CHAPTER – II REVIEW OF LITERATURE Working Capital Management
Meaning and Definition of working Capital The term working capital refers to that portion of an organization’s capital which is required in the short-run to finance current assets such as cash, bank balance, debtors, marketable securities, bills receivable and inventories. The value of these assets keeps changing over a period of time.
The institute of Chartered Accountant of India defines working capital as under:
“working capital means the funds available for day-to-day operations of and enterprise.”
Shubin defines working capital as “capital required for purchase of raw-materials and for meeting day-to-day expenditure on salaries, wages, rents and advertising, etc”
James C. Ven Horne has opined that, “Working capital management usually is considered to involve the administration of current assets – namely, cash and marketable securities, receivables and inventories and the administration of current liabilities”.
Thus Thus,, work workin ing g capi capita tall is capi capita tall requi require red d for for meet meetin ing g the the needs needs of curre current nt operations. The assets constituting working capital are relatively temporary in nature
Working capital is also known as ‘revolving or circulating capital’ or ‘fluctuating capital’ or ‘short-term capital.’
T.S. Reddy, Y. Hari Prasad Reddy – Financial and Management Accounting. Different concepts of Working Capital
There are two concepts of working capital •
Gross Concepts Net concepts
Under the gross concept’ it is termed as Gross Working Capital and under the ‘net
concept’ it is termed as Net Working Capital.
Gross working capital refers to the sum total of all current assets of a business enterprise. E.g. Cash, short term securities, accounts receivable, inventories, short-term bank deposits etc. and include all current assets with can be easily converted into cash within an accounting year.
Classification of Working capital
Working capital can broadly be classified in two different ways •
One the basis of concept and
On the basis of time
1. On the basis of concept is classified as Gross working capital and net working capital
2. On the basis of time working capital may be classified under fixed or regular or permanent working capital or variable working capital.
P.K.Sikdar – Advanced Cost and Management Accounting
Need for Working Capital
Working Capital is need because of the existence of operating cycle. The duration of time required to complete certain sequences of events in connection with normal business activities of an n enterprise is called the operating cycle. Can be narrated as under: •
Conversion of cash into raw material.
Conversion of raw material into work-in-progress.
Conversion of W.I.P into finished goods.
Conversion of finished goods, into debtors and bills receivable or B/R.
Conversion of debtors and bills receivable into cash.
Importance of Working Capital
A business enterprise must maintain an adequate level of working capital in order
to run its business smoothly. Both excessive and inadequate working capital positions are harmful. Excessive working capital results in idle funds on which no profit is earned. Again, insufficiency of working capital results in interruptions of production and inefficiencies which impair the profitability of the enterprise.
Significance of Working Capital Management
In a typical manufacturing firm, current assets exceed one-half of total assets. Excessive levels can result in a substandard Return on Investment (ROI).Current liabilities are the principal source of external financing for small firms. Requires continuous, day-to-day managerial supervision.
Working capital management affects the company’s risk, return, and share price.
Sheeba Kapil and Kqnwal Nayan Kapil – Financial Management
Measures to Improve Working Capital Management:
The essence of effective working capital management is proper cash flow
forecasting. This should take into account the impact of unforeseen events, market cycles, loss of a prime customer and actions by competitors. The effect of unforeseen demands of working capital should be factored in. It pays to have contingency plans to tide over unexpected events. While market-leaders can manage uncertainty better, even other companies must have risk-management procedures. These must be based on objective and realistic view of the role of working capital.
Addressing the issue of working capital on a corporate-wide basis has certain advantages. Cash generated at one location can well be utilized at another. For this to happen, information access, efficient banking channels, good linkages between production and billing, internal systems to move cash and good treasury practices should be in place.
An innovative approach, combining operational and financial skills and an allencompassing view of the company’s operations will help in identifying and implementing strategies that generate short-term cash. This can be achieved by having the right set of executives who are responsible for setting targets and performance levels. They are then held accountable for delivering, encouraged to be enterprising and to act as change agents.
Effective dispute management procedures in relation to customers will go along way in freeing up cash otherwise locked in due to disputes. It will also improve customer service and free up time for legitimate activities like sales, order entry and cash collection. Overall, efficiency will increase due to reduced operating costs.
V.K. Bhalla – Working Capital Management
The danger of excessive Working Capital
changes in both the current and non-current accounts to determine thee inflow of cash. Hence, there is no need for separate statement for the changes in the working capital. Further, it may be noted there that this statement is prepared on the basis of actual cash concept. However, if information about the cash inflow and outflow is not available, national cash concept may be used. For example, when raw materials are acquired on credit basis, it results in outflow of national cash. Here, we assume that the supplier of raw materials has given cash loan which the company utilized for acquiring the raw materials.
Techniques of cash flow statement
The cash flow statement is prepared with the help of balance sheet, profit and loss account and some additional information. As mentioned above, cash inflow and cash outflow are explained and shown in cash flow statement. All sources from which cash moves in the concern are narrated and on the other hand, the various uses to which cash is put to and thus cash moves out of the concern are shown in this statement. The net effect of such cash movements is known as net cash flow which is added / deducted to the opening balance of cash/bank to give closing balance of cash/bank. Therefore, it becomes necessary to have at least theoretical knowledge about the various items of cash inflow and the various items of cash outflow.