Introduction

What is working capital

The capital of a business which is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities.

Definition

“ Working capital is how much in liquid assets that a company has on hand. Working capital is needed to pay for planned and unexpected expenses, meet the short-term obligations of the business, and to build the business. “

What is the Accounting Formula to Determine a Business’ Working Capital?

The accounting formula used to calculate the available working capital of a business is:

Current Assets - Current Liabilities = Working Capital

Working capital can be reflected as a positive or negative number depending on how much debt the business is carrying.

Where Does Working Capital Come From?

Working capital comes from:

Net income;Long-term loans (non-current liabilities);Sale of capital (non-current) assets; andFunds contributed by the owners and investors (stockholders).

Working Capital is required to Start and Grow a Business:

When you first start a business you need start-up working capital since the business is not yet making money to sustain itself. The number one reason most businesses fail during their first two years of operation is due to a lack of working capital.

Need for Working Capital

Working capital is the life blood and nerve center of business. Working capital is very essential to maintain smooth running of a business. No business can run successfully without an adequate amount of working capital. The main advantages or importance of working capital are as follows:

1. Strengthen the SolvencyWorking capital helps to operate the business smoothly without any financial problem for making the payment of short-term liabilities. Purchase of raw materials and payment of salary, wages and overhead can be made without any delay. Adequate working capital helps in maintaining solvency of the business by providing uninterrupted flow of production.

2. Enhance GoodwillSufficient working capital enables a business concern to make prompt payments and hence helps in creating and maintaining goodwill. Goodwill is enhanced because all current liabilities and operating expenses are paid on time.

3. Easy Obtaining LoanA firm having adequate working capital, high solvency and good credit rating can arrange loans from banks and financial institutions in easy and favorable terms.

4. Regular Supply Of Raw MaterialQuick payment of credit purchase of raw materials ensures the regular supply of raw materials for suppliers. Suppliers are satisfied by the payment on time. It ensures regular supply of raw materials and continuous production.

5. Smooth Business OperationWorking capital is really a life blood of any business organization which maintains the firm in well condition. Any day to day financial requirement can be met without any shortage of fund. All expenses and current liabilities are paid on time.

6. Ability to Face CrisisAdequate working capital enables a firm to face business crisis in emergencies such as depression.

The main components of working capital are:

Cash. Cash is one of the most liquid and important components of working capital. Holding cash involves cost because the worth of cash held, after a year will be less than the value of cash as on today. Excess of cash balance should not be kept in business because cash is a non-earning asset.-Hence, a proper and judicious cash management is of utmost importance in business.

Marketable Securities. These securities also don't give much yield to the business because of two reasons, (i) Marketable securities act as a substitute for cash, (ii) These are used are temporary investments. These are held not for speculative balances, but only as a guard against possible shortage of bank credit.

Accounts Receivable. Too many debtors always lock up the firm's resources especially during inflationary tendencies. This is a two step account. When goods are sold, inventories are reduced and accounts receivables are created. When payment is made, debtors reduce and cash level increases. Thus, quantum of debtors depends on two things, (i) volume of Credit sales (ii) average length of time between sales and collections. The entrepreneur should determine the optimal credit standards. An optimal credit policy should be established and the firm's operations should be continuously monitored to achieve higher sales and minimum bad debt losses.

Inventory. Inventories represent a substantial amount of firm's assets. Inventories must be properly managed so that this investment doesn't become too large, as it would result in blocked capital which could be put to productive use elsewhere. On

the other hand, having too little or small inventory could result in loss of sales or loss of customer goodwill. An optimum level of inventory, therefore, should be maintained.

