CA Intermediate · Financial Management and Strategic Management

Introduction to Working Capital Management: formula sheet

Full chapter guide

Key formulas

Gross working capital: GWC = Total current assets; Focuses on how funds are invested. Also called the quantitative concept.
Net working capital: NWC = Current assets − Current liabilities; Also called the qualitative concept. It shows the part of current assets financed by long-term funds.
Positive and negative working capital: NWC > 0: positive. NWC < 0: negative. NWC = 0: nil; Judge it on the sign of NWC, not on the size of current assets alone.
Permanent and temporary working capital: Total working capital = Permanent (core) + Temporary (fluctuating); Permanent is the minimum level needed at all times. Temporary varies with seasons and demand.
Raw material storage period: Average raw material stock ÷ Raw material consumed per day; Raw material consumed per day = annual consumption ÷ 365 (or 360 if the question says so).
Work-in-progress period: Average WIP stock ÷ Cost of production per day; If WIP is only partly complete, adjust the cost of production for the degree of completion when the question gives it.
Finished goods storage period: Average finished goods stock ÷ Cost of goods sold per day; Use cost of goods sold, not sales.
Receivables (debtors) collection period: Average debtors ÷ Credit sales per day; ICAI problems sometimes use cost of sales when sales value is not given. Follow the data in the question.
Payables (creditors) deferral period: Average creditors ÷ Credit purchases per day; Use credit purchases of raw material.
Operating cycle: R + W + F + D; R = raw material period, W = WIP period, F = finished goods period, D = debtors period. For a trader: inventory period + debtors period.
Cash conversion cycle: Operating cycle − Payables period = R + W + F + D − C; C = creditors period. Also called net operating cycle.
Working capital linked to the cycle: Cash cost per day × Cash conversion cycle (days); A quick estimate of funds locked up. Use cost excluding depreciation if the question asks for cash cost.
Gross operating cycle (link to the factors): Gross operating cycle = Raw material holding period + WIP period + Finished goods holding period + Receivables collection period; Other things equal, a longer operating cycle means a higher working capital need. Most factors work by changing one of these periods. The net operating cycle (cash cycle) = Gross operating cycle − Creditors payment period.
Net working capital: Net working capital = Current assets − Current liabilities; Use this to show how a factor changes the need in numbers.
Direction rule for factors: Longer cycle, more sales, more credit given, inflation, growth → working capital need ↑. Cash sales, faster turnover, longer supplier credit → need ↓; A rule of thumb. State the reason in the exam, not just the direction.
Net working capital: Net working capital = Current assets − Current liabilities; Gross working capital is just the total of current assets.
Raw material stock: Raw material stock = Annual raw material consumed ÷ 12 × months held; Use ÷ 52 for weeks or ÷ 365 (or 360, as told) for days.
Work-in-progress: WIP = (Material × % complete + Labour × % complete + Overheads × % complete) for the period of production ÷ 12 × months in process; Material is usually 100% complete at the start. Labour and overheads use the stated degree of completion.
Finished goods: Finished goods = Annual cash cost of production ÷ 12 × months held; Exclude depreciation. Value at cost, not selling price.
Debtors: Debtors = Annual cash cost of sales ÷ 12 × credit months; Use selling price only if the question says so.
Creditors and outstanding expenses: Creditors = Annual credit purchases ÷ 12 × credit months; Outstanding expense = Annual expense ÷ 12 × payment lag in months; Creditors relate to raw material purchases. Wages and overheads use their own lag.
Cash cost: Cash cost = Total cost − Depreciation − Other non-cash charges; This is the base for the cash cost approach.
Safety margin: Total requirement = Net working capital × (1 + margin %); Applies when the margin is stated on net working capital. If it is stated on sales or on current assets, apply it to that base.
Total working capital need: Total current assets = Permanent working capital + Temporary working capital; Permanent is the minimum level at all times. Temporary is the fluctuating amount above it.
Net working capital: Net working capital = Current assets − Current liabilities; Used to see how much of current assets is funded by long-term sources.
Conservative financing rule: Long-term funds finance fixed assets + permanent WC + part (or all) of temporary WC; Higher cost, lower risk, lower return. Surplus funds may be idle in off-season.
Aggressive financing rule: Short-term funds finance temporary WC + part of permanent WC (and sometimes part of fixed assets); Lower cost, higher risk, higher return.
Matching (moderate) financing rule: Long-term funds = Fixed assets + Permanent WC; Short-term funds = Temporary WC; Finance maturity matches asset life.
Cost comparison of plans: Total financing cost = (Long-term funds × long-term rate) + (Short-term funds × short-term rate); Compute for each plan, then compare with expected EBIT to find profit and return.
Current ratio: Current assets ÷ Current liabilities; Low and falling suggests over-trading. Very high suggests under-trading or idle funds.
Quick ratio: (Current assets − Inventories) ÷ Current liabilities; Use it to test whether liquid assets cover short-term dues.
Working capital turnover: Sales ÷ Net working capital; Very high points to over-trading. Very low points to under-trading.
Inventory turnover: Cost of goods sold ÷ Average inventory; Compare with past years and the industry. Do not judge it alone.
Debtors turnover: Credit sales ÷ Average debtors; A shift in the debtor days shows a change in credit and collection.
Return on capital employed: EBIT ÷ Capital employed × 100; Low with idle funds suggests under-trading or over-capitalisation.

