1. WorkingWorking
CapitalCapital
ManagementManagement
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2. Definition of WorkingDefinition of Working
CapitalCapital
Working Capital refers to that part of the Working Capital refers to that part of the
firm’s capital, which is required for firm’s capital, which is required for
financing short-term or current assets such a financing short-term or current assets such a
cash marketable securities, debtors and cash marketable securities, debtors and
inventories. Funds thus, invested in current inventories. Funds thus, invested in current
assets keep revolving fast and are assets keep revolving fast and are
constantly converted into cash and this cash constantly converted into cash and this cash
flow out again in exchange for other current flow out again in exchange for other current
assets. Working Capital is also known as assets. Working Capital is also known as
revolving or circulating capital or short-revolving or circulating capital or short-www.StudsPlanet.com

3. KINDS OF WORKING CAPITALKINDS OF WORKING CAPITAL
WORKING CAPITAL
BASIS OF
CONCEPT
BASIS OF
TIME
Gross
Working
Capital
Net
Working
Capital
Permanent
/ Fixed
WC
Temporary
/ Variable
WC
Regular
WC
Reserve
WC
Special
WC
Seasonal
WC
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4. Significance of Gross WCSignificance of Gross WC
 Optimum investment in CAOptimum investment in CA
Investment in CA must be adequate CA investment should not Investment in CA must be adequate CA investment should not
be inadequate or excessive inadequate WC can disturb be inadequate or excessive inadequate WC can disturb
production and can also threaten the solvency of firm , if it fails production and can also threaten the solvency of firm , if it fails
to meet its current obligation excessive investment in CA to meet its current obligation excessive investment in CA
should be avoided , since it impairs firms profitability should be avoided , since it impairs firms profitability
 Financing of CAFinancing of CA
Need for WC arises due to increasing level of business activity Need for WC arises due to increasing level of business activity
& it is to provided quickly some time surplus fund may arises & it is to provided quickly some time surplus fund may arises
which should be invested in Short term securities , they should which should be invested in Short term securities , they should
not be kept idle not be kept idle
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5. Significance of Net Working CapitalSignificance of Net Working Capital
 Maintaining Liquidity positionMaintaining Liquidity position
For maintaining liquidity position there is a For maintaining liquidity position there is a
need to maintain CA sufficiently in excess of need to maintain CA sufficiently in excess of
CL CL
 Judge Financial Soundness of a firm Judge Financial Soundness of a firm
The Net working capital helps creditors and The Net working capital helps creditors and
investors to judge financial soundness of a investors to judge financial soundness of a
firm firm
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6. BALANCE SHEET OF ABC COMPANY AS ON 31-3-2000BALANCE SHEET OF ABC COMPANY AS ON 31-3-2000
LiabilitiesLiabilities R’sR’s AssetsAssets R’sR’s
Equity SharesEquity Shares 200000200000 GoodwillGoodwill 2000020000
8% Debentures8% Debentures 100000100000 Land and BuildingLand and Building 150000150000
Reserve & SurplusReserve & Surplus 5000050000 Plant and MachineryPlant and Machinery 100000100000
Sundry CreditorsSundry Creditors 150000150000 InventoriesInventories
Bills PayableBills Payable 3000030000 Finished GoodsFinished Goods 6000060000
Outstanding ExpensesOutstanding Expenses 2000020000 Work in processWork in process 4000040000
Bank OverdraftBank Overdraft 5000050000 Prepaid ExpensesPrepaid Expenses 2000020000
Provision for TaxationProvision for Taxation 2000020000 Marketable SecuritiesMarketable Securities 6000060000
Proposed DividendProposed Dividend 3000030000 Sundry DebtorsSundry Debtors 9000090000
Bills ReceivablesBills Receivables 2000020000
Cash & Bank BalanceCash & Bank Balance 9000090000
TOTALTOTAL 650000650000 TOTALTOTAL 650000650000www.StudsPlanet.com

7. Difference between permanent & temporary workingDifference between permanent & temporary working
capitalcapital
Amount Variable Working CapitalAmount Variable Working Capital
ofof
WorkingWorking
CapitalCapital
Permanent Working CapitalPermanent Working Capital
TimeTime
Permanent and temporary working capital for Stable firm
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8. Variable Working Capital
Amount
of
Working
Capital
Permanent Working Capital
Time
Permanent and temporary working capital for Growing firm
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9.  Operating cycle conceptOperating cycle concept
 Maximization of share holder’s wealth of a firm is possible onlyMaximization of share holder’s wealth of a firm is possible only
when there are sufficient return from the operationswhen there are sufficient return from the operations
 Successful sales activity is necessary for earning profit sales do notSuccessful sales activity is necessary for earning profit sales do not
convert into cash immediatelyconvert into cash immediately
 There is invisible time lap between the sale of good and receipt ofThere is invisible time lap between the sale of good and receipt of
cashcash
