INTRODUCTION: The term working capital is commonly used for the capital required for day-to-day working in a business

concern, such as for purchasing raw material, for meeting day-today expenditure on salaries, wages, rents rates, advertising etc. But there are much disagreement among various financial authorities (Financiers, accountants, businessmen and economists) as to the exact meaning of the term working capital. DEFINITION AND CLASSIFICATION OF WORKING CAPITAL: Working capital refers to the circulating capital required to meet the day to day operations of a business firm. Working capital may be defined by various authors as follows: 1. According to Weston & Brigham - Working capital refers to a firms investment in short term assets, such as cash amounts receivables, inventories etc. 2. Working capital means current assets. Mead, Baker and Malott 3. The sum of the current assets is the working capital of the business J.S.Mill

CURRENT ASSETS constitute the following: Inventories: Inventories represent raw materials and components, work-in progress and finished goods. Trade Debtors: Trade Debtors comprise credit sales to customers. Prepaid Expenses: These are those expenses, which have been paid for goods and services whose benefits have yet to be received. Loan and Advances: They represent loans and advances given by the firm to other firms for a short period of time. Investment: These assets comprise short-term surplus funds invested in government securities, shares and short-terms bonds. Cash and Bank Balance: These assets represent cash in hand and at bank, which are used for meeting operational requirements. One thing you can see here is that this current asset is purely liquid but non-productive.

Current liabilities form part of working capital that represents obligations which the firm has to clear to the outside parties in a short-period, generally within a year. CURRENT LIABILITIES comprise the following: Sundry Creditors: These liabilities stem out of purchase of raw materials on credit terms usually for a period of one to two months. Bank Overdrafts: These include withdrawals in excess of credit balance standing in the firms current accounts with banks.

Short-term Loans: Short-terms borrowings by the firm from banks and others form part of current liabilities as short-term loans. Provisions: These include provisions for taxation, proposed dividends and contingencies.

Working capital Current assets Cash Accounts receivable Notes receivable Marketable securities Inventory Prepaid expenses Total current assets Current liabilities Accounts payable Notes payable Accrued expenses Taxes payable

Total current liabilities

Net working capital = current assets minus current liabilities.

CONCEPT OF WORKING CAPITAL 1. GROSS WORKING CAPITAL: It refers to the firms investment in current assets. Current assets are the assets, which can be converted into cash within an accounting year or within an operating cycle. You can include here cash, short-term securities, debtors (accounts receivable & book debts), bills receivable and stock. 2. NET WORKING CAPITAL: But the net working capital refers to the difference between current assets and current liabilities. Current liabilities are those claims of outsider, which are expected to mature for payment within an accounting year & include creditors, bills payable & the outstanding expenses. In other words you can say that this is the excess of current assets over current liabilities.

KINDS OF WORKING CAPITAL 1. Permanent working capital: This component represents the value of the current assets required on a continuing basis over the entire year, and for several years. Permanent working capital is the minimum amount of current assets, which is needed to conduct a business even during the dullest season of the year. The minimum level of current assets is called permanent or fixed working capital as this part is permanently blocked in current assets. This amount varies from year to year, depending upon the growth of the company and the stage of the business cycle in which it operates. It is the amount of funds required to produce the goods and services, which are necessary to satisfy demand at a particular point of time. It represents the current assets, which are required on a continuing basis over the entire year. It is maintained as the medium as to continue the operations at any time. Characteristics of Permanent working capital It is classified on the basis of the time period It constantly changes from one asset to another and continues to remain in the business process. Its size increase with the growth of business operations. 2. Temporary working capital: Contrary to the above you will find that temporary working capital represents a certain amount of fluctuations in the total current assets during a short period. These fluctuations are increased or decreased and are generally cyclical in nature. Additional current assets are required at different times during the operating year. Variable working capital is the amount of additional current asset that are required to meet the seasonal needs of a firm, so is also called as the seasonal working capital. For example: additional inventory will be required for meeting the demand during the period of high sales When the peak period is over variable working capital starts decreasing or very little during the normal period. It is temporarily invested in current assets. Say for an example a shopkeeper invests more money during winter season because he/ she require keeping more amount of stock of woolen cloths. The same happens in a sugar factory how: the factory manager buys more quantity of sugarcane during the harvesting season and they continuously stops for some time. Characteristics of Temporary working capital It is not always gainfully employed, though it may change from one asset to another asset, as permanent working capital does. It is particularly suited to business of a seasonal or cyclical nature. Diagrammatic representation of temporary and permanent working capital

