working capital assignment

Working Capital

Working capital is a measure of a company's liquidity, specifically its short-term financial health and whether it has the cash on hand for normal business operations.

The number is the difference between a company's current assets and current liabilities:

Working capital = current assets - current liabilities

Working capital is an important number when assessing a company's financial health, as a positive number is a good sign while a negative number can be a sign of a failing business.

Of note, working capital is also known as net working capital.

Below is an overview of working capital including how to calculate it, how it's used, working capital management and its ratios, and the factors that affect working capital.

What is working capital?

Working capital is a measure of a company's liquidity. Essentially, it assesses short-term financial health since it shows whether a company has enough cash to keep running.

For reference, liquidity refers to the conversion of assets into cash. Being liquid means that a company can cover the difference between the cash going in and the cash going out of the business, or, in other terms, the difference between its current assets and liabilities.

In accounting, the word “current” refers to assets and liabilities that can be sold or used in less than one year. This means they are considered cash or cash-like.

Below is a table with examples of current assets and liabilities:

If a company's short-term assets are not enough to cover its short-term liabilities, then the company may be forced to sell a long-term asset in order to cover those liabilities. An example of a long-term asset would be machinery, buildings, etc.

In this case, the company would be considered illiquid. An illiquid company may need to raise more capital, such as by taking on more debt, or even declare bankruptcy. Companies in this position are not considered to be healthy.

This is what the working capital number helps companies assess. In short, it answers the question “how financially healthy is this business?” by determining short-term liquidity.

It's also part of a business strategy called working capital management, which employs three ratios to ensure a good balance between staying liquid and using resources efficiently. These will be covered in a later section.

Summary The working capital calculation helps companies understand the difference between their current assets and liabilities. It shows whether they have enough cash to keep running, assessing their liquidity and short-term financial health.

How is working capital calculated?

Working capital is the difference between a company's current assets and current liabilities.

Both of these numbers can be found on the balance sheet , which is listed on a company's 10-Q or 10-K filing, its investor relations page, or on financial data sites like Stock Analysis .

Here's how to calculate working capital:

Example calculation

Below is an example calculation of working capital for a clothing manufacturer.

The company has USD $500,000 in current assets, consisting of cash, fabric, and finished clothes. Its current liabilities are USD $350,000, consisting of bills and short-term debts.

Here is the calculation:

$500,000 - $350,000 = $150,000

This means the company has $150,000 available, indicating it has the ability to fund its short-term obligations. This is a sign of a healthy business.

If the numbers were reversed and the company had $500,000 in liabilities and $350,000 in assets — meaning its working capital was -$150,000 — it would fail to meet its short-term obligations and would need to seek additional financing or potentially trigger a credit default.

Working capital is a bit like having cash or savings in a short-term account versus having money tied up in a house or other asset that you wouldn't be planning to sell right away.

The more surplus a business has, the more cushion it has in times of economic uncertainty. On the other hand, too much surplus cash is not an efficient use of capital. It's a balance.

Where to find working capital listed

For publicly traded companies, you likely won't need to calculate working capital yourself.

For example, below is a screenshot of Johnson and Johnson's ( JNJ ) balance sheet data. Total current assets and total current liabilities are both listed, as well as working capital, which is already calculated for you.

Source: Johnson & Johnson's Balance Sheet

Summary Working capital is calculated by deducting current liabilities from current assets. The numbers needed for the calculation can be found on a company's balance sheet or on stock data websites.

Why is working capital useful?

Working capital is a number that's useful for both companies and investors to know, as it shows whether or not a company is liquid. It can also provide insights into efficiencies.

It's a measure of liquidity and financial health

If a company has a positive working capital number, this means its current assets are greater than its current liabilities. Put simply, this indicates that the company would be able to access enough cash to cover its short-term needs.

A company in this position is financially strong and well-positioned to go forward.

If, on the other hand, a company has a negative working capital number, then it does not have the capacity to cover all of its short-term debts or cash needs using its current assets.

A company in this situation would need to sell a larger asset, such as equipment or property, if they suddenly needed to pay a debt. Or, they could consider raising funds by taking on more debt. In the worst-case scenario, the company may need to declare bankruptcy.

Such companies are considered to have poor liquidity, meaning they're financially weak.

It's an indicator of operational efficiency

Working capital is also an indicator of a company's operational efficiency, as companies that have high amounts of working capital can decide to use this to grow.

This would clearly not be an option for companies with negative working capital, since they can't even cover their short-term debts.

However, keep in mind that like all financial indicators, working capital should be used alongside other metrics to get a full picture of a company's financial situation.

Summary Working capital measures short-term financial health and operational efficiency. In short, a positive working capital number is a sign of financial strength, while a negative number is a sign of poor health, though it's still important to consider the larger picture.

Working capital management and financial ratios

Working capital management is a business strategy that companies use to monitor how efficiently they are using their current assets and liabilities.

Working capital management is focused on maintaining a sufficient cash flow that can meet short-term liabilities like operating costs or debt obligations. This is done by monitoring several ratios that are designed to ensure the company is using its resources efficiently.

The basic idea is to have enough cash or cash-like assets — that is, those that can be converted into cash in fewer than 12 months — to cover any short-term liabilities.

This focus also keeps the amount of time required to convert assets to a minimum, which is known as the net operating cycle or the cash conversion cycle.

Working capital management relies on the efficient management of the cash conversion cycle, which is the relationship of key activities that can be viewed through financial ratios.

The ratios are the current ratio, the collection ratio, and the inventory turnover ratio.

Ultimately, these ratios are a measurement of how well working capital is being managed.

The current ratio

The current ratio shows how well a company is able to meet short-term debts. It's similar to the working capital calculation, as the same inputs are used, but it results in a ratio instead.

Here is the formula:

Current ratio = current assets / current liabilities

If the current ratio is below one, then it's likely a company will struggle to cover its current liabilities, such as paying its suppliers or short-term debts.

As noted earlier, this is a sign of poor financial health and means a company may need to sell a long-term asset, take on debt, or even declare bankruptcy.

Nevertheless, it's important to note that sometimes a ratio below one is normal, though further investigation is required.

Most companies aim for a ratio between 1.2–2.0 since this shows the company has good liquidity but is not wasting money by holding on to cash or cash-like instruments that are not generating revenue. Companies with ratios above two are likely to be doing just that ( 1 ).

The collection ratio

The collection ratio looks at how well a company manages to receive payments from customers using who pay with credit.

The ratio will be lower if the company is good at getting its customers to pay within the required period but higher if not.

Effectively, this ratio looks at how easily a company can turn its accounts receivable into cash.

Collection ratio = (days in accounting period x average outstanding accounts receivables) / total net credit sales in the period

The inventory turnover ratio

The inventory turnover ratio looks at how well a company manages its inventory, which is another aspect of managing cash and cash-like assets that goes into working capital.

The balance here is between having enough inventory to meet customer needs and not miss out on any sales, versus having too much money tied up in inventory.

Inventory turnover ratio = cost of goods sold / average balance sheet inventory

If a company has a low ratio relative to its peers, then it's not selling many products from its inventory and its inventory management is likely inefficient.

If the ratio is high relative to peers, then the company is running its inventory very tightly and could end up missing out on sales if it doesn't have enough products to cover demand.

Summary Working capital management is a close analysis of assets and liabilities that focuses on maintaining sufficient cash flow to cover short-term liabilities. It relies on a few key ratios: the current ratio, the collection ratio, and the inventory turnover ratio.

Factors that affect working capital

Working capital needs vary by industry and business model. Below is more information about specific sectors as well as additional factors that play a role.

Working capital norms vary by sector

Different industries have varying norms around what's considered an ideal number.

The key consideration here is the production cycle, since this is how long it will take the company to generate liquid assets from its operations.

Some sectors, like manufacturing, have longer production cycles, meaning it takes more time to generate cash from their core operations. These industries will have higher working capital requirements since they have fewer options for covering urgent liquidity needs.

Sectors with quicker turnover, such as most service industries, will not need as much working capital because they can raise short-term funds more easily due to the nature of the business.

Other factors that affect working capital needs

In understanding whether a company or sector will have higher working capital needs, it's useful to look at the business model and operating cycle.

The operating cycle is the number of days between when a company has to spend money on inventory versus when it receives money from the sale of that inventory.

How and when companies have to fund regular expenses is also relevant.

For example, consider retail. Retail tends to have long operating cycles since companies have to buy their stock long before they can sell it. This is especially true for physical stores.

Generally, stores don't sell their goods on day one of operating. Their business model, therefore, requires them to have higher working capital in the form of inventory. This is because they can't rely on making sales if they suddenly need to pay a debt.

Retail also has periods of high sales that need to be prepared for, such as holidays. During these periods, working capital will need to be even more substantial.

Contrast this with many tech industries, which may not even sell a physical product. In these cases, working capital is lower because there are no large inventories being stored.

An example of this would be an online software company where customers download the product after purchase. Sometimes, a company like this can even get away with having a negative working capital.

Additionally, if this company was small, it could likely survive for quite some time on a very small amount of working capital. This is something to keep in mind when evaluating start-ups.

As a company grows, its overhead costs will increase. Therefore, it's important to keep an eye on the numbers as a company grows larger and its working capital needs increase. Beginning a startup is one thing, but managing it through growth is another altogether.

Summary What's considered a good or normal number for working capital varies by industry, the length of the operating cycle, timelines, company size, and other factors.

The takeaway

Working capital reveals a company's financial health by assessing how liquid it is when it comes to assets and liabilities.

Companies with a positive working capital are in a good position to be able to cover their current liabilities using their current assets.

The opposite is true for companies with negative working capital, who may need to seek financing, such as by taking on debt or selling stock, or declare bankruptcy.

Additionally, companies with solid working capital are in a good position to pay unexpected short-term costs, as well as to grow their business.

What's considered a good or normal working capital number varies by industry, as it's closely related to the business model and operating cycle — that is, when cash goes in and out.

Working capital is also part of working capital management, which is a way for companies to make sure they are sufficiently liquid yet still using cash and assets wisely.

Keep in mind that while working capital is highly useful when assessing potential investments, it should always be considered in context and alongside other metrics.

To best assess a company's financials, it's important to have a well-rounded view.

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Working Capital

Step-by-Step Guide to Understanding Working Capital in Accounting

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What is Working Capital?

Working Capital is a fundamental accounting metric that measures a company’s short-term financial health by subtracting current liabilities from current assets on the balance sheet.

The working capital metric is relied upon by practitioners to serve as a critical indicator of liquidity risk and operational efficiency of a particular business.

Conceptually, working capital represents the financial resources necessary to meet day-to-day obligations and maintain the operational cycle of a company (i.e. reinvestment activity).

Given a positive working capital balance, the underlying company is implied to have enough current assets to offset the burden of meeting short-term liabilities coming due within twelve months.

• Working capital is a critical measure of a company’s short-term liquidity and operational efficiency, calculated by subtracting current liabilities from current assets,
• Analyzing the historical trends in working capital and comparing them to industry benchmarks can provide critical insights into a company’s operating performance.
• A positive working capital balance indicates sufficient cash to meet short-term obligations, implying financial stability and operational flexibility.
• A negative working capital balance raises concerns about the company’s ability to meet short-term obligations, potentially signaling financial distress and the need for immediate liquidity.
• While high levels of working capital provide a safety cushion, excessive levels can indicate inefficient asset management, such as excess inventory or poor receivables collection.
• Effective working capital management is critical to maintaining financial resilience, supporting growth initiatives, and optimizing operational performance in a competitive business environment.

Table of Contents

How to Calculate Working Capital

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In financial accounting, working capital is a specific subset of balance sheet items and is calculated by subtracting current liabilities from current assets .

Working capital is a core component of effective financial management, which is directly tied to a company’s operational efficiency and long-term viability.

In simple terms, working capital is the net difference between a company’s current assets and current liabilities and reflects its liquidity (or the cash on hand under a hypothetical liquidation).

Therefore, working capital serves as a critical indicator of a company’s short-term liquidity position and its ability to meet immediate financial obligations.

• Current Assets ➝ Current assets can be converted into cash within one year (<12 months), such as cash and cash equivalents, marketable securities, short-term investments, accounts receivable, inventory, and prepaid expenses.
• Current Liabilities ➝ Current liabilities are short-term obligations that are due within one year (<12 months), like accounts payable, short-term loans, the current portion of long-term debt, and accrued expenses.

The working capital of a company—the difference between operating assets and operating liabilities—is used to fund day-to-day operations and meet short-term obligations.

Generally speaking, the working capital metric is a form of comparative analysis where a company’s resources with positive economic value are compared to its short-term obligations.

The management of capital is critical to the business cycle, including the acquisition of raw materials, production of goods or services, sales on credit (i.e. customer paid using credit rather than cash ), and collection of the owed payment in cash.

In the event of any unexpected occurrence that disrupts the workflow cycle, such as the unanticipated need to produce more inventory in excess of the original plan—or the delay in the issuance of an owed payment of invoices beyond 30 days—an increase in working capital can be required to sustain its operating activities.

The formula to calculate working capital—at its simplest—equals the difference between current assets and current liabilities.

• Current Assets ➝ Current assets are converted into cash within a year (<12 months).
• Current Liabilities ➝ Current liabilities are near-term obligations due within a year (<12 months)

The current assets and current liabilities are each recorded on the balance sheet of a company, as illustrated by the 10-Q filing of Alphabet, Inc (Q1-24).