 The time taken to convert raw material into cash is known asThe time taken to convert raw material into cash is known as
operating cycleoperating cycle
 Conversion of cash into raw materialConversion of cash into raw material
 Conversion of raw material into work in progressConversion of raw material into work in progress
 Conversion of Work in progress into finished goodsConversion of Work in progress into finished goods
 Conversion of finished good into Sales ( Debtors and cash )Conversion of finished good into Sales ( Debtors and cash )
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10. Operating Cycle inOperating Cycle in
Manufacturing firmManufacturing firm
Cash
Raw
Materials
W I P
Finished
Goods
Debtors SALES
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11. Operating cycle ofOperating cycle of
Non ManufacturingNon Manufacturing
FirmFirm
cash
Receivables
Stock of finished goods
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12. Formula for calculatingFormula for calculating
Operating cycle forOperating cycle for
Manufacturing firmManufacturing firm
OC = ICP+ARPOC = ICP+ARP
OC = Operating cycleOC = Operating cycle
ICP = Inventory Conversion periodICP = Inventory Conversion period
ARP = Account Receivable PeriodARP = Account Receivable Period
ICP =ICP = Average InventoryAverage Inventory
Cost of good sold /365Cost of good sold /365
ARP =ARP = Average Account ReceivableAverage Account Receivable
Sales/365Sales/365
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13.  ABC Company Provide theABC Company Provide the
following information , Computefollowing information , Compute
the operating cyclethe operating cycle
 Sales 3000 Lakhs Sales 3000 Lakhs
 Inventory Opening R’s 610 Lakhs ; Inventory Opening R’s 610 Lakhs ;
closing R’s 475 Lakhs closing R’s 475 Lakhs
 Receivable opening R’s 915 Lakhs; Receivable opening R’s 915 Lakhs;
Closing R’s 975 LakhsClosing R’s 975 Lakhs
 Cost of Goods Sold R’s 2675 LakhsCost of Goods Sold R’s 2675 Lakhs
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14. CASH CONVERSION CYCLECASH CONVERSION CYCLE
The amount of time a firm’s resources are tied The amount of time a firm’s resources are tied
up calculated by subtracting the average up calculated by subtracting the average
payment period from the operating cycle the payment period from the operating cycle the
time period between the date a firm pays its time period between the date a firm pays its
supplier and the date it receives cash from its supplier and the date it receives cash from its
customer customer
CCC = OC – APPCCC = OC – APP
AAI = AAI = Average InventoryAverage Inventory
Cost of good sold /365Cost of good sold /365
ARP = ARP = Average Account ReceivableAverage Account Receivable
Annual Sales/365 Annual Sales/365
APP = APP = Account Payable PeriodAccount Payable Period
Cost of good sold /365Cost of good sold /365
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15. Calculate CCCCalculate CCC
(CASH CONVERSION CYCLE)(CASH CONVERSION CYCLE)
 Average use of Inventory 80 daysAverage use of Inventory 80 days
 Account receivable collection period 50 daysAccount receivable collection period 50 days
 Account payable period is 40 daysAccount payable period is 40 days
CCC= OC- APPCCC= OC- APP
OC = AAI+ARPOC = AAI+ARP
80+50=13080+50=130
CCC =130-40 =90 daysCCC =130-40 =90 days
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16. Purchase of Sale of Goods Purchase of Sale of Goods Collection of Collection of
Raw Material Raw Material on Credit on Credit Account Receivables Account Receivables
On creditOn credit
Average age of Average age of Account receivableAccount receivable
Inventory Inventory (AII)(AII) period period (ARP)(ARP)
Account Payable Account Payable
Period Period (APP)(APP)
Payment to Payment to
suppliers suppliers
Receipt of InvoiceReceipt of Invoice Operating Cycle (OC)Operating Cycle (OC)
Cash Conversion cycleCash Conversion cycle
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17. Resource flows for a manufacturing firmResource flows for a manufacturing firm
Fixed
Assets
Production
Process
Generates
Inventory
Via Sales Generator
Accounts
receivable
Used in
Accrued Direct
Labour and
materials
Accrued Fixed
Operating
expenses
Cash and
Marketable
Securities
Suppliers
Of Capital
External Financing
Return on Capital
Collection
process
Used to
purchase
Used to
purchase
Used in
Working
Capital
cycle
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18. Calculate cash conversionCalculate cash conversion
cyclecycle
 Sales R’s 1587.95Sales R’s 1587.95
 Cost of Good sold R’s 1406.27Cost of Good sold R’s 1406.27
 Inventory opening 195.82, closing 202.29Inventory opening 195.82, closing 202.29
 Account receivables opening 423.03 closingAccount receivables opening 423.03 closing
449.46449.46
 Account payable opening 140.40, closingAccount payable opening 140.40, closing
168.33168.33
CCC = OC –APPCCC = OC –APP
OC = AAI + ARPOC = AAI + ARP
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19. FORECASTING / ESTIMATION OFFORECASTING / ESTIMATION OF
WORKING CAPITALWORKING CAPITAL
REQUIREMENTSREQUIREMENTS
Factors to be consideredFactors to be considered
 Total costs incurred on materials, wages and overheadsTotal costs incurred on materials, wages and overheads
 The length of time for which raw materials remain in storesThe length of time for which raw materials remain in stores
before they are issued to production.before they are issued to production.