How to calculate working capital:

Working capital = current assets – current liabilities

Working Capital Focus

TYPES OF WORKING CAPITAL

Types of working capital:

Working capital

Basis of conceptBasis of time

Net working capital

Permanent /Fixed Working capital

Temporary / variable working capital

Seasonal working capital

Special working capital

Regular working capital

Reserve working capital

Gross working capital

Types of Working Capital:

Working capital is classified into different types and the classification is based on the following views:

1. Balance Sheet View2. Operating Cycle View

Gross Working Capital (GWC): Current assets in the balance sheet of a company are known as gross working capital. Current assets are those short term assets which can be converted into cash within a period of one year. The grey area in the management of current assets or gross working capital is its unpredictability i.e. it is very difficult to ascertain the exact time of conversion of such assets. Why such a nature is problematic? It is because the liabilities occur at their time and do not wait for our current asset to realize. This mismatch or the gap creates a need for arranging working capital financing.

Net Working Capital (NWC): Net working capital is a very frequently used term. There are two ways to understand net working capital. First one says it is simply the difference of current assets and the current liabilities in the balance sheet of a business. The other understanding discloses little deeper or hidden meaning of the term. As per that, NWC is that part of current assets which are indirectly financed by long term assets. Compared to gross working capital, net working capital is considered more relevant for effective working capital financing and management.

Difference between net working capital and Gross working capital Net working capital Gross working capital

Net working capital is the concept of qualitative nature

It is indicating the firm’s ability to meet its operating expense and current.

It expressed as current assets minus current liability.

It is a concept very popular in accounting system

Net concept suitable for sole trader and partnership firms

Its is useful to find out the true financial position of a company

Increase in bank loan cannot increase working capital..Retained profits sale of fixed assets will increase net working capital.

Gross concept of working capital quantitative nature

It is pointing out the total amount available for financing the current assets

Its indicates the total sum of current assestsIt is a concept very popular in financial management circles.

Gross concept suitable for companies

It cannot reveal the true financial position of a company

Every increase in borrowing will increase the gross working capital. Under net concept no change in working capital

On the basis of Operating Cycle View, types of working capital are as below:

o Permanent / Fixed Working Capital: Dealing with current asset and fixed assets is totally different. Determining the financing requirement in case of fixed assets is simply the cost of the asset. Same is not true for current assets because value of current assets is constantly changing and it is difficult to accurately forecast that value at any point of time. To simplify the complexity to some extent, on the basis of past trend and experience, we can find a level below which current asset has never gone. The current assets below this level are called permanent or fixed working capital.

Characteristics of permanent working capital

(1) Continue to exist for a longer period of time is the business activites.

(2) Constantly changes in the business from one asset to another.

(3) Required to meet peramanent obligations along with other fixed assets.

(4) Grows the size or volume of business operations.

(5) Classifiesd on the basis of the time factor.

(6) Minimum level of working capitl always required to be maintained.

(7) Depends on the nature of opreting cycle of the firm.

Example Of Different Types Of working capital.

Types of Working Capital

Net Working Capital

Permanent / Fixed Working

Capital

Temporary / Variable Working Capital

Requirement

3000 2500 500

2500 2500 0

2800 2500 300

3200 2500 700

In the example, 2500 is the permanent working capital below which the net working capital has not gone.

o Regular Working Capital: It is the permanent working capital which is normally required in the normal course of business for the working capital cycle to flow smoothly.

o Reserve Working Capital: It is the working capital available over and above regular working capital. It is kept for contingencies which may arise due to unexpected situations.

Temporary / Variable WC: Temporary working capital is easy to understand after getting hold over permanent working capital. In simple terms, it is the difference between net working capital and permanent working capital. The main characteristic which can be made out from the example is “fluctuation”. The temporary working capital therefore cannot be forecasted. In the interest of measurability, this can be further bifurcated as below which can create at least some base to forecast.

Characteristics of Temporary working capital

1 It is an extra working capital needed to changing production and sales activities.2 It is created to meet liquidity requirements.3 Temporary working capital is fluctuating during the operating period.4 It fluctuates according to the level of operating.5 It is needed for shorter period.