The current assets section is listed in order of liquidity, whereby the most liquid assets are recorded at the top of the section.

On the other hand, the current liabilities section is listed in order of the due date, in which the near-term obligations that must be met sooner are recorded first — albeit, not all publicly-traded companies abide by that reporting convention.

Note, only the operating current assets and operating current liabilities are highlighted in the screenshot, which we’ll soon elaborate on.

Working Capital on Balance Sheet Example (Source: Alphabet Q1-2024 )

Working capital is composed of current assets and current liabilities.

• Current Assets ➝ Current assets are expected to be converted into cash within twelve months (or one year), which is the time frame deemed the standard operating cycle.
• Current Liabilities ➝ Likewise, current liabilities are anticipated to be paid within a company’s twelve months.

The most common examples of current assets on the balance sheet are each defined in the subsequent table:

On the other hand, the most common current liabilities are described in the following chart:

The working capital ratio is a method of analyzing the financial state of a company by measuring its current assets as a proportion of its current liabilities rather than as an integer.

The formula to calculate the working capital ratio divides a company’s current assets by its current liabilities.

• Positive Working Capital Ratio ➝ Therefore, if a company exhibits a working capital ratio in excess of 1.0x, that implies net positive working capital.
• Negative Working Capital Ratio ➝ Conversely, the company has net negative working capital if the working capital ratio is below 1.0x.

One common financial ratio used to measure working capital is the current ratio , a metric designed to provide a measure of a company’s liquidity risk.

The current ratio is calculated by dividing a company’s current assets by its current liabilities.

The current ratio is of limited utility without context. Still, a general rule of thumb is that a current ratio of > 1.0x implies a company is more liquid because it has liquid assets that can presumably be converted into cash and will more than cover the upcoming short-term liabilities.

The quick ratio—or “acid test ratio”—is a closely related metric that isolates only the most liquid assets, such as cash and receivables , to gauge liquidity risk.

Why? The benefit of neglecting inventory and other non-current assets is that liquidating inventory may not be simple or desirable, so the quick ratio ignores those as a source of short-term liquidity.

On the subject of modeling working capital in a financial model , the primary challenge is determining the operating drivers that must be attached to each working capital line item.

The working capital items are fundamentally tied to the core operating performance, and forecasting working capital is simply a process of mechanically linking these relationships on the three financial statements (e.g. income statement , cash flow statement, and balance sheet).

The balance sheet organizes assets and liabilities in order of liquidity (i.e. current vs long-term), making it easy to identify and calculate working capital (current assets less current liabilities).

The change in net working capital (NWC) is tracked on the cash from operations (CFO) section of the cash flow statement (CFS)—or statement of cash flows—which reconciles net income for non-cash items like depreciation and amortization (D&A) and changes in working capital.

The cash flow from operating activities section aims to identify the cash impact of all assets and liabilities tied to operations, not solely current assets and liabilities.

To further complicate matters, the changes in working capital section of the cash flow statement (CFS) commingles current and long-term operating assets and liabilities.

Therefore, the section boxed in red on the statement of cash flows of Alphabet (NASDAQ: GOOGL) could contain changes in long-term operating assets and liabilities.

Change in Working Capital Section on Cash Flow Statement (Source: Alphabet Q1-24 )

The balance sheet organizes items based on liquidity, but the cash flow statement organizes items based on their nature.

The three sections of a cash flow statement under the indirect method are as follows.

• Cash from Operating Activities (CFO) ➝ Net Income, Depreciation and Amortization (D&A), Change in Working Capital
• Cash from Investing Activities (CFI) ➝ Capital Expenditure (Capex), Sale of PP&E
• Cash from Financing Activities (CFF) ➝ Debt Issuance, Equity Issuance

As it so happens, most current assets and liabilities are related to operating activities (inventory, accounts receivable, accounts payable, accrued expenses, etc.).

Those line items are thus consolidated in the operating activities section of the cash flow statement (CFS) under “changes in operating assets and liabilities.”

Because most of the working capital items are clustered in operating activities, finance professionals generally refer to the “changes in operating assets and liabilities” section of the cash flow statement as the “changes in working capital” section.

However, this can be confusing since not all current assets and liabilities are tied to operations. For example, items such as marketable securities and short-term debt are not tied to operations and are included in investing and financing activities instead.

In practice, cash and other short-term investments, such as treasury bills (T-Bills), marketable securities, commercial paper, and any interest-bearing debt, like loans and corporate bonds , are excluded when calculating net working capital (NWC).

Why? Cash and cash equivalents, as well as debt and interest-bearing securities, are non-operational items that do not directly contribute toward generating revenue (i.e. not part of the core operations of a company’s business model).

The net working capital (NWC) calculation only includes operating current assets like accounts receivable (A/R) and inventory, as well as operating current liabilities such as accounts payable and accrued expenses.

The net working capital (NWC) metric is different from the traditional working capital metric because non-operating current assets and current liabilities are excluded from the calculation.

• Cash and Cash Equivalents ➝ The net working capital (NWC) metric must omit cash and cash equivalents, such as marketable securities and short-term investments. Cash and cash equivalents are not part of the core operations of a company’s revenue model and are closer to investing activities (i.e. interest income).
• Short-Term Debt and Interest-Bearing Securities ➝ The net working capital (NWC) metric must exclude short-term borrowings, the portion of long-term debt due within twelve months (<12), and any interest-bearing securities. Likewise, debt and interest-bearing securities are also excluded from net working capital (NWC) because such instruments are closer to financing activities (i.e. interest expense).

The difference between working capital and net working capital (NWC) are as follows:

One nuance to calculating the net working capital (NWC) of a particular company is the minimum cash balance—or required cash—which ties into the working capital peg in the context of mergers and acquisitions ( M&A ).

In short, the working capital peg is the minimum baseline amount of working capital required in order for a business to continue operating per usual post-closing of the transaction, agreed upon by the buyer and seller in an M&A transaction.

There is much negotiation that occurs between the buyer and seller in M&A, including conditional clauses, surrounding the topic of the working capital peg (or “target”).

In fact, certain practitioners include the minimum cash balance in the net working capital (NWC) metric, based on the notion that the company must retain some cash on hand to continue running its business, which is referred to as “required cash.”

Therefore, the working capital peg is set based on the implied cash on hand required to run a business post-closing and projected as a percentage of revenue (or the sum of a fixed amount of cash).

Cash, accounts receivable, inventories, and accounts payable are often discussed together because they represent the moving parts involved in a company’s operating cycle (a fancy term that describes the time it takes, from start to finish, to buy or producing inventory, selling it, and collecting cash for it).

For example, if it takes an appliance retailer 35 days on average to sell inventory and another 28 days on average to collect the cash post-sale, the operating cycle is 63 days.

• Operating Cycle = 35 days + 28 days = 63 days

In other words, there are 63 days between when cash was invested in the process and when cash was returned to the company.

Conceptually, the operating cycle is the number of days that it takes between when a company initially puts up cash to get (or make) stuff and getting the cash back out after you sell the stuff.

Since companies often purchase inventory on credit, a related concept is the working capital cycle—often referred to as the “net operating cycle” or “cash conversion cycle”—which factors in credit purchases.

The working capital cycle formula is days inventory outstanding (DIO) plus days sales outstanding (DSO) , subtracted by days payable outstanding (DPO) .

In our example, if the retailer purchased the inventory on credit with 30-day terms, it had to put up the cash 33 days before it was collected. Here, the cash conversion cycle is 33 days, which is pretty straightforward.

• Cash Conversion Cycle (CCC) = 35 days + 28 days – 30 days = 33 days

The following chart lists the most common working capital metrics:

For many firms, the analysis and management of the operating cycle is the key to healthy operations.

For example, imagine the appliance retailer ordered too much inventory – its cash will be tied up and unavailable for spending on other things (such as fixed assets and salaries). Moreover, it will need larger warehouses, will have to pay for unnecessary storage, and will have no space to house other inventory.

Imagine that in addition to buying too much inventory, the retailer is lenient with payment terms to its own customers (perhaps to stand out from the competition). This extends the time cash is tied up and adds a layer of uncertainty and risk around collection.

Suppose an appliance retailer mitigates these issues by paying for the inventory on credit (often necessary as the retailer only gets cash once it sells the inventory).

Cash is no longer tied up, but effective working capital management is even more important since the retailer may be forced to discount more aggressively (lowering margins or even taking a loss) to move inventory to meet vendor payments and escape facing penalties.

Taken together, this process represents the operating cycle (also called the cash conversion cycle).

Companies with significant working capital considerations must carefully and actively manage working capital to avoid inefficiencies and possible liquidity problems.

In our example, a perfect storm could look like this:

• Poor Working Capital Management ➝ Retailer bought a lot of inventory on credit with short repayment terms
• Economic Downturn ➝ The economy is contracting, and economic growth is slowing down, so customers are not paying as quickly as expected.
• Fluctuations in Market Demand ➝ The demand for the retailer’s product offerings changes, and some inventory flies off the shelves while other inventory isn’t selling.

In this perfect storm, the retailer doesn’t have the funds to replenish the inventory flying off the shelves because it hasn’t collected enough cash from customers.

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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While our hypothetical appliance retailer appears to require significant working capital investments (translation: It has cash tied up in inventory and receivables for 33 days on average), Noodles & Co, for example, has a very short operating cycle.

We can see that Noodles & Co has a short cash conversion cycle (<3 days).

On average, Noodles needs approximately 30 days to convert inventory to cash, and Noodles buys inventory on credit and has about 30 days to pay.

Hence, the company exhibits a negative working capital balance with a relatively limited need for short-term liquidity.

The suppliers, who haven’t yet been paid, are unwilling to provide additional credit or demand even less favorable terms.

In this case, the retailer may draw on their revolver, tap other debt, or even be forced to liquidate assets. The risk is that when working capital is sufficiently mismanaged, seeking last-minute sources of liquidity may be costly, deleterious to the business, or, in the worst-case scenario, undoable.

While each component—inventory, accounts receivable, and accounts payable—is important individually, collectively, the items comprise the operating cycle for a business and thus must be analyzed both together and individually.

Working capital as a ratio is meaningful when compared alongside activity ratios, the operating cycle, and the cash conversion cycle over time and against a company’s peers.

Put together, managers and investors can gain critical insights into a business’s short-term liquidity and operations.

In closing, we’ll summarize the key takeaways we’ve described from the presentation of working capital on the financial statements:

• While the textbook definition of working capital is current assets less current liabilities, finance professionals refer to the subset of working capital tied to operating activities as simply working capital.
• The balance sheet working capital items include operating and non-operating assets and liabilities, whereas the “changes in working capital” section of the cash flow statement only includes operating assets and liabilities.
• The cash flow statement, informally named the “changes in working capital” section, will include some non-current assets and liabilities (and thus excluded from the textbook definition of working capital) as long as they are associated with operations.

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Oh and in the second footnote: is it “$2.95mm/60 months” or “$2.95mm/59 months” ? Because you write “divided by 59 months”, but you divide by 60 months in your calculation. Maybe there is something I did not grasp?

Many thanks

Yohann: The text should read $2.95 million / 60 days. This is simply an accrual accounting quirk (an arcane quirk but simple accrual accounting). The company would recognize $49,167 ($2.95 million divided by 60 months) even though it will only pay for 59 months (since the first month’s rent is …  Read more »

This is great adivce!

This is a very good article. Thank you for sharing. I look forward to publishing more such works. There are not many such articles in this field.

Hey I think I’ve spotted 3 typos: (1) “The benefit of ignoring inventory and other *non-current* assets is that liquidating inventory may not be simple or desirable…” –> should read: “and other *current* assets” ? (2) “Adding to the confusion is that the ‘changes in operating *activities* and liabilities’…” –> …  Read more »

1. Yes, this should read other “current” assets. 2. Yes, this should read operating “assets” not activities. 3. Yes, this applies to my response to your second question above.

how do we record working capital in the financial statements e.g I borrowed 200,000.00 Short term long to pay salaries and other expenses.

Hi, Khumo, In that case, your short term debt would be credited (increase by) $200K, and your cash debited (increase by) $200K. Then your cash would be credited (decrease by) $200K, and your retained earnings debited (decrease by) $200K by way of expense, which lowers net income and thus lowers …  Read more »

You article is very valuable for me. Hoping to read more. Thank you.

Thanks for your feedback, Oliver, and we are glad it was helpful!

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What Is Working Capital?

Understanding working capital.

• Limitations

Special Considerations

The bottom line.

• Corporate Finance
• Financial statements: Balance, income, cash flow, and equity

Working Capital: Formula, Components, and Limitations

Learn about company liquidity, operational efficiency, and short-term health

Pete Rathburn is a copy editor and fact-checker with expertise in economics and personal finance and over twenty years of experience in the classroom.

Working capital, also known as net working capital (NWC), is the difference between a company’s current assets —like cash, accounts receivable/customers’ unpaid bills, and inventories of raw materials and finished goods—and its  current liabilities , such as accounts payable and debts. It's a commonly used measurement to gauge the short-term financial health and efficiency of an organization.

Key Takeaways

• Working capital, also called net working capital (NWC), is the difference between a company’s current assets and current liabilities.
• It measures a company’s liquidity and short-term financial health, indicating the ability to fund operations and respond to financial stress or opportunities.
• Negative working capital occurs when current liabilities exceed current assets, suggesting potential liquidity issues.
• Positive working capital shows a company can support ongoing operations and invest in future growth.
• High working capital isn’t always a good thing. It might indicate that the business has too much inventory, is not investing its excess cash, or is not taking advantage of low-cost debt opportunities.

