Working Capital Management

Last Updated: 30 Dec 2020
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I extend my sincere thanks to our Director, Prof. B. Srinivasan for inculcating in us, a passion for excellence in all our activities including this project. I am grateful to my external guide Mr. O. ARIVAZHAGAN, CEO, International Institute of Project Management (IIPM) for providing me the much needed practical insights and guidance in carrying out this project.

I would also like to acknowledge with thanks, the support received from the other office staff, had the patience to teach and give an exposure into the corporate world. I would also acknowledge Mr. Sampath Kumar who taught the basic concepts clearly. I would extend my hearty gratitude towards my family and friends who gave me full support for completing the project.

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In a perfect world, there would be no necessity for current assets and liabilities because there would be no uncertainty, no transaction costs, information search costs, scheduling costs, or production and technology constraints. The unit cost of production would not vary with the quantity produced. Borrowing and lending rates shall be same.

Capital, labor, and product market shall be perfectly competitive and would reflect all available information, thus in such an environment, there would be no advantage for investing in short term assets. However the world we live is not perfect. It is characterized by considerable amount of uncertainty regarding the demand, market price, quality and availability of own products and those of suppliers. There are transaction costs for purchasing or selling goods or securities. Information is costly to obtain and is not equally distributed.

There are spreads between the borrowings and lending rates for investments and financing of equal risks. Similarly each organization is faced with its own limits on the production capacity and technologies it can employ there are fixed as well as variable costs associated with production goods. In other words, the markets in which real firm operated are not perfectly competitive. These real world circumstances introduce problem’s which require the necessity of maintaining working capital. In corporate financial management, the term Working capital management” (net) represents the excess of current assets over current liabilities.


In simple words working capital is the excess of current Assets over Current liabilities. Working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. Working capital management entails short term decisions - generally, relating to the next one year period - which is "reversible". Decisions relating to working capital and short term financing are referred to as working capital management.

This involves managing the relationship between a firm's short-term assets and its short-term liabilities. There are many advantages to a business that actively manages its cash flow. There are a number of different ways to calculate working capital, because each firm may have a slightly different way of doing business. The formula used in this report is more accurate. This report explains about the effective management of Working Capital and its advantages to the company . It also gives knowledge regarding negative working capital and Inventory being treated as an liability rather than asset.

Company Background: International Institute of Project Management (IIPM) was founded in the year 2001 with the aim to advance the profession of Project Management in India and Asia-pacific region in the fields of Software projects, Construction projects, Manufacturing / New product Development projects and Entertainment projects. IIPM is committed to providing Consulting and Training services in the above areas using the state -of-the art- tools, software and techniques for the potential clients. IIPM's motto is "International standards of Project Management Services in Asia”.

Construction, IT / IS, New Product Development (NPD), Event Management businesses use Project Management to manage Projects within time & cost budgets with limited resources and under critical constraints. Courses offered will provide Training that will equip attendees with the basics of Modern Project Management - Tools and Techniques so as to complete projects on time and within budget with emphasize on IT / Construction PM. In addition to the regular onsite/offsite Project Management training courses and workshops, they also offer our services in the following areas for corporate clients only. A custom software development for PM integration, With Excel, word, Access, MS Project 2000 and Earned value analysis, customize macro's, Menus using VBA, Extra cost claim management, Time extension verification Preparation of As-Built drawings LD / Penalty Claims Base line schedule preparation for new projects in MS project 98 / 00 Primavera P3 [by special arrangement] Site progress video graph Still digital photographs ( for E-mail / Internet publishing ) Independent peer-review of project progress Expert witness for project related court claims Aims and Objectives: Know what Project Management is. Responsibilities of a Project Management. ?Define clear scope for your Projects. Estimation Techniques. ?Construction / IT Project Management Develop a W. B. S / OBS to freeze the scope. Avoid scope creep. Learn CPM / PERT Techniques. ?Introduction to PM Software Packages Learn how to handle project change orders Learn the Soft Skills / People skills a PM has to possess. ?Learn the Contract Types / Procurement methods etc. Esteemed Clients: World Bank, Larsen, HP, Polaris, HCL, Infosys, Tata Consultancy Services, IBM, Cognizant, Sutherland , Royal Bank of Scotland, Airtel, HSBC, FLsmidth, InfoTech, ITC, Suzlon etc.