Seasonal Working Capital: Seasonal working capital is that temporary increase in working capital which is caused due to some relevant season for the business. It is applicable to businesses having impact of seasons for example, manufacturer of sweaters for whom relevant season is the winters. Normally, their working capital requirement would increase in that season due to higher sales in that period and then go down as collection from debtors is more than sales.

Special Working Capital: Special working capital is that rise in temporary working capital which occurs due to a special event which otherwise normally does not take place. It has no basis to forecast and has rare occurrence normally. For example, country where Olympic Games are held, all the business require extra working capital due to sudden rise in business activity.

Am

ount

of w

orki

ng c

apita

l

Time

Temporary working capital

Temporary or variable working capital line

Permanent or fixed working capital

Fixed working capital line

Balance sheet working capital:

The balance sheet working capital is one which is calculated from the items appreaing in the balance sheet. Gross working capital, which is represented by current assets which have to be ensure continuity of production. Net working capital, which is represented by the excess of current assets over current liabilities. Both gross working capital and net working capital are the examples of the balance sheet working capital.

Cash working capital:

The narrow concept of cash refers to working capital. A firm’s cash working capital is required to make payment to its supplies, to incur day to day expenses and to pay salaries, wages, interest and dividends. The items of cash working capital appearing in the profit and loss account. Cash working capital shows the impacts of various transactions on cash position of firm.

Reasons for change in working capital:orking capital is comprised of all current assets minus all current liabilities. Thus, a positive working capital position represents an incremental investment in a business, while a negative working capital position represents a source of funds for a business. In summary:

Working capital assets, such as accounts receivable and inventory, consume cash

Working capital liabilities, such as accounts payable, are a source of cash

In nearly all companies, there is a positive amount of working capital on the books. Managers should constantly be looking for ways to reduce their investment in a business, so you need to know what is causing a change in working capital.

The change in working capital is considered to be the difference in the net working capital amount from one accounting period to the next. Thus, if net working capital at the end of February is $150,000 and it is $200,000 at the end of March, then the change in working capital was an increase of $50,000. The business would have to find a way to fund that increase in its working capital asset, perhaps through one of the following financing options:

Selling shares Increasing profits Selling assets Incurring new debt

Here are a number of actions that can cause changes in working capital:

Credit policy. A company tightens its credit policy, which reduces the amount of accounts receivable outstanding, and therefore frees up cash. However, there may be an offsetting decline in net sales. A looser credit policy has the reverse effect.

Collection policy. A more aggressive collection policy should result in more rapid collections, which shrinks the total amount of accounts receivable. This is a source of cash. A less aggressive collection policy has the reverse effect.

Inventory planning. A company may elect to increase its inventory levels in order to improve its order fulfillment rate. This will increase the inventory investment, and so uses cash. Reducing inventory levels has the reverse effect.

Purchasing practices. The purchasing department may decide to reduce its unit costs by purchasing in larger volumes. The larger volumes increase the investment in inventory, which is a use of cash. Buying in smaller quantities has the reverse effect.

Accounts payable payment period. A company negotiates with its suppliers for longer payment periods. This is a source of cash, though suppliers may increase prices in response. Reducing the accounts payable payment terms has the reverse effect.

Growth rate. If a company is growing quickly, this calls for large changes in working capital from month to month, as the business must invest in more and more accounts receivable and inventory. This is a major use of cash. The problem can be reduced with a corresponding reduction in the rate of growth.

Hedging strategy. If a company actively uses hedging techniques to generate offsetting cash flow, there are less likely to be unexpected changes in working capital, though there will be a transactional cost associated with the hedging transactions themselves.

Monitoring changes in working capital is one of the key tasks of the chief financial officer, who can alter company practices to fine-tune working capital levels. It is also important to understand changes in working capital from the perspective of cash flow forecasting, so that a business does not experience an unexpected demand for cash.