Investopedia / Yurle Villegas

Working capital is calculated from the assets and liabilities on a corporate balance sheet , focusing on immediate debts and the most liquid assets. Calculating working capital provides insight into a company's short-term liquidity and efficiency. A company with positive working capital generally has the potential to invest in growth and expansion. But if current assets don't exceed current liabilities, the company has negative working capital, and may face difficulties in growth, paying back creditors, or even avoiding bankruptcy.

In corporate finance, "current" refers to a time period of one year or less. Current assets are those that can be converted into cash within 12 months, while current liabilities are obligations that must be paid within the same timeframe.

The amount of working capital needed varies by industry, company size, and risk profile. Industries with longer production cycles require higher working capital due to slower inventory turnover. Alternatively, bigger retail companies interacting with numerous customers daily, can generate short-term funds quickly and often need lower working capital.

Working Capital Formula

To calculate working capital , subtract a company's current liabilities from its current assets. Both figures can be found in public companies' publicly disclosed financial statements, though this information may not be readily available for private companies.

Working Capital = Current Assets – Current Liabilities

Working capital is often expressed as a dollar figure. For example, if a company has $100,000 in current assets and $30,000 in current liabilities, it has $70,000 of working capital. This means the company has $70,000 at its disposal in the short term if it needs to raise money for any reason.

A business can either have positive or negative working capital:

• Positive working capital : When this calculation is positive, it indicates that the company's current assets exceed its current liabilities, as in the above example. The company has more than enough resources to cover its short-term debt and some leftover cash if all current assets are liquidated to pay this debt.
• Negative working capital : When the calculation is negative, the company's current assets are insufficient to cover its current liabilities. This is a warning sign that the company has more short-term debt than short-term resources. It typically indicates poor short-term health, low liquidity, and potential problems in paying its debt obligations.

It's worth noting that while negative working capital isn't always bad and can depend on the specific business and its lifecycle stage, prolonged negative working capital can be problematic.

Components of Working Capital

Working capital consists of current assets and current liabilities. A company's balance sheet contains all working capital components, though it may not need all the elements discussed below. For example, a service company that doesn't carry inventory will simply not factor inventory into its working capital calculation.

Current Assets

Current assets are economic benefits that the company expects to receive within the next 12 months. The company has a claim or right to receive the financial benefit, and calculating working capital poses the hypothetical situation of liquidating all items below into cash.

• Cash and cash equivalents : All of the company's money on hand, including foreign investments and low-risk, short-term investments like money market accounts
• Inventory : Unsold goods, including raw materials, work-in-progress, and finished goods not yet sold
• Accounts receivable : Claims to cash for items sold on credit, net of any allowance for doubtful payments
• Notes receivable : Claims to cash from other agreements, usually documented with a signed agreement
• Prepaid expenses : The value for expenses paid in advance, which, while hard to liquidate, still carry short-term value
• Others : Any other short-term asset. For example, some companies may recognize a short-term deferred tax asset that reduces a future liability.

Current Liabilities

Current liabilities encompass all debts a company owes or will owe within the next 12 months. The overarching goal of working capital is to understand whether a company can cover all of these debts with the short-term assets it already has on hand.

• Accounts payable : Unpaid vendor invoices for supplies, raw materials, utilities, property taxes, rent, or any other operating expense owed. Credit terms on invoices are often net 30 days, capturing nearly all invoices.
• Wages payable : Unpaid salaries and wages for staff members. Depending on payroll timing, this typically accrues up to one month's worth of wages.
• Current portion of long-term debt : Short-term payments related to long-term debt. Only the upcoming 12 months' payments are included in working capital calculations.
• Accrued tax payable : Obligations to government bodies, including accruals for tax obligations not due for months but payable within the next 12 months
• Dividend payable : Authorized payments to shareholders. While a company may decline future dividend payments, it must fulfill obligations on already authorized dividends.
• Unearned revenue : Capital received in advance of completing work. If a company fails to complete a job, it may need to return this capital to the client.

Theresa Chiechi © Investopedia, 2019

Limitations of Working Capital

Working capital can be very insightful in determining a company's short-term health. However, some downsides to the calculation can make the metric sometimes misleading. Here are four limitations of working capital:

• Changing values : Working capital is always changing. If a company is fully operating, several—if not most—current asset and current liability accounts will likely change. Therefore, by the time financial information is accumulated, it's likely that the company's working capital position has already changed.
• Nature of assets : Working capital fails to consider the specific types of underlying accounts. For example, a company with positive working capital but whose current assets are entirely in accounts receivable may face liquidity issues if customers delay payments.
• Asset devaluation : On a similar note, assets can quickly become devalued. This may happen due to factors beyond the company's control, such as customer bankruptcy affecting accounts receivable or inventory becoming obsolete or stolen. Physical cash is also at risk of theft, impacting working capital.
• Unknown debt : Working capital calculations assume all debt obligations are accounted for. In fast-paced environments or during mergers, missed agreements or incorrectly processed invoices can skew the accuracy of working capital figures.

Most major new projects, like expanding production or entering into new markets, often require an upfront investment , reducing immediate cash flow. Therefore, companies needing extra capital or using working capital inefficiently can boost cash flow by negotiating better terms with suppliers and customers.

Companies can forecast future working capital by predicting sales, manufacturing, and operations. Forecasting helps estimate how these elements will impact current assets and liabilities.

On the other hand, high working capital isn’t always a good thing . It might indicate that the business has too much inventory or isn't investing excess cash. Alternatively, it could mean a company fails to leverage the benefits of low-interest or no-interest loans .

Another financial metric, the current ratio , measures the ratio of current assets to current liabilities. Unlike working capital, it uses different accounts in its calculation and reports the relationship as a percentage rather than a dollar amount.

Example of Working Capital

As of March 2024, Microsoft (MSFT) reported $147 billion of total current assets, which included cash, cash equivalents, short-term investments, accounts receivable, inventory, and other current assets.

The company also reported $118.5 billion of current liabilities, which comprise accounts payable, current portions of long-term debts, accrued compensation, short-term income taxes, short-term unearned revenue , and other current liabilities.

Therefore, as of March 2024, Microsoft's working capital metric was approximately $28.5 billion. If Microsoft were to liquidate all short-term assets and extinguish all short-term debts, it would have almost $30 billion remaining cash.

How Do You Calculate Working Capital?

Working capital is calculated by taking a company’s current assets and deducting current liabilities. For instance, if a company has current assets of $100,000 and current liabilities of $80,000, then its working capital would be $20,000. Common examples of current assets include cash, accounts receivable, and inventory . Examples of current liabilities include accounts payable, short-term debt payments, or the current portion of deferred revenue .

Why Is Working Capital Important?

Working capital is crucial for businesses to remain solvent. Even a profitable business can face bankruptcy if it lacks the cash to pay its bills. For example, if a company has $1 million in cash from retained earnings and invests it all at once, it might not have enough current assets to cover its current liabilities.

Is Negative Working Capital Bad?

Generally, yes, if a company's current liabilities exceed its current assets. This indicates the company lacks the short-term resources to pay its debts and must find ways to meet its short-term obligations. However, a short period of negative working capital may not be an issue depending on the company's stage in its business life cycle and its ability to generate cash quickly.

How Can a Company Improve Its Working Capital?

A company can improve its working capital by increasing current assets and reducing short-term debts. To boost current assets, it can save cash, build inventory reserves, prepay expenses for discounts, and carefully extend credit to minimize bad debts. To reduce short-term debts, a company can avoid unnecessary debt, secure favorable credit terms, and manage spending efficiently.

Working capital is critical to gauge a company's short-term health, liquidity, and operational efficiency. You calculate working capital by subtracting current liabilities from current assets, providing insight into a company's ability to meet its short-term obligations and fund ongoing operations. 

Positive working capital generally means a company has enough resources to pay its short-term debts and invest in growth and expansion. Conversely, negative working capital indicates potential cash flow problems, which might require creative financial solutions to meet obligations.

Working capital is a useful measure to track. Still, it's important to look at the types of assets and liabilities and the company's industry and business stage to get a more complete picture of its finances.

Purdue University. " Working Capital: What Is It and Do You Have Enough? "

Cornell Law School, Legal Information Institute. " Current Asset ."

Microsoft. " Earnings Release FY 24 Q3 ."

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Working Capital Formula

Working capital is equal to current assets minus current liabilities.

What is the Working Capital Formula?

The working capital formula is:

Working Capital = Current Assets – Current Liabilities

The working capital formula tells us the short-term liquid assets available after short-term liabilities have been paid off. It is a measure of a company’s short-term liquidity and is important for performing financial analysis, financial modeling , and managing cash flow .

Below is an example balance sheet used to calculate working capital.

Example calculation with the working capital formula

A company can increase its working capital by selling more of its products. If the price per unit of the product is $1000 and the cost per unit in inventory is $600, then the company’s working capital will increase by $400 for every unit sold, because either cash or accounts receivable will increase.

Comparing the working capital of a company against its competitors in the same industry can indicate its competitive position. If Company A has working capital of $40,000, while Companies B and C have $15,000 and $10,000, respectively, then Company A can spend more money to grow its business faster than its two competitors.

What is working capital?

Working capital is the difference between a company’s current assets and current liabilities . It is a financial measure, which calculates whether a company has enough liquid assets to pay its bills that will be due within a year. When a company has excess current assets, that amount can then be used to spend on its day-to-day operations.

Current assets , such as cash and equivalents , inventory, accounts receivable, and marketable securities, are resources a company owns that can be used up or converted into cash within a year.

Current liabilities are the amount of money a company owes, such as accounts payable , short-term loans, and accrued expenses, that are due for payment within a year.

Positive vs negative working capital

Having positive working capital can be a good sign of the short-term financial health of a company because it has enough liquid assets remaining to pay off short-term bills and to internally finance the growth of its business. With a working capital deficit, a company may have to borrow additional funds from a bank or turn to investment bankers to raise more money.

Negative working capital means assets aren’t being used effectively and a company may face a liquidity crisis. Even if a company has a lot invested in fixed assets, it will face financial and operating challenges if liabilities are due. This may lead to more borrowing, late payments to creditors and suppliers, and, as a result, a lower corporate credit rating for the company.

When negative working capital is ok

Depending on the type of business, companies can have negative working capital and still do well. Examples are grocery stores like Walmart or fast-food chains like McDonald’s that can generate cash very quickly due to high inventory turnover rates and by receiving payment from customers in a matter of a few days. These companies need little working capital being kept on hand, as they can generate more in short order.

Products that are bought from suppliers are immediately sold to customers before the company has to pay the vendor or supplier. In contrast, capital-intensive companies that manufacture heavy equipment and machinery usually can’t raise cash quickly, as they sell their products on a long-term payment basis. If they can’t sell fast enough, cash won’t be available immediately during tough financial times, so having adequate working capital is essential.

Learn more about a company’s Working Capital Cycle , and the timing of when cash comes in and out of the business.

Adjustments to the working capital formula

While the above formula and example are the most standard definition of working capital, there are other more focused definitions.

Examples of alternative formulas:

• Current Assets – Cash – Current Liabilities (excludes cash)
• Accounts Receivable + Inventory – Accounts Payable (this represents only the “core” accounts that make up working capital in the day-to-day operations of the business)

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Working capital in financial modeling

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• Working capital management
• Study resources
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• Technical articles and topic explainers

This article covers the following syllabus areas:

• C1 – the nature, importance and elements of working capital
• C2a – explain the cash operating cycle and the role of accounts payable and accounts receivable’ and
• C2b – explain and apply relevant accounting ratios.  

Working capital management is a core area of the syllabus and can form part, or the whole of, a 20-mark question in the exam, as well as being examined by objective test questions. It is, however, essential to study the whole syllabus and not only the specific areas covered in this article.

Importance of working capital management

Working capital represents the net current assets available for day-to-day operating activities. It is defined as current assets less current liabilities and, in exam questions, the components are usually inventory and trade receivables, trade payables and bank overdraft.

Many businesses that appear profitable are forced to cease trading due to an inability to meet short-term obligations when they fall due. Successful management of working capital is essential to remaining in business.

Working capital management requires great care due to potential interactions between its components. For example, extending the credit period offered to customers can lead to additional sales. However, the company’s cash position will fall due to the longer wait for customers to pay, potentially leading to the need for a bank overdraft. Interest on the overdraft may even exceed the profit arising from the additional sales, particularly if there is also an increase in the incidence of bad debts.

Working capital management is central to the effective management of a business because:

• current assets comprise the majority of the total assets of some companies
• shareholder wealth is more closely related to cash generation than accounting profits
• failure to control working capital, and hence to manage liquidity, is a major cause of corporate collapse.

Objectives of working capital management   

One of the two key objectives of working capital management is to ensure liquidity. A business with insufficient working capital will be unable to meet obligations as they fall due, leading to late payments to employees, suppliers and other providers of credit. Late payments can result in lost employee loyalty, lost supplier discounts and a damaged credit rating. Non-payment (default) can lead to the compulsory liquidation of assets to repay creditors.

The other key objective is profitability. Funds tied up in working capital tend to earn little, or no, return. Hence, a company with a high level of working capital may fail to achieve the return on capital employed (Operating profit ÷ (Total equity and long-term liabilities)) expected by its investors.   

