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Masaryk University
Faculty of Economics and Administration
Field of study: Finance
The Management of Working Capital
Author: Elnur Ibrahimov
Brno, 2014
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THE MANAGEMENT OF WORKING CAPITAL
TABLE OF CONTENT
INTRODUCTION …………………………………………………………..……………………………….. 3
OBJECTIVE OF WORKING CAPITAL MANAGEMENT ………………………………………… 3
CONCEPTs AND DEFINITION OF WORKING CAPITAL ……………………………………..3
TYPES OF WORKING CAPITAL MANAGEMENT ………………………………………………… 4
THE POLICY OF WORKING CAPITAL MANAGEMENT ……………………………………….. 5
CONCLUSION …………………………………………………………………………………………………. 8
REFERENCES …………………………………………………………………………………………………… 9
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INTRODUCTION
Generally, working capital typically means the firm’s current or short-term assets such as
cash, receivables, inventory and marketable securities. These items are also referred to as
circulating* capital.
Working capital management is concerned with the problems that arise in attempting to
manage the current assets, the current liabilities and the interrelations that exist between
them. As we knew, current assets refer to those assets which in the ordinary course of
business can be, or will be, converted into cash within one year without undergoing a
diminution in value and without disrupting the operations of the firm. For instance, cash,
marketable securities, accounts receivable and inventory. By the way, current liabilities are
those liabilities that are intended, at their inception, to be paid in the ordinary course of
business, within a year, out of the current assets or the earnings of the concern. For
example, it is possible to be mentioned accounts payable, bills payable, bank overdraft and
outstanding expenses.
OBJECTIVE OF WORKING CAPITAL MANAGEMENT
As already mentioned above, basically, the main purpose of working capital management
is to manage the firm’s current assets and liabilities in such a way that a satisfactory level of
working capital is maintained. From this point of view, it can be clearly seen that the
interaction between current assets and current liabilities is, therefore the main theme of
the theory of the working capital management.
CONCEPTS OF WORKING CAPITAL
According to the real process of working capital, we can say working capital is the capital
you require for the working for example, functioning of your business in the short run.
There are two possible interpretations of working capital concept:
 Gross working capital- refers to the firm’s investment in the current assets and
includes cash, short term securities, debtors, bills receivables and inventories.
It is necessary to concentrate on the fact that the investment in the current assets
should be neither excessive nor inadequate.
 Net working capital- generally refers to the difference between the current assets
and the current liabilities.
* Circulation capital means assets of a company that are changed in the ordinary course of business from one
form to another, as for example, from cash to inventories to receivable, receivable to cash.
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Current liabilities are those claims of outsiders, which are expected to mature for the
payment within an accounting year include creditors, bills payable, bank overdraft and
outstanding expenses.
When current assets exceed current liabilities it is called positive working capital and
when current liabilities exceed current assets it is called negative working capital.
TYPES OF WORKING CAPITAL MANAGEMENT
Commonly, there are two types of working capital are needed in the business:
1. Permanent Working Capital
2. Variable Working Capital
These two types of working capital can also be classified as under:
Permanent working capital: This is the minimum level of current assets, which is
continuously required by the firm to carry on its business operations. It is permanent in the
same way as the firm’s fixed assets are. Depending upon the changes in the production and
sales, the need for working capital, over and above the permanent working capital, will
fluctuate.
Working Capital
Permanent Working Capital Variable Working Capital
Initial
Working
Capital
Regular
Working
Capital
Seasonal
Working
Capital
Special
Working
Capital
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Variable working capital: This is the working capital which, keeps on changing with the
change in the production and sales activities. It is the extra working capital, over the above
the permanent working capital, that is needed to support the changing production and
sales activities. This type of working capital is also called as fluctuating or variable working
capital.
The difference between the permanent and variable working capital may be represented in
the following two diagrams:
Difference between permanent and variable working capital
THE POLICY OF WORKING CAPITAL MANAGEMENT
An important aspect of working capital policy is to maintain and provide sufficient liquidity
to the firm. The decision on how much working capital be maintained involves a trade-off,
Amount of
Working Capital
Time
Permanent working capital
Variable working capital
Amount of
Working Capital
Time
Permanent working capital
Variable working capital
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for instance, having a large net working capital may reduce the liquidity-risk faced by the
firm, but it can have a negative effect on the cash flows. That’s why the net effect on the
value of the firm should be used to determine the optimal amount of working capital.
Generally three types of working capital policy are accepted, (!) Moderate working capital
policy; (!!) Conservative working capital policy; (!!!) The Aggressive working capital policy.
Actually, these policies describe the relationship between the sales level and the level of
current assets.
In other words, determine an appropriate financial-mix, it can be used mostly three
approaches:
1. Hedging approach, also it is called the matching approach;
2. Conservative approach;
3. An aggressive approach.
In accordance with the approach of Hedging or Marching, the maturity of the sources of
the funds should march the nature of the assets to be financed. This kind of approach
suggests that long-term funds should be used to finance the fixed portion of current assets
requirements in a manner similar to the financial of fixed assets.
Time
Fixed Assets
Amount of Working
Capital ($)
Fluctuated Current
Assets
Permanent Current Assets
Long-term;
Debt +Equity Capital
Short-term Debt
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Hedging or Marching Approach
Conservative approach suggests that the estimated requirements of total funds should
be met from long-term sources; the use of short-term funds should be restricted to only
emergency situations or when there is an unexpected outflow of funds.
Conservative approach
Time
Permanent Current Assets
Fixed Assets
Amount of Working
Capital
Short-
term
Debt
Longterm
Debt
+ Equity
capital
Debt
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Furthermore, the other most important working capital policy is called an aggressive policy
if the firm decides to finance a part of the permanent working capital by the short term
sources. The aggressive policy seeks to minimize exceed liquidity while meeting the short
Aggressive approach
term requirements. The firm may accept even greater risk of insolvency in order to save
cost of long term financing and thus in order to earn greater return.
CONCLUSION
To sum up, I want to note that working capital occupies a peculiar position in the Capital
structure of a firm. It is the life-blood of all types of enterprises, manufacturing and trading
both. If the business has enough working capital, it can maintain its operating efficiency.
Not only that, but adequate working capital provides psychological satisfaction and relief to
the management. Only those enterprises, which have adequate working capital, can survive
in times of depression. It has been observed that number of business enterprises have
failed due to inefficient management of working capital. Form this point of view, the
management of working capital becomes a tedious exercise for a financial manager of a
firm. The most important point of that, working capital management is not only for big
companies it is also quite important for small firms.
Amount of
Working
Capital
Time
Permanent of Current Assets
Fixed Assets
Short-term
Debt
Long-term
Debt +
Equity
capital
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REFERENCES
 Principles of Corporate Finance/ BREALEY MYEARS ALLEN
 Introduction to Finance/ G. MADURA
 Analysis of Investment and Management of Portfolios/ REILLY BROWN