ICAI Notes- Unit 1: Management of Working Capital | Financial Management & Strategic Management for CA Intermediate PDF Download

 Page 1


 
 
CHAPTER 
9 
LEARNING OUTCOMES 
MANAGEMENT OF
WORKING CAPITAL
? Understanding the meaning, need and importance of working capital for
smooth functioning of an entity.
? Understanding the factors which determine the working capital.
? Learning the methods of estimating working capital.
? Understanding the various components of working capital with its
management.
? Understanding methods of receivable management.
? Learning the methods of evaluating receivables and implementation of
credit policy.
? Learning the importance and management of treasury (cash) in an entity.
? Learning the various sources of working capital finance.
? Learning the importance of optimal inventory level and management of
payables.
@The Institute of Chartered Accountants of India
Page 2


 
 
CHAPTER 
9 
LEARNING OUTCOMES 
MANAGEMENT OF
WORKING CAPITAL
? Understanding the meaning, need and importance of working capital for
smooth functioning of an entity.
? Understanding the factors which determine the working capital.
? Learning the methods of estimating working capital.
? Understanding the various components of working capital with its
management.
? Understanding methods of receivable management.
? Learning the methods of evaluating receivables and implementation of
credit policy.
? Learning the importance and management of treasury (cash) in an entity.
? Learning the various sources of working capital finance.
? Learning the importance of optimal inventory level and management of
payables.
@The Institute of Chartered Accountants of India
 
 
 
FINANCIAL MANAGEMENT 
 
9.2 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
This chapter is Divided into Six Units: 
UNIT I: Introduction to Working Capital Management 
UNIT II: Treasury and Cash Management 
UNIT III: Management of Inventory 
UNIT IV: Management of Receivables 
UNIT V: Management of Payables 
UNIT VI: Financing of Working Capital 
CHAPTER OVERVIEW 
 
Management of Working Capital 
Determinants of 
Working Capital 
Estimation of Working 
Capital 
Working Capital Cycles 
Inventory 
Management 
Payables Management 
Financing of  
Working Capital  
Cash (Treasury) 
Management: 
? Functions of Treasury 
Department 
? Treasury Management 
? Cash Management 
Models 
Receivable 
Management: 
? Factors determining 
credit policy 
? Financing of 
receivables 
? Monitoring of 
receivables 
@The Institute of Chartered Accountants of India
Page 3


 
 
CHAPTER 
9 
LEARNING OUTCOMES 
MANAGEMENT OF
WORKING CAPITAL
? Understanding the meaning, need and importance of working capital for
smooth functioning of an entity.
? Understanding the factors which determine the working capital.
? Learning the methods of estimating working capital.
? Understanding the various components of working capital with its
management.
? Understanding methods of receivable management.
? Learning the methods of evaluating receivables and implementation of
credit policy.
? Learning the importance and management of treasury (cash) in an entity.
? Learning the various sources of working capital finance.
? Learning the importance of optimal inventory level and management of
payables.
@The Institute of Chartered Accountants of India
 
 
 
FINANCIAL MANAGEMENT 
 
9.2 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
This chapter is Divided into Six Units: 
UNIT I: Introduction to Working Capital Management 
UNIT II: Treasury and Cash Management 
UNIT III: Management of Inventory 
UNIT IV: Management of Receivables 
UNIT V: Management of Payables 
UNIT VI: Financing of Working Capital 
CHAPTER OVERVIEW 
 
Management of Working Capital 
Determinants of 
Working Capital 
Estimation of Working 
Capital 
Working Capital Cycles 
Inventory 
Management 
Payables Management 
Financing of  
Working Capital  
Cash (Treasury) 
Management: 
? Functions of Treasury 
Department 
? Treasury Management 
? Cash Management 
Models 
Receivable 
Management: 
? Factors determining 
credit policy 
? Financing of 
receivables 
? Monitoring of 
receivables 
@The Institute of Chartered Accountants of India
 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.3 
UNIT – I 
INTRODUCTION TO WORKING CAPITAL 
MANAGEMENT 
1. MEANING AND CONCEPT OF WORKING 
CAPITAL 
In accounting terms, working capital is defined as the difference between current 
assets and current liabilities. If we break down the components of working capital, 
we will find working capital as follows: 
Working Capital = Current Assets – Current Liabilities 
Current Assets:  An asset is classified as current when: 
(i) It is expected to be realised or intends to be sold or consumed in normal 
operating cycle of the entity or within twelve months after the reporting 
period whichever is longer; and 
(ii) The asset is held primarily for the purpose of trading in the ordinary course of 
business. 
For the purpose of working capital management, current assets of an entity can be 
grouped into the following categories: 
(a)  Inventory (raw material, work in process and finished goods) 
(b)  Receivables (trade receivables and bills receivables) 
(c)  Cash or cash equivalents (including short-term marketable securities) 
(d)  Prepaid expenses 
Other current assets may also include short term loans or advances, any other 
accrued revenue etc. 
Current Liabilities: A liability is classified as current when: 
(i) It is expected to be settled in normal operating cycle of the entity or within 
twelve months after the reporting period whichever is longer; and 
@The Institute of Chartered Accountants of India
Page 4


