Working Capital Management
Working capital management ensures short-term assets are sufficient for operations without over-investing in low-return balances. The exam tests operating cycle, cash conversion cycle, EOQ and receivables policy.
Core rules
- Gross working capital = total current assets; net working capital = current assets − current liabilities.
- Operating cycle = inventory period + receivables period; cash conversion cycle = operating cycle − payables period.
- EOQ = √(2AO/C), where A is annual usage, O order cost and C carrying cost per unit per year.
- Receivables policy compares incremental contribution with incremental carrying, bad-debt and discount costs.
- Permanent working capital is financed long-term; seasonal peaks may use short-term bank finance.
Worked example
Inventory days 60, receivable days 45 and payable days 30 give a cash conversion cycle of 75 days. Annual cash operating costs are ₹730 lakh, so daily outflow is ₹2 lakh and the cycle needs 75×2 = ₹150 lakh of working capital. If payables were stretched to 40 days, the cycle would fall to 65 days and the requirement to ₹130 lakh, but supplier risk and lost discounts must be assessed.
Traps
Use COGS, not sales, for inventory days where possible; do not treat all current liabilities as free finance; seasonality can make year-end ratios misleading; and a negative cash conversion cycle is not automatically safe if suppliers can demand cash.