CMA Intermediate · Financial Management and Business Data Analytics

Introduction to Working Capital Management: formula sheet

Full chapter guide

Key formulas

Gross working capital: Gross working capital = Total current assets; Includes cash, bank, debtors, bills receivable, inventory, prepaid expenses and short-term investments.
Net working capital: Net working capital = Current assets − Current liabilities; Positive means surplus of current assets; negative means a working capital deficit.
Total working capital split: Gross working capital = Permanent working capital + Temporary working capital; Permanent is the minimum level through the year; temporary is the seasonal excess above it.
Current ratio (link to liquidity): Current ratio = Current assets ÷ Current liabilities; Net working capital is positive when this ratio is above 1.
Raw material storage period: Average raw material stock ÷ Average daily raw material consumption; Daily consumption = annual consumption ÷ 365 (or 360 if the question says so).
Work-in-progress period: Average WIP stock ÷ Average daily cost of production; If WIP is given with completion percentages, use the equivalent cost of WIP.
Finished goods storage period: Average finished goods stock ÷ Average daily cost of goods sold; Use cost, not sales value.
Receivables (debtors) collection period: Average debtors ÷ Average daily credit sales; Use credit sales if given. If the question gives only sales, use sales. If debtors are valued at cost, use cost of sales as the question directs.
Payables (creditors) payment period: Average creditors ÷ Average daily credit purchases; 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, all in days.
Cash conversion cycle: Operating cycle − Creditors payment period = R + W + F + D − C; C = creditors period in days. Also called net operating cycle.
Number of cycles per year: 365 ÷ Operating cycle (days); Use the day-count given in the question.
Working capital (gross): Gross working capital = Total current assets; Also called the quantitative concept.
Net working capital: Net working capital = Current assets − Current liabilities; Also called the qualitative concept.
Gross operating cycle: Gross operating cycle = RM days + WIP days + FG days + Debtor days; This is the total time from buying raw material to collecting cash, before allowing for supplier credit. Other things equal, a longer cycle means a higher working capital need.
Net operating (cash conversion) cycle: Net operating (cash conversion) cycle = Gross operating cycle − Creditor days; This is the period for which the firm must fund itself after allowing for credit from suppliers.
Direction of effect rule: Longer cycle, higher sales, liberal credit, inflation → need rises; Faster collection, longer supplier credit and shorter production time → need falls.
Total current assets: Current assets = Permanent current assets + Temporary current assets; Split the data first. Permanent is the minimum level through the year.
Matching policy: Long-term funds = Fixed assets + Permanent current assets; Short-term funds = Temporary current assets; Maturity of finance matches life of the asset.
Conservative policy: Long-term funds > Fixed assets + Permanent current assets; Short-term funds < Temporary current assets; Part of temporary current assets is financed from long-term funds.
Aggressive policy: Short-term funds > Temporary current assets; Long-term funds < Fixed assets + Permanent current assets; Part of permanent needs is financed from short-term funds.
Net working capital: Net working capital = Current assets − Current liabilities; Aggressive policy gives lower net working capital and a lower current ratio.
Financing cost: Interest = Amount × Rate × Time; Use it to compare total financing cost under each policy; match the period to the months funds are used.
Net working capital: Net working capital = Current assets − Current liabilities; Add the safety margin after this figure, unless the question says otherwise.
Raw material stock: Annual raw material consumption ÷ 12 × months of stock; Use weeks ÷ 52 or days ÷ 365 if the period is given that way.
Work in progress: (Material + stage% × Labour + stage% × Overheads) per unit × units in WIP; Use 100% for material if it is added at the start. Overheads here exclude depreciation under the cash cost method.
Finished goods: Cash cost of production per unit × units held in stock; Excludes depreciation under the cash cost method. Selling and distribution costs are usually excluded unless stated.
Debtors: Cost of sales (or selling price, if asked) per period × credit period; Under the cash cost method, use cash cost of sales. Use sales value only if the question instructs.
Creditors: Annual credit purchases ÷ 12 × months of credit; Based on purchases of raw material, not on consumption, unless the two are equal.
Outstanding expenses: Monthly expense × months of lag; Applies to wages and overheads paid in arrears. Never include depreciation.
Safety margin: Total requirement = Net working capital × (1 + margin%); If the margin is stated on sales or on current assets, apply it on that base.
Tandon Method 1: maximum permissible bank finance (MPBF): MPBF = 0.75 × (CA − CL), where CL excludes bank borrowings; The borrower finances 25% of the working capital gap from long-term funds. Here CA − CL is the working capital gap.
Working capital gap: Working capital gap = Total current assets − Current liabilities (excluding bank borrowings); Used as the base for Methods 1 and 2.
Tandon Method 2: MPBF: MPBF = 0.75 × Total current assets − Current liabilities (excluding bank borrowings); Borrower keeps 25% of total current assets as NWC. This leaves a larger margin with the borrower than Method 1.
Tandon Method 3: MPBF: MPBF = 0.75 × (Current assets − Core current assets) − Current liabilities (excluding bank borrowings); Core current assets are the permanent minimum level of current assets. They are funded entirely from long-term sources.
Current ratio under each method: Method 1: minimum current ratio of about 1.17:1; Method 2: 1.33:1; Method 3: a still higher ratio; These are the norms associated with each method, not figures you compute from a question's data.
Effective cost of factoring or discounting (annualised): Cost % = (Charges ÷ Net amount advanced) × (365 ÷ Days); Use the amount actually received, not the invoice value, as the base.

