Q.During the Covid-19 pandemic, the restaurant industry faced many challenges. The slowdown led to huge decrease in demand. From April 2022, the effect of Covid started reducing. The economy started picking up and a boom was noticed in the restaurant industry. As a result, larger amount of working capital was required with increased production and sales. The factor affecting the working capital requirement discussed above is : (A) Seasonal factor (B) Production cycle (C) Operating efficiency (D) Business cycle
🔒You're viewing a preview — the full solution, concept, methods & PYQ mapping are locked.
🔒 Start your 14-day free trial to unlock the full solution →Concept understanding — Working Capital Management
Working Capital Management: A First Look
The Intuition: Why "Working" Capital?
Imagine you run a small chai stall. Every morning, you need to buy milk, tea leaves, sugar, and cups. You pay for these today. You sell chai throughout the day, but customers pay you at the end of the day (or even later if they run a tab).
There's a gap: you spend money before you receive money. That gap is the working capital cycle.
- Working capital = the money "tied up" in your day-to-day operations (inventory, unpaid bills from customers, cash in hand).
- Working capital management = how you manage that gap — ensuring you have enough cash to keep the stall running without running out of money.
Key idea: Working capital is not about long-term assets (like buying a new stove). It's about the short-term financial health of your business.
The Precise Statement
Working Capital Management is the process of planning and controlling the firm's current assets and current liabilities to ensure:
- The firm can meet its short-term obligations (pay suppliers, salaries, rent).
- The firm operates efficiently (no excess cash sitting idle, no shortage of inventory).
- The firm maximizes profitability (by minimizing the cost of holding current assets).
The Formula
Net Working Capital=Current Assets−Current Liabilities
- Current Assets (convert to cash within 1 year): Cash, inventory, accounts receivable (money owed by customers).
- Current Liabilities (due within 1 year): Accounts payable (money you owe suppliers), short-term loans, accrued expenses.
Positive net working capital → firm can pay its short-term debts.
Negative net working capital → risk of insolvency (can't pay bills on time).
The Three Pillars of Working Capital Management
| Component | What it is | Why manage it? |
|---|---|---|
| Cash Management | How much cash to keep on hand | Too little → can't pay bills. Too much → idle money (lost interest). |
| Receivables Management | Money customers owe you | Offer credit to boost sales, but delay in collection hurts cash flow. |
| Inventory Management | Raw materials, work-in-progress, finished goods | Too much inventory → storage cost, risk of spoilage. Too little → lost sales. |
--- …
The core concept here is Working Capital Management, which involves ensuring a business has sufficient short-term assets to meet its short-term liabilities and operational needs.
The scenario describes a shift from an economic slowdown (due to Covid-19) to a boom in the restaurant industry, leading to increased demand, production, and sales, and consequently, a greater need for working capital. This fluctuation in overall economic activity—from recessionary conditions to a period of growth and expansion—is characteristic of the business cycle. Different phas …
The scenario moves from a pandemic-driven slowdown (low demand) to an economic boom (higher production and sales). These economy-wide swings are phases of the business cycle, which directly change how much working capital a firm needs. The correct option is (D).
Working capital is the finance needed to run day-to-day operations — it is the excess of current assets (cash, inventory, receivables) over current liabilities (payables, short-term loans). Its requirement is not fixed; it rises and falls with the level of business activity. This is a core idea in CBSE Class 12 Business Studies (Financial Management), and the question tests which factor is causing the change here.
Working capital = Current Assets minus Current Liabilities. A firm needs more of it when sales and production expand, because more money gets tied up in stock and debtors.
Let us trace the scenario:
- Slowdown phase (Covid-19): demand fell sharply. In a downturn, sales shrink, less inventory is held and production is scaled down, so the working capital requirement falls.
- Recovery/boom phase (from April 2022): the economy picked up and the restaurant industry boomed. Higher production and sales meant more inventory, more debtors and more cash locked in operations — so a larger amount of working capital was required.