Introduction: Working capital (abbreviated WC) is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Net working capital is calculated as current assets minus current liabilities. It is a derivation of working capital that is commonly used in valuation techniques such as DCFs (Discounted cash flows). If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit. The business uses cash to acquire resources (assets such as stocks) •The resources are put to work and goods and services produced. These are then sold to customers •Some customers pay in cash (great), but others ask for time to pay. Eventually they pay and these funds are used to settle any liabilities of the business (e. g. pay suppliers) •And so the cycle repeats Hopefully, each time through the cash flow cycle, a little more money is put back into the business than flows out. But not necessarily, and if monitor cash flow and take corrective action when necessary, a business may find itself sinking into trouble.

The cash needed to make the cycle above work effectively is known as working capital. Working capital also gives investors an idea of the company's underlying operational efficiency. Money that is tied up in inventory or money that customers still owe to the company cannot be used to pay off any of the company's obligations So, if a company is not operating in the most efficient manner (slow collection), it will show up as an increase in the working capital. This can be seen by comparing the working capital from one period to another.

Effective management and control of various components of the Working Capital has been rated as one of the most important function of financial management in any of the industrial and business units. Every business needs adequate liquid resources in order to maintain day-to-day cash flow. It needs enough cash to pay wages and salaries as they fall due and to pay creditors if it is to keep its workforce and ensure its supplies. Maintaining adequate working capital is not just important in the short-term. Sufficient liquidity must be maintained in order to ensure the survival of the business in the long-term as well.

Even a profitable business may fail if it does not have adequate cash flow to meet its liabilities as they fall due. Working Capital Management is concerned with the problems that arise in attempting to manage the Current Assets, the Current Liabilities and the inter-relationship that exists between them.


Working capital may be classified in to ways: 1. On the basis of concept. On the basis of time. On the basis of concept working capital can be classified as gross working capital and net working capital. On the basis of time, working capital may be classified as: 1. Permanent or fixed working capital. . Temporary or variable working capital


Permanent or fixed working capital is minimum amount which is required to ensure effective utilization of fixed facilities and for maintaining the circulation of current assets. Every firm has to maintain a minimum level of raw material, work- in-process, finished goods and cash balance. This minimum level of current assts is called permanent or fixed working capital as this part of working is permanently blocked in current assets. As the business grow the requirements of working capital also increases due to increase in current assets.


Temporary or variable working capital is the amount of working capital which is required to meet the seasonal demands and some special exigencies. Variable working capital can further be classified as seasonal working capital and special working capital. The capital required to meet the seasonal need of the enterprise is called seasonal working capital. Special working capital is that part of working capital which is required to meet special exigencies such as launching of extensive marketing for conducting research, etc.

Temporary working capital differs from permanent working capital in the sense that is required for short periods and cannot be permanently employed gainfully in the business.


NATURE OF THE BUSINESS: The requirements of working is very limited in public utility undertakings such as electricity, water supply and railways because they offer cash sale only and supply services not products, and no funds are tied up in inventories and receivables. On the other hand the trading and financial firms requires less investment in fixed assets but have to invest large amt. f working capital along with fixed investments.

SIZE OF THE BUSINESS: Greater the size of the business, greater is the requirement of working capital.

PRODUCTION POLICY: If the policy is to keep production steady by accumulating inventories it will require higher working capital.

LENTH OF PRDUCTION CYCLE: The longer the manufacturing time the raw material and other supplies have to be carried for a longer in the process with progressive increment of labor and service costs before the final product is obtained.

So working capital is directly proportional to the length of the manufacturing process.

SEASONALS VARIATIONS: Generally, during the busy season, a firm requires larger working capital than in slack season.

WORKING CAPITAL CYCLE: The speed with which the working cycle completes one cycle determines the requirements of working capital. Longer the cycle larger is the requirement of working capital.

RATE OF STOCK TURNOVER: There is an inverse co-relationship between the question of working capital and the velocity or speed with which the sales are affected.

A firm having a high rate of stock turnover will needs lower amt. of working capital as compared to a firm having a low rate of turnover. 8.

CREDIT POLICY: A concern that purchases its requirements on credit and sales its product / services on cash requires lesser amt. of working capital and vice-versa.

BUSINESS CYCLE: In period of boom, when the business is prosperous, there is need for larger amt. of working capital due to rise in sales, rise in prices, optimistic expansion of business, etc.

On the contrary in time of depression, the business contracts, sales decline, difficulties are faced in collection from debtor and the firm may have a large amt. of working capital.

RATE OF GROWTH OF BUSINESS: In faster growing concern, we shall require large amt. of working capital.

EARNING CAPACITY AND DIVIDEND POLICY: Some firms have more earning capacity than other due to quality of their products, monopoly conditions, etc. Such firms may generate cash profits from operations and contribute to their working capital.