ADEQUATE WORKING CAPITAL: The firm should maintain a sound working capitalposition. It should have adequate working capital to run its business operations. Both excessive as well as inadequate working capital positions are dangerous from

firm's point of view. Excessive working capital means holding costs and idle funds which earn no profit for the firm. Paucity of working capital not only impairs the firm's profitability but also results in production interruptions and inefficiencies and sales disruption

Availability of Raw Materials Regularly:- Adequacy of working capital makes itpossible for a firm to pay the suppliers of raw materials on time. As a result it willcontinue to receive regular supplies of raw materials and thus there will be no disruption in production process

Advantage of Adequate Working Capital:

Availability of Raw Materials Regularly:- Adequacy of working capital makes itpossible for a firm to pay the suppliers of raw materials on time. As a result it willcontinue to receive regular supplies of raw materials and thus there will be no disruption in production process.

Full Utilization of Fixed Assets:- Adequacy of working capital makes it possible for afirm to utilize its fixed assets fully and continuously. For example, if there is inadequatestock of raw material, the machines will not be utilized in full and their productivity willbe reduced.

Full Utilization of Fixed Assets:- Adequacy of working capital makes it possible for afirm to utilize its fixed assets fully and continuously. For example, if there is inadequatestock of raw material, the machines will not be utilized in full and their productivity willbe reduced.

Cash Discount :- A firm having the adequate working capital can avail the cashdiscount by purchasing the goods for cash or by making the payment before the duedate.

Increase in Credit Rating :- Paying its short-term obligations in time leads to a strongcredit rating which enables the firm to purchase goods on credit on favourable termsand to maintain its line of credit with banks etc. it facilities the taking of loan in case ofneed.

Advantages of Favourable Business Opportunities:- Whenever there arechances of increase in prices of raw materials, the firm can purchase sufficientquantity if it has adequate of working capital. Similarly, if a firm receives a bulk order for

the supply of goods it can take advantage of such opportunity if it has sufficientworkng capital.

Facility in Obtaining Bank Loans:- Banks do not hesitate to advance even theunsecured loan to a firm which has the sufficient working capital. This is because theexcess of current assets over current liabilities itself is a good security.

Facility in Obtaining Bank Loans:- Banks do not hesitate to advance even theunsecured loan to a firm which has the sufficient working capital. This is because theexcess of current assets over current liabilities itself is a good security.

Increase in Efficiency of Management:- Adequacy of working capital has afavourable psychological effect on the managers. This is because no obstacle arisesin the day-to-day business operations. Creditors, wages and all other expenses arepaid on time and hence it keeps the morale of managers high.

Meeting Unseen Contingencies: - Adequacy of working capital enables a companyto meet the unseen contingencies successfully.

Disadvantage of excessive and inadequate working capital

EXCESSIVE AND INADEQUATE WORKING CAPITAL: A business enterpriseshould maintain adequate working capital according to the needs of its business operations.The amount of working capital should neither be excessive nor inadequate. If the workingcapital is in excess if its requirements it means idle funds adding to the cost of capital butwhich earn nom profits for the firm. On the contrary, if the working capital is short of itsrequirements, it will result in production interruptions and reduction of sales and, in turn, willaffect the profitability of the business adversely.

Disadvantage of Excessive Working Capital:-

Excessive Inventory:- Excessive working capital results in unnecessaryaccumulation of large inventory. It increases the chances of misuse, waste, theft etc.

Excessive Debtors:-Excessive working capital will results in liberal credit policywhich, in turn, will results in higher amount tied up in debtors and higher incidence ofbad debts.Adverse Effect on Profitability:-Excessive working capital means idle funds in thebusiness which adds to the cost of capital but earns no profits for the firm. Hence it hasa bad effect on profitability of the firm.

Inefficiency of Management:-Management becomes careless due to excessiveresources at their command. It results in laxity of control on expenses and cashresources.

