Financial management

FINACIAL MANAGEMENT

WORKING CAPITAL

INTRODUCTION

Working capital management is also one of the important parts of the

financial management. It is concerned with short-term finance of the business
concern which is a closely related trade between profitability and liquidity.
Efficient working capital management leads to improve the operating performance
of the business concern and it helps to meet the short term liquidity. Hence, study
of working capital management is not only an important part of financial
management but also is overall management of the business concern.

Meaning Working Capital

Working capital refers to that part of firm’s capital, which is required for
financing short-term assets.

Working Capital is another part of the capital which is needed for meeting
day to day requirement of the business concern.

DEFINITIONS

According to the definition of Shubin, “Working Capital is the amount of

funds necessary to cover the cost of operating the enterprises”.

According to the definition of Genestenberg, “Circulating capital means

current assets of a company that are changed in the ordinary course of business
from one form to another, for example, from cash to inventories, inventories to
receivables, receivables to cash”.

According to the definition of Mead, Baker and Malott, “Working Capital

means Current Assets”.
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According to the definition of J.S.Mill, “The sum of the current asset is the
working capital of a business”.

According to the definition of Weston and Brigham, “Working Capital

refers to a firm’s investment in short-term assets, cash, short-term securities,
accounts receivables and inventories”.

CONCEPT OF WORKING CAPITAL

Working capital can be classified or understood with the help of the

following two important concepts.

a) Gross Working Capital

b) Net Working Capital

Working Capital Concept

A) Gross Working Capital

Gross Working Capital is the general concept which determines the
working capital concept. Thus, the gross working capital is the capital
invested in total current assets of the business concern. Gross Working
Capital is simply called as the total current assets of the concern.
GWC = CA
B) Net Working Capital
Net Working Capital is the specific concept, which, considers both
current assets and current liability of the concern. Net Working Capital is
the excess of current assets over the current liability of the concern
during a particular period. If the current assets exceed the current
liabilities it is said to be positive working capital; it is reverse, it is said to
be Negative working capital.

NWC = C A – CL
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TYPES OF WORKING CAPITAL

a) Gross Working Capital

Gross Working Capital is the general concept which determines the

working capital concept. Thus, the gross working capital is the capital
invested in total current assets of the business concern. Gross Working
Capital is simply called as the total current assets of the concern.

b) Net Working Capital

Net Working Capital is the specific concept, which, considers both

current assets and current liability of the concern. Net Working Capital is the
excess of current assets over the current liability of the concern during a
particular period. If the current assets exceed the current liabilities it is said
to be positive working capital; it is reverse, it is said to be Negative working
capital.

c) Negative working capital

When the current liabilities are more than the current assets it is called
negative working capital.
d) Permanent Working Capital
It refers to the minimum amount of investment which should be there
in the fixed or minimum current assets like inventory, accounts
receivable, or cash balance etc., in order to carry out business smoothly.
This investment is of a regular or permanent type and as the size of the
firm expands, the requirement of permanent working capital also
increases. Tandon Committee has referred to this type of working capital
as "hard core working capital".
e) Variable Working Capital
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The excess of working capital over permanent working capital is
known as variable working capital.

Such working capital keeps on fluctuating from time to time on the basis of
business activities. It may again be sub-divided into seasonal and special
working capital. Seasonal Working Capital is required to meet the seasonal
demands of busy periods occurring at stated intervals. On the other hand,
special working capital is required to meet extra-ordinary needs for
contingencies. Events like strike, fire, unexpected competition, rising price
tendencies or initiating a big advertisement campaign require such capital.

FACTORS DETERMINING WORKING CAPITAL REQUIREMENTS

The working capital requirement of a concern depends upon a large number
of factors, which areas follow:
1. Nature or Character of Business:
Public utility undertakings like Electricity, Water supply and Railways need
very limited working capital because they offer cash sales only and supply services
not products. On the other hand, Trading and Financial firms require 156 less
investment in fixed assets but have to investment large amount in current assets
like inventories, receivables etc.

2. Size of Business:
Greater the size of business unit, generally larger will be the requirement of
working capital. In some case even a smaller concern need more working capital
due to high overhead charges, inefficient use of resources etc.
3. Production Policy:
The production could be kept either steady by accumulating inventories
during slack
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periods with a view to meet high demand during the peak season or the production
could be curtailed during the slack season and increased during peak season. If the
policy is to keep the production steady by accumulating inventories it will require
higher working capital.
4. Seasonal Variations:
In certain industries, raw material; is not available throughout year. They
have to buy raw material in bulk during the season to ensure an uninterrupted flow
and process them during the entire year. A huge amount is blocked in the form of
material inventories during such season, which give rise to more working capital.
5. Working Capital Cycle:
In manufacturing concern, the working capital cycle starts with the purchase
of raw material and ends with the realization of cash from the sales of finished
products. This cycle involves purchase of raw material and starts, its conversion
into stock of finished goods through work in progress with progressive increment
of labor and service costs, conversion of finished stock into sales, Debtor and
receivables and ultimately realization of cash and this cycle continues again from
cash to purchase of raw material so on.
6. Rate of Stock Turnover:
There is high degree of inverse co relationship between the quantum of
working capital and the velocity or speed with which the sales are affected. A firm
with having a high rate of stock turnover will need lower amount of working
capital as compared to the firm having a low rate of turnover.
7. Credit Policy:
A concern that purchases its requirement on credits and sells its products
/services on cash require lesser amount of working capital. On the other hand,
concern buying its requirement for cash and allow credit to its customers, will need
larger amount of working capital as very huge amount of funds are bound to be
tied up in debtors or bills receivables.
8. Business Cycle:
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Business Cycle refers to alternate expansion and contraction in general
business activity. In period of boom i.e. when the business is prosperous, there is
need for larger amount of working capital due to increase in sales, rise in prices,
and expansion of business. On the contrary in the times of depression i.e., when
there is down swing of cycle, the business contracts, sales decline, difficulties are
faced in collection from debtors and firms may have a large amount of working
capital lying idle.
9 .Rate of Growth of Business:
For the fast growing concern, larger amount of working capital is required.