Permanent or temporary working capital in case of stable firm

Working Capital

Temporary Working Capital Permanent Working Capital

Time

Permanent & temporary working capital in case of growing firm

Working Capital Temporary Working Capital

Permanent Working Capital

Time

Determinants of WC
We can explain the determinants of working capital as follows: Nature of business: The working capital requirements of an enterprise are basically related to the conduct of the business. Public utility undertakings like Electricity, Water supply, Railways, etc. need very limited working capital because they offer cash sales only and supply services, not products and as such no funds are ties up in inventories and receivables. But at the same time have to invest fewer amounts in fixed assets. The manufacturing concerns on the other hand require sizable working capital along with fixed investments, as they have to build up the inventories. Terms of sales and purchases: Credit sales granted by the concerns too its customers as well as credit terms granted by the suppliers also affect the working capital. If the credit terms of the purchases are more favorable and at the same time those of sales less liberal, less cash will be invested in the inventory. With more favorable credit terms, working capital requirements can be reduced. Manufacturing cycle: The length of manufacturing cycle influences the quantum of working capital needed. Manufacturing process always involves a time lag between the time when raw materials are fed into the production line and finished goods are finally turned out by it. The length of the period of manufacture in turn depends on the nature of product as well as production technology used by a concern. Shorter the manufacturing cycle; lesser the working capital required. Rapidity of turnover: If the inventory turnover is high, the working capital requirements will be low. With a better inventory control, a firm is able to reduce its working capital requirements. When a firm has to carry on a large slow moving stock, it needs a larger working capital as against another whose turnover is rapid. A firm should determine the minimum level of stock, which it will have to maintain throughout the period of its operation. Business cycle: Cyclical changes in the economy also influence quantum of working capital. In a period of boom i.e., when the business ism prosperous, there is s need of larger amount of working capital due to increases in sales, rise in price etc and vice-a-versa during period of depression. Changes in technology: Changes in technology may lead to improvements in processing of raw materials, savings in wastage, greater productivity, and more speedy production. All these improvements may enable the firm to reduce investments in inventory.

Seasonal variation: The inventory of raw materials, spares and stores depends on the condition of supply. If the supply is prompt and adequate the firm can manage with small inventory. However, if the supply were unpredictable and scant then the firm, to ensure the continuity of production, would have to acquire stocks as and when they are available and carry larger inventory on an average. Market conditions: The degree of competition prevailing in the market place has an important bearing on working capital needs. When competition is keen, a larger inventory of finished goods is required to promptly serve customers who may not be inclined to wait because other manufacturers are ready to meet their needs. Seasonality of operation: Firms, which have marked seasonality in their operations usually, have highly fluctuating working requirements. Let us take an example to illustrate this point. Consider firm manufacturing fans. The sale of fans reaches a peak during the summer months and drops sharply during the winter period. The working capital need of such a firm is likely to increase considerably in summer months and decrease significantly during winter season. Dividend policy: It has a dominant influence on the working capital position of a firm. If the firm is following a conservative dividend policy, the need for working capital can be met with retained earnings. Working capital cycle: Larger the working capital cycle, more is the requirement of working capital. NEED FOR WORKING CAPITAL Working capital is needed till a firm gets cash on sale of finished products. It depends on two factors: Manufacturing cycle i.e. time required for converting the raw material into finished product; and Credit policy i.e. credit period given to Customers and credit period allowed by creditors. Thus, the sum total of these times is called an Operating cycle and it consists of the following six steps: Conversion of cash into raw materials. Conversion of raw materials into work-in-process. Conversion of work-in-process into finished products. Time for sale of finished goodscash sales and credit sales. Time for realisation from debtors and Bills receivables into cash.

Credit period allowed by creditors for credit purchase of raw materials, inventory and creditors for wages and overheads. Chart for operating cycle or working capital cycle.

Debtors & Bills Receivables

Sales

Cash Sales Sales

Finished Goods

Raw Materials

Work-in-Progress

Problems The calculation of net working capital may also be shown as follows; Working Capital = Current Assets Current Liabilities = (Raw Materials Stock + Work-in-progress Stock + Finished Goods Stock + Debtors + Cash Balance) (Creditors + Outstanding Wages + Outstanding Overheads). Where, Raw Materials = Cost (Average) of Materials in Stock. Work-in-progress Stock = Cost of Materials + Wages +Overhead of Work-in-progress. Finished Goods Stock = Cost of Materials + Wages +Overhead of Work-in-progress. Creditors for Material = Cost of Average Outstanding Creditors. Creditors for Wages = Averages Wages Outstanding. Creditors for Overhead = Average Overheads Outstanding

Estimation of Working Capital Requirements Amount 1 Current Asset: Minimum Cash Balance Inventories: Raw Materials Work-in-progress Finished Goods Receivables: Debtors Bills Gross Working Capital (CA) **** **** **** **** **** **** Amount Amount

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**** ****

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II Current Liabilities: Creditors for Purchases Creditors for Wages Creditors for Overheads Total Current Liabilities (CL) Excess of CA over CL + Safety Margin Net Working Capital

**** **** **** ****

**** **** **** **** ****

Q.1 The management of Royal Industries has called for a statement showing the working capital to finance a level of activity of 1,80,000 units of output for the year. The cost structure for the companys product for the above mentioned activity level is detailed below : Cost per unit Raw material Rs. 20 Direct labour Rs. 5 Overheads (including depreciation of Rs. 5 per unit) Rs. 15 Rs. 40 Profit Rs. 10 Selling price Rs. 50 Additional information: (a) Minimum desired cash balance is Rs. 20,000 (b) Raw materials are held in stock, on an average, for two months. (c) Work-in-progress (assume 50% completion stage) will approximate to half-a-months production. (d) Finished goods remain in warehouse, on an average, for a month. (e) Suppliers of materials extend a months credit and debtors are provided two months credit; cash sales are 25% of total sale. (f) There is a time-lag in payment of wages of a month; and half-a-month in the case of overheads.

From the above facts, you are required to prepare a statment showing working capital requirements.