WORKING CAPITAL

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WORKING CAPITAL

SYNOPSIS:

*    Introduction

*    Concept of Working Capital

*     Importance of Working Capital

*     Requirement of Working Capital

 

INTRODUCTION

           In financial management, two important decisions are very vital and crucial.

They are decision regarding fixed assets/fixed capital and decision regarding

Working capital/current assets. Both are important and a firm always analyzes

Their effect to final impact upon profitability and risk.

          Fixed capital refers to the funds invested in such fixed or permanent assets as

land, building, and machinery etc. Whereas working capital refers to the funds

locked up in materials, work in progress, finished goods, receivables, and

cash etc.

       Thus, in very simple words, working capital may be defined as “capital

invested in current assets.” Here current assets are those assets, which

can be converted into cash within a short period of time and the cash received

is again invested into these assets. Thus, it is constantly receiving or

circulating. Hence, working capital is also known as circulating capital or

floating capital.

 

CONCEPT OF WORKING CAPITAL

There are two concepts of working capital. These are:

1. Gross working capital: (Total Current Assets)

The gross working capital, simply called as working capital refers to the firm’s

investment in current assets. Current assets are the assets, which can be

converted into cash within an accounting year or operating cycle. Thus, Gross

working capital, is the total of all current assets. It includes

1. Inventories (Raw materials and Components, Work-in-Progress, Finished

Goods, Others)

2. Trade Debtors

3. Loans and Advance

4. Cash and Bank Balances

5. Bills Receivables.

 

6. Short-term Investment

 

2. Net Working Capital: (Total Current Assets – Total Current Liabilities)

Net working capital refers to the difference between current assets and

current liabilities. Current liabilities are those claims of outsiders, which are

expected to mature for payment within an accounting year. Net working

capital may be positive or negative. A positive net working capital will arise

when current assets exceed current liabilities and a negative net working

capital will arise when current liabilities exceed current assets i.e. there is no

working capital, but there is a working capital deficit. It includes

1. Trade Creditors.

2. Bills Payable.

3. Accrued or Outstanding Expenses.

4. Trade Advances

5. Short Term Borrowings (Commercial Banks and Others)

6. Provisions

7. Bank Overdraft

“Working Capital represents the amount of current assets that have not been

supplied by current, short term creditors.” “Gross working capital refers to the amount of funds invested in current assets that are employed in the business process while, Net Working Capital refers to the difference between current assets and current liabilities.”  “Working Capital is the excess of current assets that has been supplied by the long-term creditors and the stockholders.” The two concepts of working capital, gross working capital and net working capital are exclusive. Both are equally important for the efficient management of working capital. The gross working capital focuses attention on two aspects How to optimize investment in current assets? and How should current assets be financed? While, net working capital concept is qualitative. It indicates the liquidity position of the firm and suggests the extent to which working capital needs may be financed by permanent sources of funds.

 

5.3 IMPORTANCE OF WORKING CAPITAL

Working capital is one of the important measurements of the financial

position. The words of H. G. Guthmann clearly explain the importance of

working capital. “Working Capital is the life-blood and nerve centre of the

business.” In the words of Walker, “A firm’s profitability is determined in part

by the way its working capital is managed.” The object of working capital

management is to manage firm’s current assets and liabilities in such a way

that a satisfactory level of working capital is maintained. If the firm cannot

maintain a satisfactory level of working capital, it is likely to become insolvent

and may even be forced into bankruptcy. Thus, need for working capital to run

day-to-day business activities smoothly can’t be overemphasized.

 

 

5.4 REQUIREMENTS OF WORKING CAPITAL

There are no set rules or formula to determine the working capital

requirements of the firms. A large number of factors influence the working

capital need of the firms. All factors are of different importance and also

importance change for the firm over time. Therefore, an analysis of the

relevant factors should be made in order to determine the total investment in

working capital. Generally the following factors influence the working capital

requirements of the firm:

· Nature and size of the business

· Seasonal fluctuations

· Production policy

· Taxation

· Depreciation policy

· Reserve policy

· Dividend policy

· Credit policy:

· Growth and expansion

· Price level changes

· Operating efficiency

· Profit margin and profit appropriation

 

5.5 WORKING CAPITAL ANALYSIS OF GSRTC

With a view to appraise working capital and liquidity position of GSRTC, the

analysis has been made from the point of view of short term creditors,

efficiency in the use of working capital, and investment in working capital

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