day to day expenses like wages, salaries, overheads and other operating expenses. Because sufficient working capital can not only pay maturity liabilities but also outstanding liabilities without any more delay. One of advantages of positive working capital that Company can do every risky work without any tension of self security.

Optimal Level of Working Capital Optimal level of working capital is that level where company is capable to pay day to day expenses and company has enough cash to buy the stocks in case if it does not receive money from debtors on the time. This level is achieved by thinking and using the techniques of working capital management. We all know that both low level or over level of working capital is harmful for development of business. If company has not enough cash to repay its liability, it will create the risk of solvency and liquidity and company may go for liquidation. In case, company has over working capital, it will be misuse of money because that money is not gaining any earning and its opportunity cost will suffer by shareholders and ultimately it will decrease the value of share in share market. So, as finance manager, you should try to create equilibrium or optimal or optimum level of working capital.

Working Capital Forecasts Working capital forecasts means to estimate the value of working capital in one year. Following are main items which are estimated in working capital forecasts. 1. Future Operating Costs We estimated our future operating cost, more future operating cost means more need of cash and cash is the part of working capital. It means, we need more working capital in that situation. For estimating this, w analyze past income statements of company. 2. Forecast Revenue Growth By sales and other revenue's trend analysis, we can forecast revenue growth. This will tell us, how will working capital manage from revenue in future. 3. Changes of Working Capital To analyze the past working capital changes is useful for working capital future forecast. Working capital is difference between current assets and current liabilities. If we check two years' working capital changes, we can estimate what changes in working capital in next year.

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Determinants of Working Capital 1. Small or Large Business It is the first determinant of working capital that it is affected with the nature of business. Business may be small or large. In small business, company need high working capital because, small business is relating to trading of goods, for starting small business, you need very small fixed capital but need high working capital for paying day to day expenses. But in large business, we require more fixed capital than working capital for purchasing fixed asset. 2. Small or Large Demand Nature of demand also absolutely affects the working capital need. Some product can be easily sold by businessman, in that business; you need small amount of working capital because your earned money from sale can easy fulfill the shortage of working capital. But, if demand is very less, it is required that you have to invest large amount of working capital because your all fixed expenses must be paid by you. For paying fixed capital you need working capital. 3. Production Policy Production policy is also main determinant of working capital requirement. Different company may different production policy. Some companies stop or decrease the production level in off seasons, in that time, company may also reduce the number of employees or decrease the purchasing of new raw material, so, it will certainly decrease the amount of working capital but on the side, some company may continue their productions in off season, in that case, they need definitely large amount of working capital. 4. Credit Policy Credit policy is relating to purchasing and selling of goods on credit basis. If company purchases all goods on credit and sells on cash basis or advance basis, then it is certainly company need very low amount of working capital. But if in company, goods are purchased on cash basis, and sold on credit basis, it means, our earned money will receive after sometime and we require large amount of working capital for continuing our business. 5. Dividend Policy Dividend policy also effect working capital requirement. Company can distribute major part of net profit. But, if there is no reserve, we have to invest large amount in working capital because, lacking of reserve will affect on adversely on fulfill our liabilities. In that case, we have to yield working capital by taking short term loan for paying uncertain liability. 6. Working Capital Cycle Working capital cycle shows all steps which starts from cash purchasing of raw material and then this converted into finished product, after this it is converted into sale, if it is credit sale, debtors will also the part of working capital cycle and when we gets money from our debtors, it is the final part of working capital cycle. If we receive fastly from our debtors, we need small amount working capital. Otherwise, for purchasing new raw material, we need more amount of working capital.