 The length of the production cycle or WIP, i.e., the time takenThe length of the production cycle or WIP, i.e., the time taken
for conversion of RM into FG.for conversion of RM into FG.
 The length of the Sales Cycle during which FG are to be keptThe length of the Sales Cycle during which FG are to be kept
waiting for sales.waiting for sales.
 The average period of credit allowed to customers.The average period of credit allowed to customers.
 The amount of cash required to pay day-to-day expenses of theThe amount of cash required to pay day-to-day expenses of the
business.business.
 The amount of cash required for advance payments if any.The amount of cash required for advance payments if any.
 The average period of credit to be allowed by suppliers.The average period of credit to be allowed by suppliers.
 Time – lag in the payment of wages and other overheadsTime – lag in the payment of wages and other overheadswww.StudsPlanet.com

20. PROFORMA - WORKING CAPTIAL ESTIMATESPROFORMA - WORKING CAPTIAL ESTIMATES
1.1. TRADING CONCERNTRADING CONCERN
STATEMENT OF WORKING CAPITAL REQUIREMENTS
Amount (Rs.)
Current Assets
(i) Cash ----
(ii) Receivables ( For…..Month’s Sales)---- ----
(iii) Stocks ( For……Month’s Sales)----- ----
(iv)Advance Payments if any ----
Less : Current Liabilities
(i) Creditors (For….. Month’s Purchases)- ----
(ii) Lag in payment of expenses -----_
WORKING CAPITAL ( CA – CL ) xxx
Add : Provision / Margin for Contingencies -----
NET WORKING CAPITAL REQUIRED XXX
STATEMENT OF WORKING CAPITAL REQUIREMENTS
Amount (Rs.)
Current Assets
(i) Cash ----
(ii) Receivables ( For…..Month’s Sales)---- ----
(iii) Stocks ( For……Month’s Sales)----- ----
(iv)Advance Payments if any ----
Less : Current Liabilities
(i) Creditors (For….. Month’s Purchases)- ----
(ii) Lag in payment of expenses -----_
WORKING CAPITAL ( CA – CL ) xxx
Add : Provision / Margin for Contingencies -----
NET WORKING CAPITAL REQUIRED XXX
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21. 1. MANUFACTURING CONCERN1. MANUFACTURING CONCERN
STATEMENT OF WORKING CAPITAL REQUIREMENTS
Amount (Rs.)
Current Assets
(i) Stock of R M( for ….month’s consumption) -----
(ii)Work-in-progress (for…months)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(iii) Stock of Finished Goods ( for …month’s sales)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(iv) Sundry Debtors ( for …month’s sales)
(a) Raw Materials -----
(b) Direct Labour -----
(c) Overheads -----
(v) Payments in Advance (if any) -----
(iv) Balance of Cash for daily expenses -----
(vii)Any other item -----
Less : Current Liabilities
(i) Creditors (For….. Month’s Purchases) -----
(ii) Lag in payment of expenses -----
(iii) Any other -----
WORKING CAPITAL ( CA – CL )xxxx
Add : Provision / Margin for Contingencies -----
NET WORKING CAPITAL REQUIRED XXX
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22. Prepare an estimate of Working capital requirementPrepare an estimate of Working capital requirement
from the following information of a trading concern:from the following information of a trading concern:
Projected annual salesProjected annual sales 100000 units100000 units
Selling priceSelling price R’s 8 per unitR’s 8 per unit
% age of Net profit on sales% age of Net profit on sales 25%25%
Average Credit Period allowed toAverage Credit Period allowed to
customercustomer 8 weeks8 weeks
Average Credit Period allowed byAverage Credit Period allowed by
suppliersupplier 4 weeks4 weeks
Average stock holding in terma ofAverage stock holding in terma of
sales requirementsales requirement 12 weeks12 weeks
contingenciescontingencies 10%10%www.StudsPlanet.com

23. Points to be remembered whilePoints to be remembered while
estimating WCestimating WC
 (1) Profits should be ignored while calculating working capital(1) Profits should be ignored while calculating working capital
requirements for the following reasons.requirements for the following reasons.
 (a) Profits may or may not be used as working capital(a) Profits may or may not be used as working capital
 (b) Even if it is used, it may be reduced by the amount of Income tax,(b) Even if it is used, it may be reduced by the amount of Income tax,
Drawings, Dividend paid etc.Drawings, Dividend paid etc.