Quick revision

Gross working capital = total current assets; net working capital = current assets − current liabilities.
Permanent working capital is the minimum level always needed; temporary varies with seasons and activity.
Operating cycle = days of raw material + WIP + finished goods + receivables.
Cash conversion cycle = operating cycle − payables deferral period (days).
A shorter cash conversion cycle means less money tied up in operations.
In estimation, state the valuation basis for each item. Take debtors at cost of sales (cash cost or total cost, as the question directs) unless the question specifies sales value. Value WIP according to the stated completion percentages for materials, labour and overheads.
Do not include depreciation in cash cost for working capital unless the question directs it.
Add all items in a clear format, then give net working capital and any safety margin only if the question asks for it.
Conservative policy: more long-term funds, lower risk, higher cost. Aggressive policy: more short-term funds, higher risk, lower cost.
Matching policy funds permanent needs with long-term sources and temporary needs with short-term sources.
Over-trading means business volume is high compared with the capital base, which causes liquidity strain; under-trading means capital is idle and activity is low.
There is no negative marking, so attempt every MCQ.

Common mistakes

Treating net working capital as the same as gross working capital. Fix: Read the question for the word net. Net always means deduct current liabilities.
Including long-term loans or fixed assets in the calculation. Fix: Check the due date. Only items falling due or realised within the operating cycle or one year are current.
Treating the operating cycle and the cash conversion cycle as the same. Fix: Remember: operating cycle ends at cash collection from debtors. Cash cycle subtracts the creditors period.
Dividing every item by sales. Fix: Use raw material consumption for raw material, cost of production for WIP, cost of goods sold for finished goods, sales for debtors, and purchases for creditors.
Listing factor names with no explanation Fix: Add direction and reason to every factor, in one line each.
Saying seasonality always needs more working capital Fix: Say it creates temporary peaks and fluctuating need. Off-season need falls. Firms often fund peaks with short-term finance.
Including depreciation in the cost of stock, WIP, finished goods or debtors. Fix: Under the cash cost approach, strip out depreciation first. Write the cash cost per unit before any other working.
Valuing debtors at selling price when the question wants cost. Fix: Use cash cost of sales unless the question states debtors at sales value. Read the instruction before you calculate.
Saying a conservative policy gives higher return. Fix: Remember that idle funds and costlier long-term finance reduce return. Conservative means low risk and low return.
Treating permanent working capital as the same as fixed assets. Fix: Permanent working capital is the minimum current assets level. It is financed like a long-term need, but it is not a fixed asset.

Exam tips

Expect a short theory question: differentiate gross and net working capital, or explain positive and negative working capital. Use a two-column comparison in words with a small example.
In numericals, show the classification of items. Many marks go to correctly excluding long-term items.
MCQs often give a list of items and ask for NWC. Compute carefully since options usually include GWC as a trap.
Always add one line of interpretation after the figure. It separates a full-mark answer from a partial one.
Link the topic to liquidity versus profitability whenever the question asks why working capital matters.
Read the base carefully. ICAI numericals often give both sales and cost of sales. Pick the base that matches each item.
State the days in the year at the start. If the question gives 360, use 360 throughout.
Show each period as a division line. Step marks are given even if the final figure is off.