Therefore, when determining the appropriate level of working capital there is a trade-off between liquidity and profitability:

The trade-off is perhaps most obvious with regards to the holding of cash. Although cash obviously provides liquidity it generates little return, even if held in the form of cash equivalents such as treasury bills. This is particularly true in an era of low interest rates (for example, in November 2016 the annualised yield on three-month US dollar treasury bills was approximately 0.4%).

Although an optimal level of working capital may exist it may not be achievable due to factors beyond management’s control, such as an unreliable supply chain influencing inventory levels. However businesses must at least avoid the extremes:

• Overtrading – insufficient working capital to support the level of business activities. This can also be described as under-capitalisation and is characterised by a high and rising proportion of short-term finance to long-term finance
• Over-capitalisation – an excessive level of working capital, leading to inefficiency.

Liquidity ratios

If the current ratio falls below 1 this may indicate problems in meeting obligations as they fall due. Even if the current ratio is above 1 this does not guarantee liquidity, particularly if inventory is slow moving. On the other hand a very high current ratio is not to be encouraged as it may indicate inefficient use of resources (for example, excessive cash balances).

The level of a firm’s current ratio is heavily influenced by the nature if its business for example:

• Traditional manufacturing industries require significant working capital investment in inventory (comprising raw materials, work in progress and finished goods) and trade receivables (as their business customers expect to be offered generous credit terms). Therefore companies operating in such industries may reasonably be expected to have current ratios of 2 or more.
• Modern manufacturing companies may use just-in-time management techniques to reduce the level of buffer inventory and hence reduce their current ratios to some extent.
• In some industries, a current ratio of less than 1 might be considered acceptable. This is especially true of the retail sector which is often dominated by ‘giants’ such as Wal-Mart (in the US) and Tesco (in the UK). Such retailers are able to negotiate long credit periods with suppliers while offering little credit to customers leading to higher trade payables as compared with trade receivables. These retailers are also able to keep their inventory levels to a minimum through efficient supply chain management. 

The quick ratio is particularly relevant where inventory is slow moving.

Efficiency ratios

This shows how quickly inventory is sold; higher turnover reflects faster-moving inventory.

However, working capital ratios are often easier to interpret if they are expressed in ‘days’ as opposed to ‘turnover’:

Note that exam questions may tell you to assume there are 360 days in the year. Furthermore, many exam questions only provide information about inventory as at the year-end, in which case this must be used as a proxy for the average inventory level.

Inventory days estimates the time taken for inventory to be sold. Everything else being equal a business would prefer lower inventory days. 

In exam questions you may have to assume that:

(i) year-end receivables are representative of the average figure; and (ii) all sales are made on credit.

Receivables days estimates the time taken for customers to pay. Everything else being equal a business would prefer lower receivables days. 

• Year-end payables are representative of the average figure
• Cost of sales approximates annual credit purchases
• All purchases are made on credit.

Payables days estimates the time taken to pay suppliers. A business would prefer to increase its payables days, unless this proves expensive in terms of lost settlement discounts or leads to other problems such as a damaged reputation – a ‘good corporate citizen’ is expected to pay promptly.

In this ratio working capital is defined as the level of investment in inventory and receivables less payables. In exam questions you may have to assume that year-end working capital is representative of the average figure over the year.

The sales to working capital ratio indicates how efficiently working capital is being used to generate sales. Everything else being equal the business would prefer this ratio to rise.

Cash operating cycle

The cash operating cycle (also known as the working capital cycle or the cash conversion cycle) is the number of days between paying suppliers and receiving cash from sales.

Cash operating cycle = Inventory days + Receivables days – Payables days.

In the manufacturing sector inventory days has three components:

(i) raw materials days (ii) work-in-progress days (the length of the production process), and (iii) finished goods days.

However, exam questions tend to be based in the retail sector where no such sub-analysis is required.

The longer the operating cycle the greater the level of resources ‘tied up’ in working capital. Although it is desirable to have as short a cycle as possible, there may be external factors which restrict management’s ability to achieve this:

• Nature of the business – a supermarket chain may have low inventory days (fresh food), low receivables days (perhaps just one to two days to receive settlement from credit card companies) and significant payables days (taking credit from farmers). In this case the operating cycle could be negative (ie cash is received from sales before suppliers are paid). On the other hand a construction company may have a very long operating cycle due to the high levels of work-in-progress.
• Industry norms – if key competitors offer long periods of credit to their customers it may be difficult to reduce receivables days without losing business.
• Power of suppliers – an attempt to delay payments could lead to the supplier demanding ‘cash on delivery’ in future (ie causing payables days to actually fall to zero rather than rising).

Interpretation of ratios

For a meaningful evaluation to be made of a firm’s working capital management it is necessary to identify:

• Trends – the change in a ratio over time. If an exam question provides two, or more, years of financial statements then appropriate ratios should be calculated for each year.
• External benchmarks – industry average (sector) ratios are commonly published by business schools or consultancies. If an exam question provides industry average data then you are expected to use this to benchmark the performance of the firm in the scenario. However do not assume that the only relevant ratios are those for which industry average data is available.

The following table is provided for reference purposes:

Topple Co has the following forecast figures for its first year of trading:

Sales $3,600,000

Purchases expense $3,000,000

Average receivables $306,000

Average inventory $495,000

Average payables $230,000

Average overdraft $500,000

Gross profit margin 25%

Industry average data:

Inventory days  53

Receivables days  23

Payables days  47

Current ratio  1.43

Assume there are 365 days in the year.

REQUIRED: Calculate and comment on Topple Co’s cash operating cycle, current ratio, quick ratio and sales to working capital ratio.

The length of the cash operating cycle indicates that there will be 70 days between Topple Co receiving cash from sales and paying cash to suppliers. This is significantly longer than the industry average of 29 days (53 + 23 – 47) and likely to lead to liquidity problems, as evidenced by the size of the overdraft.

Topple Co expects to take approximately the same credit period from its suppliers as is taken by its own customers, whereas the industry norm is to take a significantly longer credit period from suppliers (47 days) than is taken by customers (23 days). Therefore, slow inventory turnover is the main cause of Topple Co’s long working capital cycle. This may be inevitable in the first year of trading but is it important that systems are implemented to ensure efficient inventory management. The extent of future reductions in inventory days may be limited by the nature of the business as the industry average is 53 days.

It is perhaps unsurprising that Topple Co’s receivables days is also above the industry average as the firm may have been forced to offer generous terms of trade in order to attract customers away from its more established competitors, In addition Topple Co may still be in the process of establishing and implementing credit control procedures.

On the other hand Topple Co is paying its own suppliers much more quickly than the industry norm. Although this puts pressure on liquidity, Topple Co may be taking advantage of settlement discounts offered by suppliers or, as a new firm without an established trading history, it may simply not be offered extended credit periods by suppliers.

The above comparisons to sector data must be treated with caution as working capital management may be poor across the sector, leading to benchmarks which Topple Co should not endeavour to replicate. As a long-term target Topple Co should benchmark its performance against the leader in the sector.  

The current ratio indicates that, over the year, there will be $1.10 of current assets per $1 of current liabilities, which does not compare favourably with the industry average of 1.43 and may not be sufficient as Topple Co’s inventory appears to be slow moving. More relevant, therefore, is the quick ratio which indicates only $0.42 of liquid assets per $1 of current liabilities, although no industry average data is available to benchmark this figure.

The overdraft would need to be continuously monitored to ensure it remains within any agreed limit, and contingency plans put into place for refinancing. However if Topple Co is started up with an appropriate level of long-term finance then an overdraft may be avoided entirely.

Each $1 invested in working capital is expected to generate $6.30 of revenue. Although this may not appear to be a particularly efficient use of resources, the first year’s trading may not be representative. Once Topple Co becomes more established it should benchmark its sales to working capital ratio against sector data if available.

This article has covered the foundations of working capital management, focusing on the analysis of current assets and current liabilities. The Financial Management syllabus also demands detailed knowledge of specific models and techniques for each component of working capital – cash, inventory, receivables and payables – and a well-prepared candidate must also be competent in using these.  

References: PwC Global Working Capital Survey 2015

Mike Ashworth, a subject matter expert in financial management

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Working Capital Management

Explore ‘Working Capital Management’ to grasp the critical aspects of managing short-term financial decisions effectively. Learn about optimizing cash flow, managing inventories, and balancing receivables and payables. Understand how to maintain liquidity while ensuring operational efficiency and financial stability in a business.

1 Conceptual Framework

Definition of Working Capital

Constituents of working capital, types of working capital, cyclical flow and characteristics of working capital.

• Planning for Working Capital Working Capital and Inflation

Trends in Working Capital

2 Operating Environment of Working Capital

Monetary and Credit Policies

Financial markets.

• Economic Liberalisation and Industry

3 Determination of Working Capital

• Determination of Working Capital Needs: Different Approaches
• Factors Influencing Determination

Tandon Committee Norms

Present policy of banks.

4 Management of Receivables

• Credit Policy
• Credit Evaluation Models

Monitoring Receivables

Collecting receivables, strategic issues in receivables management.

5 Management of Cash

• Motives of holding cash

Determinants of Cash Flows

Cash forecasting, managing uncertainty in cash flow forecast, managing surplus cash, electronic funds transfer and anywhere banking, mis in cash management.

6 Management of Marketable Securities

Need for Investments in Securities

• Types of Marketable Securities 

Market for Short-term Securities

Optimisation models, strategies for managing securities.

7 Management of Inventory

Components of Inventory

Need for inventory, inventory system, costs in inventory system, optimising inventory cost, selective inventory control models, inventory management under uncertainty, emerging trends in inventory management.

8 Theories and Approaches

Creation of Value through Working Capital Management

Approaches to working capital investment, approach to financing working capital, effect of choice of financing on roi.

9 Payables Management

• Payables: Their Significance

Types of Trade Credit

Determinants of trade credit, cost of credit, advantages of payables, effective management of payables.

10 Bank Credit – Principles and Practices

Principles of Bank Lending

Style of credit, classification of advances according to security, modes of creating charge over assets, secured advances, purchase & discounting of bills, non fund based facilities, credit worthiness of borrowers.

11 Other Sources of Short Term Finance

Public Deposits

Commercial paper, inter-corporate loans, bonds and debentures, factoring of receivables.

12 Working Capital Management in SMES

Small & Medium Enterprises Vs. Large Companies

Role of small and medium enterprises in india, working capital management for smes – differential features, working capital cycle, objectives of working capital management in smes, managing working capital, determinants of working capital in smes, components of working capital management, effective working capital management for smes.

• Strategic Planning – Strengthen Working Capital Performance

13 Working Capital Management in Large Companies

Significance of Working Capital Management

Large and small firms – financing options, differences in smes and large companies working capital.

• Factors Affecting Large Companies Working Capital Needs

Impact of COID-19 Pandemic

Working capital efficiency improvement- during pandemic.

• Strengthening Operational Agility – Strategic Partnerships

14 Working Capital Management in MNCS

Special Issues of concern: Operational Environment

Cash management, receivables management, inventory management.

15 Case Studies 

Cash Management in Paytm

Receivables management – case study of tcs, inventory management – case study of maruti suzuki india ltd., financing of working capital by commercial banks – case study of sbi, syllabus with topics linked.

Dive into the world of working capital, understand its definition, and discover why it’s the financial lifeline of every business.

Explore the building blocks of working capital—current assets and current liabilities—and discover how they form the basis of financial stability and operational efficiency for businesses.

Explore the diverse types of working capital and gain insights into how they contribute to a company’s financial liquidity and operational flexibility.

Navigate the cyclical flow and explore the key characteristics of working capital, gaining insights into its dynamic nature and the factors that shape its role in financial management.

Planning for Working Capital: Navigating Financial Stability

Explore the significance of working capital planning and its relationship with inflation, gaining insights into strategies that help businesses maintain financial stability in dynamic economic environments.

Explore the evolving trends in working capital management and gain insights into strategies that help businesses adapt to the dynamic financial landscape.

Operating Environment of Working Capital

Explore the multifaceted operating environment of working capital and gain insights into strategies that enable businesses to effectively manage their financial dynamics.

Explore the profound impact of monetary and credit policies on working capital and gain insights into strategies that enable businesses to adapt to these policy-driven financial currents.

Explore the multifaceted world of financial markets and gain insights into how they influence working capital, providing valuable guidance for businesses seeking financial stability.

Economic Liberalization and Industry: Impacts on Working Capital

Explore the relationship between economic liberalization, industry dynamics, and working capital management, providing insights for businesses operating in today’s globalized and deregulated markets.

Determination of Working Capital

Explore the art of determining working capital needs, unraveling the approaches, key factors, and strategies that businesses employ to maintain the right financial balance.

Determination of Working Capital Needs: Exploring Different Approaches

Factors Influencing Determination of Working Capital Needs

Explore the intricate web of factors that influence the determination of working capital needs, shedding light on the dynamic nature of this critical financial balance.

Explore the significance and impact of the Tandon Committee Norms on working capital management in India, shedding light on their objectives and key recommendations.

Explore the current policies and practices of banks in relation to working capital management, shedding light on credit assessment, interest rates, lending options, and the role of digital banking in today’s financial landscape.

Crafting an Effective Credit Policy

Explore the essence of an effective credit policy, its components, significance, and the role it plays in guiding businesses in extending credit to customers while managing risk and maintaining financial stability.