 
 
CHAPTER 
9 
LEARNING OUTCOMES 
MANAGEMENT OF
WORKING CAPITAL
? Understanding the meaning, need and importance of working capital for
smooth functioning of an entity.
? Understanding the factors which determine the working capital.
? Learning the methods of estimating working capital.
? Understanding the various components of working capital with its
management.
? Understanding methods of receivable management.
? Learning the methods of evaluating receivables and implementation of
credit policy.
? Learning the importance and management of treasury (cash) in an entity.
? Learning the various sources of working capital finance.
? Learning the importance of optimal inventory level and management of
payables.
@The Institute of Chartered Accountants of India
 
 
 
FINANCIAL MANAGEMENT 
 
9.2 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
This chapter is Divided into Six Units: 
UNIT I: Introduction to Working Capital Management 
UNIT II: Treasury and Cash Management 
UNIT III: Management of Inventory 
UNIT IV: Management of Receivables 
UNIT V: Management of Payables 
UNIT VI: Financing of Working Capital 
CHAPTER OVERVIEW 
 
Management of Working Capital 
Determinants of 
Working Capital 
Estimation of Working 
Capital 
Working Capital Cycles 
Inventory 
Management 
Payables Management 
Financing of  
Working Capital  
Cash (Treasury) 
Management: 
? Functions of Treasury 
Department 
? Treasury Management 
? Cash Management 
Models 
Receivable 
Management: 
? Factors determining 
credit policy 
? Financing of 
receivables 
? Monitoring of 
receivables 
@The Institute of Chartered Accountants of India
 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.3 
UNIT – I 
INTRODUCTION TO WORKING CAPITAL 
MANAGEMENT 
1. MEANING AND CONCEPT OF WORKING 
CAPITAL 
In accounting terms, working capital is defined as the difference between current 
assets and current liabilities. If we break down the components of working capital, 
we will find working capital as follows: 
Working Capital = Current Assets – Current Liabilities 
Current Assets:  An asset is classified as current when: 
(i) It is expected to be realised or intends to be sold or consumed in normal 
operating cycle of the entity or within twelve months after the reporting 
period whichever is longer; and 
(ii) The asset is held primarily for the purpose of trading in the ordinary course of 
business. 
For the purpose of working capital management, current assets of an entity can be 
grouped into the following categories: 
(a)  Inventory (raw material, work in process and finished goods) 
(b)  Receivables (trade receivables and bills receivables) 
(c)  Cash or cash equivalents (including short-term marketable securities) 
(d)  Prepaid expenses 
Other current assets may also include short term loans or advances, any other 
accrued revenue etc. 
Current Liabilities: A liability is classified as current when: 
(i) It is expected to be settled in normal operating cycle of the entity or within 
twelve months after the reporting period whichever is longer; and 
@The Institute of Chartered Accountants of India
 
 
 
FINANCIAL MANAGEMENT 
 
9.4 
(ii) It is settled either by the use of current assets or by creation of new current 
liability. 
For the purpose of working capital management, current liabilities of an entity can 
be grouped into the following categories: 
(a)  Payable (trade payables and bills payables) 
(b)  Outstanding payments (wages & salary, overheads & other expenses etc.) 
Other current liabilities may also include short term borrowings, current portion of 
long-term debts, short term provisions that are payable within twelve months such 
as provision for taxes etc. 
Working Capital Management is process which is designed to ensure that an 
organization operates efficiently by monitoring & utilizing its current assets and 
current liabilities to the best effect. Primary objective is to enable a company 
maintaining sufficient cash flows in order to meet its day-to-day operating 
expenses and its short-term obligations. 
The concept of working capital can also be explained through two angles.  
 
(a) Value: From the value point of view, Working Capital can be defined as Gross 
Working Capital or Net Working Capital.  
Gross working capital refers to the firm’s investment in current assets.   
Net working capital refers to the difference between current assets and current 
liabilities.  
  