Disadvantage of Inadequate Working Capital:

Difficulty in Availability of Raw-Material:- Adequacy of working capital results innon-payment of creditors on time. As a result the credit purchase of goods onfavourable terms becomes increasingly difficult. Also, the firm cannot avail the cashdiscount.

Full Utilization of Fixed Assets not Possible: Due to the frequent interruption in thesupply of raw materials and paucity of stock, the firm cannot make full utilization of itsmahines etc.

Difficulty in the Maintenance of Machinery: Due to the inadequacy of workingcapital, machines are not cared and maintained properly which results in the closure ofproduction on many occasions.

Decrease in Credit Rating: Because of inadequacy of working capital, firm is unableto pay its short-term obligations on time. It decays the firm's relations with its bankersand it becomes difficult for the firm to borrow in case of need.

Non Utilization of Favourable Opportunities: For example, a firm cannot purchasesufficient quantity of raw materials in case of sudden decrease in the prices. Similarly,if the firm receives a big order, it cannot execute it due to shortage of working capital.

Decrease in Sales: Due to the shortage of working capital, the firm cannot keepsufficient stock of finished goods. It results in the decrease in sales. Also, the firm willbe forced to restrict its credit sales. This will further reduce the sales.

Difficulty in the Distribution of Dividends: Because of paucity of cash resources,firm will not be able to pay the dividend to its shareholders.

Decrease in the Efficiency of Management: It will become increasingly difficult forthe management to pay its creditors on time and pay its day-to-day expenses. It willalso be difficult to pay the wages regularly which will have an adverse effect on themorale of managers.

Determination of working capital

The factors determining working capital needs of a business firm are as follows:

1.      Size of the firm:

A large firm needs more working capital than a small firm. In order to sustain the high volume of production and sales, a large firm has to maintain greater current assets.

2.      Nature of Business:

A trading concern has to maintain more inventory than a manufacturing concern. Therefore, more working capital is required by a trading concern. Public utility concerns such as railways, electricity supply concerns, gas agencies require less working capital because most of their transactions are on cash basis. Similarly, hotels and restaurants need little working capital as stock and debtors are not high.

3.      Type of Production Process:

A firm using labour intensive technique needs more working capital to pay wages and salaries. A highly automatic plant will need less working capital and more fixed capital. Working capital requirements are higher when raw materials account for a major proportion of the total cost.

4.      Length of Operating Cycle:

Longer is the time gap between purchase of raw materials and receipt of cash from debtors, greater is the need for working capital. That is why firms having a lengthy and roundabout manufacturing process require more working capital. For example, a heavy engineering firm has a longer operating cycle than a rice mill.

5.      Inventory Turnover:

Where the inventory is large and its turnover is slow, working capital required is more. Inventory turnover means the speed with which sales are made. For example, a jeweller has to maintain a high inventory of different types of jewellery and the movement of inventory is slow. Therefore, the working capital requirements of a jeweller are more than those of a grocer.

6.      Terms of Credit:

An enterprise with a liberal credit policy require more working capital. Such a firm allows credit to all its customers, the period of credit is comparatively long and debts are hot collected strictly within the credit period. Similarly, a concern enjoying liberal credit from the suppliers need less working capital.

7.      Banking facilities:

Where good, quick and dependable credit is available from commercial banks, a concern can manage its operations with relatively less working capital. In such a case, cash requirements are small.

8.      Seasonal variations:

Some enterprises need greater working capital during particular seasons. For example, a sugar mill requires more working capital during December to April when production takes place. It requires much less working capital in other months.

9.      Contingencies:

If the demand for and prices of products of a small enterprise are subject to wide and unexpected fluctuations, provision has to be made for arranging higher amounts of working. capital. Trade cycles may affect the amount of working capital required in an enterprise.

10.    Terms of purchase and sale:

If the firm purchases raw materials and other needs on credit and sells on cash basis, it requires less working capital. If it buys on cash basis and sells its product on credit, it will need a large amount of working capital because of instant payments and slow collections.

