Working Capital Management - Study Guide
This domain tests the cash needed for day-to-day operations and how inventory, receivables and payables affect it. Expect operating-cycle and working-capital calculations, plus evaluation of liquidity policies.
Core ideas
- Gross working capital = current assets; net working capital = current assets − current liabilities.
- Operating cycle = inventory days + receivables days − payables days, approximately, when using the same basis.
- A conservative policy holds more current assets and uses long-term finance; it is safer but lowers return. An aggressive policy uses short-term finance and lean current assets; it raises return and risk.
- EOQ = √(2DS/H), where D is annual demand, S is ordering cost and H is holding cost per unit.
- Monitor receivables with ageing schedules and credit terms; monitor inventory with turnover and stock-out risk.
Worked example
A firm has inventory days of 60, receivables days of 45 and payables days of 30. Operating cycle = 60 + 45 − 30 = 75 days. If daily operating cash outflow is ₹20,000, the working-capital requirement is about 75 × ₹20,000 = ₹15,00,000. The reasoning: the firm pays for inputs before collecting from customers, so it must finance the gap. Using sales instead of cash cost would overstate the need if margins are high.
Traps
A shorter cycle is not always better if it causes stock-outs or lost sales. Do not use annual sales blindly for daily cash need. Seasonal firms need peak-period funding, not just average. Stretching payables improves the cycle but can damage supplier relations and raise financing costs.