Working capital
On the basis of Value
Gross Net
On the basis of Time
Permanent Fluctuating
@The Institute of Chartered Accountants of India
Page 5


 
 
CHAPTER 
9 
LEARNING OUTCOMES 
MANAGEMENT OF
WORKING CAPITAL
? Understanding the meaning, need and importance of working capital for
smooth functioning of an entity.
? Understanding the factors which determine the working capital.
? Learning the methods of estimating working capital.
? Understanding the various components of working capital with its
management.
? Understanding methods of receivable management.
? Learning the methods of evaluating receivables and implementation of
credit policy.
? Learning the importance and management of treasury (cash) in an entity.
? Learning the various sources of working capital finance.
? Learning the importance of optimal inventory level and management of
payables.
@The Institute of Chartered Accountants of India
 
 
 
FINANCIAL MANAGEMENT 
 
9.2 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
This chapter is Divided into Six Units: 
UNIT I: Introduction to Working Capital Management 
UNIT II: Treasury and Cash Management 
UNIT III: Management of Inventory 
UNIT IV: Management of Receivables 
UNIT V: Management of Payables 
UNIT VI: Financing of Working Capital 
CHAPTER OVERVIEW 
 
Management of Working Capital 
Determinants of 
Working Capital 
Estimation of Working 
Capital 
Working Capital Cycles 
Inventory 
Management 
Payables Management 
Financing of  
Working Capital  
Cash (Treasury) 
Management: 
? Functions of Treasury 
Department 
? Treasury Management 
? Cash Management 
Models 
Receivable 
Management: 
? Factors determining 
credit policy 
? Financing of 
receivables 
? Monitoring of 
receivables 
@The Institute of Chartered Accountants of India
 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.3 
UNIT – I 
INTRODUCTION TO WORKING CAPITAL 
MANAGEMENT 
1. MEANING AND CONCEPT OF WORKING 
CAPITAL 
In accounting terms, working capital is defined as the difference between current 
assets and current liabilities. If we break down the components of working capital, 
we will find working capital as follows: 
Working Capital = Current Assets – Current Liabilities 
Current Assets:  An asset is classified as current when: 
(i) It is expected to be realised or intends to be sold or consumed in normal 
operating cycle of the entity or within twelve months after the reporting 
period whichever is longer; and 
(ii) The asset is held primarily for the purpose of trading in the ordinary course of 
business. 
For the purpose of working capital management, current assets of an entity can be 
grouped into the following categories: 
(a)  Inventory (raw material, work in process and finished goods) 
(b)  Receivables (trade receivables and bills receivables) 
(c)  Cash or cash equivalents (including short-term marketable securities) 
(d)  Prepaid expenses 
Other current assets may also include short term loans or advances, any other 
accrued revenue etc. 
Current Liabilities: A liability is classified as current when: 
(i) It is expected to be settled in normal operating cycle of the entity or within 
twelve months after the reporting period whichever is longer; and 
@The Institute of Chartered Accountants of India
 
 
 
FINANCIAL MANAGEMENT 
 
9.4 
(ii) It is settled either by the use of current assets or by creation of new current 
liability. 
For the purpose of working capital management, current liabilities of an entity can 
be grouped into the following categories: 
(a)  Payable (trade payables and bills payables) 
(b)  Outstanding payments (wages & salary, overheads & other expenses etc.) 
Other current liabilities may also include short term borrowings, current portion of 
long-term debts, short term provisions that are payable within twelve months such 
as provision for taxes etc. 
Working Capital Management is process which is designed to ensure that an 
organization operates efficiently by monitoring & utilizing its current assets and 
current liabilities to the best effect. Primary objective is to enable a company 
maintaining sufficient cash flows in order to meet its day-to-day operating 
expenses and its short-term obligations. 
The concept of working capital can also be explained through two angles.  
 
(a) Value: From the value point of view, Working Capital can be defined as Gross 
Working Capital or Net Working Capital.  
Gross working capital refers to the firm’s investment in current assets.   
Net working capital refers to the difference between current assets and current 
liabilities.  
  
Working capital
On the basis of Value
Gross Net
On the basis of Time
Permanent Fluctuating
@The Institute of Chartered Accountants of India
 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.5 
A positive working capital indicates the company’s ability to pay its short-term 
liabilities. On the other hand, a negative working capital shows inability of an entity 
to meet its short-term obligations.  
(b) Time: From the point of view of time, working capital can be divided into two 
categories viz., Permanent and Fluctuating (temporary).   
Permanent working capital refers to the base working capital, which is the minimum 
level of investment in the current assets that is carried by the entity at all times to 
carry its day-to-day activities. It generally stays invested in the business, unless the 
operations are scaled up or down permanently which would also result in increase 
or decrease in permanent working capital. It is generally financed by long term 
sources of finance. 
Temporary working capital refers to that part of total working capital, which is 
required by an entity in addition to the permanent working capital.  It is also called 
variable or fluctuating working capital which is used to finance the short-term 
working capital requirements which arises due to fluctuation in sales volume. For 
instance, an organization would maintain increased levels of inventory to meet 
increased seasonal demand. 
The following diagrams shows Permanent and Temporary or Fluctuating or variable 
working capital: 
 
Both kinds of working capital i.e. permanent and fluctuating (temporary) are 
necessary to facilitate production and sales through the operating cycle.    
@The Institute of Chartered Accountants of India