UNIT V

Working Capital Management:

• Concepts & Principles of Working Capital,
• Need for working capital,
• Classification and importance of working capital,
• Working capital cycle, Inventory Management,
• Cash Management,
• Accounts receivable Management and Factoring,
• Credit policy, Financing working capital.
 Need of Working Capital
• For purchase of raw materials, components and spares.
• To pay wages and salaries.
• To incur day-to-day expenses and overhead costs such as fuel, power etc.
• To meet selling costs as packing, advertisement
• To provide credit facilities to customers.
• To maintain inventories of raw materials, work in progress, stores and spares
and finished stock.
The amount of working capital needed goes on increasing with growth and
expansion of business till it attains maturity.
 Concept of working capital
• There are two possible interpretations of the working capital
concept:
1. Balance sheet concept
2. Operating cycle concept

Balance sheet concept

There are two interpretations of working capital under the balance
sheet concept.
a. Excess of current assets over current liabilities
b. Gross or total current assets.
• The excess of current assets over current liabilities is called the net
working capital or net current assets.
• Working capital is really what a part of long term finance is locked in and
used for supporting current activities.
• The balance sheet definition of working capital is meaningful only as an
indication of the firm’s current solvency in repaying its creditors.
• When firms speak of a shortage of working capital they in fact possibly
imply scarcity of cash resources.
• In fund flow analysis, an increase in working capital, as conventionally
defined, represents employment or application of funds.
• Operating cycle concept
• A company’s operating cycle typically consists of three primary activities:
• Purchasing resources,
• Producing the product and
• Distributing (selling) the product.
These activities create funds flows that are both unsynchronized and uncertain.
Unsynchronized because cash disbursements (for example, payments for resource
purchases) usually take place before cash receipts (for example, collection of
receivables).
They are uncertain because future sales and costs, which generate the respective
receipts and disbursements, cannot be forecasted with complete accuracy.
“ 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”

……Genestenbreg
 TYPES OF WORKING CAPITAL

WORKING CAPITAL

BASIS OF BASIS OF
CONCEPT TIME

Gross Net Permanent Temporary

Working Working / Fixed / Variable
Capital Capital WC WC

Seasonal Special
WC WC
Regular Reserve
WC WC
 How Inventory Management Works?

Inventory Control
Demand Forecasting Inventory Tracking Setting Reorder Techniques Receiving and
• The process • Companies use Points
Utilize techniques Storing Inventory
begins with tools like • Inventory Order Management such as ABC
estimating future barcodes, RFID management Proper storage
analysis
demand based tags, or inventory systems define Once stock reaches practices are
(categorizing
on historical management reorder points— the reorder point, inventory by followed to
sales data, software to specific stock new orders are ensure easy
importance), Just-
market trends, monitor stock levels at which automatically or In-Time (JIT), or access, minimize
and seasonal levels in real- new orders manually triggered. damage, and
Economic Order
factors. time should be placed Quantity (EOQ) to optimize
optimize inventory warehouse space.
levels.
 Contd..

Inventory Auditing and Inventory Valuation and

Reconciliation Reporting
• Regular inventory audits, such as • Businesses use valuation
cycle counts, are conducted to methods like FIFO, LIFO, or
compare physical stock with weighted average to assess the
recorded data value of their inventory
 INVENTORY MANAGEMENT TECHNIQUES
MANAGING INVENTORIES EFFICIENTLY DEPENDS ON TWO QUESTIONS

1. How much should be ordered?

2. When it should be ordered?

The first question “how much to order” relates to ECONOMIC ORDER

QUANTITY and
The second question “when to order”arises because of uncertainty and
relates to determining the RE-ORDER POINT
 ECONOMIC ORDER QUANTITY [ EOQ ]
The ordering quantity problems are solved by the firm by determining the
EOQ ( or the Economic Lot Size ) that is the optimum level of inventory.
There are two types of costs involved in this model.
ordering costs
carrying costs

The EOQ is that level of inventory which MINIMIZES the total of ordering and
carrying costs.
 Cash Management

Cash Management refers to the process of managing a company’s

cash flows to ensure that there is enough cash available to meet
short-term obligations and to fund day-to-day operations. Effective
cash management involves optimizing the timing of cash inflows
and outflows, maximizing the return on cash holdings, and
minimizing the risk of loss or theft of cash.
 Components of Cash Management:

Forecasting cash flows Managing receivables: Managing payables:

• This involves estimating how • This involves monitoring the • Cash management also
much cash will be received aging of accounts receivable, involves managing accounts
from customers, when it will following up with customers payable, which refers to the
be received, and how much who have outstanding money that a company owes
cash will need to be paid out balances, and taking steps to to its suppliers and other
to suppliers, employees, and collect payment on overdue vendors.
other parties. accounts.
 Contd..

Investing cash: Managing cash balances Minimizing cash losses:

• Companies can earn a return • This involves monitoring cash • This includes implementing
on their cash holdings by balances on a regular basis, internal controls to prevent
investing excess cash in short- setting cash targets, and using fraud and theft, using secure
term investments such as cash sweep accounts to cash handling procedures, and
money market funds, automatically transfer excess ensuring that cash is properly
certificates of deposit, and cash into higher-yielding secured and stored.
Treasury bills. investment accounts.
Motives for holding Cash
1-Transaction Motive

Transaction motive refers to the need to hold cash for day-

to-day business operations.

