Page 10 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 1: Introduction to Working Capital Management

4. Conversion of finished goods into debtors and bills receivables through sales Notes
5. Conversion of debtors and bills receivables into cash
The cash conversion cycle shows the time interval over which additional no spontaneous
sources of working capital financing must be obtained to carry out the firm’s activities. An
increase in the length of the operating cycle, without a corresponding increase in the
payables deferral period, lengthens the cash conversion cycle and creates further working
capital financing needs for the company.
Operating cycle in case of a trading firm consists of the following events:

1. Cash into inventories
2. Inventories into accounts receivable
3. Accounts receivable into cash

Self Assessment

Fill in the blanks:

1. There exists a close correlation between sales fluctuations and invested amounts in
.........................
2. Institute of Chartered Accountants of India suggests and follows the system of a
......................... form of balance sheet.
3. Under the conventional method, ......................... enters into the computation of working
capital.

4. A company’s operating cycle typically consists of three primary activities: ...................... ,
....................... and ....................
5. The ......................... shows the time interval over which additional no spontaneous sources
of working capital financing must be obtained to carry out the firm’s activities.

1.2 Importance of Working Capital

Working capital is the life blood and nerve centre of a business. Just as circulation of blood is
essential in the human body for marinating life, working capital is very essential to maintain
the smooth running of a business. No business can run successfully without an adequate amount
of working capital. The main advantages of maintaining adequate amount of working capital
are as follows:

1. Solvency of the business: Adequate working capital helps in maintaining solvency of the
business by providing uninterrupted flow of production.
2. Goodwill: Sufficient working capital enables a business concern to make prompt payments
and hence helps in creating and maintaining goodwill.
3. Easy Loans: A concern having adequate working capital, high solvency and good credit
standing can arrange loans from banks and other on easy and favourable terms.
4. Cash discounts: Adequate working capital also enables a concern to avail cash discounts
on the purchases and hence it reduces costs.

5. Regular supply of raw materials: Sufficient working capital ensures regular supply of raw
materials and continuous production.

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