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7. Manufacturing Cycle Manufacturing cycle means the process of converting raw material into finished product. Long manufacturing cycle will create the situation in which we require large amount of working capital. Suppose, we have to construct the building, for constructing colony of buildings, it may consume the time more than 5 years, so according to this we need working capital. 8. Business Cycle There are two main part of business cycle, one is boom and other is recession. In boom, we need high money or working capital for development of business but in recession, we need only low amount of working capital. 9. Price Level Changes If there is increasing trend of products prices, we need to store high amount of working capital, because next time, it is precisely that we have to pay more for purchasing raw material or other service expenses. Inflation and deflation are two major factors which decide the next level of working capital in business. 10. Effect of External Business Environmental Factors There are many external business environmental factors which affect the need of working capital like fiscal policy, monetary policy and bank policies and facilities.

Working Capital Management Introduction of Working Capital Management Working capital management is the device of finance. It is related to manage of current assets and current liabilities. After learning working capital management, commerce students can use this tool for fund flow analysis. Working capital is very significant for paying day to day expenses and long term liabilities. Meaning and Concept of Working Capital and its management Working capital is that part of company’s capital which is used for purchasing raw material and involve in sundry debtors. We all know that current assets are very important for proper working of fixed assets. Suppose, if you have invested your money to purchase machines of company and if you have not any more money to buy raw material, then your machinery will no use for any production without raw material. From this example, you can understand that working capital is very useful for operating any business organization. We can also take one more liquid item of current assets that is cash. If you have not cash in hand, then you can not pay for different expenses of company, and at that time, your many business works may delay for not paying certain expenses. If we define working capital in very simple form, then we can say that working capital is the excess of current assets over current liabilities. Types of Working Capital 1. Gross working capital

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Total or gross working capital is that working capital which is used for all the current assets. Total value of current assets will equal to gross working capital.

2. Net Working Capital Net working capital is the excess of current assets over current liabilities. Net Working Capital = Total Current Assets – Total Current Liabilities This amount shows that if we deduct total current liabilities from total current assets, then balance amount can be used for repayment of long term debts at any time.

3. Permanent Working Capital Permanent working capital is that amount of capital which must be in cash or current assets for continuing the activities of business. 4. Temporary Working Capital Sometime, it may possible that we have to pay fixed liabilities, at that time we need working capital which is more than permanent working capital, then this excess amount will be temporary working capital. In normal working of business, we don’t need such capital. In working capital management, we analyze following three points Ist Point What is the need for working capital? After study the nature of production, we can estimate the need for working capital. If company produces products at large scale and continues producing goods, then company needs high amount of working capital. 2nd Point What is optimum level of Working capital in business? Have you achieved the optimum level of working capital which has invested in current assets? Because high amount of working capital will decrease the return on investment and low amount of working capital will increase the risk of business. So, it is very important decision to get optimum level of working capital where both profitability and risk will be balanced. For achieving optimum level of working capital, finance manager should also study the factors which affects the requirement of working capital and different elements of current assets. If he will manage cash, debtor and inventory, then working capital will automatically optimize. 3rd Point What are main Working capital policies of businesses?

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Policies are the guidelines which are helpful to direct business. Finance manager can also make working capital policies.

1st Working capital policy Liquidity policy Under this policy, finance manager will increase the amount of liquidity for reducing the risk of business. If business has high volume of cash and bank balance, then business can easily pays his dues at maturity. But finance manger should not forget that the excess cash will not produce and earning and return on investment will decrease. So liquidity policy should be optimized. 2nd Working Capital Policy Profitability policy Under this policy, finance manger will keep low amount of cash in business and try to invest maximum amount of cash and bank balance. It will sure that profit of business will increase due to increasing of investment in proper way but risk of business will also increase because liquidity of business will decrease and it can create bankruptcy position of business. So, profitability policy should make after seeing liquidity policy and after this both policies will helpful for proper management of working capital.

