Introduction to Working Capital Definition of Working Capital Objectives of Working Capital Sources of Working Capital Working Capital & Ratio Analysis Types of Working Capital Working Capital Policies Advantages Disadvantages
Working capital is the life blood and nerve centre of a business. Just as, working capital is very essential to maintain the smooth running of a business Working capital refers to that part of firm’s capital which is required for financing short term or current assets such as cash, marketable securities, debtors, and inventories. In other words working capital is the amount of funds necessary to cover the cost of operating the enterprise. Meaning: Working capital means the funds (capital) available and used for day to day operations ( working) of an enterprise. It consists broadly of that portion of assets of a business which are used in or related to its current operations. It refers to funds which are used during an accounting period to generate a current income of a type which is consistent with major purpose of a firm existence.
Working capital :is the fund which is used for daily operation of businesses. That acts as important concept in finance. Working capital: represents the funds available with the company for day to day operations. working capital: finances the cash conversion cycle. company cannot survive with negative working capital which represents that the company has no funds for day to day operations Working capital is: Current asset – current Liabilities.
Every business needs some amount of working capital. It is needed for following purposes- For the purchase of raw materials, components and spares. To pay wages and salaries. To incur day to day expenses and overhead costs such as fuel, power, and office expenses etc. To provide credit facilities to customers etc. Factors that determine working capital: The working capital requirement of a concern depend upon a large number of factors such as Size of business? Nature of business. Seasonal variations working capital cycle Operating efficiency Profit level.
The working capital requirements should be met both from short term as well as long term sources of funds. Financing of working capital through short term sources of funds has the benefits of lower cost and establishing close relationship with banks. Financing of working capital through long term sources provides the benefits of reduces risk and increases liquidity.
Ratio Analysis is one of the important techniques that can be used to check the efficiency with which working capital is being managed by a firm. The most important ratios for working capital management are as follows. Gross Working Capital : Cash and short-term assets expected to be converted to cash within a year. Businesses use the calculation of gross working capital to measure cash flow Gross working capital does not account for current liabilities, but is simply the measure of total cash and cash equivalent on hand. Gross working capital tends not to add much to the business assets, but helps keep it running on a day-to-day basis. Net working capital: is the difference between current assets and current liabilities. An analysis of the net working capital will be very help full for knowing the operational efficiency of the company NET WORKING CAPITAL = CURRENT ASSETS-CURRENT LIABILITIS
Positive working capital: means that the company is able to pay off its short-term liabilities -> When current asset outweigh Debts. Negative working capital: means that a company currently is unable to meet its short-term liabilities with its current assets (cash, accounts receivable and inventory). -> When a company has debts than C.Asset.
Essentially: working capital is the answer to the question: *How much short term funding do you need to operate this business?*. Short term funding is important because, with long term funding already in place, the business still needs short term funding to operate. Without the short term funding, the business will go bankrupt.
if you have invested your money to purchase machineries of company and if you don’t have enough money to buy raw material, then your machinery will no use for any production without raw material
Working capital an be divided into two categories: Permanent working capital: It refers to that minimum amount of investment in all current assets which is required at all times to carry out minimum level of business activities. Temporary working capital: The amount of such working capital keeps on fluctuating from time to time on the basis of business activities.
Liquidity: Under this policy, finance manager will increase the amount of liquidity for reducing the risk of business. If business has high volume of cash and balance, then business can easily pays its dues at maturity. Profitability policy Under this policy, finance manger will keep low amount of cash in business and try to invest maximum amount of cash and bank balance. It will sure that profit of business will increase due to increasing of investment in proper way but risk of business will also increase because liquidity of business will decrease and it can create bankruptcy position of business. So, profitability policy should make after seeing liquidity policy and after this both policies will helpful for proper management of working capital.
Policies Liqui profit Risk ability dityGWC Average Average AverageNWC High Low LowPWC Low High High
It can arrange loans from banks and others on easy and favorable terms. It helps the business concern in maintaining the goodwill. It enables a concern to face business crisis in emergencies such as depression It creates an environment of security, confidence, and over all efficiency in a business. It helps in maintaining solvency of the business.
Gives a company the ability to meet its current liabilities. Expand its volume of business. Take advantage of financial opportunities as they arise.
Rate of return on investments also fall with the shortage of working capital. Excess working capital may result into over all inefficiency in organization. Excess working capital means idle funds which earn no profits. Inadequate working capital can not pay its short term liabilities in time.
· You cant expand, cant pay your staff, cant pay yourself, and cant pay your suppliers. So in a nutshell, no cash flow, or working capital, no viable business. · Lack of sufficient working capital and inability to liquidate current assets are frequent causes of business failure.
After study the nature of production, we can estimate the need for working capital. If company produces products at large scale and continues producing goods, then company needs high amount of working capital. As we discussed working capital is the life blood of the business so we should keep it controlled I think if we use from Gross Working capital we can expedite our business well and every thing in average will work more.
Thank you!Prepared by Abdul Fahim Ehsas RIHSKabul, Afghanistan