Decoding Credit Evaluation Models

Explore the world of credit evaluation models, shedding light on their significance, types, and how they enable businesses to make informed credit decisions while effectively managing risk and resources.

Explore the significance of receivables monitoring, the key steps involved, and how businesses can employ technology to ensure timely payments, maintain financial stability, and mitigate credit risk effectively.

Explore the strategies and techniques for collecting receivables efficiently, ensuring a consistent cash flow and minimizing the risk of bad debts, while leveraging technology to streamline the process.

Explore the strategic challenges in receivables management and discover effective strategies for addressing them to ensure financial stability and growth.

Management of Cash

Explore the significance of cash management, strategies for optimizing cash flow, and the tools and techniques that businesses can employ to ensure their financial success through efficient cash management.

Motives of Holding Cash

Explore the key reasons behind holding cash as part of your working capital management strategy. Learn how to make the most of your financial resources.

Discover the factors that shape the ebb and flow of cash within businesses and learn strategies to optimize financial health.

Discover the power of cash forecasting in our in-depth guide. Learn methods, strategies, and why it’s essential for your financial stability – Cash Forecasting.

Learn how to tackle the uncertainty that plagues cash flow forecasting in business. Discover strategies to ensure your financial ship stays steady.

Discover the strategies for managing surplus cash effectively, from short-term investments to debt reduction. Make surplus cash work for business’s growth and financial stability.

Discover the world of Electronic Funds Transfer and Anywhere Banking. Say goodbye to bank queues and hello to convenience with digital banking.

Learn how Management Information Systems (MIS) are transforming cash management, providing accuracy, efficiency, and strategic insights for better financial decision-making.

Management of Marketable Securities

Explore the world of marketable securities, including types, management strategies, and their role in financial success. Learn how to make the most of these versatile investments.

Discover why investments in securities are essential for wealth preservation, growth, and achieving financial goals. Explore the versatile world of stocks, bonds, and more.

Types of Marketable Securities

Explore the various types of marketable securities, including common stocks, bonds, CDs, and more. Learn how these securities can fit into your investment strategy.

Explore the market for short-term securities, its key players, and the significance of these markets in the broader financial system. Discover the various types of short-term securities and their roles in preserving capital and maintaining liquidity.

Discover the world of optimization models, their components, applications, and how they empower decision-makers to find the best solutions to complex problems. Explore their significance in various fields, from operations research to finance and healthcare.

Explore effective strategies for managing securities, including diversification, risk assessment, income generation, and long-term perspective. Learn how to optimize your investment portfolio for financial success.

Management of Inventory

Explore the world of inventory management, including its components, key aspects, best practices, and emerging trends. Discover how businesses can optimize their inventory operations for efficiency and cost control.

Explore the various components of inventory, including raw materials, work-in-progress, finished goods, MRO inventory, safety stock, and deadstock. Understand the significance of each component in the supply chain and efficient inventory management.

Discover the compelling need for inventory in business operations, from meeting customer demand and buffering against uncertainty to achieving economies of scale and responding to seasonal demand. Understand the crucial role inventory plays in business success.

Explore the world of inventory systems, their key components, benefits, and how they contribute to streamlined business operations. Learn about the importance of inventory databases, barcode technology, and reporting capabilities in effective inventory management.

Explore the different costs associated with an inventory system, including purchase costs, holding costs, ordering costs, stockout costs, excess inventory costs, carrying costs, obsolescence costs, handling costs, risk costs, and opportunity costs. Understand the financial implications of each cost and how efficient inventory management can lead to cost savings and improved profitability.

Discover strategies and best practices for optimizing inventory costs, including demand forecasting, ABC analysis, JIT inventory, safety stock, supplier relationships, EOQ, technology adoption, and lean inventory practices. Learn how effective inventory management can lead to cost savings and improved financial efficiency.

Explore selective inventory control models such as ABC analysis and VED analysis, and learn how they can help businesses prioritize critical items and optimize inventory management. Discover the benefits and steps for effective implementation of selective inventory control strategies.

Discover the challenges and strategies for managing inventory effectively under uncertainty. Explore how businesses can address fluctuating demand, supply chain disruptions, lead time variability, and economic fluctuations while optimizing inventory management.

Explore the latest trends in inventory management, including data analytics, automation, cloud-based systems, blockchain, sustainability, demand-driven approaches, multi-channel management, 3D printing, IoT sensors, circular economy principles, and inventory optimization services. Learn how these trends are reshaping inventory management in the digital age.

Theories and Approaches to Working Capital Management

Explore the theories and approaches to working capital management, from creating value through efficient management to different investment and financing strategies. Understand how choices in working capital management can impact ROI and the unique considerations for SMEs, large companies, and MNCs.

Discover how efficient working capital management can create significant value for businesses by reducing financing costs, enhancing cash flow, and capitalizing on investment opportunities. Learn key strategies to optimize working capital and drive profitability.

Explore different approaches to working capital investment, including conservative, aggressive, and moderate strategies. Understand the factors that influence the choice of approach, such as industry type, risk tolerance, economic conditions, and investment opportunities.

Explore different approaches to financing working capital, including long-term financing, short-term financing, and a combination of both. Understand the factors that influence the choice of financing approach, such as risk tolerance, cost of financing, cash flow stability, growth plans, and market conditions.

Discover how the choice of working capital financing, whether long-term, short-term, or a mix, can impact a company’s Return on Investment (ROI). Learn how to balance financing options to optimize ROI and support financial growth while managing risks effectively.

Payables Management

Explore the significance of payables management, types of trade credit, factors influencing trade credit terms, costs associated with payables, and strategies for optimizing payables management. Learn how effective payables management can improve cash flow and supplier relationships.

Payables: Their Significance in Business Operations

Discover the significance of payables in business operations, including their role in working capital management, supplier relationships, cost reduction, financial stability, and competitive advantage. Learn why effective payables management is crucial for a company’s financial health and success.

Explore the different types of trade credit, including spontaneous trade credit, suppliers’ trade credit, bills of exchange, and factoring. Learn the advantages and considerations of each type and how they can impact cash flow and financial planning for businesses.

Understand the key determinants of trade credit, including industry norms, market conditions, financial health, negotiation skills, and supplier relationships. Discover how these factors shape trade credit terms and impact a company’s working capital management and financial health.

Discover what the cost of credit entails, including interest rates, fees, and incentives. Learn about the factors that influence the cost of credit, such as creditworthiness, type of credit, market conditions, and lender policies. Understand why managing the cost of credit is vital for businesses’ financial efficiency and competitiveness.

Discover the advantages of payables (accounts payable) in business, including working capital management, cash flow flexibility, cost-efficiency, improved supplier relationships, enhanced creditworthiness, and competitive advantages. Learn how effective payables management can contribute to a company’s financial success and growth.

Discover strategies and best practices for effectively managing payables (accounts payable) in business. Learn how clear payment terms, strategic prioritization, automation, negotiation, and communication with suppliers can optimize working capital and cash flow, reduce costs, and foster positive supplier relationships.

Bank Credit – Principles and Practices

Explore the significance of bank credit, its principles, styles, and how businesses can make the most of it to ensure smooth operations. Learn effective credit utilization techniques.

Discover the essential principles of bank lending and how they impact loan approval. Understand the importance of creditworthiness assessment, risk management, and transparency in the lending process.

Discover the various styles of credit and their purposes. Learn how to choose the right credit style to meet your financial needs effectively.

Understand the differences between secured and unsecured advances, including collateral requirements, interest rates, and risk factors. Learn how to choose the right type of advance based on your financial situation and needs.

Learn about the various ways assets can be used as collateral to secure loans and credit. Understand the differences between modes like hypothecation, pledge, mortgage, assignment, and charge on securities.

Secured advances offer borrowers access to capital with lower interest rates by using collateral. Learn about the advantages, considerations, and key features of secured advances for both borrowers and lenders.

Explore the concepts of purchasing and discounting bills of exchange, vital practices in finance and commerce. Learn how businesses use these tools to manage cash flow and obtain short-term financing.

Discover how non-fund based facilities empower businesses to engage in various activities without direct capital investment. Learn about the types and advantages of these versatile financial tools.

Discover the importance of assessing the creditworthiness of borrowers in the lending process. Understand the factors that influence creditworthiness and how borrowers can improve their financial viability.

Other Sources of Short Term Finance

Discover alternative sources of short-term finance to meet immediate business needs. Explore options like public deposits, commercial paper, inter-corporate loans, and inventory financing to diversify capital sources.

Discover public deposits as a source of short-term financing for businesses. Learn how public deposits work, their benefits, and key considerations for companies seeking quick access to capital.

Discover commercial paper as a flexible source of short-term financing for businesses. Learn about its issuance process, advantages, and considerations for both issuers and investors.

Discover the concept of inter-corporate loans and how they strengthen financial collaboration among businesses within corporate groups. Learn about their purposes, benefits, and considerations for companies engaged in related party loans.

Discover the concepts of bonds and debentures and their roles in long-term financing. Learn how these debt securities work, their benefits, and what businesses and investors should consider when using them.

Explore factoring of receivables as a means to unlock immediate cash flow for businesses. Understand the process, advantages, and considerations involved in this financial practice.

Working Capital Management in SMES

Explore working capital management strategies customized for small and medium-sized enterprises (SMEs). Understand the objectives, challenges, and specialized approaches to achieve financial stability and growth in the SME sector.

Dive into the financial dynamics that set SMEs and large companies apart. Understand the roles, significance, and financial strategies of these two distinct segments in the business world.

Discover how Small and Medium Enterprises (SMEs) in India are driving economic growth through employment generation, innovation, and regional development. Explore their significance and the challenges they face in contributing to the nation’s prosperity.

Explore the specialized approach to working capital management designed for Small and Medium-sized Enterprises (SMEs). Learn about the differential features, challenges, and strategies that SMEs employ to manage their working capital effectively.

Delve into the intricacies of the working capital cycle, a fundamental concept in financial management. Learn how it measures liquidity, operational efficiency, and financial health and discover strategies to manage it effectively in business operations.

Discover the key objectives of working capital management customized for Small and Medium-sized Enterprises (SMEs). Understand how these objectives ensure financial stability, support growth, and enable efficient resource allocation for SMEs.

Discover the importance of managing working capital for businesses and the strategies they use to ensure financial stability and support growth. Learn why efficient working capital management is crucial for maintaining a healthy financial position.

Understand the determinants of working capital in SMEs and their impact on financial stability. Explore strategies that Small and Medium-sized Enterprises (SMEs) can employ to navigate these factors and ensure optimal working capital management.

Discover the interconnected components of working capital management and their role in maintaining a company’s financial health. Learn how cash management, accounts receivable, inventory, and other elements collectively ensure liquidity and operational efficiency.

Explore the significance of effective working capital management for SMEs and the strategies they can implement to achieve financial stability and growth. Learn how cash flow forecasting, inventory optimization, and other practices contribute to SMEs’ long-term financial success.

Strategic Planning: Strengthening Working Capital Performance for Success

Explore the role of strategic planning in optimizing working capital and achieving financial stability for Small and Medium-sized Enterprises (SMEs). Learn how strategic planning aligns financial goals with operational strategies and assesses risks to drive long-term success.

Working Capital Management in Large Companies

Discover the intricacies of working capital management in large companies, including financing options and strategies for navigating the impact of the COVID-19 pandemic.

Discover the significance of working capital management for businesses, from ensuring smooth operations to supporting growth and enhancing creditworthiness.

Explore the distinct financing options available to large corporations and small businesses, highlighting the diverse approaches they take to secure capital.

Explore the differences in working capital management between small and medium-sized enterprises (SMEs) and large corporations, from scale and access to financing to risk tolerance and decision-making processes.

Factors Affecting Large Companies’ Working Capital Needs

Discover the key factors that influence the working capital needs of large companies, from industry cycles and global operations to technology adoption and economic conditions.

Explore the specific impact of the COVID-19 pandemic on the working capital management of large companies, including supply chain disruptions, liquidity concerns, and the acceleration of digital transformation.

Discover how large companies improved their working capital efficiency during the COVID-19 pandemic through strategies such as lean inventory management, digital transformation, and strengthened supplier relationships.

Strengthening Operational Agility Through Strategic Partnerships

Discover how large companies improved their operational agility during the COVID-19 pandemic through strategic partnerships, including diversifying supply chains, accessing expertise, and fostering innovation.

Working Capital Management in MNCs

Explore the intricacies of working capital management in multinational corporations (MNCs), including currency risk, diverse market conditions, complex supply chains, and global regulatory compliance. Learn how MNCs optimize their global financial operations.

Explore the special issues of concern related to the operational environment of multinational corporations (MNCs) and how they impact working capital management, including currency fluctuations, transfer pricing regulations, complex supply chains, and regulatory compliance.

Discover the challenges, strategies, and significance of effective cash management in multinational corporations (MNCs), including currency diversity, regulatory compliance, centralized cash management, and risk mitigation.

Management of Receivables

Dive deep into the art of receivables management, exploring credit policies, evaluation models, monitoring strategies, and collection techniques to ensure efficient cash flow and financial stability.

Explore the complexities, challenges, and strategies of effective receivables management in multinational corporations (MNCs), including currency diversity, cross-border transactions, and regulatory compliance. Learn why efficient receivables management is crucial for financial stability and global expansion.