Quick revision

Gross working capital = total current assets.
Net working capital = current assets − current liabilities.
Permanent working capital is the minimum level needed all the time; temporary varies with season and demand.
Operating cycle = inventory holding period + receivable collection period, with the manufacturing stages included for a manufacturer.
Cash conversion cycle = operating cycle − payables deferral period.
A longer cycle means more funds are blocked and a higher working capital need.
Aggressive policy funds part of permanent needs with short-term funds: higher risk, usually lower cost.
Conservative policy uses more long-term funds: lower risk, usually higher cost.
Matching policy funds permanent needs with long-term and temporary needs with short-term funds.
In estimation, value stock and debtors on the basis the question states, and state your assumptions.
Add the cash balance and any safety margin only if the question gives them.
Trade credit, bank credit, commercial paper and factoring are common short-term sources.

Common mistakes

Including fixed assets or long-term loans in the working capital calculation. Fix: Include only current assets and current liabilities. Check if an item is due or realisable within 12 months.
Treating net working capital as always equal to gross working capital. Fix: Gross is only current assets. Net deducts current liabilities. Write both formulas at the start.
Using sales for every period instead of the correct base. Fix: Match each balance with its own flow: raw material with consumption, WIP with production cost, finished goods with cost of goods sold, debtors with credit sales, creditors with credit purchases.
Forgetting to subtract the creditors period for the cash cycle. Fix: Read the question wording. Operating cycle excludes payables; cash conversion cycle or net operating cycle deducts them.
Listing factors without saying how they affect the requirement. Fix: Add a short phrase on direction for each factor, such as 'liberal credit raises debtors, so need rises'.
Saying a longer credit period given by suppliers raises working capital need. Fix: Credit given to customers raises need. Credit taken from suppliers lowers the cash the firm must fund.
Treating all current assets as short-term assets that need short-term finance only. Fix: Always split into permanent and temporary current assets. Permanent current assets are needed all year and are financed by long-term funds under matching.
Saying the conservative policy gives the highest profit because it is safe. Fix: Conservative means low risk and generally lower return, since long-term funds cost more and surplus funds may sit idle.
Including depreciation in WIP, finished goods or debtors. Fix: Remove depreciation first and work with the cash cost per unit. Only include it if the question asks for the total cost method.
Valuing every asset at selling price. Fix: Value raw material, WIP and finished goods at cost. Value debtors at cost unless the question says to use sales value.

Exam tips

Start every theory answer with a one-line definition, then the formula, then an example. This pattern earns step marks.
For MCQs, check whether the question says gross or net. Many wrong options differ only by current liabilities.
In differences between permanent and temporary working capital, use at least four points and one example.
In numerical questions, show the list of current assets and current liabilities separately. Marks are given for correct classification even if the final figure is wrong.
For importance questions, give both sides: the benefits of adequate working capital and the costs of too little or too much.
In MCQs, check the wording: operating cycle or cash/net operating cycle decides whether you subtract creditors days.
Show a four-line table of stage, balance, base and days in written answers so you earn step marks even if one figure is wrong.
State the day-count and any assumption (such as using closing balances) at the start of your answer.