 (2) Calculation of WIP depends on the degree of completion as regards(2) Calculation of WIP depends on the degree of completion as regards
to materials, labour and overheads. However, if nothing is mentionedto materials, labour and overheads. However, if nothing is mentioned
in the problem, take 100% of the value as WIP. Because in such a case,in the problem, take 100% of the value as WIP. Because in such a case,
the average period of WIP must have been calculated as equivalentthe average period of WIP must have been calculated as equivalent
period of completed units.period of completed units.
 (3) Calculation of Stocks of Finished Goods and Debtors should be(3) Calculation of Stocks of Finished Goods and Debtors should be
made at cost unless otherwise asked in the question.made at cost unless otherwise asked in the question.
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24. Prepare statement ofPrepare statement of
working capital requirement,working capital requirement,
Profit &Loss A/C, BalanceProfit &Loss A/C, Balance
Sheet AssumingSheet Assuming
 Share CapitalShare Capital 150000150000
 8% Debentures8% Debentures 200000200000
 Fixed assetFixed asset 130000130000
 MaterialMaterial 40%40%
 Direct lab ourDirect lab our 20%20%
 OverheadsOverheads 20%20%
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25. The following further particular are availableThe following further particular are available
 It is proposed to maintain a level of activityIt is proposed to maintain a level of activity
of 2,00,000 unitsof 2,00,000 units
 Selling price is R’s 12/- per unitSelling price is R’s 12/- per unit
 Raw Material are expected to remain inRaw Material are expected to remain in
stores for an average period of one monthstores for an average period of one month
 Material will be in process , on averageMaterial will be in process , on average
half a monthhalf a month
 Finished goods are required to be in stockFinished goods are required to be in stock
for an average period of one monthfor an average period of one month
 Credit allow to debtors is two monthCredit allow to debtors is two month
 Credit allow by supplier is one monthCredit allow by supplier is one month
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26. Working Capital Financing MixWorking Capital Financing Mix
Approaches to Financing
Mix
The Hedging or
Matching Approach
The Conservative
Approach
The Aggressive
Approach
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27. Hedging approach to asset financingHedging approach to asset financing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-term
Debt
Long-term
Debt +
Equity
Capital
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28. The Hedging approachThe Hedging approach
 Hedging approach refers to a process ofHedging approach refers to a process of
matching maturities of debt with the maturities ofmatching maturities of debt with the maturities of
financial need . In this approach maturity offinancial need . In this approach maturity of
source of fund should match the nature of assetsource of fund should match the nature of asset
to be financedto be financed
 This approach is also known as matchingThis approach is also known as matching
approach.approach.
 The hedging approach suggests that theThe hedging approach suggests that the
permanent working capital requirement should bepermanent working capital requirement should be
financed with fund from long term sources whilefinanced with fund from long term sources while
the temporary working capital requirementthe temporary working capital requirement
should be financed with short term funds.should be financed with short term funds.www.StudsPlanet.com

29. Estimated Total Investment in Current Asset of company X forEstimated Total Investment in Current Asset of company X for
the year 2000the year 2000
MonthMonth
InvestmentInvestment
in Currentin Current
AssetAsset
(R's )(R's )
Permanent orPermanent or
FixedFixed
InvestmentsInvestments
(R's)(R's)
TemporaryTemporary
or seasonal Investor seasonal Invest
(R's)(R's)
JanuaryJanuary 5040050400 4500045000 54005400
FebruaryFebruary 5000050000 4500045000 50005000
MarchMarch 4870048700 4500045000 37003700
AprilApril 4800048000 4500045000 30003000
MayMay 4600046000 4500045000 10001000
JuneJune 4500045000 4500045000 --
JulyJuly 4750047500 4500045000 25002500
AugustAugust 4800048000 4500045000 30003000
SeptemberSeptember 4950049500 4500045000 45004500
OctoberOctober 5070050700 4500045000 57005700
NovemberNovember 5200052000 4500045000 70007000
DecemberDecember 4850048500 4500045000 35003500
TOTALTOTAL 4430044300
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30. Conservative ApproachConservative Approach
 This approach suggested that the entireThis approach suggested that the entire
estimated investments in current asset should beestimated investments in current asset should be
finance from long term source and short termfinance from long term source and short term
should be use only for emergency requirementshould be use only for emergency requirement
 Distinct features of this approachDistinct features of this approach
 Liquidity is greaterLiquidity is greater
 Risk is minimizedRisk is minimized
 The cost of financing is relatively more asThe cost of financing is relatively more as
interest has to be paid even on seasonalinterest has to be paid even on seasonal
requirement for the entire periodrequirement for the entire period
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31. Conservative approach to asset financingConservative approach to asset financing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-term
Debt
Long-term
Debt +
Equity
capital
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32. Trade off between Hedging andTrade off between Hedging and
conservative approachesconservative approaches
 The hedging approaches implies low cost , highThe hedging approaches implies low cost , high
profit and high risk while the conservativeprofit and high risk while the conservative
approach leads to high cost , low profit , low riskapproach leads to high cost , low profit , low risk
Both the approaches are the two extreme andBoth the approaches are the two extreme and
neither of them serve the purpose of efficientneither of them serve the purpose of efficient
working capital managementworking capital management
 A trade off between the two will then be anA trade off between the two will then be an
acceptable approach , One way of determiningacceptable approach , One way of determining
the trade off is by finding the AVG of maximumthe trade off is by finding the AVG of maximum
and minimum requirement of current asset orand minimum requirement of current asset or
working capitalworking capital www.StudsPlanet.com

33. Aggressive approach to asset financingAggressive approach to asset financing
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
Short-term
Debt
Long-term
Debt +
Equity
capital
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34. Aggressive approachAggressive approach
 The aggressive approach suggests that the entireThe aggressive approach suggests that the entire
estimated requirement of current asset should beestimated requirement of current asset should be
financed from short-term sources and even afinanced from short-term sources and even a
part of fixed asset investment be financed frompart of fixed asset investment be financed from
short - term sourcesshort - term sources
This approach make the finance mix :This approach make the finance mix :
 More RiskyMore Risky
 Less costlyLess costly
 More ProfitableMore Profitable
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35. Prepare a projected balancePrepare a projected balance
sheet , profit and loss a/csheet , profit and loss a/c
and then an estimation ofand then an estimation of
working capital .working capital .