Explore the complexities, challenges, and strategies of effective inventory management in multinational corporations (MNCs), including supply chain diversity, currency risk, and regional demand variations. Learn why efficient inventory management is crucial for cost reduction, global market responsiveness, and working capital optimization.

Explore how Paytm effectively manages cash, ensuring user trust, regulatory compliance, business growth, and financial stability in the dynamic world of digital payments and financial technology.

Explore how Tata Consultancy Services (TCS), a global IT services giant, effectively manages receivables to maintain financial stability, optimize working capital, and foster client relationships.

Explore how Maruti Suzuki India Ltd., a leading automobile manufacturer, excels in inventory management through JIT manufacturing, supplier collaboration, demand forecasting, and efficient warehousing. Learn how these strategies contribute to cost efficiency, manufacturing excellence, and customer satisfaction.

Discover how State Bank of India (SBI), the largest commercial bank in India, provides effective working capital financing solutions to businesses. Learn how SBI’s tailored loans, competitive rates, and digital access impact liquidity, growth, and operational continuity for enterprises.

Working Capital Management Analysis

Introduction

Working capital management implicates the administration of current assets as well as current liabilities. It is the main part of a firm’s short-term financial planning since it encompasses the management of cash, inventory and accounts receivable. Working capital management is most important for several reasons. The current assets of a typical manufacturing firm account for over half of its total assets. Excessive levels of current assets can easily result in a firm realizing a substandard return on investment. However, firms with too few currents assets may incur shortages and difficulties in maintaining smooth operations.

For small companies, current liabilities are the principal source of external financing. The fast growing but larger company also makes use of current liability financing. For these reasons the financial manager and stuff devote a considerable portion of their time to working capital matters. The management of cash, accounts receivable, accounts payable, accruals and other means of short term financing is the direct responsibility of the financial manager.

Through the survey I tried to find out how efficiently “Shakti Engineering Limited” manages their working capital.

Objective of The Report

The primary objective of this report is to fulfill the requirement of the BBA program. Another objective of the report is to prove my experience through internship program.

The specific objectives of this report are

• Evaluation of working capital management
• Evaluation of Liquidity position & working capital utilization
• Analyzing the level of current assets with relation to current liabilities

Scope of The Report

The report will focus on the practices of working capital management in Shakti Engineering Ltd. This report has been prepared on the basis of experience gathered during the period of internship. Most of the data used in the reporting of the study are from secondary sources. All the data related to the reporting requirements are not available due to confidential reservation practices for the benefit of the organization. There are very few similar organizations in our country. So I was not able to compare with other companies.

Methodology

Two types of data are collected, one is primary data and second one is secondary data. Primary data were collected from the employees of the division in the branch while working there as an internee. And the details were collected from a number of secondary sources.

Primary data collection Process:

• Face to face conversation with officers and staff

Secondary data collection Process:

• Different file study.
• Different books.

Analytical tools:

• Microsoft excel was used to analyze the data.
• Different tables and graphs were used to represent the analysis.

It is observable that almost all studies have some boundaries. During performing my work, I had to face some unavoidable limitations.

There were some confidential issues like financial issues, for which they were very strict and careful in revealing those information. Although they have provided all the possible information but there were some inadequacy of information.

Lack of enough materials like books, journals and other papers capture me for severe brainstorming during working this report.

About the Company

Shakti Engineering Limited was established in 1986. The primary objective of the Organization is to provide engineering, engineering-management and manufacturing services in various fields. The corporate operational spirit since inception – recognizing the sever resource constrains in the country has been “Progress through innovation and Efficiency.”

Mission Statement…

• To be a Profitable Enterprise of International Standards,
• Organized and run Professionally,
• With High Efficiency.
• Financial Growth of the Company must ensure a proportional improvement in long term financial prospects of the people working in the company.

Quality Assurance

To ensure the quality of products, the company follows a standard quality control system and maintains strict vigil throughout the production process. The company has promptly inspects of the quality of raw materials used at its manufacturing unit. Further the finished products are again scrutinized by the quality control inspection to prevent any sub standard product to reach the hands of the customer. In addition to it the company takes pride to acquire with the fact that the company has not received any complaints from the customers.

The Manufacturing Division

The Organization is manufacturing electrical equipment – mainly Distribution Transformers, Switchgear and PFI Plant. SEL has successfully designed and manufactured transformer in 11.415 KV 3 phase and 6.325.24 KV 1-phase ranges, besides other special transformers. The organization is recognized as manufacturer of transformer by all Power Supply Utilities in the country dealing with electric power systems.

The firm has attained capacity of manufacturing transformers from 5 kVA to 2 MVA of voltage up to 33 kV. The company has supplied more than 1000 transformers to Government, Semi-government Authorities and Private companies. The maintenance and repairing section of Shakti Engineering Limited has repaired nearly 2000 transformers.

Manufacture, supply and installation of High-tension switchgear, Low tension Switchgear and Power Factor Improvement (PFI) plant are also undertaken by the company.

Shakti Engineering Limited has manufactured and supplied voltage regulators, UPS, changeover switches, etc, and has provided services for installation and maintenance of thesecustomers.

 Product Range

 Telecommunication Division

Shakti Engineering Ltd is providing point-to-point Satellite Telecommunication Links through VSAT as representative of PAK DATACOM LIMITED, Pakistan. Till date such satellite telecommunication Links have been provided to USA, Singapore, Thailand and Hong Kong.

Since 1995, Shakti Engineering Limited has been working in the field of satellite telecommunication system. The first VSAT (Very Small Aperture Terminal) link was commissioned by the company as Bangladesh Representative of Pak Datacom Ltd.

Several international VSAT links connected to Hawaii, Singapore, Honk Kong and Bangkok and domestic links located between Dhaka, Chittagong, Khulna, Barisal and Sylhet have been provided by the company. SEL provides full after sales service and 24x7x365 network monitoring and maintenance.

• Point to point VSAT link to Internet Service Providers (ISP) and Corporate Users
• Point to Point and Point to MultipointRadio Links

Company Provides

• Customized solution.
• 24x7x365 network monitoring.
• 24x7x365 network maintenance.
• Quick Maintenance Service and network expansion.
• Data circuit available from 64 kbps to 8 Mbps and Broad Band Radio up to 11 Mbps.
• High Quality and wide footprint coverage through Loral Cyberstar(Agila 2 and other), Shin Satellite (Thaicom), Asiasat, Apstar, Intelsat.
• Flexible packaging- Equipment, space segment, full circuit, half circuit basis as per customer choice.
• Network availability of 99.8% and above.

Partners & Associates

• PAK Datacom Limited
• Singapore Technologies Electronics
• SHIN Satellite
• Radyne ComStream
• GMI Pramac Group
• Microelectronics Technologies inc.
• LORAL Skynet
• Nippon Steel
• Savita Chemicals

Cash Management

Cash is the important current asset for the operations of the business. Cash is the basic input needed to keep the business running on a continuous basis it is also the ultimate output expected to be realized by selling the service or product manufactured by the firm. The firm should keep sufficient cash, neither more nor less. Cash shortage will disrupt the firm’s operations while excessive cash will simply remain idle, without contributing anything towards the firm’s profitability. Thus a major function of the Financial Manager is to maintain a sound cash position.

Cash is the money which a firm can disburse immediately without any restriction. The term cash includes currency and cheques held by the firm and balances in its bank accounts. Sometimes near cash items, such as marketable securities or bank time deposits are also included in cash. The basic characteristics of near cash assets are that they can readily be converted into cash. Cash management is concerned with managing of:

i)          Cash flows in and out of the firm

ii)         Cash flows within the firm

iii)        Cash balances held by the firm at a point of time by financing deficit or inverting surplus cash.

Sales generate cash which has to be disbursed out. The surplus cash has to be invested while deficit cash has to be borrowed. Cash management seeks to accomplish this cycle at a minimum cost. At the same time it also seeks to achieve liquidity and control. Therefore the aim of Cash Management is to maintain adequate control over cash position to keep firm sufficiently liquid and to use excess cash in some profitable way.

The Cash Management is also important because it is difficult to predict cash flows accurately. Particularly the inflows and that there is no perfect coincidence between the inflows and outflows of the cash. During some periods cash outflows will exceed cash inflows because payment for taxes, dividends or seasonal inventory build up etc. On the other hand cash inflows will be more than cash payment because there may be large cash sales and more debtors’ realization at any point of time. Cash Management is also important because cash constitutes the smallest portion of the current assets, yet management’s considerable time is devoted in managing it. An obvious aim of the firm now-a-days is to manage its cash affairs in such a way as to keep cash balance at a minimum level and to invest the surplus cash funds in profitable opportunities. In order to resolve the uncertainty about cash flow prediction and lack of synchronization between cash receipts and payments, the firm should develop appropriate strategies regarding the following four facets of cash management.

1.   Cash Planning: – Cash inflows and cash outflows should be planned to project cash surplus or deficit for each period of the planning period. Cash budget should prepared for this purpose.

2.   Managing the cash flows: – The flow of cash should be properly managed. The cash inflows should be accelerated while, as far as possible decelerating the cash outflows.

3.   Optimum cash level: – The firm should decide about the appropriate level of cash balances. The cost of excess cash and danger of cash deficiency should be matched to determine the optimum level of cash balances.

4.   Investing surplus cash: – The surplus cash balance should be properly invested to earn profits. The firm should decide about the division of such cash balance between bank deposits, marketable securities and inter corporate lending.

The ideal Cash Management system will depend on the firm’s products, organization structure, competition, culture and options available. The task is complex and decision taken can affect important areas of the firm.

Functions of Cash Management:

Cash Management functions are intimately, interrelated and intertwined Linkage among different Cash Management functions have led to the adoption of the following methods for efficient Cash Management:

• Use of techniques of cash mobilization to reduce operating requirement  of cash
• Major efforts to increase the precision and reliability of cash forecasting.
• Maximum effort to define and quantify the liquidity reserve needs of the firm.
• Development of explicit alternative sources of liquidity
• Aggressive search for relatively more productive uses for surplus money assets.

The above approaches involve the following actions which a finance manager has to perform.

1. To forecast cash inflows and outflows

2. To plan cash requirements

3. To determine the safety level for cash.

4. To monitor safety level for cash

5. To locate the needed funds

6. To regulate cash inflows

7. To regulate cash outflows

8. To determine criteria for investment of excess cash

9. To avail banking facilities and maintain good relations with bankers

Motives for holding cash:

There are four primary motives for maintaining cash balances:

1. Transaction motive

2 .Precautionary motive

3. Speculative motive

4. Compensating motivess

(1) Transaction Motive : This motive refers to the holding of cash in order to meet the day-to-day expenses of the business. These transactions including purchase of raw material, packing materials, wages, operating expenses, taxes, dividend etc. (1) since the timing of cash inflows and the cash outflows differ significantly, a minimum cash balance is required. At the same time, there is regular inflow of cash from sales proceeds, income from investments etc. But inflows and outflows-of cash do not perfectly coincide. (2) Sometimes the firm has surplus cash in certain periods, which the firm invests in easily marketable securities. These are sold and cash realized when need for payment arises in business. (3) Some firms keep cash on hand to meet some anticipated payments. It may invest such surplus cash in such a way that it will mature when anticipated payment is to be made. (4) The company is also required to keep some cash on hand to make regular annual payments, e.g. once in a year, cash is needed to pay dividend. Similarly, advance tax is payable every three months for which a firm is required to hold some cash. Here again it can be invested in short term marketable securities.

(2) Precautionary Motive : This motive for holding cash refers to maintaining a cash balance to meet unexpected contingencies, which may arise as a result of

– Uncontrollable circumstances, such as floods, strikes, earthquakes etc.

– Sharp increase in the cost of materials, labor etc.

– Unexpected delay in collection of accounts receivables.

Thus precautionary balance is required to meet unforeseen contingencies. If the event for which cash balance is kept is more unpredictable, the larger would be the cash needed. If there has been a careful planning, less cash would be required.

If the firm has a good prestige in the market, it can borrow from banks or from other sources at a short notice, it will require less cash to be maintained for contingencies. Insurance against some of the risks may also come to the help, in the sense that money can be recovered from insurance company and so less cash may be maintained. But no cut and dried formula can be suggested. Conditions would differ from industry to industry and also from firm to firm. It is for the finance manager to determine the cash to be held looking to the circumstances available. Generally such cash is held in the form of marketable securities, so that it can earn some return.

(3) Speculative Motive : It refers to the desire of a firm to keep cash to take advantage of profitable opportunities, which are outside the normal course of business. It helps to take advantage of

– Purchasing raw materials at reduced prices by availing the benefits of cash discount.

– Speculating on interest rate movements etc.

The holding of cash for speculative motive by a business firm is debatable. It is believed that business firms should not indulge in speculative transactions, as it involves risks that can put firm in trouble. Another viewpoint is that surplus cash, if any, should also be invested in sound securities, so that it earns some return. Such transactions made at times will raise the profitability of business. However, it requires caution, foresight and skill. Hence, the best way is not to hold cash for speculative motive.

(4) Compensating Motive : Banks provide different types of services to the firms, e.g. clearance of cheque, transfer of funds etc. against a nominal fee or commission. Generally, clients (firms) are required to maintain a minimum cash balance at the bank which cannot be utilized by them for transaction purpose. The bank can use the same for generating returns. To get compensated for free services, they provide to customers, the banks require the clients to always keep a bank balance sufficient to earn a return equal to the cost of services. Such balances are called compensating balance.