Treasury Management and its Functions If we have to describe treasury management, then we can state that it is the management of cash, fund, currency, bank and financial risk. So, it is an imperative tool of finance. In this management, finance manager checks the cash inflow and outflow. He makes the list of all receivable amounts which will increase treasure house of company. He also tracks the dates in which he has to receive the fund from debtors. Under this management, he estimates all financial risk for investment of cash. All investment is on the basis of investment policy. Many organizations have separate treasury department. If company deals with foreign currency, then management of foreign currency risk is the duty of treasury department. Suppose, Google Inc. USA Company which is a MNC and it receives the fund from advertisers and shares with adsense publisher. A good treasury officer can give the advice to Google Inc. about when company should pay the bill of adsense publishers. Suppose, there are 90, 00,000 adsense publishers and approximate $ 100 which company has to pay to each Indian adsense publisher after one month. Now within 15 days, Google Inc. will choose that day when the price of dollar in Rupees will be minimum. Suppose, if company paid on 21st Feb. 2010 $100 to one publisher when the price of dollar is Rs. 46.5 and pays Rs. 2139 and if the next day, price will decrease 0 .5 dollar. Then, it means Google Inc. is in foreign currency loss Rs. 50 each publisher because, company has power to pay in next day and save Rs. 50 for each adsense publisher. If company has to pay $100, then company can receive loss of Rs. 45 Crore due to foreign currency loss. So, to manage foreign currency and control is major project under treasury management. In government departments, fund management is under treasury management. Treasury department makes map to collect for govt. treasure and decide how to use it for welfare works. Finance manager creates good relationship for getting locker facility at cheap rates and company can keep its important documents in locker of banks. These documents and commercial papers can be sold by banks in money market and company can take part in money market by indirect way. Finance manager also do the duty to

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sell company’s fixed assets at high price and he also acquire the properties for company at cheap rate for effective utilization of treasure of company.

Function of Treasury Management 1. To maintain the liquidity of business It is the main function of treasury management to maintain the liquidity of business. Without proper liquidity, it is risk for business to operate smoothly. By using cash flow analysis and working capital management. Treasury officer make good ratio of liquid assets and liquid liability. 2. To Minimize Currency Risk In above example of Google Inc. business, I have already explained that it is the function of treasury management to minimize the currency risk. For this, treasury managers touch with currency market of world. They analyze the reason of crisis in currency market. Sometime this crisis will be benefited for them because they have to pay less to other country for getting their service at cheap rates. 3. To provide quick finance to Company It is also function of treasury department to supply quick finance to company, when it needs the money. For this, a good network in financial market is required.

Management of Cash Meaning of management of cash Cash is most liquid asset just like petrol. So, it is very easy that someone can take it from your control. Management of cash teaches us to control cash in such a way that i) No one can take it without our permission. ii) It is enough for operation of company. iii) Better system of collection and payment of cash Management of Cash is the function of treasury department of company. Following are main things which are required for proper management of cash: 1. Bank Reconciliation These days, all business deals are completed with banks. Your so many cheques go to bank for collection and so many cheques are issued to other parties. But, you cash book does not match with your bank statements. For proper cash management, you should learn bank reconciliation. It means to take care the reasons of not matching cash book with bank statements. You can learn it at here. 2. Management of Online Cash Your business may be fast online just like e-bay or Amazon. All these sites provide you secure payment section

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for buying products. But, their treasury department has to do hard work to manage online cash. All online cash is watched by treasury experts. 3. ATM Transfer Even ATM transfer can be found from bank statements. But special care of ATM transfer will be helpful to your for better management. Company's officer may use ATM transfer for paying money to overseas employees. So, treasury audit officer should check whether it is issued to proper employee by proper authority. 4. Proper Transfer of Store or department cash If there are large number of stores of your company, at that time, proper transfer of store cash to head office is very necessary. Only use single bank account for all stores is not good technique. Use different bank account for different store or department. When the transfer the money to that bank account, it can be tracked. After all different banks transfer to main bank account.

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Management of Marketable Securities Planning function is very important than any other function of management of marketable securities because planning is relating to the choice of marketable securities. In money market, we can find different marketable securities, we have to decide what amount will we invest in what marketable securities? Because wrong planning may reduce our working capital, so we have to become conscious. Suppose, we invested our money in that marketable securities which were risky. Due to greed, we liquidated just 60% of our original invested money. That is wrong. We have to see both risk and return. Proper equilibriu...