This pattern of contraction followed by expansion is exactly what the business cycle describes — the recurring phases of boom, recession, recovery and depression in overall economic activity.
Why the other options do not fit: …
- CBSE 2026Set ANNUAL1 markMCQQ.________ is the difference between Current Assets and Current Liabilities. (A) Capital employed (B) Net Fixed Assets (C) Net Working Capital (D) Gross Working Capital
›Reveal solutionSolution
Net Working Capital = Current Assets − Current Liabilities — this is the standard measure of a firm's short-term liquidity.
Definitions to distinguish the options
- Gross Working Capital: Simply the total investment in current assets (no deduction of liabilities).
- Net Working Capital (option C): Current Assets minus Current Liabilities — this is the amount of current assets financed by long-term funds, and is a key indicator of a firm's short-term solvency/liquidity position. …
- CBSE 2025Set 66/2/11 markMCQQ.'Isha Sweets' was set by Isha Sharma to prepare and sell organic, vegan and healthy sweets alternatives like hazelnuts date ladoos, dry fruit date burfi, stuffed mejdool date etc. For the last many years, the demand for her products was very high as people these days prefer to buy healthier alternatives for consumption as well as gifting purposes. But this year suddenly, the cost of dates, dry fruits and other ingredients used for preparing these healthy sweets had increased. With rising prices of raw materials, larger amounts of funds were required to maintain a constant volume of production and sales. As a result, the working capital requirement of 'Isha Sweets' became higher. The factor which led to an increase in the working capital requirements of 'Isha Sweets' was : (A) Availability of raw material (B) Inflation (C) Scale of business (D) Production cycle
›Reveal solutionSolution
The problem describes a situation where raw material costs have increased, leading to a higher working capital requirement for 'Isha Sweets'. This increase in costs is a direct consequence of inflation, which necessitates more funds to maintain the same level of production. The correct option is (B).
Working capital is the lifeblood of any business, representing the funds needed for its day-to-day operations. It is essentially the difference between current assets (like inventory, debtors, cash) and current liabilities (like creditors, short-term loans). A healthy amount of working capital ensures a business can meet its short-term obligations and continue its production and sales activities smoothly.
The requirement for working capital is influenced by various factors. Understanding these factors helps businesses anticipate their funding needs and manage their finances effectively. In the case of 'Isha Sweets', we are told that the cost of raw materials increased, which in turn led to a higher working capital requirement to maintain the same volume of production. Let's break down why this happens and evaluate the given options.
-
Understanding Working Capital and its Drivers
Working capital is calculated as:
Working Capital = Current Assets − Current Liabilities
For a manufacturing business like 'Isha Sweets', current assets primarily include raw material inventory, work-in-progress, finished goods inventory, and cash. Current liabilities include amounts owed to suppliers (creditors) and other short-term obligations. The amount of working capital needed depends on several factors, including the nature of the business, its scale, the length of its production cycle, and economic conditions.
-
Analyzing the Scenario for 'Isha Sweets'
The problem states: "cost of dates, dry fruits and other ingredients used for preparing these healthy sweets had increased. With rising prices of raw materials, larger amounts of funds were required to maintain a constant volume of production and sales."
This is the core information. The key here is the increase in the cost of raw materials. To produce the same quantity of sweets, Isha now needs to spend more money on ingredients. This directly translates to a higher investment in raw material inventory, which is a component of current assets, thus increasing the overall working capital requirement.
-
Evaluating Option (A) Availability of raw material
Availability of raw material can certainly impact working capital. If raw materials become scarce, a business might need to purchase larger quantities when available, or pay a premium, both of which could increase working capital. However, the problem explicitly states "the cost... had increased" and "rising prices of raw materials," not primarily a lack of availability. While scarcity can lead to higher prices, the direct cause mentioned is the price increase itself, not the underlying availability issue.
