What is Working Capital Management?

Working Capital Management: It is a management of inventory, cash and account receivable in a company. By managing working capital company is able to pay its day to day operating expenses.

Formula:

Net Working Capital = Current Assets – Current Liabilities

Net Operating Working Capital = Operating Current Assets – Operating Current Liabilities

Working capital Cycle: It is a process of conversion starts from purchasing a raw material and ends with receiving cash from debtors. It is also known as operating cycle. There are 5 stages in operating cycle:

·         Storage of raw material: It is a period in which raw materials are kept in store if there is a time for conversion of raw material into processing level.

Raw material storage period = Average stock of raw material / Average daily consumption of raw material

Average stock of raw material = (Opening stock + Closing stock) / 2

Average daily consumption = Total consumption of raw material / Number of working days in a year

·         Processing period: It takes time to convert the raw material into finished goods.

Processing period = Average stock of work in progress / Average daily cost of production

Average stock of work in progress = (Opening work in progress + Closing work in progress) / 2

Average daily cost of production = Total cost of production / 365

·         Finished goods period: There is a time gap between finished goods convert into sales.

Finished goods period = Average cost of finished goods / Average daily cost of goods sold

Average cost of finished goods = (Opening finished goods + Closing finished goods) / 2

Average daily cost of goods sold = Total cost of goods sold / 365

·         Accounts Receivable period: It is a period in which finished goods sold in credit to debtors.

Accounts Receivable Period = Average debtors / Average credit sales

Average debtors = (Opening debtors + Closing debtors) / 2

Average credit sales = Total credit sales / 365

·         Accounts Payable Period: It is a period in which cash is paid to raw material supplier which is purchases in credit.

Accounts Payable Period = Average creditors / Average credit purchases

Average creditors = (Opening creditors + Closing Creditors) / 2

Average credit purchases = Total credit purchases / 365

Working Capital strategies:

There are 3 strategies used in working capital management:

·         

      Aggressive working capital policy: In this policy the company finances its some part of permanent working capital from short term and the remaining part with long term sources. It increases the risk level and also increases the chance of high return. It reduces the liquidity in the company.

·         Conservative working capital policy:  In this policy the company uses the long term source to finance its permanent working capital and small part of temporary working capital. It reduces the risk level and increases the liquidity level in a company.

·         Matching/Hedging working capital policy: In this policy the company finances its permanent working capital through long term source and fluctuating working capital with short term source.

   

      Importance of working Capital management:

·         There is a time gap between conversions of raw material into cash.  At that time working capital is require to meet operating expenses and pay short term liabilities.

·         Company needs optimum working capital because high working capital in a company leads wastage of funds and there is no return on that capital and low working capital leads to low liquidity in a company and increases the risk level.

·         If a company has optimum working capital it increases the credit worthiness of company.