 Issued Share CapitalIssued Share Capital 300000300000
 6% Debentures6% Debentures 200000200000
 Fixed assetFixed asset 200000200000
 Raw MaterialRaw Material 50%50%
 Lab ourLab our 20%20%
 OverheadsOverheads 20%20%
 ProfitProfit 10%10%
 There is a regular production andThere is a regular production and
sales cyclesales cycle
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36.  Raw Material are kept in stores for anRaw Material are kept in stores for an
average period of two monthaverage period of two month
 Finished goods remain in stock for anFinished goods remain in stock for an
average period of three monthaverage period of three month
 Production during the previous year wasProduction during the previous year was
180000 units and it is planned to maintain180000 units and it is planned to maintain
the same in the current year alsothe same in the current year also
 Each unit of production is expected to beEach unit of production is expected to be
in process for half a monthin process for half a month
 Credit allow to customer is three monthCredit allow to customer is three month
and given by supplier is two monthand given by supplier is two month
 Selling price is Rs 4 per unitSelling price is Rs 4 per unit
 Calculation of debtors may be made atCalculation of debtors may be made at
selling priceselling price www.StudsPlanet.com

37. Management of Working CapitalManagement of Working Capital
 Working capital in general practice refer to theWorking capital in general practice refer to the
excess of CA over CL.excess of CA over CL.
 Management of working capital therefore isManagement of working capital therefore is
concerned with the problems that arise inconcerned with the problems that arise in
attempting to manage the CA, the CL and theattempting to manage the CA, the CL and the
inter-relationship that exists between them.inter-relationship that exists between them.
 The basic goal of WCM is to manage the CA & CLThe basic goal of WCM is to manage the CA & CL
of a firm in such a way that a satisfactory level ofof a firm in such a way that a satisfactory level of
WC is maintained.WC is maintained.
 Working Capital Management Policies of a firmWorking Capital Management Policies of a firm
have a great effect on its profitability, liquidity andhave a great effect on its profitability, liquidity and
structural health of the organizationstructural health of the organization
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38. Working capital management is 3 dimensional inWorking capital management is 3 dimensional in
NatureNature
Dimension I
Profitability,
Risk, & Liquidity
Dimension I
Profitability,
Risk, & Liquidity
Dimension II
Composition & Level
of CA
Dimension II
Composition & Level
of CA
Dimension III
Composition & Level
of CL
Dimension III
Composition & Level
of CL
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39. Working Capital IssuesWorking Capital Issues
AssumptionsAssumptions
 50,000 maximum units50,000 maximum units
of productionof production
 Continuous productionContinuous production
 Three different policiesThree different policies
for current asset levelsfor current asset levels
are possibleare possible
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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40. Impact on LiquidityImpact on Liquidity
Liquidity AnalysisLiquidity Analysis
PolicyPolicy LiquidityLiquidity
AA HighHigh
BB AverageAverage
CC LowLow
Greater current asset levelsGreater current asset levels
generate more liquidity; allgenerate more liquidity; all
other factors held constant.other factors held constant.
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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41. Impact onImpact on
Expected ProfitabilityExpected Profitability
Return on InvestmentReturn on Investment ==
Net ProfitNet Profit
Total AssetsTotal Assets
LetLet Current AssetsCurrent Assets = (Cash += (Cash +
Rec. + Inv.)Rec. + Inv.)
Return on InvestmentReturn on Investment ==
Net ProfitNet Profit
CurrentCurrent ++ Fixed AssetsFixed Assets
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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42. Impact onImpact on
Expected ProfitabilityExpected Profitability
Profitability AnalysisProfitability Analysis
PolicyPolicy ProfitabilityProfitability
AA LowLow
BB AverageAverage
CC HighHigh
As current asset levels decline,As current asset levels decline,
total assets will decline andtotal assets will decline and
the ROI will rise.the ROI will rise.