-
Evaluating Option (B) Inflation
Inflation refers to the general increase in prices and fall in the purchasing value of money. When the cost of raw materials increases, it is a direct manifestation of input cost inflation. If the prices of dates, dry fruits, and other ingredients rise, Isha Sweets needs more money to buy the same quantity of these materials. This means more funds are tied up in inventory, leading to a higher working capital requirement. This perfectly matches the description in the problem. …
-
- CBSE 2025Set ANNUAL1 markMCQQ.The source of working capital is(a) Debtors(b) Bank overdraft(c) Cash sales(d) All of these
›Reveal solutionSolution
Debtors, bank overdraft and cash sales are all sources of working capital.
Working capital is the capital needed for day-to-day operations (to finance current assets). It is obtained from several short-term sources: realising money from debtors (credit customers paying up), bank overdraft / short-term bank credit, and cash sales t …
- CBSE 2025Set ANNUAL1 markQ.Fill in the blank: Current assets is usually financed through _________.
›Reveal solutionSolution
Current assets are typically financed through short-term sources because of the matching principle of finance.
The 'matching' or 'hedging' approach to financing says that the duration of financing should match the duration for which funds are needed. Current assets (inventory, debtors, cash/bank balances, prepaid expenses) are, by definition, assets expected to be converted into cash or consumed within one year, so it would be inefficient and costly to lock them into long-term finance (which generally costs more and remains tied up even when the current asset itself has already turned over). Instead, current assets are usually financed through short-term sources such as trade credit from suppliers, bank overdraft/cash credit, short-term loans, factoring, or commercial paper (for large, cr …
- CBSE 2024Set ANNUAL1 markMCQQ.Current assets of a business firm should be financed through -(a) Current liability only(b) Long-term liability only(c) Partly from both types, i.e.(i) &(ii)(d) None of these
›Reveal solutionSolution
Current assets are best financed through a mix of both current (short-term) liabilities and long-term liabilities — a part of working capital that is permanently needed is financed long-term, while the fluctuating/seasonal part is financed through short-term sources.
Current assets consist of two components:
- Permanent/core working capital — the minimum level of current assets (cash, stock, debtors) that the business needs at all times to run operations continuously; since this need never falls to zero, it should ideally be financed through long-term sources (owner's funds, long-term loans), because relying on short-term funds for a permanent need creates renewal risk and uncertainty.
- Temporary/fluctuating working capital — the extra current assets needed to meet seasonal or peak-period requirements; since this need is temporary, it is appropriately financed through short-term/current liabilities (trade credit, bank overdraft, short-term loans), which can be repaid once the temporary need passes. …
- CBSE 2023Set 66/1/11 markMCQQ.During the Covid-19 pandemic, the restaurant industry faced many challenges. The slowdown led to huge decrease in demand. From April 2022, the effect of Covid started reducing. The economy started picking up and a boom was noticed in the restaurant industry. As a result, larger amount of working capital was required with increased production and sales. The factor affecting the working capital requirement discussed above is : (A) Seasonal factor (B) Production cycle (C) Operating efficiency (D) Business cycle
›Reveal solutionSolution
The scenario moves from a pandemic-driven slowdown (low demand) to an economic boom (higher production and sales). These economy-wide swings are phases of the business cycle, which directly change how much working capital a firm needs. The correct option is (D).
Working capital is the finance needed to run day-to-day operations — it is the excess of current assets (cash, inventory, receivables) over current liabilities (payables, short-term loans). Its requirement is not fixed; it rises and falls with the level of business activity. This is a core idea in CBSE Class 12 Business Studies (Financial Management), and the question tests which factor is causing the change here.
NoteWorking capital = Current Assets minus Current Liabilities. A firm needs more of it when sales and production expand, because more money gets tied up in stock and debtors.
