Working Capital Management in India: Complete Business Guide

Introduction: The Cash Crunch Nobody Saw Coming

Vikram’s electronics distribution business was thriving—revenue had grown from ₹3 crores to ₹12 crores in four years. But in the fifth year, disaster struck. Despite record sales, he couldn’t pay suppliers, missed loan EMIs, and nearly shut down.

“I was profitable on paper—making ₹80 lakhs profit,” Vikram recalls. “But my cash was stuck everywhere: ₹1.5 crores in inventory, ₹2 crores in receivables from retailers, and I was paying suppliers within 30 days while collecting in 90 days.”

Vikram’s problem wasn’t profitability—it was working capital management. This silent killer destroys more profitable businesses than any other financial issue.

What is Working Capital?

Definition

Working Capital = Current Assets - Current Liabilities

It represents the short-term liquidity available to run day-to-day operations.

Components

Current Assets:

• Cash and bank balances
• Inventory (raw materials, WIP, finished goods)
• Accounts receivable (debtors)
• Short-term investments
• Prepaid expenses

Current Liabilities:

• Accounts payable (creditors)
• Short-term borrowings
• Accrued expenses
• Taxes payable
• Current portion of long-term debt

Net Working Capital Example

The Working Capital Cycle

Understanding the Cash Conversion Cycle

Purchase         →    Production    →    Sale    →    Collection
Raw Materials         Process            Finished      Cash
                                         Goods
    ↑                                                      ↓
    ←←←←←←←←←←←← Pay Suppliers ←←←←←←←←←←←←←←←←←←←←←←←←

Cash Conversion Cycle (CCC) = DIO + DSO - DPO

Where:

• DIO = Days Inventory Outstanding
• DSO = Days Sales Outstanding
• DPO = Days Payables Outstanding

Example Calculation

Interpretation: This business needs to fund 75 days of operations from the time it pays for inventory to when it collects from customers.

Industry CCC Benchmarks (India)

Note: Negative CCC means the company collects from customers before paying suppliers—ideal situation!

Inventory Management

Types of Inventory

1. Raw Materials

• Materials waiting to enter production
• Risk: Price fluctuation, obsolescence

2. Work-in-Progress (WIP)

• Partially completed goods
• Risk: Process bottlenecks

3. Finished Goods

• Ready for sale
• Risk: Slow-moving stock, obsolescence

Inventory Costs

Carrying Costs:

• Storage and warehousing
• Insurance
• Opportunity cost of capital
• Obsolescence and spoilage
• Handling and security

Ordering Costs:

• Purchase order processing
• Transportation
• Receiving and inspection
• Setup costs

Inventory Management Techniques

1. ABC Analysis

Classify inventory by value contribution:

Example: Auto Parts Dealer

2. Economic Order Quantity (EOQ)

Optimal order quantity minimizing total inventory costs:

EOQ = √(2 × D × S / H)

Where:
D = Annual demand
S = Ordering cost per order
H = Holding cost per unit per year

Example:

• Annual demand: 10,000 units
• Ordering cost: ₹500 per order
• Holding cost: ₹50 per unit/year

EOQ = √(2 × 10,000 × 500 / 50) = √200,000 = 447 units

3. Just-in-Time (JIT)

Minimize inventory by receiving goods only when needed.

Requirements:

• Reliable suppliers
• Quality systems
• Demand predictability
• Close supplier relationships

Indian Adoption: Growing in auto, electronics manufacturing

4. Safety Stock

Buffer inventory for unexpected demand or supply delays:

Safety Stock = Z × σ × √LT

Where:
Z = Service level factor
σ = Standard deviation of demand
LT = Lead time

Inventory Red Flags

• Inventory growing faster than sales
• Inventory turnover declining
• Increasing obsolete/slow-moving stock
• Write-offs becoming frequent
• Storage costs rising disproportionately

Receivables Management

Credit Policy Components

1. Credit Terms

• Credit period (30, 45, 60, 90 days)
• Cash discount (2/10 net 30)
• Credit limit per customer

2. Credit Standards

• Minimum requirements for credit
• Customer evaluation criteria
• Documentation requirements

3. Collection Policy

• Collection procedures
• Follow-up schedule
• Legal action triggers

Evaluating Creditworthiness

The 5 Cs of Credit:

Practical Checks in India:

• Trade references (3 minimum)
• Bank references
• CIBIL/Commercial credit bureau
• Financial statements (2-3 years)
• Site visit for large exposures

Collection Process

Structured Collection Timeline:

Receivables Financing Options

1. Factoring

• Sell receivables to a factor
• Get immediate cash (80-90% of invoice value)
• Factor collects from customer

Cost: 12-24% annually

2. Invoice Discounting

• Borrow against receivables
• Company retains collection responsibility
• Bank/NBFC provides advance

Cost: 10-16% annually

3. Letter of Credit (LC)

• Bank guarantee of payment
• Common in international trade
• Eliminates credit risk

Receivables Metrics

DSO Calculation:

DSO = (Accounts Receivable / Credit Sales) × 365

Aging Analysis:

Payables Management

Strategic Payables Management

Objectives:

• Preserve cash as long as possible
• Maintain supplier relationships
• Capture available discounts
• Optimize payment timing

Payment Terms Negotiation

Factors Affecting Negotiating Power:

• Purchase volume
• Payment reliability
• Market alternatives
• Supplier dependence
• Industry norms

Common Indian Terms:

Discount Decision

Should you take an early payment discount?