The dividend policy also affects the requirement of working capital. A firm maintaining a steady high rate of cash dividend irrespective of its profits, needs working capital than the firm that retains larger part of its profits and does not pay so high rate of cash dividend.

PRICE LEVEL CHANGES: Changes in the price level also affect the working capital requirements. Generally rise in prices leads to increase in working capital. Working Capital Management: Working Capital Management will use a combination of policies and techniques for the management of working capital.

The policies aim at managing the current assets (generally cash and cash equivalents, inventories and debtors) and the short term financing, such that cash flows and returns are acceptable. There are 3 main points to working capital management: 1. Consider the need for working capital, 2. get the optimum level of working capital where profitability and risks are in balance, and use liquidity and 3. Profitability policies of working capital. Cash Management. Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs.

Inventory Management. Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials - and minimizes reordering costs - and hence increases cash flow. Besides this, the lead times in production should be lowered to reduce Work in Process (WIP) and similarly, the Finished Goods should be kept on as low level as possible to avoid over production - see Supply chain management; Just In Time (JIT);Economic order quantity (EOQ); Economic quantity Debtor’s Management. Identify the appropriate credit policy, i. . credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa); see Discounts and allowances. Short term financing. Identify the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan (or overdraft), or to "convert debtors to cash".

Working Capital and Cash Conversion Cycle

The cash conversion cycle (CCC) is a key measurement of small business liquidity. The cash conversion cycle is the number of days between paying for raw materials or goods to be resold and receiving the cash from the sale of the goods either made from that raw material or purchased for resale. The cash conversion cycle measures the time between outlay of cash and the cash recovery. The cycle is a measure of the time that funds are tied up in the cycle. The CCC measure illustrates how quickly a company can convert its products into cash through sales.

The shorter the cycle, the more working capital a business generates, and the less it has to borrow. Effective management of the cash conversion cycle is imperative for small business owners. Indeed, the CCC is cited by economists and business consultants as one of the truest measures of business's health, particularly during periods of growth. Other often used ratios and measures of a company's activity may not provide advance notice of a cash flow problem as well as the CCC. The objective is to keep the CCC as low as possible.


Cash conversion cycle calculation

Cash conversion cycles for small businesses are predicated on four central factors:

  1. The number of days it takes customers to pay what they owe;
  2.  The number of days it takes the business to make its product (or complete its service);
  3. The number of days the product (or service) sits in inventory before it is sold;
  4.  The length of time that the small business has to pay its vendors.

The following formulas may be used to determine these factors:

  • Accounts receivable days—divide the receivables balance by the last 12 months' sales, then multiply the result by 365 (the number of days in a year). Inventory days—take the inventory balance, divide it by the last 12 months' cost of goods sold, and then multiply the result by 365.
  • Accounts payable days—take the company's payables balance, divide it by the last 12 months' cost of goods sold, and then multiply the resulting figure by 365.

This will render the number of days a company's cash is tied up and is the first step in calculating how much money the company will want to secure for its revolving line of credit. Working Capital Calculation: There are a number of different ways to calculate working apital, because each firm may have a slightly different way of doing business. The most typical way to measure working capital is current assets minus current liabilities We subtract cash under the assumption that you need some cash for emergencies, but firms certainly don't use every last dollar for everyday business needs. Some cash may be restricted from use, and various other reasons may increase the need for cash. We add back short-term debt, because it works like a businesses' credit card. Working Capital = Current Assets - Current Liabilities

Working capital ratio = Current Assets/Current Liabilities


Step 1. Total your current assets. This includes cash and assets that are liquid or easily converted into cash within 1 year, such as accounts receivable, prepaid expenses, inventory, and securities (e. g. stocks, bonds). The value of your current assets is your gross working capital. After deducting current liabilities from your current assets, you get the amount of your net working capital.

Step 2. Total your current liabilities. These are the liabilities that need to be paid within 1 year such as accounts payable, wages, dividends, and taxes.

Step 3. Calculate your working capital using this formula: Current Assets - Current Liabilities = Working Capital. If you have current assets of $50,000 and current liabilities of $24,000, your working capital will be $26,000. $50,000 (current assets) - $24,000 (current liabilities) = $26,000 (working capital) If your current liabilities are more than your current assets, the result will be a working capital deficit.

Step 4. Figure out your current ratio. The formula for current ratio is current assets divided by current liabilities. Your current ratio will give you an idea if you have enough working capital to sustain your business and meet your short-term financial obligations. The ideal current ratio is 2. If it falls below or above 2, it could be a sign of financial mismanagement. For instance, a current ratio below 2 could mean you are unable to pay off your current liabilities and a current ratio above 2 could mean a poor use of capital.