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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43. Impact on RiskImpact on Risk
 Decreasing cashDecreasing cash reduces thereduces the
firm’s ability to meet itsfirm’s ability to meet its
financial obligations.financial obligations. MoreMore
risk!risk!
 Stricter credit policiesStricter credit policies reducereduce
receivablesreceivables and possibly loseand possibly lose
sales and customers.sales and customers. MoreMore
risk!risk!
 Lower inventory levelsLower inventory levels
increase stockouts and lostincrease stockouts and lost
sales.sales. More risk!More risk!
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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44. Impact on RiskImpact on Risk
Risk AnalysisRisk Analysis
PolicyPolicy RiskRisk
AA LowLow
BB AverageAverage
CC HighHigh
Risk increases as the level ofRisk increases as the level of
current assets are reduced.current assets are reduced.
Optimal Amount (Level) of Current AssetsOptimal Amount (Level) of Current Assets
0 25,000 50,000
OUTPUT (units)
ASSETLEVEL
Current Assets
Policy CPolicy C
Policy APolicy A
Policy BPolicy B
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45. Summary of the OptimalSummary of the Optimal
Amount of Current AssetsAmount of Current Assets
SSUMMARYUMMARY OOFF OOPTIMALPTIMAL CCURRENTURRENT AASSETSSET AANALYSISNALYSIS
PolicyPolicy LiquidityLiquidity ProfitabilityProfitability RiskRisk
AA HighHigh LowLow LowLow
BB AverageAverage AverageAverage AverageAverage
CC LowLow HighHigh HighHigh
1. Profitability varies inversely with liquidity.1. Profitability varies inversely with liquidity.
2. Profitability moves together with risk.2. Profitability moves together with risk.
(risk and return go hand in hand!)(risk and return go hand in hand!)
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46. Techniques of analysis of workingTechniques of analysis of working
capitalcapital
The analysis of working capital can be conductedThe analysis of working capital can be conducted
through a number of devices such asthrough a number of devices such as
 Ratio analysisRatio analysis
 Fund flow analysisFund flow analysis
 Working capital BudgetingWorking capital Budgeting
 Ratio analysis : A ratio is a simple arithmeticalRatio analysis : A ratio is a simple arithmetical
expression of the relationship of one number toexpression of the relationship of one number to
another , this technique can be employed foranother , this technique can be employed for
measuring short term liquidity or working capitalmeasuring short term liquidity or working capital
position of a firm.position of a firm. www.StudsPlanet.com

47. The following ratios may beThe following ratios may be
calculated for this purposecalculated for this purpose
 Liquidity RatioLiquidity Ratio
a)a) Current RatioCurrent Ratio
b)b) Acid test ratio/quick ratio/liquid ratioAcid test ratio/quick ratio/liquid ratio
c)c) Cash Position ratio/absolute liquid ratioCash Position ratio/absolute liquid ratio
 Inventory turnover ratioInventory turnover ratio
 Receivable turnover ratioReceivable turnover ratio
 Payable turnover ratioPayable turnover ratio
 Working capital turnover ratioWorking capital turnover ratio
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48.  Current ratio may be define as theCurrent ratio may be define as the
relationship between CA and CLrelationship between CA and CL
 This ratio is also known as WCR.This ratio is also known as WCR.
(Working capital ration).(Working capital ration).
 It is helpful to measure short – termIt is helpful to measure short – term
financial position or liquidity of a firmfinancial position or liquidity of a firm
Current ratio:Current ratio: Current assetCurrent asset
Current liabilitiesCurrent liabilities
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49. CURRENT ASSETS
CURRENT
LIABILITIES
Cash in hand
Bills Payable
Cash at bank Sundry Creditors
Sundry Debtors
Accrued or Outstanding
Expenses
Marketable securities
(Short term)
Short term loan and
advances
Bills Receivable Dividend payable
Inventories of Stock Bank Overdraft
Work in progress
Finished goods
Prepaid Expenses www.StudsPlanet.com

50. Quick or Acid test or LiquidQuick or Acid test or Liquid
RatioRatio
 An asset is said to be liquid if it can be convertAn asset is said to be liquid if it can be convert
into cash with in a short period with out loss ofinto cash with in a short period with out loss of
valuevalue
 Inventory cannot be termed to be liquid assetInventory cannot be termed to be liquid asset
because they cannot be convert into cashbecause they cannot be convert into cash
immediatelyimmediately
 The quick ratio can be calculatedThe quick ratio can be calculated
Quick ratio:Quick ratio: liquid assetliquid asset
Current liabilitiesCurrent liabilities
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51. Quick or liquid Current Liabilities
Cash in hand Bills Payable
Cash at bank Sundry Creditors
Sundry Debtors
Accrued or Outstanding
Expenses
Marketable securities
Short term advances
Temporary Investments Dividend payable
Bank Overdraft
Income tax payable
Convection quick ratio of 1:1 is consider satisfactory
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52. Cash Position ratio/absolute liquid ratioCash Position ratio/absolute liquid ratio
 Absolute Liquid assets include cash in hand andAbsolute Liquid assets include cash in hand and
cash at bank and marketable securities orcash at bank and marketable securities or
temporary investmentstemporary investments
 The acceptable norms for this ratio is 50% or .The acceptable norms for this ratio is 50% or .