2-Precautionary Motive: Precautionary motive is the

desire to hold cash as a buffer against uncertainties
3-Speculative Motive: Speculative motive involves
holding cash to take advantage of profitable investment
opportunities that may arise unexpectedly

4-Compensating Balance Motive:

Some firms are required to maintain a minimum cash
balance with banks as part of loan agreements or to maintain
good relationships with financial institutions
Advantages of Cash Management

Improved Maximizing
liquidity: returns:

Improved
Cost Savings:
creditworthiness:
 Disadvantages of Cash Management:

Opportunity costs: Cost of implementation

One potential • Implementing effective cash Increased risk
management practices may
disadvantage of cash require upfront investments in Effective cash
management is that technology, training, and management involves
excess cash holdings may personnel, which can be costly managing cash balances
represent missed and investing excess cash
opportunities for growth in short-term investments.
or investment
 MANAGEMENT OF RECEVABLES
Receivables ( Sundry Debtors ) result from CREDIT
SALES.
A concern is required to allow credit in order to expand
its sales volume.
Receivables contribute a significant portion of current
assets.
But for investment in receivables the firm has to incur
certain costs (opportunity cost and time value )
Further, there is a risk of BAD DEBTS also.
It is, therefore very necessary to have a proper control
and management of receivables.
 Benefits of Accounts Receivable
Management:
Better Customer
Improved Cash Flow: Reduced Bad Debts
Relationships
• Timely collection of • Implementing proper • Consistent follow-up
receivables ensures credit control and transparent
that a company has mechanisms reduces credit policies help in
sufficient cash to the risk of customers maintaining a good
meet its short-term defaulting on relationship with
obligations such as payments, customers, ensuring
payroll, utilities, and preventing significant continued business.
supplier payments losses.
 Components of Accounts Receivable
Management:
• Credit Policy:
• Invoicing:
• Monitoring and Reporting:
• Collection Process:
• Incentives and Penalties:
• Automation and Technology:
 1-Credit Policy:

Payment Terms:
Creditworthiness
The policy should define Credit Limits
Criteria
clear payment terms such as • Setting credit limits
• This can be done the duration (e.g., 30, 60, or for individual
through credit 90 days), discounts for early customers ensures
checks, reviewing payment, and penalties for that no customer is
financial statements, late payments. given more credit
and analyzing than they can afford
payment histories. to repay.
 2-Invoicing:

• Using accounting software to generate and send

Automating invoices automatically ensures that they are
sent out on time and in a consistent format.
Invoices:

• The invoice should clearly state the amount due,

Clear and the due date, and the payment terms. Including
details such as purchase orders, product
Detailed Invoices descriptions, and taxes helps avoid confusion
and disputes.
 Monitoring and Reporting:

Aging Analysis Key Performance Customer Credit

Indicators (KPIs) Reviews:

• An aging report • Companies • Periodic reviews

categorizes often track KPIs of customer
receivables such as Days accounts help
based on how Sales ensure that
long they have Outstanding customers
been (DSO), which remain
outstanding measures the creditworthy,
(e.g., 30 days, average time it and adjustments
60 days, 90+ takes to collect to credit limits
days). receivables. can be made as
necessary
 Collection Process:

Negotiation and
Payment Reminders: Escalation Procedures:
Settlements:
• Sending reminders to • If payment is • his approach can
customers as the due significantly overdue, increase the likelihood
date approaches or just the collection process of recovering at least
after the due date has may involve more part of the debt.
passed. aggressive measures
such as direct phone
calls, involving a
collections agency, or
pursuing legal action.
 Incentives and Penalties:

• Early Payment Discounts: Offering a small discount (e.g., 2%

off if paid within 10 days) encourages prompt payment and
improves cash flow.
• Late Payment Penalties: Charging interest or late fees for
overdue accounts can discourage late payments and help offset
the costs of carrying overdue receivables.
•
 Automation and Technology:

• Technology plays a significant role in improving the efficiency of

accounts receivable management. Automation tools such as
accounting software, customer relationship management (CRM)
systems, and electronic invoicing platforms can streamline
processes, reduce human error, and improve the tracking of
outstanding invoices.
 Challenges in Accounts Receivable
Management:
• While effective AR management brings numerous benefits, businesses face several
challenges:
• Customer Defaults:
• Despite careful credit assessments, some customers may still default on payments,
especially during economic downturns.
• Disputes over Invoices:
• Discrepancies between customer expectations and the invoiced amount can delay
payments. Resolving disputes requires clear communication and attention to detail.
• Cash Flow Imbalance:
• Even with a robust AR system, if a company is overly reliant on a few large
customers, delayed payments can cause significant cash flow issues.
DIMENSIONS OF RECEIVABLES MANAGEMENT

OPTIMUM LEVEL OF INVESTMENT IN TRADE RECEIVABLES

Profitability

Costs &
Profitability Optimum Level

Liquidity

Stringent Liberal