IMPORTANCE OR ADVANTAGES OF ADEQUATE WORKING

CAPITAL :
Working capital is the lifeblood and nerve center of a business. No business can
run successfully without and adequate amount of working capital. The main
advantage of maintaining adequate amount of working capital is as follow:
1. Solvency of the business:
Adequate amount of working capital helps in marinating solvency of
business by providing uninterrupted flow of production.
2. Goodwill:
Sufficient amount of working capital enables business concern to make the
prompt payment and helps in creating and marinating goodwill.
3. Easy Loans:
A concern having adequate amount of working capital, high solvency and
credit standing can arranges loans from banks.
4. Cash Discounts:
Adequate amount of working capital also enables a concern to avail cash
discounts on the purchases and hence it reduces the costs.
5. Exploitation of favorable market condition:
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Adequate amount of working capital enables a concern to exploit favorable
market conditions such as purchasing its requirement in bulk when the prices are
lower and by holding its inventories for higher prices.
6. Ability to face the crises:
Adequate amount of working capital enables a concern to face the business
crises in emergencies such as depression because during such periods, generally
there is much pressure on working capital.
7. Quick and regular return on investments:
Adequate amount of working capital enables a concern pay quick and
regular dividends to its investors as there may not be much pressure to plough back
profits.
8. Regular supply of raw material:
Adequate amount of working capital ensures regular supply of raw material
and continuous production.

OBJECTIVE OF WORKING CAPITAL:

1. For the purchase of raw materials components and spares.

2. To pay wages and salaries,
3. To incur day-to-day expenses,
4. To provide credit facilities to the customers,
5. To maintain the inventories of raw materials work – in –progress and
finished stock.

SOURCES OF WORKING CAPITAL

1. Source of regular working capital,

a) Issue of shares:
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Company can collect the required fund by the issue of equity
shares. Company collects the maximum working capital by the
source only. This source is not burden to the organization.
b) Issue of debenture:
It is another source of regular working capital. Debenture is a
borrowed capital. So debenture is an acknowledge of company in
debtnes issued under its common seal containing terms and
conditions in respect of interest and principal.
c) Retained profit:
It is one the best sources of fixed and working capital
requirement from the retained profit of an existing unit. Because it
is more convenient easy and cheaper. Because company need not
pay any interest.

2. Sources of seasonal working capital:

a) Indigenous bankers (money lenders):
Money lenders are playing very important role prior to the
establishment of modern banking. Even today also giving loans for
personal consumption and trading purpose. In case of emergency
cottage and small scale industries obtain short term credit from
indigenous bankers.
b) Commercial banks:
Commercial banks are most important sources of seasonal
working capital to the organizations.
Majority the company including small and cottage industries
obtain greater part of the working capital from the commercial
banks by way of overdraft cash credit.
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c) Public deposits:
Public deposit are accepted by industrial and commercial
organization from 6 months to 5 years. Established companies can
get ready response from the public their surplus in deposit account.
So its simple method of raising the short term finance.
PROBLEMS
EXERCISE 1
Prepare an estimate of working capital requirement from the
following information of a trading concern.
Projected annual sales 10,000 units
Selling price Rs. 10 per unit
Percentage of net profit on sales 20%
Average credit period allowed to customers 8 Weeks
Average credit period allowed by suppliers 4 Weeks
Average stock holding in terms of sales requirements 12 Weeks
Allow 10% for contingencies Solution

Statement of Working Capital Requirements

Rs.
Current Assets
Debtors (8 weeks) 80,000×8/52 12,307
(at cost) Stock (12 weeks) 80,000×12/52 18,462
30,770
Less: Current Liability

Credits (4 weeks) 80,000×4/52 6,154

24,616

Add 10% for contingencies 2,462

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Working Capital Required 27,078

Working Notes:
Sales = 10000×10 = Rs. 1,00,000
Profit 20% of Rs. 1,00,000 = Rs. 20,000
Cost of Sales=Rs. 1,00,000 – 20,000 = Rs. 80,000
As it is a trading concern, cost of sales is assumed to be the
purchases.

Vani govt. first grade college-hiriyur