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Cogprerssve) (lack of Siauldity), Ewa ' Q wegative, net honking Copitol —uinnplioy that ¢ w Log dem funds Jhowe been ured fox fived asseby, W Soak don funds howe been wed bi Aived omeby W Lor Herm funda Jrone been ured fey cument neh UW. Shot deren funda Irae been wed ft cumend etichy, Chas try ges oa er FA fowet) (SOK aeed but he Love ok) B Av por which ome of the GoUowig oppmorched , 0 fins finances ov pant-of lh deroponamy) nomuivs Capitol , Vln Jong) chown Wivomatmy doo marek Armd ¥§ Coollnceds eee te [HEY] © amadehing og prooch, 0) Apprersive opproseh AB ConrenvoNve _ogprerch , W) Trodilhferal OPpanch Bm per which of athe rilonud oppo > & Bh Wnarees a PAF ob AM rormbngat henley taal alt, Bronk deren Beomeieg (CH mented tne ve ty & ately ‘tencopds UF Roprerrive vppraoch © tmrewodive tancont , WY) Trodithional spprdeh,Deficit Working Capital Excess of current liabilities over current assets is deficit working capital. The deficit working capital is not a theoretical rather it occurs when a firm is nearly in crisis of some magnitude. This is a situation where the level of current assets is lower as compared to current liabilities. This situation occurs when the realisable value of current assets is significantly less than book value. For example, when the stock appear in books of accounts at higher level but actually realised at a substantially lower level. The gross working capital is the capital invested in total current assets of the firm with an aim to convert into sales within a short period, normally, of one year. On the other, hand current liabilities are source of cash, which provide funds to current assets, and aimed to be paid back within a shorter time duration, normally, less than a year. ‘The concepts gross working capital, and net working capital, mostly, discussed with reference to each other. At the same point of time, they have their own applications in decision making. It is generally considered that gross working capital is a financial management concept, and net working capital is an accounting concept, both have equal importance in decision making. ‘The gross working capital indicates the following: > Total funds required to revolve its business operations than the source from where they are funded > The gross working capital provide help in determining the rate of return on investments in working capital > The level of gross working capital is a signal for management in two ways. Firstly, in case of shortage of funds, sources may be generated at short-notice, secondly, an excessive working capital is an alarm of slow movement of turnover. v In manufacturing firms, seasonal industries, bulk items producing industries, fast moving consumable goods industries, gross working capital isa significant part of their total investments The net working capital is the qualitative indicator of the business operations, it shows > It shows the ability of a firm to pay off current Liabilities in short-term period. 184 || Finance for Non-Finance Executives > Since it's a qualitative check, thus, a difference between current assets and current liabilities also helps in studying types of assets involved in total current assets. Especially when payments to creditors are not being made, despite having high amount of current assets, } Itis a helping device of every creditor to check the liquidity soundness of the firm before making any contract to deliver goods or services on credit basis. > Itisa signal of short-term solvency of the firm. ® Itshows how much funds should be used to funds current assets from long-term: sources. > Net working capital is not an amount of current assets excess over current liabilities, rather it shows that portion of current assets financed with long-term funds,Aspects of Working Capital Management The key aspects of working capital management are: (i) Estimation of the working capital vis-t-vis considering the substantial influencing factors into account while making estimation. (ii) Raising the source for working capital (iii) Management of individual current assets. The first part of working capital management, we have studied in above part of this chapter. The second issue pertaining to raising the source of working capital is discussed under four approaches. A firm usually select anyone of them depending upon nature of business and management policy. These approaches are: 1. Matching Approach or Hedging Approach 2. Conservative Approach 3. Aggressive Approach 4. Zero Working Capital Approach 1. Matching or Hedging Approach Under this approach a portion of long-term sources of finance is used to fund working capital requirement, a growth in business over the time requires additional investment in fixed assets as well as working capital, the additional raised demand is also meet out from long-term sources. The temporary working capital is matched against short-term sources of finance or in other words against current liabilities. Under this approach, the maturity of debtors is matched with creditors due period, so that finance can be raised and paid off at same point of time. This approach has been presented in figure 9.3 below. } ‘Short-term Financing Long-term Sources of Financing Level of Assets (°) Fixed Assets Time Figure 9.3: Matching ApproachWorking Capital Management || 193 2. Conservative Approach Under this approach firms behave like risk averse, therefore, a portion o temporary working capital is also financed through long-term funds. This policy is applicable either in case of new firms, or where huge amount of working capital is required or gestations period are long. Figure 9.4 below shows the conservative approach of working capital. } Short-term Financing Long-term Financing Level of Assets (2) Time Figure 9.4: Conservative Approach 3. Aggressive Approach Under this approach firms use short-term source of financing even in permanent working capital, This approach is applicable where the recovery from creditors is quick and fast, especially in case where goods are sold on cash basis only, e.g., a fast- food firm may follow such type of working capital approach, but it does not suit to heavy industries. The combination of permanent capital and temporary capital along with financing pattern has been stated in Figure 9.5 below. Short-term Financing Level of Assets (2) Long-term Financing Fixed Assels Time Figure 9.5: Aggressive Approach194 || Finance for Non-Finance Executives 4, Zero Working Capital Approach Under this approach, firms do not finance their working capital from long-term funds, in fact there is no permanent working capital under such cases, The temporary working capital is funded from short-term source of finance. This approach is applicable to service industries, where there is a remote need of working capital, ¢.g., transportation industry has very less investment in working capital, but huge investment in fixed assets. Their business runs on cash basis, in most of cases. Therefore, no need is raised to funds from long-term sources to fund temporary working capital. This has been shown in Figure 9.6 ‘Short-term Financing Level of Assets (2) Long-term Financing Fixed Assets Time Figure 9.6: Zero Working Capital Approach From the above discussion, it can be concluded that firms adopt different types of working capital approaches, as shown in figure 9.7, to fund their assets, including fixed as well as current assets. Conservative Policy Moderate Policy Aggersive Policy Level of Current Assets Output Figure 9.7: Approaches to Working Capital PolicyWorking Capital Management || 195 Under a conservative policy, the level of working capital tends to more, as shown at point C in figure 9.7, at a given level of output. On the other hand, the firms follow aggressive policy has lesser amount of current assets, as shown at point A in figure 9.7, in comparison of moderate and conservative policy. A moderate approach may be said as balanced approach The third step of working capital management, involves control of each current assets, e.g., cash management, inventory management, bills receivable, debtors’ management. We have already discussed some ratios in respect of inventory and debtors, e.g,, inventory turnover ratio, debtor’s turnover ratio and collection period ete. Inventory, and cash management further includes various topics e.g., economic order quantity, store ledger, cash budget etc. These are not discussed here due to limited syllabi requirement.