Let us trace the scenario:
- Slowdown phase (Covid-19): demand fell sharply. In a downturn, sales shrink, less inventory is held and production is scaled down, so the working capital requirement falls.
- Recovery/boom phase (from April 2022): the economy picked up and the restaurant industry boomed. Higher production and sales meant more inventory, more debtors and more cash locked in operations — so a larger amount of working capital was required.
This pattern of contraction followed by expansion is exactly what the business cycle describes — the recurring phases of boom, recession, recovery and depression in overall economic activity.
Why the other options do not fit: …
- CBSE 2023Set MARCH1 markMCQQ.Which of the following is a money market instrument?(a) Treasury bills(b) Debentures(c) Equity shares(d) Preference shares
›Reveal solutionSolution
The correct option is (a) Treasury bills.
…
- CBSE 2023Set ANNUAL1 markMCQQ.Bank overdraft facilities are available on (A) Savings Bank A/c (B) Current A/c (C) Term Deposit A/c (D) All of these
›Reveal solutionSolution
Bank overdraft is available on a current account.
An overdraft is a short-term borrowing facility allowing a customer to withdraw more money than is in the account, up to an agreed limit. Banks grant it on current accounts, which businesses use for regular, high-volume transactions. Savings and term-deposit accounts do not carry overdraft faciliti …
- CBSE 2023Set ANNUAL1 markQ.What is Working capital?
›Reveal solutionSolution
Working capital is the money needed for routine, day-to-day operations — current assets minus current liabilities.
Working capital refers to the funds a firm needs to finance its short-term, day-to-day activities such as holding stock, carrying debtors and paying routine expenses. Net working capital is calculated as current assets minus current liabilities, and it reflects the firm's short-t …
- CBSE 2022Set ANNUAL1 markMCQQ.Maximum tenure of treasury bill is – (A) Two years (B) One year (C) Three years (D) Four years
›Reveal solutionSolution
The correct option is (B) One year — the maximum tenure of a treasury bill is up to one year.
Treasury bills (T-bills) are instruments of the money market, used by the Government of India to borrow short-term funds. They are issued at a discount and redeemed at face value, in standard maturities …
- CBSE 2020Set ANNUAL1 markQ.Answer in one word/one sentence: What is working capital?
›Reveal solutionSolution
Working capital = funds for day-to-day operations (current assets − current liabilities).
Working capital is the finance required for the routine, day-to-day running of a business — buying raw materials, paying wages and meeting operating expenses. In the net sense, it equals current assets (stock, debtors, cash) minus current liabilities (creditors, short-term loans). …
- CBSE 2020Set ANNUAL1 markMCQQ.Higher working capital usually results in(a) higher current ratio, higher risk and higher profits(b) lower current ratio, higher risk and profits(c) higher equity, lower risk and lower profits(d) lower equity, lower risk and higher profits
›Reveal solutionSolution
Higher working capital generally means a higher current ratio, lower risk, and lower profitability — the classic liquidity-profitability trade-off.
The Financial Management chapter explains the "Factors Affecting the Working Capital Requirement" through the lens of liquidity versus profitability:
- Working capital = current assets − current liabilities. Holding a larger cushion of current assets (cash, receivables, inventory) relative to current liabilities raises the current ratio, i.e. improves short-term liquidity.
- A firm with ample working capital can comfortably meet its day-to-day obligations, so the risk of running short of cash (insolvency risk) is lower.
- However, funds parked in cash/inventory/receivables generally earn little or nothing, instead of being invested in income-generating fixed assets or operations — so profitability tends to be lower as well.
- The reverse is also true: a firm that deliberately runs with lean/low working capital is taking on higher liquidity risk, but is channelling more funds into productive use, which can raise profitability. …
🎓Unlock everything free for 14 days
- ✓Full step-by-step solutions
- ✓Concept-first explanations
- ✓Methods, shortcuts & mistakes
- ✓PYQ mapping + timed mock tests
Full access for 14 days. No credit card required.