However, the current ratio will vary depending on the type of business. In this example, the current ratio is 50,000/24,000 = 2. 08 Step 5. Manage your working capital. There are 2 important things necessary in managing working capital: The ratio analysis and the management of all the components of your working capital such as inventory, accounts receivable and accounts payable.

WORKING CAPITAL TEMPLATE: (Sample) Current ratio3. 38Cash ratio0. 24 Quick ratio2. 91Working capital$3,761 AssetsLiabilities Current assets Current liabilities

Cash and cash equivalents 373 Loans payable and current portion long-term debt 38 Short-term investments 1,517 Accounts payable and accrued expenses 1,205 Accounts receivable 1,918 Income taxes payable 327 Inventories 743 Accrued retirement and profit-sharing contributions 10 Deferred income taxes 445 Prepaid expenses and other current assets 345 Total current assets $ 5,341 Total current liabilities $ 1,580

Other assets Other liabilities Property, plant, and equipment at cost 10,963 Long-term debt 2,345 Less accumulated depreciation (3,098)Accrued retirement costs 1,211 Property, plant, and equipment (net) 6,495 Deferred income taxes 485 Long-term cash investments 472 Deferred credits and other liabilities 331 Equity investments 1,972 Deferred income taxes 437 Other assets 634

Total other assets $ 17,875 Total other liabilities $ 4,372 Total assets $ 23,216 Total liabilities $ 5,952


  • Solvency of the business: Adequate working capital helps in maintaining the solvency of the business by providing uninterrupted of production.
  • Goodwill: Sufficient amount of working capital enables a firm to make prompt payments and makes and maintain the goodwill.
  • Easy loans: Adequate working capital leads to high solvency and credit standing can arrange loans from banks and other on easy and favorable terms. Cash Discounts: Adequate working capital also enables a concern to avail cash discounts on the purchases and hence reduces cost.
  • Regular Supply of Raw Material: Sufficient working capital ensures regular supply of raw material and continuous production.
  • Regular Payment of Salaries, Wages and Other Day TO Day Commitments: It leads to the satisfaction of the employees and raises the morale of its employees, increases their efficiency, reduces wastage and costs and enhances production and profits.

Exploitation of Favorable Market Conditions: If a firm is having adequate working capital then it can exploit the favorable market conditions such as purchasing its requirements in bulk when the prices are lower and holdings its inventories for higher prices. High Morale: Adequate working capital brings an environment of securities, confidence, high morale which results in overall efficiency in a business.


  1. Excessive working capital means ideal funds which earn no profit for the firm and business cannot earn the required rate of return on its investments.
  2. Redundant working capital leads to unnecessary purchasing and accumulation of inventories.
  3. Excessive working capital implies excessive debtors and defective credit policy which causes higher incidence of bad debts.
  4. It may reduce the overall efficiency of the business.
  5. If a firm is having excessive working capital then the relations with banks and other financial institution may not be maintained.
  6. Due to lower rate of return n investments, the values of shares may also fall.
  7. The redundant working capital gives rise to speculative transactions.


  1. It puts at rest the development of the firm, because due to inadequate working capital management is unable to work on profitable projects.
  2. Fixed assets cannot be utilized properly.
  3. Return on investment decreases
  4. Management cannot take advantage of business opportunities.
  5. Production process stops due to lack of raw materials
  6. Decrease in stock of finished goods causes loss of sales.
  7. Inability to pay short term liabilities 8. Goodwill will be affected.

Emerging concepts: Negative working capital: The state where a company is operating with no capital because the company's current liabilities exceed the available current assets is termed as NEGATIVE WORKING CAPITAL. A company cannot operate with negative working capital for an extended period of time because the company will be unable to meet payment requirements on certain liabilities if the additional funds are not acquired. A company can quickly identify this state by looking at the accounts receivable information and comparing that to accounts payable information.

Negative working capital simply means the company’s financial position is operating under water. In layperson’s language the company does not have sufficient assets to cover their ongoing bills coming due. Unless management undertakes dramatic action, the company will be out of business. Negative Working Capital Can Be Good: Some companies can generate cash so quickly they actually have a negative working capital. This is generally true of companies in the restaurant business (McDonald's had a negative working capital of $698. 5 million between 1999 and 2000).

