MEANING AND DEFINITION OF WORKING CAPITAL
Working capital management refers to the management of current assets and current liabi1ities. Working capital is the excess of current assets over curr curren entt liab liabil ilit itie ies. s. Curr Curren entt asse assets ts areare--- cash cash,, mark market etab able le secu securi riti ties es,, inventories and bills receivables. Current liabilities mainly include bills payable, notes payable and miscellaneous accruals. Current assets are those assets which are normally converted into cash within an accounting year; and current liabilities are usually paid within an accounting year. Definitions— J. S. Mill, !he sum of the current assets is the working capital of a business." C. W. Gerstener!, Working capital has ordinarily been defined as the excess of current assets over current liabilities." Me"#, Molott "n# Fil#, Working capital means current assets." Cl"ssifi$"tion of Wor%in! C"&it"l ' #t is based on the concepts of time and re$uirements. %n the basis of $uantitative and $ualitative concepts working capital can be classified into
two catego categorie ries, s, e.g., e.g., &i' (ross (ross Working rking Capita Capitall and &ii' &ii' )et Working rking Capital. !here are also two other other types of working working capital* capital* &i' +ermanent, +ermanent, &ii' !emporary working capital. &i' Gross Wor%in! C"&it"l'' #t refers to the companys total funds re$uired for maintaining current assets, such as--cash, marketable securities, bills receivables, inventories, etc., which are normally converted into cash within an accounting year. &ii' Net Wor%in! )et work workin ing g capi capita tall is the the exce excess ss of or%in! C"&it"l' C"&it"l''' )et current assets over current liabilities. #n other words, it is that portion of a firms firms current assets which is financed by long term funds. #t may be either positive or negative. Per(" Per("nen nentt Wor% r%in! in! C"&it" C"&it"l'' l'' #t refer &iii' eferss the the irr irredu educib cible minimum amount which is permanently blocked in the business and that cannot be converted into cash in the normal course of business. #t represents the current assets re$uired on a continuing basis over the entire year. year. ince it is permanently needed for the business operations operations and financed by by long-term funds. funds. &iv' Te(&or"r) Wor%in! C"&it"l'' #t is also called variable working capi capita tal. l. ny amou amount nt over over and and abov abovee the the perm perman anen entt lev level of
working capital is temporary working capital. #t represents additional current assets needed at different times during the operating year. ince it is re$uired for carrying out seasonal or special operations of short duration such as extensive marketing campaigns and it should be financed by the short-term sources. Nee# "n# Si!nifi$"n$e of Wor%in! C"&it"l firm needs working capital for its daily operations. /aw materials inventories are needed for manufacturing. 0uring to the time lag between manufacturing of finished goods and sales, a firm needs cash for financing inventories, bills receivables and other routine business expenses. #f right amount of working capital is not available, the firm will not be in a position to sustain its business operations. !he time gap between the sales and their actual realisation in cash is technically termed as operating cycle of the business. Working capital needs of a company, therefore, depend on the length of its operating cycle. company must have ade$uate working capital, i.e., as much as needed by the company. #t should neither be excessive nor inade$uate. 2xcessive working capital means idle funds laying with the firm and not earning any
profit for it while inade$uate working capital means that the enterprise does not have sufficient funds for financing it daily business activities, which ultimately results in production interruptions and reduced productivity. *. In$re"se in Goo#+ill "n# Det C"&"$it)— /apidity in payments creates goodwill and increases the debt capacity of the firm. /egular availability of ade$uate working capital creates confidence among investors and lenders that they will get their due interest and principal in time. !hus, a firm with ade$uate working capital can raise the re$uisite funds from market, borrow short-term credit from banks and purchase inventories of raw materials for the business. . Lo"ns fro( Fin"n$i"* Instit-tions'' !he presence of ade$uate working capital and current assets help a company to raise unsecured and secured loans from financial institutions and arrange loans from the banks on easy and favourable terms. . In$re"se# Effi$ien$)'' #f ade$uate working capital is maintained in the business, the firm can successfully carry out its operations, research and development programmes etc., which would lead to increased production efficiency. +roduction efficiency, in turn, will increase the
