The direct approach to working capital control is to develop effective policies for the control of each of the components of working capital. Since deviations occur in actual operations, indirect control techniques are needed by management to reduce its working capital requirements. Control of cash, receivables, and inventories be maintained in a synchronized way so that a matching balance in all parameters of working capital could be obtained.
Banks normally provide working capital finance to hold an acceptable level of current assets viz. raw materials and stores, stocks in progress, finished goods, and sundry debtors for achieving a pre-determined level of production and sales. The assessment of funds required to be blocked in each of these items of the working capital required by industry is discussed as under:
1. Raw Material: Raw material, of any kind, is necessarily required by an industrial unit to continue the production process. The different raw materials could be procured from different sources may be indigenous or overseas and accordingly different treatment of procurement time is bound to be given. The mode of payment for the raw material may also be different. Thus, affecting the credit requirements of the client, the funds blocked up in procurement and stocking of material will have to be taken into consideration. Total materials including those in transit and for which advance payment is made can normally be expressed in terms of a number of months consumption and requirements of funds can be assessed by multiplying the figure by the amount of monthly consumption.
2. Work in Process: The time taken by the raw material to be converted into a finished product is the period of material processing and all the expenses of the process are involved in it. Therefore, the assessment of funds blocked in the process is made by taking into account the raw material consumption during the processing period and the expenses incurred during such period i.e. the cost of production for the period of processing.
3. Finished goods in the next stage: The funds blocked in finished goods inventories are assessed by estimating the manufacturing cost of the product.
4. Sundry Debtors: When goods sold are not realized in cash, sundry debtors are generated. The credit period followed by a particular industrial unit in practice is generally the result of industry practices. Investment in accounts receivable remains blocked from the time of sale till the time amount is realized from debtors. The assessment of funds blocked should be on the basis of the cost of production of the materials against which the bank extends working capital credit.
5. Expenses: One month’s total expenses, direct or indirect, are provided by way of cushion in assessing the requirement of funds which may include rent, salaries, etc. depending upon the length of the operating cycle.
6. Trade Credit: received on purchases reduces working capital funds requirements and has to be taken into account for the correct assessment of funds.
7. Advances: received along with purchase orders for the products also reduce the fund’s requirements for working capital.