UNIVERSITY INSTITUTE OF LEGAL STUDIES

PANJAB UNIVERSITY
CHANDIGARH

A PROJECT REPORT SUBMITTED AS A PART OF CURRICULLUM

OF BCom LLb (Hons) IN THE SUBJECT MATTER OF
FINANCIAL MANAGEMENT, ON THE TOPIC:

WORKING CAPITAL MANAGEMENT:

NATURE, MEANING, CLASSIFICATION AND
ITS ADVANTAGES AND DISADVANTAGES

SUBMITTED TO: SUBMITTED BY:

Mrs Alka Shubham Bharti

(Teacher in charge) BCom LLB
SECTION - C
ROLL NO- 247/18
 ACKNOWLEDGEMENTS

I have taken efforts in this project however; it would not have been
possible without the kind support and help of Mrs. Alka . I am ineffably
indebted for her conscientious guidance and encouragement that has
helped me to accomplish this project report on “WORKING CAPITAL
MANAGEMENT : NATURE, MEANING, CLASSIFICATION,
ADVANTAGES AND DISADVANTAGES OF WORKING
CAPITAL MANAGEMENT.”

I am overwhelmed in all humbleness and gratitude to exhibit my sincere

and heartfelt obligation towards all the personages who have helped me
in this endeavour. Without their active guidance, help and cooperation
and encouragement, I would not have made headway in this project.
I would also like to extend my heartfelt gratitude to University Institute of
Legal Studies for giving me this opportunity.

I also acknowledge with deep sense of reverence, my

gratitude towards my parents and my sister who have incessantly
supported me morally as well as economically to undertake this project.
At last but not the least, heartfelt gratitude goes to all my friends who
have directly or indirectly helped to complete this project. Any omission
in this brief acknowledgement does not mean lack of gratitude.
 CERTIFICATE:
This is to certify that the project entitled, “WORKING CAPITAL
MANAGEMENT : NATURE, MEANING, CLASSIFICATION
ADVANTAGES AND DISADVANTAGES OF WORKING
CAPITAL MANAGEMENT” , submitted by Shubham Bharti ([Link].
LL.B. Hons. 4th Semester)’ is an authentic work carried out under the
supervision and able guidance of “Mrs. Alka”.

The matter embodied in the project has not been plagiarised or submitted
to any other University / Institute for the award of any Degree or Diploma.
It is a bona-fide record of independent research done by Shubham Bharti
and submitted to University Institute of Legal Studies, Panjab
University in partial fulfilment for the award of the Degree of [Link].
LL.B. (Hons.).
DEFINITION:
The term ‘Working Capital Management’ primarily refers to the efforts of
the management towards effective management of current assets and
current liabilities. Working capital is nothing but the difference between
the current assets and current liabilities. In other words, an efficient
working capital management means ensuring sufficient liquidity in the
business to be able to satisfy short-term expenses and debts.

In a broader view, ‘working capital management’ includes working

capital financing apart from managing the current assets and liabilities.
That adds the responsibility for arranging the working capital at the
lowest possible cost and utilizing the capital cost-effectively.

Definitions of Working Capital, as per various

Management experts are as under:
- “Working Capital is the excess of current assets over current liabilities.”
- H.G,

-“Working Capital is descriptive of that capital which is not fixed. But the
more common use of the Working Capital is to consider it as the
difference between the book value of the C.A. and current liabilities.”
- Hoglend. J. Bierman, and A. K. Mc Adams,.

-“Working Capital represents the excess of C.A. over current liabilities”

- J.L. Brown and L.R.
Housard.

-“Working Capital to a firm’s investment in short term assets cash short

term securities, accounts, receivables and inventories.”
-Weston the Brigham

-“Working Capital represents only the current capital assets.”

- Meal Baker Malott and
Field
 NATURE:

The nature of working capital is as discussed below:

* It is used for purchase of raw materials, payment of wages and

expenses.

* It changes form constantly to keep the wheels of business moving.

* Working capital enhances liquidity, solvency, creditworthiness and

reputation of the enterprise.

* It generates the elements of cost namely: Materials, wages and

expenses.

* It enables the enterprise to avail the cash discount facilities offered by

its suppliers.

* It helps improve the morale of business executives and their efficiency

reaches at the highest climax.

* It facilitates expansion programmes of the enterprise and helps in

maintaining operational efficiency of fixed assets.
CONCEPT OF WORKING CAPITAL
MANAGEMENT
There are two concepts of working capital viz .quantitative and qualitative. Some
people also define the two concepts as gross concept and net concept.

