Working Capital Management

Working Capital Management

This course contains the basics of Working Capital Management

Course introduction
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Interview Questions
Pragnya Meter Exam

Working Capital Management


Ratio analysis is, therefore often supplemented with cash flow analysis. In this unit, we shall discuss the concept of cash flow, the nature, management uses of cash flow analysis in the context of working capital management, especially the liquidity aspect of it.


The objectives of this Unit are:

  1. to describe the concept of cash flow and its relevance to management of working capital in general and business liquidity in particular.
  2. to explain and illustrate the process of cash flow analysis.
  3. to highlight the managerial uses of cash flow analysis.


An analysis based on fund flow statement does not take into account the offsetting movement among the individual current assets and liabilities. An increase or decrease in the individual elements of current assets (other than cash) and liabilities affect cash in different ways. For example, increases in sundry creditors and bank overdraft have different implication in terms of repayment of cash. Sundry credits’ bill may fall due after one month or two months. But bank overdraft facility may be for a longer duration.

Thus, it is possible that the firm is in a sound financial position as reflected by the amount of net working capital but it has difficulty in meeting its short-term commitments. For this purpose, cash flow statement is prepared and its analysis is conducted to assess the ability of the firm to meet its obligations to trade creditors, bankers and to pay interest to debenture holders and dividend to its shareholders.

Cash flow analysis take a more conservative approach about the liquidity position of the firm by taking a limited view of the pool of funds available to the firm. It is cash and cash equivalent items only that form the liquidity position of the firm according to this view, when cash basis is adopted for analysis, slight modifications are made in the steps suggested earlier for fund flow analysis. Now instead of NWC, the focus shifts to change in the cash account.

While we had to look for either non-current item to find out change in NWC, we have to analyze all non-cash balance sheet accounts to look for change in cash account. You will recall that changes in current assets and current liabilities form a part of operating cycle of the firm. The impact of these changes on cash can thus be readily captured by appropriately adjusting net income from operations.


Net income
Add: Depreciation
Add: Amortization expenses
Add: Decrease in each current asset (except cash)
Add: Loss on sale of non-current asset
Add: Increase in each current liability
Less: Gain on sale of non-current assets
Less: Increase in each current asset (except cash)
Less: Decrease in each current liability
Cash from operation (+ / – )
Once cash from operations is calculated, cash flow statement may be drawn.

Statement of sources and uses of cash
Sources -
Cash from operations -
Sales of long term investment -
Sale of other fixed assets -
Issue of Share capital -
Acquisition of fixed assets -
Payment of dividend -
Purchase of marketable securities -
Change in cash (+ / – )


Cash flow statement as depicted above is similar to fund statement except that it focuses attention on cash instead of working capital. A careful look into the cash flow statement can help to answer such questions as follows:

  • How much is the amount of cash?
  • How much change has taken place in case of overtime?
  • How much cash is provided by operation of the business?
  • Is there a proper balance between various sources of cash?
  • How much cash is used?
  • For which purpose?
  • How much cash has to be obtained as compared with what the firm has and from what source etc.?

The answer to these questions based on cash flow analysis can greatly facilitate the management of the structural health and liquidity aspects of working capital effectively.