ASSIGNED BY:

RAWAL
2K19/BBA/149

UNIVERSITY OF SINDH, JAMSHORO

CHAPTER#
WORKING CAPITAL MANAGEMENT

INTRODUCTION:
Working capital management is essentially an accounting strategy with a focus on the
maintenance of a sufficient balance between a company's current assets and liabilities. An
effective working capital management system helps businesses not only cover their
financial obligations but also boost their earnings.
Proper management of working management is essential to a company’s fundamental
financial health and operational success as a business. A hallmark of good business
management is the ability to utilize working capital management to maintain a solid
balance between growth, profitability, and liquidity.
There are two major concepts of working capital – net working capital and gross working
capital. When accountants use the term working capital, they are generally referring to
net working capital, which is the dollar difference between current assets and current
liabilities.
This is one measure of the extent to which the firm is protected from liquidity problems.
From a management viewpoint, however, it makes little sense to talk about trying to
actively
manage a net difference between current assets and current liabilities, particularly when
that
difference is continually changing.
Financial analysts, on the other hand, mean current assets when they speak of working
capital. Therefore, their focus is on gross working capital. Because it does make sense for
the financial manager to be involved with providing the correct amount of current assets
for
the firm at all times, we will adopt the concept of gross working capital. As the discussion
of
working capital management unfolds, our concern will be to consider the administration of
 the firm’s current assets – namely, cash and marketable securities, receivables, and
inventory and the financing (especially current liabilities) needed to support current
assets.

KEYPOINTS:
 The goal of working capital management is to maximize operational efficiency.
 Efficient working capital management helps maintain smooth operations and can
also help to improve the company's earnings and profitability.
 Management of working capital includes inventory management and management
of accounts receivables and accounts payables.
The Importance of Working Capital Management
Working capital is a daily necessity for businesses, as they require a regular amount of
cash to make routine payments, cover unexpected costs, and purchase basic materials
used in the production of goods.
Efficient working capital management helps maintain smooth operations and can also help
to improve the company's earnings and profitability. Management of working capital
includes inventory management and management of accounts receivables and accounts
payables. The main objectives of working capital management include maintaining the
working capital operating cycle and ensuring its ordered operation, minimizing the cost of
capital spent on the working capital, and maximizing the return on current asset
investments.
Working capital is an easily understandable concept, as it is linked to an individual’s cost
of living and, therefore can be understood in a more personal way. Individuals need to
collect the money that they are owed and maintain a certain amount on a daily basis to
cover day-to-day expenses, bills, and other regular expenditures.
IMPORTANT: When a company does not have enough working capital to cover its
obligations, financial insolvency can result and lead to legal troubles, liquidation of assets,
and potential bankruptcy.
Working capital management is essentially an accounting strategy with a focus on the
maintenance of a sufficient balance between a company’s current assets and liabilities. An
effective working capital management system helps businesses not only cover their
financial obligations but also boost their earnings.
Managing working capital means managing inventories, cash, accounts payable and
accounts receivable. An efficient working capital management system often uses key
performance ratios, such as the working capital ratio, the inventory turnover ratio and the
collection ratio, to help identify areas that require focus in order to maintain liquidity and
profitability.
Working Capital Policies
Conservative  Use permanent capital for permanent assets and temporary assets.
Moderate  Match the maturity of the assets with the maturity of the financing.
Aggressive  Use short-term financing to finance permanent assets.
Let's view the characteristics of each policy.
1. CONSERVATIVE WORKING CAPITAL POLICY.
high level of investment in current assets
support any level of sales and production.
high liquidity level
Avoid short-
term financing to reduce risk, but decreases the potential for maximum value.
creation because of the high cost of long-term debt and equity financing.
Borrowing long-term is considered less risky than borrowing short-term.
This approach involves the use of long-term debt and equity to finance all long-
term fixed.
assets and permanent assets, in addition to some part of temporary current assets.
 The firm has a large amount of net working capital. It is a relatively low-risk position.
The safety of conservative approach has a cost.
Long-term financing is generally more expensive than short-term financing.
2. AGGRESSIVE WORKING CAPITAL POLICY.
Low level of investment
More short-term financing is used to finance current assets.
Support low level of production & sales.
Borrowing short-term is considered riskier than borrowing long-term.
Firm risk increases, due to the risk
of fluctuating interest rates, but the potential for higher.
returns increases because of the generally low-cost financing.
This approach involves the use of short-term debt to finance
at least the firm's temporary.
assets, some, or all its permanent current assets, and possibly some of its long-term fixed
assets. (Heavy reliance on short term debt)
The firm has very little net working capital. It is riskier.
May be a negative net working capital. It is very risky.
3. MODERATE WORKING CAPITAL POLICY
This approach tries to balance risk and return concerns.
Temporary current assets that are only going to be on the balance sheet for a short time.
should be financed with short-term debt, current liabilities. And permanent current assets
and long-term fixed assets that are going to be on the balance sheet for a long time should
be financed from long-term debt and equity sources.
The firm has a moderate amount of net working capital. It is a relatively amount of risk.
balanced by a relatively moderate amount of expected return.
In the real world, each firm must decide on its balance of financing sources and its
approach to working capital management based on its industry and the firm’s.
risk and return strategy.

LIQUIDITY & PROFITABILITY:
� Lenders prefer a company having a large excess of
current assets over current liabilities whereas the
owners prefer a high return.
� Current assets have the advantage of being liquid but holding them
is not very profitable.
� Cash account is paid no interest.
� Accounts receivable earns no return.
� Inventory earns no return until it is sold.
� Non-current assets can be profitable, but they are usually not very liquid.
� Firms are usually faced with creating trade-off in their working capital management pol
icy.
� They seek a balance between liquidity and profitability that reflects their desire for pro
fit and their need for liquidity.

Working capital ratio formula:

While working capital is calculated by subtracting current liabilities from current

For example, if your business has $500,000 in assets and $250,000 in liabilities,
your working capital ratio is calculated by dividing the two. In this case, the ratio
is 2.0.