Chapter 3 – Working Capital Management

Working Capital

Gross Working Capital

  • Gross Working Capital is the capital invested in total current assets of the enterprise

Net Working Capital

  • Current Assets  –  Current Liabilities

Working Capital Gap

  • Current Assets  –  Current Liabilities other than bank borrowings

Source of Working Capital

  • Credit available on purchase
  • Short term bank borrowing
  • Surplus of long term funds over long term uses
  • Short term borrowing

 

Assessment of Working Capital Requirements

  1. Turnover Method
  • Fund-based working capital credit limits up to Rs.5 crore
  • Working Capital requirements of the borrower will be 25% of the projected annual turnover
  • 20% of the projected annual turnover should be provided by the bank
  • 5% of the projected annual turnover should be provided by the borrower (20% Margin)

Ex-

Projected turnover of ABC company is Rs.200 Lakhs

  • Working Capital  Requirement(25%)      = Rs.50 Lakhs
  • Bank Finance for Working Capital(20%) = Rs.40 Lakhs
  • Borrower Margin Requirement(5%)        = Rs.10 Lakhs

 

  1. Maximum Permissible Bank Finance Method (MPBF)

First Method of Lending

Second Method of Lending

Third Method of Lending

Total Current  Assets (TCA)

200

Total Current  Assets (TCA)

200

Total Current  Assets (TCA)

200

Less- Total Current Liabilities

100

Less- Total Current Liabilities

100

Less- Core Current  Assets 

50

Working Capital Gap (WCG)

100

Working Capital Gap (WCG)

100

Total Real Current  Assets 

150

Less- 25% of WCG

25

Less- 25% of TCA

50

Less- Total Current Liabilities

100

 

 

 

 

Working Capital Gap (WCG)

50

 

 

 

 

Less 25% of Real CA

37.5

MPBF

75

MPBF

50

MPBF

12.5

 

  1. Cash Budget Method
  • Fund-based working capital limit excess of Rs.5 crore
  • Suited to units dealing in seasonal products, construction activities and order based activities
  • More customer friendly – Peak level cash deficit working capital limit provided

The Cash Budget statement would comprise of projected receipts and payments for the next 12 months on account of :-

  • Business Operations
  • Non-Business Operations
  • Cash flow from capital accounts
  • Sundry items

 

Impact of Inadequate Working Capital

  • Not utilize fully production capacity – required working capital
  • Not able to take cash discount facilities
  • Not able to take advantages of profitable business opportunities
  • Borrow funds at exorbitant rates of interest
  • Low liquidity – impact on solvency of business
  • Operating inefficiencies – difficult to meet day to day commitments
  • Fixed assets are not efficiently utilized – Return on investment slumps
  • Firm loses its reputation

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