According to quantitative concept, the amount of working capital refers to

‘total of current assets’. Current assets are considered to be gross working capital in
this concept.
The qualitative concept gives an idea regarding source of financing capital. According
to qualitative concept the amount of working capital refers to “excess of current assets
over current liabilities.” L.J. Guthmann defined working capital as “the portion of a
firm’s current assets which are financed from long–term funds.”
The excess of current assets over current liabilities is termed as ‘Net working
capital’. In this concept “Net working capital” represents the amount of current assets
which would remain if all current liabilities were paid. Both the concepts of working
capital have their own points of importance. “If the objectives is to measure the size
and extent to which current assets are being used, ‘Gross concept’ is useful; whereas
in evaluating the liquidity position of an undertaking ‘Net concept’ becomes pertinent
and preferable.
It is necessary to understand the meaning of current assets and current liabilities for
learning the meaning of working capital, which is explained below.
Current assets – It is rightly observed that “Current assets have a short life
span. These type of assets are engaged in current operation of a business and normally
used for short– term operations of the firm during an accounting period i.e. within
twelve months. The two important characteristics of such assets are, (i) short life span,
and (ii) swift transformation into other form of assets. Cash balance may be held idle
for a week or two; account receivable may have a life span of 30 to 60 days, and
inventories may be held for 30 to 100 days.”Fitzgerald defined current assets as, “cash
and other assets which are expected to be converted into cash in the ordinary course
of business within one year or within such longer period as constitutes the normal
operating cycle of a business.”

Current liabilities – The firm creates a Current Liability towards

creditors (sellers) from whom it has purchased raw materials on credit. This liability is
also known as accounts payable and shown in the balance sheet till the payment has
been made to the creditors. The claims or obligations which are normally expected to
mature for payment within an accounting cycle are known as current liabilities. These
can be defined as “those liabilities where liquidation is reasonably expected to require
the use of existing resources properly classifiable as current assets, or the creation of
other current assets, or the creation of other current liabilities.”

TYPES OF WORKING CAPITAL

Following diagram clear the classification of working capital Accoding to the needs
of business, the working capital may be classified into following two basis:

1) On the basis of periodicity

2) On the basis of con1).

* On the basis of periodicity:

The requirements of working capital are
continuous. More working capital is required in a particular season or the peck period
of business activity. On the basis of periodicity working capital can be divided under
two categories as under:

a) Permanent working capital

b) Variable working capital

(a) Permanent working capital:

This type of working capital is known as Fixed Working Capital. Permanent

working capital means the part of working capital which is permanently locked up in
the current assets to carry out the business smoothly. The minimum amount of
current assets which is required to conduct the business smoothly during the year is
called permanent working capital. For example, investments required to maintain the
minimum stock of raw materials or to cash balance. The amount of permanent
working capital depends upon the size and growth of company. Fixed working
capital can further be divided into two categories as under:

(I) Regular Working capital:

Minimum amount of working capital required to keep the primary
circulation. Some amount of cash is necessary for the payment of wages,
salaries etc.
 (II) Reserve Margin Working capital:
Additional working capital may also be required for contingencies that
may arise any time. The reserve working capital is the excess of capital
over the needs of the regular working capital is kept aside as reserve for
contingencies, such as strike, business depression etc.

(b) Variable or Temporary Working Capital: The term variable

working capital refers that the level of working capital is temporary and fluctuating.
Variable working capital may change from one assets to another and changes with
the increase or decrease in the volume of business. The variable working capital may
also be subdivided into following two sub-groups.

1. Seasonal Variable Working capital: Seasonal working capital is the

additional amount which is required during the active business seasons of the year.
Raw materials like raw-cotton or jute or sugarcane are purchased in particular
season. The industry has to borrow funds for short [Link] is particularly suited to a
business of a seasonal nature. In short, seasonal working capital is required to meet
the seasonal liquidity of the business.

2. Special variable working capital: Additional working capital may also be

needed to provide additional current assets to meet the unexpected events or special
operations such as extensive marketing campaigns or carrying of special job etc.

3) On the basis of concept: on the basis of concept working capital is

divided into two categoties as under:

(A) Gross Working Capital: Gross working capital refers to total investment in
current assets. The current assets employed in business give the idia about the
utilization of working capital and idia about the economic postion of the company.
Thus, gross working capital the amount of funds invested in different current assets.
Gross working capital concepts is popular and acceptable concept in the field of
finance.

(B) Net Working Capital: Net working capital means current assets minus current
liabilities. The difference between current assets and current liabilities is called the net
working capital. If the net working capital is positive business is able to meet its
current liabilities. Net working capital concept provides the measurement for
determining the creditworthiness of company.
ADEQUACY OF WORKING CAPITAL

NK. Kulshrestha has observed that, “the need for maintaining an adequate
working capital can hardly be questioned. Just a circulation of blood is
very necessary in the human body to maintain life, smooth flow of funds
is very necessary to maintain the heath of the firm”. Adequate working
capital becomes necessary because of the following reasons:

* It protects a business form the adverse effects of shrinkage in the

values of current assets.

