Lesson 17 of 33 · Free
Contents
- 1 Working Capital & Liquidity
- 1.1 What working capital is
- 1.2 The five working-capital items that matter
- 1.3 The cash conversion cycle
- 1.4 Liquidity ratios you should know
- 1.5 Negative working capital — bad or good?
- 1.6 How to manage working capital
- 1.7 Lesson recap
- 1.8 Practical Indian Application
- 1.9 Indian Application & Regulatory Context
- 1.10 Worked Example — Krishna Steel Working Capital
- 1.11 Common Working Capital Mistakes
- 1.12 Frequently Asked Questions
- 1.13 Working Capital Levers and Indian Financing
Working Capital & Liquidity
The cash a business needs to keep operating. Cash conversion cycle, the great negative-working-capital businesses, and how to manage all five components.
What working capital is
Working capital is the cash and near-cash assets a business needs to keep operating on a day-to-day basis. The accounting formula is simple — current assets minus current liabilities — but the business reality is rich. A growing business often needs MORE working capital each year (more inventory to stock, more receivables outstanding) and that need has to be funded from somewhere.
The five working-capital items that matter
- Cash and equivalents — the absolute liquidity buffer.
- Accounts receivable (AR) — customers who owe you. Higher AR means cash is locked up with customers.
- Inventory — stock waiting to be sold. Higher inventory means cash is locked up in warehouses.
- Accounts payable (AP) — suppliers you owe. Higher AP means you’re effectively financed by suppliers (good, up to a point).
- Accrued expenses — wages, taxes, utilities owed but not yet paid.
The cash conversion cycle
The CCC measures how many days of working capital your business needs:
Examples:
- A grocery chain: 20 inventory days + 0 receivable days − 45 payable days = −25 days. They get paid by customers before paying suppliers. Suppliers fund the working capital.
- A SaaS company: 0 inventory days + 30 receivable days − 30 payable days = 0 days. Cash-neutral operations.
- A heavy manufacturer: 90 inventory days + 60 receivable days − 45 payable days = +105 days. The business needs roughly three months of operating expenses tied up in working capital at all times.
A growing business with a positive CCC needs to fund the growing pile of WC — either from retained profits, debt, or equity. This is why “profitable but cash-strapped” is such a common pattern.
Liquidity ratios you should know
| Ratio | Formula | Healthy range |
|---|---|---|
| Current ratio | CA ÷ CL | 1.5 – 2.0 |
| Quick (acid test) | (CA − Inv) ÷ CL | ≥ 1.0 |
| Cash ratio | (Cash + Mkt Sec) ÷ CL | ≥ 0.5 |
| Working capital turnover | Revenue ÷ Avg WC | Higher = more efficient |
Negative working capital — bad or good?
Conventional textbooks say negative working capital = liquidity crisis. The real world is more nuanced. Amazon, Walmart, Reliance Retail all famously operate with negative working capital — meaning suppliers fund their operations. That’s a sign of overwhelming bargaining power and operational excellence, not distress.
For most businesses, though, a current ratio below 1 is a problem. Check whether the negativity is structural (good — like the giants above) or driven by failing operations (bad — losses eating cash).
How to manage working capital
- Tighten AR. Invoice immediately, offer small discounts for early payment, send reminders, charge interest on overdue. Switch chronic late-payers to advance payment.
- Optimise inventory. Use ABC classification — tight control on high-value items, looser on low-value. Track inventory turnover by SKU.
- Stretch AP — within reason. Pay on the contractual day, not earlier. But don’t earn yourself a bad supplier reputation.
- Forecast monthly. Cash forecast 13 weeks out reveals shortfalls before they hit.
- Arrange backup lines. Cash credit, overdraft, working-capital loans — secured before you need them.
Lesson recap
- Working capital = current assets − current liabilities.
- Five drivers: cash, AR, inventory, AP, accrued expenses.
- Cash conversion cycle measures days of WC need.
- Negative WC isn’t always bad — depends on structural vs. distress causes.
- Active management on AR, inventory, AP is core CFO work.
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Apply what you’ve learned
Practical Indian Application
Practitioner resources: Tally Prime’s Cash Flow report; ICAI’s Guidance Note on Working Capital Management; the RBI Tandon Committee report (still referenced for bank working-capital limit assessment); CRISIL/ICRA sectoral benchmarks for industry-specific working-capital norms; CMA report templates available from major Indian banks. These together give you the practitioner’s toolkit for monitoring and managing working capital.
