Chapter 2: Working Capital Management – Questions & Answers

📌 Part A – 1 Mark Questions (Very Short Answer)

1. What is working capital?
   Working capital is the money a business needs for its day-to-day expenses.
2. What is fixed capital?
   The investment made in long-term assets like land and machinery is called fixed capital.
3. Define Gross Working Capital.
   Gross Working Capital is the total of all current assets of a business.
4. Define Net Working Capital.
   Net Working Capital is Current Assets minus Current Liabilities.
5. What is fixed working capital?
   It is the minimum amount of current assets always needed for normal business operations.
6. What is temporary or variable working capital?
   It is the extra working capital required to meet seasonal or special demands.
7. What is the working capital cycle?
   It is the cycle that starts with buying raw materials and ends with getting cash from sales.
8. According to which approach are all current assets financed from long-term sources?
   The Conservative approach.
9. According to which approach are all current assets financed from short-term sources?
   The Aggressive approach.
10. Which approach is also called the matching approach?
    The Hedging approach.
11. Name any two current assets.
    Cash and Inventory (or Debtors, Bills Receivable, etc.).
12. Name any two current liabilities.
    Sundry Creditors and Bank Overdraft (or Bills Payable, etc.).
13. What is positive net working capital?
    It means Current Assets are more than Current Liabilities.
14. What is negative net working capital?
    It means Current Liabilities are more than Current Assets.
15. Give an example of a business that needs very little working capital.
    Electricity supply company or a railway.
16. Give an example of a business that needs a lot of working capital.
    A trading company or a cloth shop.
17. Complete the cycle: Cash → ______ → Work in Progress → ______ → Sales → ______.
    Raw Material, Finished Goods, Debtors.

📌 Part B – 2/4 Marks Questions (Short Answer)

1. Why is working capital important for a business? (Write any 4 points)

   • It ensures production never stops.
   • It helps the business pay all bills on time.
   • It helps to build a good reputation in the market.
   • It allows the business to buy in cash and get discounts.
   • It helps the business face emergencies and crises.
   • It creates confidence among employees and owners.

   (Any four points are enough for 2 marks)

2. Explain the different concepts of working capital.

   • Gross Working Capital: The total value of all current assets.
   • Net Working Capital: Current Assets minus Current Liabilities. It shows the liquidity position.
   • Permanent Working Capital: The minimum amount always needed to run the business.
   • Temporary Working Capital: Extra funds needed during peak seasons or for special purposes.

3. List the main components of current assets and current liabilities.

   Current Assets (Own): Inventory (stock), Sundry Debtors, Bills Receivable, Cash & Bank Balance, Pre-paid Expenses.

   Current Liabilities (Owe): Sundry Creditors, Bills Payable, Bank Overdraft, Short-term Loans, Outstanding Expenses.

4. What are the dangers of having excessive working capital?

   • Money remains idle and does not earn any profit.
   • Too much stock can lead to theft, waste, and losses.
   • Bad credit policy can increase bad debts.
   • The value of shares may fall due to low returns.
   • It can lead to unnecessary and risky speculation.

5. What are the dangers of having inadequate working capital?

   • The firm cannot pay its short-term bills on time, losing its reputation.
   • It cannot get the benefit of cash discounts.
   • It cannot take advantage of good market opportunities.
   • It cannot pay daily expenses smoothly.
   • The rate of return on investment also falls.

6. Briefly explain the three approaches to working capital financing.

   • Conservative Approach: Uses only long-term sources (like shares, debentures) for all current assets. It is safe but costly.
   • Aggressive Approach: Uses only short-term sources (like bank credit) for all current assets. It is risky but less costly and can yield higher profits.
   • Hedging/Matching Approach: Uses long-term funds for permanent needs and short-term funds for temporary needs. It is a balanced method.

📌 Part C – 6/8 Marks Questions (Long Answer)

1. Explain in detail the factors that determine the working capital requirements of a firm.

   • 1. Nature of Business: Trading companies need more working capital. Public utilities (like electricity) need very little.
   • 2. Size of Business: A larger business generally needs more working capital than a smaller one.
   • 3. Production Policy: If a company keeps high inventory to maintain stable production, it needs more working capital.
   • 4. Length of Production Cycle: A longer production cycle (like in a shipyard) requires more working capital.
   • 5. Working Capital Cycle: If the cycle (cash to cash) is long, more working capital is needed.
   • 6. Credit Policy: If a company buys in cash but sells on credit, it needs more working capital. The opposite needs less.
   • 7. Business Cycles: During a boom, more working capital is needed. During a recession, less is needed.
   • 8. Growth Rate: Fast-growing companies need more working capital.
   • 9. Price Level Changes: Rising prices (inflation) mean the firm needs more working capital to buy the same things.
   • 10. Other Factors: Management efficiency, banking facilities, and supply irregularities also play a role.

2. What is working capital management? Explain the working capital cycle with a diagram.

   Working Capital Management means planning, organizing, and controlling the use of current assets and current liabilities to maintain a good level of working capital.

   Working Capital Cycle: This cycle shows how money moves through a business. It starts with cash and ends with cash coming back.

   Cycle Steps:
   CASH → RAW MATERIAL → WORK IN PROGRESS → FINISHED GOODS → SALES → DEBTORS → CASH

   • Cash is used to buy Raw Material.
   • Raw material becomes Work in Progress during production.
   • After production, it becomes Finished Goods.
   • Finished goods are sold, sometimes on credit, creating Debtors.
   • When debtors pay, Cash comes back to the business, and the cycle starts again.

   A shorter cycle means less working capital is needed. A longer cycle means more working capital is needed.

3. From the following information, calculate the Gross Working Capital and Net Working Capital.

   Given:
   Equity Shares: ₹4,00,000, Goodwill: ₹40,000, 8% Debentures: ₹2,00,000, Land & Building: ₹3,00,000,
   Reserves: ₹1,00,000, Plant & Machinery: ₹2,00,000, Sundry Creditors: ₹3,00,000, Finished Goods: ₹1,20,000,
   Bills Payable: ₹60,000, Work-in-Progress: ₹80,000, Outstanding Expenses: ₹40,000, Prepaid Expenses: ₹40,000,
   Bank Overdraft: ₹1,00,000, Marketable Securities: ₹1,20,000, Provision for Tax: ₹40,000, Sundry Debtors: ₹1,80,000,
   Proposed Dividend: ₹60,000, Bills Receivable: ₹40,000, Cash & Bank: ₹1,80,000.

   Step 1: Calculate Gross Working Capital (Total Current Assets)
   Current Assets = Finished Goods + Work-in-Progress + Prepaid Expenses + Marketable Securities + Sundry Debtors + Bills Receivable + Cash & Bank
   = 1,20,000 + 80,000 + 40,000 + 1,20,000 + 1,80,000 + 40,000 + 1,80,000
   = ₹7,60,000

   Step 2: Calculate Total Current Liabilities
   Current Liabilities = Sundry Creditors + Bills Payable + Outstanding Expenses + Bank Overdraft + Provision for Tax + Proposed Dividend
   = 3,00,000 + 60,000 + 40,000 + 1,00,000 + 40,000 + 60,000
   = ₹6,00,000

   Step 3: Calculate Net Working Capital
   Net Working Capital = Current Assets – Current Liabilities
   = 7,60,000 – 6,00,000
   = ₹1,60,000

   Answer: Gross Working Capital = ₹7,60,000 and Net Working Capital = ₹1,60,000.