Cash Management Objectives

The Basic objective of cash management is two fold:

(a)  To meet the cash disbursement needs (payment schedule);

(b)  To minimize funds committed to cash balances. These are conflicting and mutually contradictory and the task of cash management is to reconcile them.

(a)   Meeting the payments schedule: – A basic objective of the cash management is to meet the payment schedule, i.e. to have sufficient cash to meet the cash disbursement needs of the firm. The importance of sufficient cash to meet the payment schedule can hardly be over emphasized. The advantages of adequate cash are : (i) it prevents insolvency or bankruptcy arising out of the inability of the firm to meet its obligations; (ii) the relationship with the bank is not strained; (iii) it helps in fostering good relations with trade creditors and suppliers of raw materials, as prompt payment may also help their cash management; (v) it leads to a strong credit rating which enables the firm to purchase goods on favorable terms and to maintain its line of credit with banks and other sources of credit; (vi) to take advantage of favorable business opportunities that may be available periodically; and (vi) finally the firm can meet unanticipated cash expenditure with a minimum of strain during emergencies, such as strikes , fires or a new marketing campaign by competitors.

(b) Minimizing funds committed to cash balances: – The second objective of cash management is to minimize cash balances. In minimizing cash balances two conflicting aspects have to be reconciled. A high level of cash balance will, ensure prompt payment together with all the advantages, but it also implies that large funds will remain idle ultimately results less to the expected. A low level of cash balances, on the other hand, may mean failure to meet the payment schedule that aim of cash management should be to have an optimal amount of cash balances

Elements of a Cash Management System

The basic premise of sound cash management is to ensure that cash inflows  and outflows are effectively controlled and utilized. To effectively control cash flow, institutions must implement adequate cash management techniques to expedite cash collections and check clearing in order to access and use the funds. Institutions must also develop cost-effective disbursement mechanisms for transferring funds. The board and management are ultimately responsible for selecting the best collection and payment mechanisms as well as adopting appropriate oversight and review guidelines, operating policies and procedures, and audit requirements. In some cases, institutions may deploy other financial institutions and organizations for cash management related services that can be performed more economically or efficiently. Such services include transfer and payment of funds, collection and concentration of funds, sweep account services, information reporting, and so on.

Collection – An important component of the cash management function is the collection of funds. This process involves speeding up the conversion of receipts into available funds. By minimizing the float time associated with collection of accounts receivable and extending the float on the accounts payable side, institutions can more effectively manage cash. Hence, institutions should effectively develop a system to collect payments from customers.

Concentration – This is the movement of funds from outlying depository locations to a central bank account, commonly called a concentration account, where the funds can be more efficiently used. The most frequently used methods for concentration are depository transfer checks (DTCs), electronic depository transfers (EDTs), and wire transfers. A DTC is an unsigned paper instrument payable only to the bank of deposit for credit to a specific account. Instead of writing and depositing checks to concentrate funds, an institution instructs a concentration bank to prepare DTCs drawn for deposit into the concentration account. After a DTC is deposited, it clears in the same manner as a regular check. An EDT is simply an electronic version of the paper DTC (also known as an ACH-DTC) and is normally more cost-effective. Wire transfers may also be used for concentration but is the most expensive method. They are generally used when the amounts are large enough to justify their cost and where funds are immediately needed.

Disbursement – This involves controlling the release and timing of outgoing funds. Various disbursement techniques are available for institutions to effectively manage the disbursement process. These include checks, zero balance accounts, controlled disbursement, payable through drafts, and electronic disbursement methods.

• Checks – Checks are still the most frequently used payment instrument for bill paying and provide the payor with disbursement float. However, technological advances have increased the sophistication of check fraud. These technological advances include color copiers, high-resolution laser printers, and hand-held document scanners for use with a personal computer. Electronic payments methods help prevent check fraud by eliminating the check. Without a negotiable instrument, the counterfeiter has nothing to alter or copy. Furthermore, electronic payments (e.g., ACH) also offer strong cost savings potential by eliminating check printing costs, postage for mailing checks, and bank fees associated with check processing, account reconcilement, and check fraud prevention services.
• Zero Balance Accounts (ZBAs) – A ZBA is a disbursement account on which checks are written even though the balance in the account is zero. A transfer of funds from the institution’s master account covers the checks. Funding of the ZBA account is automatic and involves only an accounting entry by the bank. Credits and debits are posted just before the close of business when a credit from the master account is posted to bring the balance back to zero. If there is a credit balance in the ZBA account, the ZBA will be debited and a credit made to the master account.
• Controlled Disbursement – Another method used to minimize balances in disbursement accounts is controlled disbursement. This is a bank service that provides same-day notification, usually by mid-morning, of the dollar amount of checks that will clear against the controlled disbursement account that day. The disbursement bank receives information from the local Federal Reserve Bank early in the morning so that the checks can be sorted and the institution notified of its funding requirement.
• Payable Through Drafts (PTDs) – A PTD is a payment instrument resembling a check that is drawn against the payor, not the bank, and on which the payor has a period of time to honor or refuse payment. PTDs are used frequently to fund loans on capital items purchased by the borrower (e.g., equipment or livestock). The use of drafts gives the institution an added measure of disbursement control and additional time to ensure that all terms have been met or expenditures authorized. Electronic PTDs are simply ACH debits to an institution’s account in which the institution is notified in time to pay or reject each item. They are used for similar purposes as paper PTDs.
• Electronic Disbursements – As with collection and concentration systems, disbursements can also be made electronically. As indicated previously, funds operated by wire transfers are moved almost instantaneously, thereby reducing float time, but are a costly way to disburse funds compared to checks and ACH transactions. Image technology can also be used to facilitate the processing of payments. This technology allows paper documents (e.g., checks) to be scanned and converted to digital information. The images may be transmitted to a computer and stored there, or sent to a fax machine. The increasing use of electronic commerce and potential cost savings are expected to stimulate growth in electronic payment systems as discussed in the following section.

Electronic Payment Systems – The growing use and the reliance on the electronic transfer of funds expose an institution to additional risk in the management of cash. Each day, the institution’s customers may make thousands of payments that result in the transfers of balances among the institutions, depository banks, and Federal Reserve Banks. In addition, institutions make their own payments in connection with carrying out their business. Because of electronic commerce, information moves faster and with greater accuracy. Consequently, the access and speed capabilities can magnify risk in an electronic environment. Since cash is a highly liquid asset, it can be easily transferred, concealed, and converted into other assets. For these reasons, institutions must have an adequate and effective information system (IS) in place. Coordination with IS examiners will be necessary to comprehensively evaluate an institution’s electronic environment. While the range of electronic funds transfer may vary from institution to institution, the most common types of electronic payment systems include the following.

• Automated Clearinghouse (ACH) System – The ACH system was developed as an electronic alternative to checks. It comprises a network of regional associations, interbank associations, and private sector processors. The Federal Reserve is the principal ACH operator, and the majority of financial institutions are members of an ACH association. In an ACH transaction, payment information is processed electronically instead of manually, thereby increasing reliability, efficiency, and cost-effectiveness. Institutions can make both credit and debit transactions with an ACH. In addition, an ACH transaction is capable of transferring more information about a payment than is possible with a check. Transactions are settled 1 or 2 business days after the payment information is entered into the payment system. In general, ACH payments can be used in place of more costly wire transfers when the amounts are known at least 1 day in advance.
• FedWire – The FedWire is the Federal Reserve funds transfer system. It is a real-time method of transferring immediate funds and supporting information between two financial institutions using their respective Federal Reserve accounts. The system is reliable and secure but relatively expensive for institutions compared to checks and ACH transactions. The FedWire functions as both a communication (i.e., clearing) and a settlement facility. The FedWire service may be accessed by direct computer interface or off-line by telephone through a personal computer based electronic delivery system named FedLine. Funds are moved almost instantaneously once the originating bank has received the request. The transaction is final and irrevocable once the originating bank has sent the funds and the Federal Reserve confirms receipt. In the event of the sending bank’s failure to settle, the Federal Reserve guarantees the transferred funds to the receiving bank. Therefore, there is no settlement risk to the recipient of a FedWire transfer. Nevertheless, other types of risk associated with the FedWire funds transfer method include potential loss because of errors, omissions, and fraud.
• Clearinghouse Interbank Payments System (CHIPS) – This is a funds-transfer network owned and operated by the New York Clearinghouse Association to deliver and receive United States (U.S.) dollar payments between domestic or foreign banks that have offices located in New York City. CHIPS was established to substitute electronic payments for paper checks arising from international dollar transactions, such as Eurodollar investments or foreign exchange contracts. The network is composed of a small number of settling participants (large U.S. chartered banks that settle end-of-day balances between each other) and a larger number of non-settling participants who maintain accounts with one of the settling banks. Unlike FedWire funds transfers, CHIPS transfers are not settled at the time the payment instructions are delivered. Instead, the transfers are settled at the end of the day through a net settlement arrangement established with the Federal Reserve Bank of New York.
• Society for Worldwide Interbank Financial Telecommunications (SWIFT) – This is a nonprofit cooperative of member banks serving as a worldwide interbank telecommunications network based in Brussels, Belgium. It is the primary message system employed by financial institutions worldwide to transmit either domestic or international payment instructions. Unlike electronic funds transfer systems, SWIFT only provides instructions to move funds. Messages are transferred requesting debits and credits and other types of messages to correspondent accounts. SWIFT does not have a settlement mechanism. Settlement occurs through FedWire, CHIPS, or other means.

Complete elimination of risk from electronic funds transfer is an impossible task. However, the increasing use of electronic transfer activities makes it essential that each System institution clearly understands the risks inherent in these activities and be aware of the methods for possibly reducing these risks to an acceptable level. The next section provides a brief discussion of some of the sources of risk involved in the overall cash management operations.

Evaluation Of Cash Management Performances

One of the most important jobs of the Finance Manager is to maintain sufficient liquidity to enable the firm to pay off its obligations when they fall due. To test a firm’s liquidity and solvency we commonly use current and quick ratios. Traditionally 2:1 current ratio and 1:1 quick ratio are taken as satisfactory standards for the purpose. The former indicates the extent of the soundness of the current financial position of a firm and the degree of safety provided to the creditors, the later signifies the ability of a firm to settle all its current obligations on a particular date.

Current ratio

The above chart is showing that the current ratio is decreasing. Although it is over 2:1 in the 5 years study period. So, I can say that the company has very sound position regarding liquidity.

Quick Ratio

The above chart is showing that the quick ratio is decreasing during the 5 years study period. Traditionally 1:1 quick ratio is taken as satisfactory standards for the purpose. The quick ratio is over 1:1 in the 5 years study period. So, I can say that the company has very sound position regarding liquidity.

Management of  Inventory

Inventories are the stock of the product made for sale by the company or semi finished goods or raw materials. Inventory of finished goods which are ready for sale is required to maintain smooth marketing operation. The inventory of raw material and work in progress is required in order to maintain an unobstructed flow of material in the production line. These inventories serve as a link between the production and consumption of goods.

The aspect of management of inventory is especially important in respect to the fact that in country like Bangladesh, the capital block in terms of inventory is about 70% of the current assets. It is therefore, absolutely imperative to manage efficiently and effectively in order to avoid unnecessary investment in them. Although to maintain low inventories may prove to be profitable but to maintain very low inventories may prove risky on the contrary.

This aspect of management if tackled in a proper way may prove to be a boon its effective and efficient management would result in the maintaining of optimum level of inventories. At this level the profitability of the organization will not be jeopardized at the cost of inventory.

Now from the above stated facts it is clear that maintaining of optimum level of inventory involves huge cost, so why should keep the inventories at all. Basically there are three main reasons for which inventories are stocked and they are:-

1.Transaction Motive: This motive lays emphasis on maintaining of inventories in order to maintain a smooth and unobstructed supply of materials for the sales and production operations.

2.Precautionary Motive: This motive emphasizes on the stocking goods in order to guard against the uncertainties of future i.e. unpredictable changes in the forces of demand, supply and other forces.

3. Speculative Motive:    This motive influences the decisions regarding the increase or decrease in the level of inventory in order to take advantage of price fluctuations.

A company should maintain adequate stock of materials for a continuous supply to the factory for an uninterrupted production. It is not possible for a company to procure raw material instantaneously whenever needed. A time lag exists between demand and supply of material. Also, there exists an uncertainty in procuring raw material in time at many occasions. The procurement of materials may be delayed because of factors beyond company’s control e.g. transport disruption, strike etc. Therefore, the firm should keep a sufficient stock of raw material at a time to have streamline Other factors which may incite us to keep stock of inventories is the quantity discounts, expected rise is price.

The work in process inventory builds up because of the production cycle. Production cycle is the time span between the introduction of raw material in to the production and the emergence of finished goods at the completion of production cycle. Till the production cycle completes, the stock of work in process has to be maintained.

Efficient firms constantly try to make the production cycle smaller by improving their production techniques.

The stock of finished goods has to be held because production and sales are not instantaneous. A firm can not produce immediately when goods are demanded by customers. Therefore to supply finished goods on regular basis, their stock has to maintain for sudden demand of customers, in case the firm sales are seasonal in nature, substantial finished goods inventory should be kept to meet the peak demand. Failure to supply products to customer, when demanded, would mean loss of the firm’s sales to the competitors.

Major Raw Material used by the Company:

ABC system of segregation of inventory at “Shakti Engineering Ltd”.