Indian Application & Regulatory Context
Working capital is the cash tied up in running daily operations — debtors + inventories − creditors. Liquidity measures how quickly the firm can settle short-term obligations. RBI’s lending norms tie maximum permissible bank finance to working-capital cycles, and Tandon Committee methods are still referenced in banking circles. Indian SMEs frequently get crushed when buyers stretch payments to 90+ days while suppliers demand 30-day terms — a working capital gap that bank cash credit limits are designed to bridge.
Worked Example — Krishna Steel Working Capital
Imagine Krishna Steel, Ahmedabad, has Inventory ₹6 crore (turnover 60 days), Trade Receivables ₹4 crore (collection 50 days) and Trade Payables ₹3 crore (payable 40 days). Working capital tied up = 6+4−3 = ₹7 crore. Cash conversion cycle = 60+50−40 = 70 days. If Krishna negotiates supplier terms to 60 days and reduces inventory to 45 days, cycle shrinks to 45+50−60 = 35 days. Working capital released = roughly ₹3 crore, which can repay overdraft (saving 9% interest = ₹27 lakh annually) or fund growth without additional bank borrowing. This single working-capital improvement effectively boosts PAT by ~₹20 lakh.
Common Working Capital Mistakes
- Ignoring seasonal cycles — agri-input firms have huge WC swings between Kharif and Rabi seasons
- Treating WC as constant — growth invariably increases WC tied up
- Missing the GST input credit cycle — ITC blocked due to supplier non-filing inflates effective WC
- Not separating advance payments from receivables in ageing reports
Frequently Asked Questions
What is the Tandon Committee method?
An RBI framework that limits bank finance to 75% of working capital gap (current assets minus current liabilities other than bank finance) — still referenced by banks for working-capital limit assessment.
Is a high Current Ratio always good?
No. A very high current ratio may indicate idle cash, slow-moving inventory or unrecovered debtors — none of which are healthy.
How does GST affect working capital?
GST input credit is locked until the supplier files GSTR-1 and the buyer claims via GSTR-3B; mismatches delay credit and inflate working capital by the unclaimed amount.
Working Capital Levers and Indian Financing
The four classical levers to free up working capital: (1) reduce inventory days through demand forecasting and just-in-time procurement; (2) reduce receivable days through early-payment discounts; (3) extend payable days through supplier negotiation within MSMED Act limits; (4) consolidate banking relationships for cleaner cash sweep. Indian firms also use bill discounting via TReDS (RBI-licensed Trade Receivables Discounting System) to monetise invoices in 24-72 hours. A firm with monthly turnover ₹50 lakh, inventory days 60, receivable days 45, payable days 30 has cash conversion cycle of 75 days. Working capital tied up ≈ ₹1.23 crore. Compressing cycle to 40 days releases ₹57 lakh.
Practitioner Workflow
Set up a quarterly working-capital dashboard in Excel or Power BI. Track Inventory Days, Receivable Days, Payable Days as a time series for your business or any listed company you follow. A 5-day compression across all three typically releases 1-2% of annual revenue as cash — meaningful regardless of profit margin. Combine with bank-side discussion to negotiate working-capital limits efficiently.
Indian Financing Options for Working Capital
The Indian banking system offers multiple working-capital instruments — each with distinct cost, flexibility, and qualification criteria:
- Cash Credit (CC): Most common; revolving facility against drawing power. Interest only on utilised portion. Typical rate: MCLR + 100-300 bps.
- Working Capital Demand Loan (WCDL): Term loan structure for working capital. Lower rate than CC (MCLR + 50-150 bps) but less flexible.
- Letters of Credit (LC): For import-export and inland purchases. Commitment fees lower than full disbursement cost.
- Bill Discounting / Factoring: Discount your invoices through banks or NBFCs. TReDS (RBI-licensed) gives best rates for MSME suppliers.
- Trade Receivables Discounting (TReDS): Auction-based receivable discounting for MSME suppliers. Rates 8-11% vs traditional 12-15%.
- Vendor Financing: Large corporates fund their supplier ecosystem. Examples: Reliance Jio, Tata Steel, Maruti supplier finance programmes.