efficiency of the employees and boost up their morale. /. E0&loit"tion of F"1o-r"le O&&ort-nities'' #n the presence of ade$uate working capital, a company can avail the benefits of favourable opportunities. 3or example, the company having ade$uate working capital can avail the benefits of bulk supply order, bulk purchases of raw materials, off season purchases, etc. 2. 3i!4 "#(inistr"ti1e s&irits— n ade$uate working capital also boosts up the morale of the executive in so far as they have an environment of creativity, security and confidence, which is an important psychological factor in improving the efficiency and morale of the business executives. 5. Meetin! Contin!en$ies "n# A#1erse C4"n!es'' Company, which has an ade$uate working capital can easily face certain business and economic crises. 3or example, the demand for goods decreases during the depression period and the payment of credit sales is also made after a long period. #n this case, companies with ade$uate working capital can only successfully meet this adverse situation. 6. Di1i#en# to S4"re4ol#ers'' !o declare and distribute attractive dividend to its shareholders an ade$uate working capital helps the firm. #t
also increases the value of shares. #n other hand, a company not having ade$uate working capital cannot distribute attractive dividend in spite of sufficient profits. 7. Confi#en$e "n# Se$-rit) '' de$uate working capital creates a confidence and security not only among the business executives but also among the customers, creditors. 8. A1"ilin! C"s4 Dis$o-nt— !he firm can avail the advantage of cash discount by making cash payments for to the suppliers of raw material and merchandise. #t will reduce the cost of production and increase the profits of the firm. F"$tors #eter(inin! +or%in! $"&it"l
!hese are the factors which determine the proper amount of working capital* *. N"t-re of 9-siness ' n ade$uate amount of working capital re$uirements of an enterprise are basically related to the nature of its business. !rading concerns re$uire large amount of working capital and they also have to keep large amounts of cash. Conversely, the public utility
concerns like railways, electricity, insurance etc., need relatively much less inventories and cash. . Pro#-$tion Poli$ies ' +roduction policies are the important factor to determine the working capital re$uirements of the firm. 4ore working capital is re$uired by those industries which produce or sale goods in a particular season. 3or example, sugar and woollen textile industries re$uire more working capital in winter season. . Si:e of 9-siness ' !he si5e may be measured either in terms of scale of operations or in assets or sales. (enerally, large scale concerns re$uire more working capital as against the small concerns for carrying out business operations. /. Len!t4 of M"n-f"$t-rin! C)$le ' !he length of this period depends on the nature of products and production technology used by a concern. 6onger the manufacturing process, the higher will be the re$uirements of working capital and vice versa. !he si5e of working capital is also influenced by the length of the manufacturing cycle. concern can reduce its working capital needs by shortening the length of its manufacturing cycle through technological improvements, and also by
liabilities side is more than the total of assets side, it represents excess cash which is not re$uired by the firm. 8ut, if the total of assets side is more than the total of liabilities side, then it indicates the deficiency of working capital. [email protected]
A#-ste# Profit "n# Loss Met4o#— #n this method, estimated profit is calculated on the basis on transactions of the ensuing period. !hereafter, increase or decrease in working capital is computed ad9usting the estimated profit by cash inflows and cash outflows. few banks in #ndia use the forms for computing working capital under this method. Co(&-t"tion of Wor%in! C"&it"l
)et #ncome Add: )on-cash items Working Capital provided by %perations Add: Cash #nflow items
/s. B.. B.. B.. B.. B...
Cash %utflow #tems
)et Changes in Working Capital
C"s4 Fore$"stin! Met4o#— #n this method, estimate is made of cash receipts and payments in the ensuing period. !he difference of these receipts and payments indicates deficiency or surplus of cash. !he management formulates plans to procure the amount of deficit. !his method, in a way is a for( of C"s4 9-#!et . &i.e., in the way of receipt and payment method'.