Ptesented bySubhasish champatisingh Roll no-03 Ibs,bbsr
Working Capital refers to that part of the firm’s capital, which is required for financing short-term or current assets such a cash marketable securities, debtors and inventories. Funds thus, invested in current assets keep revolving fast and are constantly converted into cash and this cash flow out again in exchange for other current assets. Working Capital is also known as revolving or circulating capital or short-term capital.
circulating capital means current assets of a companythat are changed in the ordinary course of business fromone form to another, as for example, from cash toinventories, inventories to receivables, receivable tocash”
As profits earned depend upon magnitude of sales and they do not convert into cash instantly, thus there is a need for working capital in the form of CA so as to deal with the problem arising from lack of immediate realization of cash against goods sold. This is referred to as “Operating or Cash Cycle” . It is defined as “The continuing flow from cash to suppliers, to inventory , to accounts receivable & back into cash “.
The firm has to maintain cash balance to pay the bills as they come due. In addition, the company must invest in inventories to fill customer orders promptly. And finally, the company invests in accounts receivable to extend credit to customers. Operating cycle is equal to the length of inventory and receivable conversion periods.
Total Current assets Where Current assets are the assets that can be converted into cash within an accounting year & include cash , debtors etc. Referred as “Economics Concept” since assets are employed to derive a rate of return.
CA – CL It indicates liquidity position of a firm. It suggests the extent to which working capital needs may be financed. Current Assets ( less )Current Liabilities Current Assets Current LiabilitiesInventories Trade Payables Raw Materials Accruals Work-in-Progress Taxation/Dividends Finished Goods Short-Term BorrowingsTrade ReceivablesPrepaymentsBank/Cash 9
Having sufficient funds available to meet all foreseen and unforeseen obligations 10
CURRENT ASSETS Inventory Sundry Debtors Cash and Bank Balances Loans and advances CURRENT LIABILITIES Sundry creditors Short term loans Provisions
1. Nature of Business- Different Industries have different Working Capital requirements. Manufacturing and Trading Companies will have a high proportion of Current Assets in the form of inventory of Raw Materials, Work-in- Progress, accounts Receivable, Cash and Accounts Payable as Current Liability. But in case of public utilities may have limited need for working capital because they only have cash sales, & supply services, not products and no funds will be tied up in debtors & stock.
2. Growth and Expansion As the company grows, it is logical to expect that a larger amount of working capital is required.3. Degree of Competition in the Market When the degree of competition in the market for finished goods in an industry is high, then companies belonging to the industry may have to resort to an increased credit period to its customers to push their products. These practices are likely to result in a high proportion of accounts receivable.
4. Technology & manufacturing process Longer the manufacturing cycle, larger will be the firm’s working capital requirements. Exa- Manufacturing cycle in case of boiler- More working capital needed depending on its size, (may range between Six to Twenty-four months. Exa- Manufacturing cycle in case of detergent powder, soaps, chocolate etc- less working capital.
Interdependence Among Components of Working capital Finished Goods Work in Selling and Progress Distribution, General Administration andSundry Financial costsDebtors orAccounts Wages, SalariesReceivables and Manufacturing costs Raw Materials, Components Stores etc. Sundry Cash Creditors or Accounts The Operating Cycle Payable
Operating Cycle ConceptCompany start with cash, go through the successivesegments of the operating cycle to get cash.Operating cycle is the time duration required to convertsales, after the conversion of resources in to inventories, into cash. Raw material storage period Conversion period Finished goods storage period Average collection period
Gross operating cycle- The duration above is known as gross operating cycle. Thegross operating cycle = Raw material Storage period + Conversion Period + Finished goods storage period + Average collection period NOTE- If there is no receivables the cycle is reduced.
Net operating cycle- When the average payment period is deducted from the gross operating cycle is known as net operating cycle The Net operating cycle = Raw material Storage period + Conversion Period + Finished goods storage period + Average collection period – Average Payment Period
The amount of current assets required to meet a firm’s long-term minimum needs.DOLLAR AMOUNT Permanent current assets TIME
The amount of current assets that varies with seasonal requirements. Temporary current assetsDOLLAR AMOUNT Permanent current assets TIME
We need working capital for the smooth functioning. Magnitude of current assets varies with the changes in the operating cycle There will always be a minimum level of current assets (i.e. permanent or fixed current assets) Depending upon the production and sales the need for the working capital over and above the fixed level will fluctuate.
A larger investment in current assets would mean a low rate of return on investment for the firm, as excess investment in current assets will not earn enough return. On the other hand a smaller investment in current assets would mean interrupted production & sales.
Both excessive as well as inadequate working capitalpositions are harmful for the company Excessive working capital • Unnecessary inventory accumulation. • Shows a defective credit policy and high collection period. • leads to marginal inefficiency of the management.
Stagnates growth Difficult to implement operating plans. Reduction in operating efficiency. Fixed assets cannot be utilised efficiently. Banks will hesitate in extending credit. Affects the goodwill of the firm.
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