* It is possible to pay all the current obligations promptly and to take

advantages of cash discounts.

* It ensures to a greater extent the maintenance of a company’s credit

standing and provides for such emergencies as strikes, floods, fibers,
etc.

* It permits the carrying of inventories at a level that would enable a

business to serve satisfactory the needs of its customers.

* It enables a company to extend favorable credit terms to customer.

* It enable a company to operate its business more efficiently because

there is no delay in obtaining materials, etc., because of credit
difficulties.

* It enables a business to withstand periods of depression smoothly.

* There may be operating losses or decreased retained earnings.

* There may be excessive non-operating or extraordinary losses.

* The management may fail to obtain funds from other sources for the
purposes of expansion.

* There may be an unwise divided policy and thereby Current funds

may be invested in non-current assets.

* The management may fail to accumulate funds necessary for meeting

debentures on maturity.
ADVANTAGES OF WORKING CAPITAL

ENSURES LIQUIDITY:

Businesses often get in trouble due to lack of cash needed for operations
and to repay short-term debts. It happens because of an ineffective or no
working capital management policy in the enterprise. Working capital
management ensures liquidity by monitoring of account receivables,
account payable, stock management and debt management. It assists in
keeping sufficient liquid cash in the business at any point of time to pay
operational costs and short-term debts. Thus, it helps in allocating the
resources in an optimum manner.

ENHANCE PROFITABILITY:

Proper application of working capital management strategy would

enhance the company’s profitability in the long run. The policy properly
manages inventory so as to avoid any operational failures. Collection
from trade receivables would be on time as receivables management is a
key part of working capital management. There would be no cases of
default in paying the trade payable on due date because of proper
management and allocation of cash.

IMPROVES FINANCIAL HEALTH:

Working capital management basically deals with the management of

cash in an enterprise. It assesses the sources of cash inflows and
determines the outflow of cash in best possible manner. Proper allocation
of cash makes a scope for the investment of remaining cash or in
repaying short-term debts. It allows the business to be financially solvent
at most of the times and thus evading any legal troubles that could have
arisen due to lack of working capital. Higher profitability would imply
higher return on capital employed. This, in turn, would attract more
capital from prospective investors leading to the unlocking of further
capacities.

DISADVANTAGES OF WORKING CAPITAL

ONLY MONETARY FACTORS

This strategy takes only monetary factors into account. Monetary items
like the value of debts receivables, the value of finished goods etc. are the
basic determinants while implementing the strategy. Non monetary
factors like recession, unsatisfied workers, change in government’s policy
towards the industry etc. are not considered or hold no relevance in this
policy.

NON-SITUATIONAL
Another disadvantage of working capital management policy is that it’s
not situational in nature. The strategy does not acknowledge sudden
changes in the market conditions as it is based on past events and figures.
The time taken to respond to certain recent events is significant to impact
business operations and profitability.

BASED ON DATA
Working capital management operates around data. It is the key soul of
any working capital management strategy. Data would include every
minute detail about the components of working capital. For example, in
trade receivables, it would require the date of sale, the period of credit,
number of grace days allowed, a penalty in case of non-fulfilment of
payment etc. Without data, this strategy holds no relevance in the
practical world.

PROBLEM IN INTERPRETATION
Working capital management involves techniques of ratio analysis.
Ratios are just a number which allows a user to interpret the result. In
most cases, it is unclear to a user whether a particular ratio is favourable
to the company or not. For example, in case of currents assets ratio, it is
advisable that a ratio which is higher than 1:1 is favourable. But on the
other hand, it is also advisable that ratios bigger than 2:1 are unfavourable,
keeping the business conditions and trade cycle in mind. Now, if a
business has a bigger trade receivables cycle than the industry’s average,
the business would not be able to interpret the ratio accurately.

CONCLUSION:

Thus, we can conclude that working capital management is a very

efficient tool at the hands of the management to properly allocate its
current assets towards its current liabilities.

A firm will be following a very conservative working

policy if it combines a high level of current assets with a high level of
long-term financing. Such a policy will not be risky at all and would be
less profitable. An aggressive firm, on the other hand, would combine
low level of current assets with a high level of long-term financing. .This
will have high profitability and high risk. In fact, the firm may follow a
conservative financing policy to counter its relatively ill liquid assets
structure in practice. The conclusion of all this it that the considerations
of assets and financing mixes are crucial to the working capital
management.
BIBLIOGRAPHY
BOOKS:

* Gupta,S.K. and Sharma,R.K., Management Accounting and Business

Finance, Kalyani Publishers 2010

WEBSITES:

* [Link]
* [Link]

* [Link]

* [Link]