From above table clearly showing the classification of materials in to three groups

 materials are Copper, stamping materials, CE & NC covers, IP coils

Stator frames, still keys

Rubber materials, Nuts & bolts, Washers, M/S Components

From the above analysis I can interpret that SEL adopted ABC technique based on Costs and usage and it is using to maintain the inventory in warehouse it reduces the damages of goods in warehouse so it increases quality of production and same time it gives information about re ordering point order delivery period.

Table shows percentage wise Costs incurred for raw materials

Above pie diagram is showing the cost incurred for the different raw materials.  Company is spending 30% on Copper, 25% on Stamping, 15% Mild still, 30% on others.

Organization is spending more money on getting the raw materials of Copper, Stamping and Mild still from different vendors. And it helps to maintain safety stock in unit.

Table shows lead time of raw materials

The graph shows that SEL gets Copper within 14 days of ordering, Stamping materials within 14 days, Stator Frames within 30 days, CE & NC Covers within 14 days, IP Coils within 14 days, Rubber within 15 days, Nuts and Bolts within 14 days, Washers within 14 days and M/S components within 14 days of ordering

It can be interpreted as procuring of Stator Frames is consuming more time and the company has to concentrate on this and should try to reduce the Lead time of procurement of Stator Frames. If lead time is high it’s indirectly effects to dispatching of goods and sales.

Calculations

Re order point

Formulae: Normal usage in lead time + Safety stock

Annual usage 2, 00,000 (2 tons)

Lead time 14 days

                                      7000+1000 = 8000 kg

Annual usage 3, 00,000 (2 tons)

                                        11,662 + 3000 = 15662 kg

Stator frames

Annual usage 4800 pieces

Lead time 30 days

                                         300 + 300 = 600 Frames

CE & NC covers

Annual usage 9600

                                         280 + 500 = 780 covers

Annual usage 72000

                                           2800 + 500 = 7800

Table shows the re order point of raw materials

Above graph is showing the reordering of raw materials to the vendors. When copper reaches to the 8000Kgs , Stamping materials reaches 11662Kgs, Stator frames reaches 600 units, CE & NC reaches to 530 units and IP coils reaches to 7800 units. The company will go for re order.

Reordering point plays key role to maintain the stock in proper order to avoid the out of stock in the company.

Evaluation Of Inventory Management:

Inventory Conversion Period

The graph is showing that in 2005-06 inventory conversion period was 89 days. It was increasing in the 5 years study period. It shows that the stock retention period is on fluctuating trend.

Inventory Turnover Ratio

Inventory turnover ratio is generally regarded as indicator of inventory efficiencies. It establishes a relationship between the total sales during a period and average inventory hold to meet that quantum. In 2005-06 it was 4.09 it shows very slow moving of inventory. But during the 5 years study period it was in decreasing trend.

Management Of Receivables

Trade credit, the tool which as a bridge for movement of goods through production and distribution stages to customer, is a force in the present day business and a essential device. Trade credit is granted with a motive of protecting the sale from ones, competitors and attaching more of the potential customers. Trade credit is said to be extended to a customer when a firm sell its services or goods and does not receive the payment for them immediately. Thus trade credit creates receivable which refer to the amount which a firm is expected to collect in near future.

Aspects of Credit Policy:

The important aspects of credit policy should be identified before establishing an optimum credit policy. The important decision variables of the credit policy are:

• Cash period: The time duration for which the credit is extended to the customers is referred to as credit period. Usually the credit period of the firm is governed by the industry norms, but firms can extend credit duration to stimulate its sales.
• Cash discounts: Cash discounts are the offer made by the firm to customer to pay less if the required amount is paid earlier. The cash discount terms indicate the rate of discount and the period for which discount has been offered. If the customer does not avail this offer, he is expected to make the payment by the due date.
• Credit Standards: The credit standards followed by the firm have an impact on sales and receivable. The sales and receivable levels are likely to be high if the credit standards of the firm are relatively loose. In contrast, if the firm has relatively tight credit standards, the sales and receivable are expected to be low. The credit standards are governed by various aspects such as the willingness of the customer to pay, the ability of the customer to pay in the economic conditions etc.
• Collection Policy: The need to collect the payments early gave rise to a policy regarding it, called as the collection policy. It aims at the speed recovery from slow payers and reduction of bad debts losses. The firm has to very cautious while it goes in for collection from slow payers. The various aspects such as willingness, capabilities, and external conditions should be taken care of before you go in collection procedure. The optimum collection policy will maximize the profitability and will be consistent with the objective of maximizing the value of the firm.

Performance Evaluation Of Receivables Management

Average collection period explains how many days of credit, a company is allowing to the customer, a higher collection period indicates towards a liberal and inefficient credit and collection performances shorter the collection period the better the credit management and liquidity of accounts receivable.

Average collection period

Analysis: The above graph is showing that average collection period of receivable is in fluctuating trend during the 5 years study period. It was 63 days in the year 2008-09. It shows the collection period of receivable is too high. The collection period of debtors should be kept at lowest level for the reduction in cost of capital and better productivity

Management Of  Payables

A substantial part of purchase of goods and services in business are on credit terms rather than against cash payment. While the supplier of goods and services tends to perceive credit as a lever for enhancing sales or as a form of non-price instrument of competition, the buyer tends to look upon it as a loaning of goods or inventory. The supplier’s credit is referred to as Accounts payable, Trade Credit, Trade Bill, Trade Acceptance, commercial drafts of bills payable depending on the nature of the credit.

Determinants Of Trade Credit

Size of the firm:

Smaller firms have increasing dependence on trade credits as they find it difficult to obtain alternative sources of finance as easily as medium or large sized firms. At the same time, larger firms that are less vulnerable to adverse turns in business can command prompt credit facility from supplier, while smaller firms may find it difficult to sustain creditworthiness during periods of financial strain and may have reduced access to credit due to weak financial position.

Industrial Credits:

Different categories of industries or commercial enterprises show varying degree of dependence on trade credit

Nature of Product:

Products that sell faster or which have higher turnover may need shorter term credit. Products with slower turnover take longer to generate cash flows and will need extended credit terms.

Financial Position of Seller:

The financial position of the seller will influence the quantities and periods of credits he wishes to extend. Financially weak suppliers will have to be strict and operate on higher credit terms to buyers. Financially stronger suppliers, on the other hand, can dictate stringent credit terms but may prefer to extend liberal credit so long as the transactions provide benefits in excess of the costs of extending credit.

Financial position of the buyer:

Buyer’s creditworthiness is an important factor in determining the credit quantum and period. It may be logical to expect large buyers not to insist on extending credit terms for small suppliers with weak bargaining power. Where goods are supplied on a consignment basis, the supplier provides extra finance for the merchandise and pays commission to consignee for the goods sold.

Cash discounts:

Cash discount influences the effective length of credit. Failure to take advantage of the cash discount could result in the buyer using the funds at an effective rate of interest higher than the alternative sources of finance available.

Degree of risk:

Estimates of credit risk associated with the buyer will indicate what credit policy is to adopt the risk may be with reference to the buyer’s financial standing or with reference to the nature of the business the buyer is in.

Evaluation of Payables Management

  Average Payment Period

Analysis: Table shows that the minimum average payment period is 12 days and maximum is 20 days. The payment period of creditors should be kept at highest level for the reduction in cost and better productivity Table reveals the increasing trend in average payment period which is good for the company.

• The company is in a sound position regarding liquidity. In the 5 years study period its current ratio is over 2:1 and quick ratio is over 1:1.
• The company uses ABC techniques to maintain its inventory efficiently and to get information about reordering point.
• The inventory conversion period is too high of the company. It is in increasing trend. It is not good for the company.
• Inventory turn over ratio is too high. It shows very slow moving of inventory.
• The average collection period of receivable is too high. I t increases the cost of capital.
• The average payment period of payables is too low. The company pays its payables too earlier.

Recommendation

• The inventory conversion period is too high of the company. It is in increasing trend. The company should take possible initiatives to reduce its inventory conversion period.
• The company should keep its inventory turnover ratio in a lower point.
• To reduce cost of capital the company should take proper steps to keep receivable collection period in a lower point.
• The company should take the advantages of deferral payments of payables.

Internship Experience

As an intern student of EasternUniversity I worked in Shakti Engineering Ltd. for three months limited period. In this limited period of time I have learned many things and most importantly it was the first introduction to the corporate world. I also learned

• How to work in stressful situation as well as work with responsibilities.
• How manage the time properly.
• About the organizational behavior.
• How to interact with the seniors and co-workers.
• About the application of theoretical knowledge in real business environment.
• How to keep records of different activities in a organization.

At sum up, I can say that the internship period was very inspiring for me.

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What is Working Capital? Definition, Example, Sources, & Benefits

By Pine Labs | August 01, 2022

Working capital is the amount of liquid assets a company has, minus any liabilities (money owed). It allows companies to finance and grow their businesses without the need for more expensive outside sources of funding.

The primary use of working capital is to fund ongoing operations. For example, if a business wants to bring a new product to market, it will need cash on hand to pay for the design, development, and distribution of the product until they can sell enough units to recover their costs.

The importance of working capital is usually emphasised in larger companies. These businesses have to finance a large number of staff and supplies, so they are more affected by changes in working capital. However, even small businesses need some working capital. A company with high working capital is considered to be in a better position than one that does not have enough working capital.

Working Capital Formula

The working capital calculation is:

Working Capital = Current Assets – Current Liabilities

Sources of Working Capital

Working capital can be acquired from numerous sources:

In the equation above, current assets are cash and its equivalents. Total cash is the difference between the sum of all bank accounts and all cash on hand. The second part of working capital is current liabilities. This is represented in the equation by debt owed to other people and money invested in stocks or bonds. 

There are three ways that companies accumulate their current assets, including through previous financial transactions, retained earnings, and sales. The retention of earnings is the primary source of current assets for a large majority of companies. This is achieved because the company makes a profit. The profit remains with the company and can be used to invest in growth or to pay off any outstanding debts. 

Working capital sources can be long-term, short-term, and spontaneous. Share capital, retained profits, debentures, long-term loans, and provision for depreciation are usually considered long-term working capital sources. The sources of short-term working capital include tax provisions, public deposits, cash credits, and others. Whereas, spontaneous working capital includes notes payable and bills payable.

What is the Working Capital Cycle? 

The working capital cycle is the time involved for a company to get from one point (where assets have been created, liabilities paid off, and profits distributed) to another. In fact, the working capital cycle starts when the company has positive working capital and ends when the company has negative working capital. Therefore, a company is considered to free up its blocked cash swiftly if it has a shorter working capital cycle. All companies, in fact, try to reduce the working capital cycle to improve liquidity in the short term.

Examples of Working Capital

Calculating Working Capital Example 1

If a company has $16,990 USD in its bank account, it also owes $9648 USD in debt to suppliers. The company and its suppliers have agreed to pay all these debts by 21st December. Similarly, the company has $4331 USD in cash on hand and a stock of $9648 USD. The company does not have any long-term debts (debts for the next 12 months or more).

According to the above situation, the working capital of this company is as follows:

Working capital = $16,990 USD – $9648 USD = $9648 USD.

The working capital of this company is $9648 USD.

Calculating Working Capital Example 2

If a company has $23,926 USD in its bank account and owes $9648 USD to suppliers. The company also has a current account of $33,077 USD. Assuming the company is owed money by suppliers during the year.

Working capital = $23,926 USD – $9648 USD = $16,990 USD.

The working capital of this company is $16,990 USD.

Calculating Working Capital Example 3

If a company has $33,077 USD in its bank account and owes $16,990 USD to suppliers. The company also has a current account of $23,926 USD. Assume the same situation happens in future months.

Working capital = $33,077 USD – $16,990 USD = $16,990 USD.

Advantages of Working Capital

1. solvency of business.

When a business has more working capital than its current liabilities, it is known as the "solvency" of the business. This is an excellent situation for any company and can be used for many different purposes.

2. Easy loans

When a company has cash on hand, it can easily get loans from banks. Even if the company's credit rate is not good, it can still get a loan because of its cash reserve. Loans from banks with good interest rates are important for small and medium-sized businesses.

3. Regular supply of raw materials

If a company has working capital, it can easily get raw materials from suppliers. This is a good situation for any company because, if everything goes well, it is able to bring in regular supplies of raw materials and, thereby, reduce its production costs.

4. The exploitation of favourable market conditions

A company that has high working capital means that the business is well-solvent. When a business has positive working capital, it can easily exploit favorable market conditions and make a profit. This can be good for the company's profitability.

5. Ability to face a crisis

A company with good working capital can be able to face a crisis and make changes in the business. When a company has a lot of cash on hand, it will not have trouble doing anything, and crisis are easily overcome. Check out more in our blog Working Capital in Retail : The firework you need for the Big Bang deals this Diwali.

Frequently Asked Questions

1. How do you calculate working capital?

The formula for working capital is as follows:

In the above formula, current assets are the cash and its equivalents, current liabilities are represented by all debts owed to other people and money invested in stocks or bonds. And the working capital refers to the total amount of liquid assets a company has on hand (the current assets).

2. What is another name for working capital?

Working capital is one way to measure a company's liquidity position. It is also called venture capital, equity capital, fixed capital, and working asset.

3. Is salary a working capital?

No. Salary cannot be calculated as the working capital of a business. Once paid, salaries cannot also be included in current liabilities.

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