2. Meaning of working capital (WC)
Funds required for short term purposes
or day to day expenses are working
capital.
WC refers to part of firm’s capital reqd.
for financing short term or current assets
also known as revolving or short term
capital or circulating capital.
3. Concepts of Working Capital
Balance sheet concept.
Two interpretations of W.C. under this concept are:-
gross working capital:-
capital invested in total current assets of an enterprise.
gross concept sometimes preferred over networking
concept due to:-
a). enables enterprise to provide correct amount of WC
at the right time.
b). every management is interested in total current
assets with which it has to operate than the sources.
c). gross concepts takes into considerations that every
increase in the funds would increase the working
capital.
d). gross concepts of WC is more useful in determining
rate of return on investments in WC.
4. Importance of Net Working Capital
It is a qualitative concept which indicates
firm’s ability to meet its operating
expenses and short term liabilities.
It indicates the margin of protection
available to the short term creditors.
Indicator of financial soundness of an
enterprise.
Net WC is refered to as working capital.
5. Operating cycle or circular flow
concept
Start with raw material.
Raw material -> work in progress ->
finished goods ->
Sales -> debtors -> Cash -> raw material.
This is a cycle.
6. CLASSIFICATION OF WC:-
WC may be classified in two ways:-
On the basis of concept
- gross working capital
- net working capital
On the basis of time
- permanent or fixed WC
a). regular WC
b). reserve WC
- temporary or variable WC
a). seasonal WC
b). special WC
7. IMPORTANCE OR ADVANTAGES
OF ADEQUATE WC:-
Maintains solvency of business.
Helps in creating & maintaining goodwill.
Helps in arranging loans from banks & others on easy
and
favourable terms.
Enables a concern to avail cash discount and hence
reduce
cost.
Ensures regular supply of raw materials.
Regular payment of salaries, wages & other day to day
commitment.
Exploitation of favourable market condition.
Enables a concern to face business crisis.
8. EXCESS OR INADEQUATE WC:-
Disadvantages of redundant or excessive WC:-
Excessive WC means idle funds which earn no profit for
the business & hence, business cannot earn a proper
rate of return on its investments.
When there is redundant WC, it may lead to
unnecessary purchasing & accumulation of inventories
causing more chance of theft, waste & losses.
Excessive WC implies excessive debtors & defective
credit policy which may cause higher incidences of bad-
debts.
It may result in overall inefficiency in org.
When there is excessive WC, relationships with banks
&other financial institutions may not be maintained due
to low rate of returns on investments, the value of share
may also fall.
9. DISADVANTAGES OR DANGERS
OF INADEQUATE WC:-
A concern which has inadequate WC cannot pay
its short term liabilities in time. Thus, loose its
reputation & shall not be able to get good credit
facilities.
Cannot buy its requirements in bulk & cannot
avail of discounts etc.
Becomes difficult for the firm to exploit
favourable market conditions & undertake
profitable projects.
Firm cannot pay its day to day expenses and it
create inefficiency.
Becomes impossible to use efficiently fixed
assets due to non availability of liquid funds.
10. THE NEED OR OBJECTS OF
WC:-
WC is needed for the following purposes:-
For the purchase of raw material.
To pay wages & salaries.
To incur day to day expenses and overhead
costs.
To meet selling costs.
To provide credit facilities to the customer.
To maintain the inventories of raw material, work
in progress, stores and spares and finished
stock.
11. ANALYSIS OF WC
Funds Working
Ratio Flow Capital
Analysis Analysis Budget
12. Ratio Analysis
It is a simple arithmetical expression of one number to
another. The technique of ratio analysis can be
employed for measuring short term liquidity or working
capital position of the firm. The following ratios may be
calculated for this purpose:-
Current ratio.
Acid test ratio.
Absolute liquid ratio.
Inventory turnover ratio.
Receivables turnover ratio.
Payables turnover ratio.
Working capital turnover ratio.
Working capital leverage.
Ratio of current liabilities to tangible net worth.
13. FUNDS FLOW ANALYSIS
Fund flow analysis is a technical device
designated to study the sources from which
additional funds were derived and the use to
which these sources were put. It is an effective
management tool to study changes in the
financial position (WC) of a business enterprise
between beginning and ending financial
statements. Funds flow analysis consists of:-
Preparing schedules of changes in WC.
Statement of sources and application of funds.
14. WORKING CAPITAL BUDGET
Budget is a financial or quantitative expression of
business plans & policies to be pursued in the future
period of time. WC budget as a part of total budgeting
process of a business is prepared estimating future long
term & short term WC capital needs & sources to finance
them & then comparing the budgeted figures with the
actual performance for calculating variances. The
successful implementation of WC budget involves the
preparing of separate budgets for various elements of
WC such as cash inventories and receivables etc. The
objectives of a WC budget is to ensure availability of
funds as and when needed and to ensure effective
utilization of these resources.
