Working Capital Management: Concepts, Operating Cycle, Cash, Inventory and Receivables (Basics) Questions

Question 1

Define working capital.

Accepted Answer

Working capital refers to funds invested in **current assets** required for day-to-day business operations.

Question 2

What is gross working capital?

Accepted Answer

Gross working capital is the total amount invested in **current assets**.

Question 3

What is net working capital?

Accepted Answer

Net working capital = **Current assets − Current liabilities**.

Question 4

Define operating cycle.

Accepted Answer

Operating cycle is the time gap between **cash payment** for purchases/expenses and **cash collection** from sales.

Question 5

State one objective of working capital management.

Accepted Answer

One objective is to maintain **optimum liquidity** for smooth operations while avoiding excessive idle funds.

Question 6

A shorter operating cycle reduces working capital requirement.

Accepted Answer

True. Faster cash conversion means less funds are blocked in current assets.

Question 7

Differentiate between gross and net working capital (any three points) using a table.

Accepted Answer

Gross vs net working capital:

| Basis | **Gross WC** | **Net WC** |
|---|---|---|
| Meaning | total **current assets** | **CA − CL** |
| Focus | investment in CA | liquidity cushion |
| Indicates | size of CA | ability to meet short-term obligations |

Thus, net working capital is more closely linked to liquidity.

Question 8

Explain operating cycle (cash conversion cycle) with a flow and list its components.

Accepted Answer

Operating cycle is the cash-to-cash time:

Flow: Cash → Inventory → Receivables → Cash

Components:
- **Inventory holding period** (RM/WIP/FG days)
- **Receivables collection period**
- **Payables deferral period** (reduces OC)

So: OC = Inventory days + Receivables days − Payables days (basic).

Question 9

Compute net working capital: Current assets ₹8,00,000 and current liabilities ₹5,00,000.

Accepted Answer

Net working capital = **CA − CL**

= 8,00,000 − 5,00,000 = **₹3,00,000**.

| CA | CL | **NWC** |
|---:|---:|---:|
| 8,00,000 | 5,00,000 | **3,00,000** |

Question 10

Explain liquidity vs profitability trade-off in working capital management (brief) with a table.

Accepted Answer

Trade-off:

- More **liquidity** (higher CA) reduces risk of default/stock-out but increases idle funds → profitability falls.
- More **profitability** focus reduces CA but increases risk of cash crunch.

| Policy | Liquidity | Profitability |
|---|---|---|
| Conservative (more CA) | **high** | lower |
| Aggressive (less CA) | lower | **higher** |

Hence, aim for **optimum working capital**.

Question 11

Compute operating cycle (basic): Inventory days 60, receivables days 30, payables days 20.

Accepted Answer

Operating cycle (OC) = Inventory days + Receivables days − Payables days

OC = 60 + 30 − 20 = **70 days**.

| Component | Days |
|---|---:|
| Inventory | 60 |
| Receivables | 30 |
| Payables (−) | (20) |
| **OC** | **70** |

Question 12

State any three methods to improve (reduce) operating cycle and working capital requirement.

Accepted Answer

Any three methods:

- reduce **inventory holding** by better forecasting/JIT
- speed up **collections** (stricter credit policy, follow-up)
- improve production efficiency to reduce WIP time
- negotiate longer **credit period** from suppliers (within terms)

Flow: Reduce inventory days + reduce receivable days + increase payable days → **OC ↓** → WC requirement ↓

Question 13

Explain cash management objectives and any three techniques (exam-style) with a table.

Accepted Answer

### Objectives
Cash management aims to maintain adequate **liquidity** for transactions and precautionary needs while minimising idle cash.

### Techniques (any three)
- **Cash budgeting**: plan inflows/outflows to avoid cash deficit.
- Speed up collections: early payment discounts, digital collections.
- Control payments: use credit terms effectively (pay on due date).
- Invest surplus in short-term instruments.

| Technique | Purpose |
|---|---|
| **Cash budget** | forecast and control cash |
| Faster collection | reduce receivables days |
| Planned payments | avoid unnecessary cash holding |

### Conclusion
Effective cash management reduces financing cost and improves operating efficiency.

Question 14

Explain inventory management and EOQ concept (exam-style) with a flow/table.

Accepted Answer

### Meaning
Inventory management ensures that inventory is available for smooth production/sales at minimum total cost.

### EOQ concept
EOQ is the order quantity that minimises total inventory cost, balancing:
- **ordering cost** (cost of placing orders)
- **carrying cost** (storage, insurance, obsolescence)

Flow: Ordering cost ↓ with larger orders, Carrying cost ↑ with larger orders → **EOQ at minimum total cost**

| Cost type | Behavior with order size |
|---|---|
| **Ordering cost** | decreases |
| **Carrying cost** | increases |

### Conclusion
By ordering near EOQ, a firm reduces total inventory cost and lowers funds blocked in inventory.

Question 15

Explain receivables management and credit policy factors (exam-style) with a table and conclusion.

Accepted Answer

### Meaning
Receivables management deals with controlling the level of **debtors/credit sales** so that sales increase without excessive risk and funds blockage.

### Credit policy factors
- credit standards (who gets credit)
- credit period (how long to pay)
- collection efforts and follow-up
- bad debt risk and customer quality

| Policy change | Effect |
|---|---|
| Relax credit | sales ↑ but **receivables & bad debts** ↑ |
| Tight credit | risk ↓ but sales may ↓ |

### Conclusion
An optimal credit policy balances **profitability** from sales with **liquidity** and credit risk control.

Basis	Gross WC	Net WC
Meaning	total current assets	CA − CL
Focus	investment in CA	liquidity cushion
Indicates	size of CA	ability to meet short-term obligations

Working Capital Management: Concepts, Operating Cycle, Cash, Inventory and Receivables (Basics)

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