Discount: 2/10 Net 30 (2% discount if paid in 10 days, otherwise full payment in 30 days)

Annualized Cost of Not Taking Discount:
= [Discount % / (100 - Discount %)] × [365 / (Full Period - Discount Period)]
= [2 / 98] × [365 / 20]
= 0.0204 × 18.25
= 37.2% annually

Decision: If your cost of capital is less than 37.2%, take the discount!

Supplier Financing Options

1. Supplier Credit

• Negotiate extended payment terms
• Free financing if well-managed

2. Reverse Factoring (Supply Chain Financing)

• Bank pays supplier early
• You pay bank later
• Supplier gets faster payment, you get longer terms

3. Channel Financing

• Financing for distributor purchases
• Bank funds your distributors
• You get faster collection

Payables Best Practices

1. Centralize payables – Single point of control
2. Standardize processes – Consistent approval workflow
3. Leverage technology – Automated payment systems
4. Negotiate strategically – Volume for better terms
5. Honor commitments – Protect supplier relationships
6. Monitor metrics – DPO, discount capture rate

Cash Management

Cash Planning

Cash Budget Components:

Cash Flow Forecasting

Weekly Cash Forecast Template:

Action: Week 2 and 4 need attention—arrange short-term funding or accelerate collections.

Cash Management Strategies

1. Accelerate Collections

• Prompt invoicing
• Electronic payments (UPI, NEFT)
• Early payment incentives
• Strict follow-up

2. Optimize Disbursements

• Use full credit period
• Centralize payments
• Schedule payments strategically
• Avoid early payments (unless discounted)

3. Minimize Idle Cash

• Sweep accounts
• Short-term investments (liquid funds)
• Cash concentration

4. Establish Credit Lines

• Working capital limits
• CC/OD facilities
• Standby arrangements

Banking Arrangements

Working Capital Facilities in India:

Working Capital Financing

Fund-Based vs Non-Fund Based

Fund-Based:

• Cash Credit
• Term loans for WC
• Bill discounting
• Factoring

Non-Fund Based:

• Letters of Credit
• Bank Guarantees
• Acceptances

Assessing Working Capital Needs

Turnover Method (Basic):

Working Capital = 25% of Projected Annual Turnover

Operating Cycle Method (Detailed):

WC = (Raw Material Holding Period × Daily RM Consumption)
   + (WIP Holding Period × Daily WIP Cost)
   + (FG Holding Period × Daily COGS)
   + (Receivable Period × Daily Credit Sales)
   - (Payable Period × Daily Credit Purchases)

Bank Assessment (India)

Banks typically assess working capital using:

1. MPBF Method (Maximum Permissible Bank Finance)

2. Tandon/Chore Committee Norms

Still referenced for credit assessment:

• Minimum current ratio: 1.25:1
• Minimum promoter contribution: 25% of WC

Working Capital Optimization Strategies

Short-Term Strategies

1. Inventory Reduction

• Clear slow-moving stock
• Negotiate consignment arrangements
• Improve demand forecasting

2. Accelerate Collections

• Tighten credit terms
• Offer early payment discounts
• Improve invoicing process

3. Extend Payables

• Negotiate longer terms
• Consolidate suppliers for leverage
• Use supplier financing programs

Long-Term Strategies

1. Process Improvement

• Reduce production cycle time
• Implement lean manufacturing
• Automate order-to-cash process

2. Supply Chain Optimization

• Vendor-managed inventory
• Just-in-time arrangements
• Supply chain financing

3. Customer Terms Revision

• Segment customers by profitability
• Offer tiered terms based on volume
• Convert credit to advance/LC

4. Technology Investment

• ERP implementation
• Automated collections
• Real-time inventory tracking

Common Working Capital Mistakes

Mistake 1: Chasing Revenue Without Cash Focus

Problem: Growing sales while cash cycle worsens Solution: Tie sales incentives to collection, not just booking

Mistake 2: Ignoring Inventory Build-up

Problem: Stocking up without demand signals Solution: Regular inventory reviews, slow-moving alerts

Mistake 3: Over-relying on Bank Finance

Problem: Using expensive bank funds when optimization could help Solution: Improve cycle efficiency before borrowing more

Mistake 4: Inconsistent Credit Policy

Problem: Sales team offering different terms to similar customers Solution: Documented credit policy with limited exceptions

Mistake 5: Poor Cash Forecasting

Problem: Sudden cash crunches despite apparent profitability Solution: Weekly/monthly rolling forecasts

Key Takeaways

1. Working capital is the lifeblood of business operations
2. Cash Conversion Cycle is the key metric to optimize
3. Inventory management directly impacts cash availability
4. Receivables discipline determines cash flow reliability
5. Payables strategy should balance cash and relationships
6. Cash forecasting prevents crises before they happen
7. Technology and processes enable sustainable optimization

Disclaimer

This article is for educational purposes only and does not constitute professional financial advice. Working capital strategies should be customized to your specific business context. Consult a qualified financial advisor or Chartered Accountant for implementing working capital management systems.

Working Capital Health Check

Monthly Review Questions:

• Is inventory turnover improving or declining?
• What’s the trend in DSO over the past 6 months?
• Are we capturing available early payment discounts?
• What’s our actual vs. sanctioned bank limit usage?
• Are there any customers showing deteriorating payment patterns?
• Is there slow-moving or obsolete inventory to address?
• Are cash forecasts proving accurate?

Working capital management isn’t glamorous, but it’s often the difference between businesses that survive and those that thrive. Master the basics, monitor the metrics, and make it a priority—your business depends on it.