Working Capital Management | PAPER III – ACCOUNTING & FINANCIAL MANAGEMENT FOR BANKERS | MODULE C: FINANCIAL MANAGEMENT

Working Capital Management

---

Working Capital refers to the capital required for the day-to-day operations of a business. It is defined as the difference between current assets and current liabilities. Effective management of working capital ensures liquidity, solvency, and profitability.

Working Capital Cycle (WCC)

The Working Capital Cycle represents the time it takes for a business to convert its net current assets into cash. It is the sum of the inventory holding period and receivables collection period minus the payables payment period.

Example: A firm holds inventory for 60 days, receives payment from customers in 30 days, and pays suppliers in 45 days.
WCC = 60 + 30 - 45 = 45 days.

Cash and Marketable Securities

Firms hold cash for transactional, precautionary, and speculative purposes. Marketable securities are short-term instruments that are easily convertible to cash, like T-bills and CPs.

Accruals and Trade Credit

Accruals include unpaid expenses. Trade credit is a vital short-term financing source extended by suppliers. It helps firms manage liquidity efficiently.

Working Capital Finance by Banks

• Cash Credit/Overdraft
• Bills Discounting
• Loan System (Cash Budget Method)

Cash Budget Method of Lending

Used mainly for seasonal industries. A cash flow forecast is prepared, and bank finance is tailored accordingly.

Example: If total projected cash deficit for 3 months is ₹30 lakhs, banks may provide up to 80% as working capital advance = ₹24 lakhs.

Regulation of Bank Finance

RBI has issued norms for lending against current assets under MPBF (Maximum Permissible Bank Finance), Tandon, and Nayak Committee guidelines.

Public Deposits & Inter-Corporate Deposits

Companies accept deposits from the public or other corporates, subject to Companies Act guidelines and SEBI rules. These are unsecured but flexible funding sources.

Short-term Loans from Financial Institutions

Firms may borrow from SIDBI, NABARD, etc., for working capital through special schemes at concessional rates.

Rights Debentures and Commercial Paper (CP)

Rights debentures are offered to existing shareholders. CPs are unsecured promissory notes issued by corporates to meet short-term funding needs (min ₹5 lakh, maturity 7 days to 1 year).

Factoring and Forfaiting

• Factoring: Sale of receivables to a third party (factor) at a discount for immediate funds.
• Forfaiting: Sale of medium/long-term export receivables (usually with bank guarantees) without recourse.

---

Mathematical Examples

1. Inventory = ₹15,00,000; COGS = ₹90,00,000. Inventory Holding Period = (15,00,000 / 90,00,000) × 365 = 60.83 days

2. Receivables = ₹10,00,000; Sales = ₹1,20,00,000. Debtors Turnover Period = (10,00,000 / 1,20,00,000) × 365 = 30.42 days

3. Payables = ₹8,00,000; Purchases = ₹96,00,000. Payables Period = (8,00,000 / 96,00,000) × 365 = 30.42 days

4. Working Capital Requirement = Inventory + Receivables - Payables = ₹15L + ₹10L - ₹8L = ₹17 Lakhs

5. Projected Cash Deficit for April-June = ₹18L. Bank finances 75% = 0.75 × 18 = ₹13.5 Lakhs

6. Cost of CP = ₹5L issued at ₹4.85L, maturity 90 days. Yield = [(5,00,000 - 4,85,000)/4,85,000] × (365/90) = 12.57%

7. Company A sells ₹10L receivables to a factor at 5% discount. Net cash = ₹10L - 5% of ₹10L = ₹9.5 Lakhs

8. Debtor Turnover Ratio = Sales / Debtors. Sales = ₹1 Cr, Debtors = ₹10L → Ratio = 10 times

9. Operating Cycle = Inventory Days + Debtors Days - Creditors Days = 60 + 30 - 40 = 50 days

10. Rights Debentures: Issue ₹1000 at ₹950. Effective cost of funds = (₹1000 - ₹950)/₹950 = 5.26%

---

MCQs on Working Capital Management

1. The working capital cycle is the time gap between:
a) Purchase of raw materials and receipt of cash from sale
b) Issue of share capital and earning profits
c) Purchase and sales of fixed assets
d) Payment of wages and rent
Answer: a

2. The Cash Budget method of lending is best suited for:
a) Export businesses
b) Regular manufacturing
c) Seasonal businesses
d) Service providers
Answer: c

3. Which of the following is not a source of working capital?
a) Commercial paper
b) Public deposits
c) Share premium
d) Factoring
Answer: c

4. Commercial Paper is issued for a minimum period of:
a) 3 days
b) 7 days
c) 30 days
d) 90 days
Answer: b

5. Forfaiting is primarily used in:
a) Domestic factoring
b) International trade
c) Inventory financing
d) Equity financing
Answer: b

6. MPBF under Tandon II method = 75% of:
a) Total Current Assets
b) Current Assets - Current Liabilities (excluding bank borrowings)
c) Current Assets - Current Liabilities (including bank borrowings)
d) Net Worth
Answer: b

7. Trade credit appears in the books as:
a) Asset
b) Expense
c) Current Liability
d) Capital Reserve
Answer: c

8. Accruals are classified as:
a) Prepaid expenses
b) Non-cash assets
c) Current liabilities
d) Long-term borrowings
Answer: c

9. Factoring typically involves:
a) Asset leasing
b) Equity sale
c) Receivables financing
d) Hire purchase
Answer: c

10. Which institution regulates Commercial Paper in India?
a) RBI
b) SEBI
c) SIDBI
d) IRDAI
Answer: a