11.    Importance of labour:

If project is labour intensive, large amount of working capital is required.

Objectives of working capital

Procurement of required amount of working capital and its effect utilisation is the important functions of working capital management. To ensure that the working capital financial plain serves as a guide to the future course of action of the financial department, the financial manager will keep in mind the following objectives while preparing the working capital financial plan.

1 Availability of adequate funds.2 Minimum cost3 Matching (balance) between profitability and liquidity4 Flexibility5 Optimum use of funds

1 Availability of Adequate Funds: A sound working capital financial plan must ensure the supply of adequate amount of working capital needed by the business enterprises, both for current and future needs.

2 Minimum Cost: the fund required by the firm should be made available at the lowest cost. It is made possible through planning-considering in advance various cost factors and trends of capital market and suggesting the best course of action.

3 Matching (Balance) between Profitability and Liquidity: A judicious balance between profitability and liquidity is one of the fundamental principles of successful finance planning. Profitability and liquidity are inversely related. The working capital financial plan must ensure sufficient amount of investment in those assets which are liquid cash and near – cash assets.

4 Flexibility: The working capital financial plan should be dynamic in nature. In other words, it should provide sufficient scope for change and re-adjustment in the financial structure. Such changes become necessary due to changes in business conditions in future.

5 Optimum Use of Funds: An important focal point of a financial working capital plan is the best of the funds raised through various sources. All the possible efforts should be made that funds do not remain idle.

Working Capital  Needs of Different Firms

Discuss the methods of analysis of working capital?

Working capital position of an enterprise is analysed by various internal and externalparties. External parties include bankers, creditors, financial institutions etc. The objective ofthese parties in analyzing the working capital is to assess the liquidity of the business, i.e. toknow whether the firm will have sufficient current assets and cash to pay their debts whenthey fall due. Method to analyse the working capital are:-

Schedule of Changes in Working Capital: With the help of this schedule increase ordecrease in various current assets and current liabilities can be ascertained. Thisschedule considers only current assets and current liabilities, at the beginning and atthe end of the year. This schedule shows either increase or decrease in workingcapital. Following rules are followed while preparing a schedule of changes in workingcapital.

Ratio Analysis : A ratio is simply one number expressed in terms of another. It foundby dividing one number into the other. Working capital can be analysed with the help ofvarious ratios mentioned below:

Liquidity Ratios:-

Current Ratio:- This ratio explains the relationship between current and current liabilities of a business. The formula for calculating the ratio is:

Current AssetsCurrent Ratio = --------------------------------- Current Liabilities

Ratio:- Liquid ratio explains the relationship between liquid assets andLiquid current liabilities of a business. The formula for calculating the ratio is:

Liquid Ratio = Liquid Assets

----------------------------- Current Liabilities

Absolute liquid ratio Cash + Bank + Marketable SecuritiesAbsolute Liquid Ratio = ------------------------------------------------------- Current Liabilities

(B) Activity Ratios:-

Cost of Goods SoldInventory Turnover Ratio = -------------------------------------------- Average Stock

Debtors Turnover Ratio:- This ratio indicates the relationship between credit sales and average debtors during the year. The formula for calculating the ratio:

Debtors Turnover Ratio = Net Credit Sales ----------------------------------------- Average Debtors + Average B/R

Creditors Turnover Ratio:- This ratio indicates the relationship between credit purchases and average creditors during the year. The formula for calculating the ratio is:

Net Credit PurchasesCreditors Turnover Ratio = ----------------------------------------------------- Average Creditors + Average B/P

Working Capital Turnover Ratio:- This ratio indicates the relationship between cost of goods sold and working capital. The formula for calculating the ratio is :

Cost of Goods SoldWorking Capital Turnover Ratio = ------------------------------------------ Working Capital

Fund Flow Statement:- This statement reveals the sources from which funds wereobtained and the uses to which funds were applied. In other words, this statementdiscloses what the main sources of funds were and how these funds were utilizedduring the year. With the help of this statement the basic reasons for increase ordecrease in working capital can be analysed. The term 'fund' does not mean 'cash'. Itis generally used to denote the difference between current assets and current liabilities. In other words, the term 'fund' stands for 'net working capital'. Thus, a fundflow statement indicates the causes of changes in the working capital of a companyduring the year.