05%05%
Cash ratio:Cash ratio: Cash & bank + Short –term securitiesCash & bank + Short –term securities
Current liabilitiesCurrent liabilities
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53. Calculate all the three ratioCalculate all the three ratio
Liabilities Rs Assets Rs
9% preference
share 500000 Goodwill 100000
Equity share
capital 1000000 Land and building 650000
8% debentures 200000 Plant 800000
Long term loan 100000
Furniture and
fixtures 150000
Bills payable 60000 Bills receivable 70000
Sundry creditors 70000 Sundry debtors 90000
Bank over draft 30000 Bank balance 45000
Outstanding
expenses 5000
short term
investments 25000
Prepaid expenses 5000
Stock 30000
1965000 1965000www.StudsPlanet.com

54. CONCLUSION:CONCLUSION:
 Current ratio of the company is notCurrent ratio of the company is not
satisfactory because the ratio 1:6 is muchsatisfactory because the ratio 1:6 is much
below then the expected Standards .below then the expected Standards .
 Acid test ratio on the other hand is moreAcid test ratio on the other hand is more
than the normal standard of 1:1than the normal standard of 1:1
 Absolute ratio is slightly low because it isAbsolute ratio is slightly low because it is
0.42 where as the accepted standard is 0.50.42 where as the accepted standard is 0.5
 In this company need to improve its shortIn this company need to improve its short
term financial positionterm financial position
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55. Inventory turnover ratioInventory turnover ratio
Inventory turn over ratio =Inventory turn over ratio = Cost of good soldCost of good sold
Average Inventory at costAverage Inventory at cost
Generally , the cost of good sold may not be knownGenerally , the cost of good sold may not be known
from the published financials , in suchfrom the published financials , in such
circumstancescircumstances
Inventory turn over ratio =Inventory turn over ratio = Net SalesNet Sales
Average Inventory at costAverage Inventory at cost
Inventory turn over ratio =Inventory turn over ratio = Cost of good soldCost of good sold
Average Inventory at selling priceAverage Inventory at selling price
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56. Inventory conversion periodInventory conversion period
Inventory conversion period =Inventory conversion period = Days in a yearDays in a year
Inventory Turnover RatioInventory Turnover Ratio
M/s Rakesh & Co supplies you the followingM/s Rakesh & Co supplies you the following
information for the year ending 31information for the year ending 31stst
Dec 1999Dec 1999
Credit Sales Rs 150000Credit Sales Rs 150000
Cash SalesCash Sales Rs 250000Rs 250000
Return Inward Rs 25000Return Inward Rs 25000
Opening Stock Rs 25000Opening Stock Rs 25000
Closing Stock Rs 35000Closing Stock Rs 35000www.StudsPlanet.com

57. Debtor/Receivable turnover ratioDebtor/Receivable turnover ratio
/Debtor velocity/Debtor velocity
Debtor(Receivable) =Debtor(Receivable) = Net credit Annual salesNet credit Annual sales
Average Trade debtorsAverage Trade debtors
Trade debtors = Sundry debtor + Bill Receivable andTrade debtors = Sundry debtor + Bill Receivable and
account receivable saccount receivable s
Average Trade Debtors = Opening Trade debtor +Average Trade Debtors = Opening Trade debtor +
Closing Trade Debtor /2Closing Trade Debtor /2
Note : Debtor should always be taken at gross value , NoNote : Debtor should always be taken at gross value , No
provision for doubtful debt be deducted from them but whenprovision for doubtful debt be deducted from them but when
the information about opening and closing balance of tradethe information about opening and closing balance of trade
debtor and credit sales is not available , then the debtorsdebtor and credit sales is not available , then the debtors
turnover ratio calculated by dividing the total sales by theturnover ratio calculated by dividing the total sales by the
balance of debtors(inclusive of Bills receivables) givenbalance of debtors(inclusive of Bills receivables) given
Debtors turn over Ratio =Debtors turn over Ratio = Total salesTotal sales
DebtorsDebtorswww.StudsPlanet.com

58. Average Collection PeriodAverage Collection Period
The average collection period represent theThe average collection period represent the
average number of days for which a firm has toaverage number of days for which a firm has to
wait before its receivable are converted into cashwait before its receivable are converted into cash
Average Collection period =Average Collection period =
Average Trade Debtors (Drs + B/R)Average Trade Debtors (Drs + B/R)
Sales per daySales per day
Sales Per daySales Per day == Net SalesNet Sales
No of working daysNo of working days
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59. OrOr
Average collection period =Average collection period =Average trade debtorsAverage trade debtors
Net SalesNet Sales
No of working daysNo of working days
If the period is in months:If the period is in months:
Average collection period =Average collection period =No of working daysNo of working days
Debtors turnover ratioDebtors turnover ratio
The two basis component of the ratio are debtorsThe two basis component of the ratio are debtors
and sales per dayand sales per day
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60. Creditor/Payable turnover ratioCreditor/Payable turnover ratio
The analysis for credit turnover is basically the sameThe analysis for credit turnover is basically the same
as of debtors turnover ratio except that in place ofas of debtors turnover ratio except that in place of
trade debtor, the trade creditor are taken and intrade debtor, the trade creditor are taken and in
place of sales , average daily purchase are taken asplace of sales , average daily purchase are taken as
the other component of the ratio.the other component of the ratio.
