Professional Documents
Culture Documents
Working Capital, in the simple words, means the capital invested in the current assets. However it has been variously defined as : Working Capital means the current assets of a company that are changed in the ordinary course of business from one form to another, as for example, from cash to inventories, inventories to receivables, receivables into cash. Working Capital is descriptive of that capital which is not fixed. But the more common use of working capital is to consider it as the difference between the book value of the current assets and current liabilities. Thus, there are two different opinions about the meaning of the term working capital. (1) According to one school of thought, working capital represents all current assets of the Company. They believe that working capital represents those assets, which change their form during the process of production. Working Capital = Total Current Assets (2) According to the other school of thought, working capital is the excess of current assets over current liabilities. Working Capital = Current Assets Current Liabilities Current assets include cash, accounts receivable, notes receivable, advances on contracts, inventories etc. Current liabilities include accounts payable, notes payable, accrued expenses, temporary loans etc. Under this concept an attempt is made to measure net working capital of the Company. To avoid the confusion involved in the interpretation of working capital, the total current assets are described as gross working capital, while the excess of total current assets over total current liabilities are described as net working capital.
Thus, there are two concepts of working capital: 1. Gross Working Capital i.e. Total Current assets 2. Net Working Capital i.e. Current assets Current liabilities Gross working capital concept focuses attention on two aspects of current assets management: a. What is the optimum level of investment in current assets? b. How should current assets be financed? Net working capital is a qualitative concept. It indicates the liquidity position of the firm and suggests the extent to which the working capital needs may be financed by permanent sources of funds. It indicates how much current assets are covered by current liabilities. The net working capital concept also covers the question of judicious mix of long-term and short-term funds for financing the current assets. Both gross and net working capital concepts are equally important for the efficient management of working capital.
TYPES OF WORKING CAPITAL : Basically two types of working capital are needed in the business: 1. Permanent Working Capital 2. Variable Working Capital These two types of working capital can also be classified as under :
Working Capital
Permanent
Variable
Lets discuss each of the types in brief: j Permanent Working Capital : This is the minimum level of current assets, which is continuously required by the firm to carry on its business operations. It is permanent in the same way as the firms fixed assets are. Depending upon the changes in the
production and sales, the need for working capital, over and above the permanent working capital, will fluctuate. Initial Working Capital : In the initial period of its operation, a firm must need enough money to pay certain expenses before the business yields cash receipt. In the initial years the banks may not grant loans or overdrafts, sales may have to be made on credit and it may be necessary to pay the creditors immediately. Therefor the owners themselves have to provide necessary funds in the initial period, which may be known as initial working capital. Regular Working Capital : The firm is always required to keep certain funds with it to continue the regular business operations, which is called as Regular Working Capital. It is required to maintain regular stock of raw materials and work-in-progress and also of the finishes goods, which must be maintained permanently at a definite level. Regular working capital is the excess of current assets over current liabilities. It ensures smooth operation of business.
j Variable Working Capital : This is the working capital which, keeps on changing with the change in the production and sales activities. It is the extra working capital, over and above the permanent working capital, that is needed to support the changing production and sales activities. This type of working capital is also called as fluctuating or variable working capital. Seasonal Working Capital : Some business operations require additional working capital during a particular season. For example, the groundnut oil producers may have to purchase groundnut in a particular season and have to employ additional labour for that purpose. These may require additional funds for a temporary period, which may be called as seasonal working capital. Special Working Capital : In all enterprises, some unforeseen events do occur like sudden increase in demand, downward movement of prices of raw materials, strike or natural calamities, when extra funds are needed to tide over such situation. Such type of extra funds is called as Special working capital. Both the kinds of working capital permanent and temporary are necessary to facilitate the production and sales through the operating cycle. However, the temporary working capital is created by the firm to meet the liquidity requirements that will last only temporarily.
I. INVENTORIES: The terms inventories include stock of raw materials, work - in - process and finished goods. The estimation of each of them will be made as follows: STOCK OF RAW MATERIALS: The average amount of raw materials to be kept in stock will depends upon the quantity of raw material required for production during a particular period and the average time taken in obtaining a fresh delivery. WORK- IN-PROCESS: The cost of work - in - process includes raw materials, wages and overheads. In determining the amount of work in process, the time period for which the good will be in the course of production most important. FINISHED GOODS: The finished goods are kept in warehouse and according to the orders of the customers, goods will be delivered.
6
process, is
II. SUNDRY DEBTORS: Debtors are those persons who will be purchase goods on credit basis. The sundry' debtors will-be calculated on the basis of credit sales. III. CASH AND BANK BALANCES: The amount of money to be kept as cash in hand or cash at bank can be estimated on the basis of past experience. IV. SUNDRY CREDITORS: The lag in payment to suppliers of raw materials, goods, etc., and likely credit purchase to be made during the period will be help in estimating the amount of creditors. V. OUTSTANDING
EXPENSES:
T EMPORARY OR V ARIABLE FOR S HORT-TERM W ORKING C APITAL: T RADE C REDIT: Trade credit re fe rs to the credit extended by the suppliers of goods in the normal coerce of business. As present day commerce is built upon credit, the trade credit arrangement of a firm with its suppliers is an important source of short-term finance. INDIGENOUS BUSINESS: Private money-lenders and other is country banks used to be the only sources of finance prior to the establishment of commercial banks. They used to change very higher rates of interest and exploited the customers to the largest extent possible. DEFERRED INCOMES: Deferred incomes are incomes received advances before supplying goods or services. They represent funds received by a firm for which it has to supply goods or services in future. COMMERCIAL
PAPER:
notes issued by firms to raise short-terms funds. It is an important money market instrument in advanced countries like U.S.A. In India, the reserve bank of India introduced commercial paper in the Indian Money Market on the recommendations of the working capital upon money market (Vague - Committee)
10
11