Cash Flow Statement:- A cash-flow statement is a statement showing and outflowsof cash during a particular period. In other words, it is a summary of sources andapplications of cash during a particular span of time. It analyses the reason forchanges in balance of cash between the two balance sheet dates. The term 'cash'here stands for cash and cash equivalents. A cash-flow statement can be for the pastor can be projected for a future period.

Case Study on L&T Liquidity Ratio Calculation

L&T 2011 & 2012 Balance Sheet

L&T 2011 & 2012 Income Statement

Management of WCThe main objective of WC management is to manage the firms current assets and liabilities in such a way that a satisfactory level of working capital is maintained.

Current assets should be sufficient enough to cover current liabilities. Different components of WC should be properly balanced.

WC Management policies have a great effect on a firm's profitability, liquidity and its structural health. The finance manager should therefore, chalk out appropriate WC Management Policies in respect of each of the components of WC so as to ensure higher profitability, proper liquidity, and sound structural strength.

In order to achieve this objective the Finance Manager has to perform two functions:

Estimating the amount of Working Capital (Need to take into account various factors that determine the working capital requirement)

Sources from which these funds have to be raised (Need to know type of WC required)

Components of Working Capital Management Cash Management Receivables Management Inventory Management

Management of CashCash, the most liquid asset, is of vital importance to the daily operations of business firms. Though the companies hold the assets in the form of cash less than 3%, its efficient management is crucial to the solvency of the business.

Motives for holding cashJohn Maynard Keynes has put forth 3 possible motives for holding cash:

Transaction Motive Precautionary Motive Speculative Motive [Compensation Motive: Banks provide certain basic services to their clients free

of charge. The clients are asked to keep a minimum balance with them which helps them to earn interest and thus compensate them for the free services so provided]

Objectives of Cash ManagementTwo basic objectives:

To make cash payments To minimize the amount locked up as cash balances

Basic Problems of Cash Management

Cash Planning Managing the cash flows Maintenance of optimal level of cash Investment of surplus cash

FloatThe cash balance shown by a firm in its books is called the book balance or ledger balance. The balance shown in its bank account is called the available balance or collected balance. The difference between the available balance and book balance is referred to as the float.

There are two kinds of float:A] Disbursement floatB] Collection float

Cheques issued by a firm create disbursement float. Cheques received by a firm lead to collection float.

The Net Float is the sum of disbursement float and collection float. It is simply the difference between the firm's available balance and its book balance. If the net float is positive, it means that the available balance is greater than the book balance. If the net float is negative, the available balance is lesser than the book balance.

Since what matters is the available balance, the finance manager should try to maximize the net float. This means that the manager should strive to speed up collections and delay disbursements.

InventoriesInventories

Danger of excess working capital: It may result in unnecessary accumulation of inventory which may lead to

increase in wastage due to mishandling, theft etc. It is an indication of defective credit policy. There is the possibility of higher

incidence of bad debts. It may lead to complacency in managing day-to-day expenses of the firm. Executives may be tempted to spend more.

Inadequate working capital is a situation where in the firm does not have sufficient funds to meet day to day running expenses. This ultimately results in interruption in the production process.

Danger of inadequate working capital Operating inefficiencies creep in when it becomes difficult of meet day-to-day

commitments. It becomes difficult to implement operating plans and achieve firms targets. It directly affects firms liquidity position and the firm may find it difficult to honour

short-term obligations.

WC, Risk and ReturnHigher level of WC decreases the risk as well as profitability. Lower level of WC increases the risk as well as the possibility of profitability