Creditors turnover ratioCreditors turnover ratio
== Net credit annual purchaseNet credit annual purchase
Average Trade creditorsAverage Trade creditors
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61. Average Payment period RatioAverage Payment period Ratio
= Average Trade Creditors( Creditors+ Bills= Average Trade Creditors( Creditors+ Bills
payable)/Average Daily purchases.payable)/Average Daily purchases.
Average daily purchase = Annual Purchase /No ofAverage daily purchase = Annual Purchase /No of
working days in a year.working days in a year.
Average Payment Period = Trade creditor * No ofAverage Payment Period = Trade creditor * No of
working days / Net annual purchase.working days / Net annual purchase.
Average Payment Period = No of working days /Average Payment Period = No of working days /
Credit turnover Ratio.Credit turnover Ratio.
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62. Working capital turnover ratioWorking capital turnover ratio
Working capital of a concern is directly related toWorking capital of a concern is directly related to
sales and current asset like debtors , billssales and current asset like debtors , bills
receivable , cash , stock etc .receivable , cash , stock etc .
Working capital turnover ratio = Cost of Sales /Working capital turnover ratio = Cost of Sales /
Average working capitalAverage working capital
Average working capital = Opening workingAverage working capital = Opening working
capital + Closing Working capital/2capital + Closing Working capital/2
** If cost of sales is not given , then the figure of** If cost of sales is not given , then the figure of
sale can be used . O n the other hand if openingsale can be used . O n the other hand if opening
working capital is not disclosed then workingworking capital is not disclosed then working
capital at the end of the year will be used.capital at the end of the year will be used.www.StudsPlanet.com

63. The following information is given about M/s S.PThe following information is given about M/s S.P
Ltd for the year ending Dec 31 2000Ltd for the year ending Dec 31 2000
 Stock turnover ratio = 6timesStock turnover ratio = 6times
 Gross Profit ratio = 20% on salesGross Profit ratio = 20% on sales
 Sales for 2000 = Rs 300000Sales for 2000 = Rs 300000
 Closing stock is Rs 10000 more than theClosing stock is Rs 10000 more than the
opening stockopening stock
 Opening Creditors = Rs 20000Opening Creditors = Rs 20000
 Closing Creditors = Rs 30000Closing Creditors = Rs 30000
 Trade debtor at the end = Rs 60000Trade debtor at the end = Rs 60000
 Net Working Capital = Rs 50000Net Working Capital = Rs 50000
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64.  FIND OUTFIND OUT
 Average StockAverage Stock
 PurchasesPurchases
 Credit turnover ratioCredit turnover ratio
 Average Payment PeriodAverage Payment Period
 Average Collection PeriodAverage Collection Period
 Working Capital turnover ratioWorking Capital turnover ratio
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65. Fund flow analysisFund flow analysis : Fund flow analysis is a: Fund flow analysis is a
technical device designated to study the sourcestechnical device designated to study the sources
from which additional fund were derived andfrom which additional fund were derived and
the use to which these sources were put . It is anthe use to which these sources were put . It is an
effective management tool to study change ineffective management tool to study change in
the financial position of businessthe financial position of business
The fund flow analysis consists ofThe fund flow analysis consists of
 Preparing schedule of change in working capitalPreparing schedule of change in working capital
 Statement of sources and application of fundsStatement of sources and application of funds
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66.  Working capital Budgeting : WorkingWorking capital Budgeting : Working
capital budget as a part of totalcapital budget as a part of total
budgeting process of a business , isbudgeting process of a business , is
prepared estimating future long termprepared estimating future long term
and short term working capital needand short term working capital need
and the sources of finance them .and the sources of finance them .
 The objective of a working capitalThe objective of a working capital
budget is to ensure availability of fundbudget is to ensure availability of fund
as and when needed and to ensureas and when needed and to ensure
effective utilization of these resources .effective utilization of these resources .
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