Unit I: Introduction to Working Capital Management | Financial Management & Economics Finance: CA Intermediate (Old Scheme) PDF Download

 Page 1


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. 
CHAPTER 
10 
Page 2


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. 
CHAPTER 
10 
 
 
10.2 
FINANCIAL MANAGEMENT  
 
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 
 
Page 3


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. 
CHAPTER 
10 
 
 
10.2 
FINANCIAL MANAGEMENT  
 
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 
 
10.3 
MANAGEMENT OF WORKING CAPITAL 
UNIT-I 
INTRODUCTION TO WORKING CAPITAL MANAGEMENT 
 10.1 MEANING AND CONCEPT OF WORKING 
CAPITAL 
In accounting term 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 
(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: 
Page 4


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. 
CHAPTER 
10 
 
 
10.2 
FINANCIAL MANAGEMENT  
 
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 
 
10.3 
MANAGEMENT OF WORKING CAPITAL 
UNIT-I 
INTRODUCTION TO WORKING CAPITAL MANAGEMENT 
 10.1 MEANING AND CONCEPT OF WORKING 
CAPITAL 
In accounting term 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 
(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: 
 
 
10.4 
FINANCIAL MANAGEMENT  
(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.  
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 
Working capital
On the basis of Value
Gross Net
On the basis of Time
Permanent Flactuating
Page 5


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. 
CHAPTER 
10 
 
 
10.2 
FINANCIAL MANAGEMENT  
 
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 
 
10.3 
MANAGEMENT OF WORKING CAPITAL 
UNIT-I 
INTRODUCTION TO WORKING CAPITAL MANAGEMENT 
 10.1 MEANING AND CONCEPT OF WORKING 
CAPITAL 
In accounting term 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 
(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: 
 
 
10.4 
FINANCIAL MANAGEMENT  
(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.  
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 
Working capital
On the basis of Value
Gross Net
On the basis of Time
Permanent Flactuating
10.5 
MANAGEMENT OF WORKING CAPITAL 
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.    
 10.2 SIGNIFICANCE OF WORKING CAPITAL 
10.2.1 Importance of Adequate Working Capital 
Management of working capital is an essential task of the finance manager.  He has 
to ensure that the amount of working capital available is neither too large nor too 
small for its requirements.   
A large amount of working capital would mean that the company has idle funds.  
Since funds have a cost, the company has to pay huge amount as interest on such 
funds that are used to invest in surplus working capital. Another way to look at it is 
that there is an opportunity cost involved where the company could have invested 
the surplus funds in long term investments and earned some return on the same.