Amazon. com is another example. This happens because customers pay upfront and so rapidly, the business has no problems raising cash. In these companies, products are delivered and sold to the customer before the company ever pays for them. The bottom line: A negative working capital is a sign of managerial efficiency in a business with low inventory and accounts receivable (which means they operate on an almost strictly cash basis). In any other situation, it is a sign a company may be facing bankruptcy or serious financial trouble. Inventory is not an asset:

Inventory is shown as one of the component of current asset on the balance sheet; Inventory is insidious in that it often, slowly, consumes a lot of the resources of a company. Of course, most companies do need a certain level of inventory in order to meet the demands of customers. This is termed as Minimum Stock Level (MSL). The minimum level or minimum stock is that level of stock below which stock should not be allowed falling. In case of any item falling below this level, there is danger of stopping of production and, therefore, the management should give top priority to the acquisition of new supplies.

There will almost always be a Lead time for operations to put up a purchase request and then purchase to deal with suppliers and then suppliers to take time to manufacture the items and then have the items delivered to the location of use. Depending on the type of products, and the availability of readymade stocks, the lead time could be in days or even months. Supposing the lead time to have shipments sent to you is 3 months, then you should standby stock for 3 months ON TOP OF the minimum stock level. Operations have to rely on demand forecasts to establish the stock level required for the lead time.

The minimum stock level can always be maintained when the reorder level takes care of the stock required during the lead time. In most cases, inventory is purchased and paid before it is sold to a customer. For some period of time it sits in a warehouse, and the cost of carrying that inventory (i. e. , interest expense) reduces the company's profits. Moving the inventory always raises the possibility of damage, but some inventory will diminish in value just sitting there. Maintaining large levels of inventory requires people to manage it, adding wages, benefits and other costs, when the company is not selling it quickly.

Otherwise it is an expensive liability. Spending time actively managing inventory will reap rewards—cash rewards. In almost every industry, the day the brand new product comes off the manufacturing line is when it is most valuable. Every week, day, minute afterwards the inventory is at risk of losing value: whether it is actual expiration dates/best before dates for food products, technology obsolescence as everyone is pushing for the next generation product or the latest edition update to a college text book.

This is why FIFO (first in first out) is such a popular pick algorithm as it rids the business of the asset that is declining the fastest and keeps the product with the longest runway on the shelf. Another reason inventory is not an asset is the working capital it ties up. Every piece of inventory your company has in its possession is money that could potentially be used elsewhere in the business. The company loses the “options” to find the best return those dollars could generate.

While it is quite possible putting that money into inventory of a hot product is absolutely the right decision, once the decision is made you cannot get that dollar back and put it into R or hiring a new person. This makes it absolutely essential that your company watch closely your investment in inventory. As in practice, inventory looks more like a liability than it does an asset. This is true for five reasons:

  1. Inventory is purchased on credit, which uses up a company's liquidity,
  2. Inventory consumes administrative, physical, and transactional resources,
  3. Inventory is inherently perishable and decreases in value the longer it sits,
  4. Inventory can only be disposed of profitably by transforming it into products,
  5. . Inventory reduces a company's ability to respond to the marketplace.

MY learning: Total working capital management: Perception Reality Working capital is a : Working capital is a : Financial issue Operational issue Balance sheet itemProfit and loss item Is improved through IT or system changes

Is improved through changing the way people work An issue that generates little value or benefitIt is a fast way to enhance shareholder benefit Positive working capital is goodNegative working capital is preferred Inventory is treated as an assetInventory is treated as liability


The working capital ratio is a key figure in financial management. It characterizes how many financial funds are required by short term, operating activities. The core objective is maintaining the lowest working capital as possible in order to reduce financial responsibility, without endangering the ability to operate the business.

There are many advantages to a Company that actively manages its cash flow:

  • It knows where its cash is tied up, spotting potential bottlenecks and acting to reduce their impact
  • It can plan ahead with more confidence. Management are in better control of the business and can make informed decisions for future development and expansion
  • It can reduce its dependence on the bank and save interest charges
  • It can identify surpluses which can be invested to earn interest. Whether it is positive working capital or Negative working capital, effective management of working capital will lead the business to a successful path for any business.


  1. Working capital management by Sathish . B. Mathur Working capital management by Narender Kumar Jain Working capital management- a comparative study by A. VijayaKumar http://logistics. http://wiki. answers. com/Q/Is_inventory_an_asset_or_liability
  2. http://en. wikipedia. org/wiki/Asset http://publib. boulder. ibm. com/infocenter/wchelp/v5r6/index. jsp? topic=/ commerce. data. doc/concepts/cin_iminventoryasset. htm
  3. http://beginnersinvest. about. com/od/analyzingabalancesheet/a/negative-working-capital. htm http://iipmchennai. org/

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