Working Capital Management m.com 3

7/31/2019 Working Capital Management m.com 3

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WORKING CAPITALWORKING CAPITAL

MANAGEMENTMANAGEMENT


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Working capital is the life blood and nerveWorking capital is the life blood and nerve

Centre of a business. As the circulation of bloodCentre of a business. As the circulation of bloodis essential in the human body for maintains ofis essential in the human body for maintains of

life, in the same way working capital islife, in the same way working capital is

essential to all the organization to maintain theessential to all the organization to maintain the

smooth running of a business.smooth running of a business.

INTRODUCTION


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Working capital is the part of total capital. It is used forWorking capital is the part of total capital. It is used for

carrying out the regular business operations.carrying out the regular business operations.

In other words, it is the amount of funds used forIn other words, it is the amount of funds used for

financing the day to day operation s or activities.financing the day to day operation s or activities.The funds invested in current assets such as stock ofThe funds invested in current assets such as stock of

materials, work-in-progress, investments, billsmaterials, work-in-progress, investments, bills

receivables, sundry debtors, bank balance etc., arereceivables, sundry debtors, bank balance etc., are

known as working capital or short term capital.known as working capital or short term capital.

MEANING OF WORKINGMEANING OF WORKING

CAPITALCAPITAL


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GERESTENBURG defines, Circulating meansGERESTENBURG defines, Circulating means

current assets of a company that are changedcurrent assets of a company that are changedin the ordinary course of business form onein the ordinary course of business form one

from to another, as for example, from cash tofrom to another, as for example, from cash to

inventories, investment to receivable,inventories, investment to receivable,

receivable into cash.receivable into cash.

DEFINITION OF WORKINGCAPITAL


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SHUBINSHUBIN define, Working capital is the amountof funds necessary to cover the cost ofoperating the enterprise.

DEFINITION OF WORKINGDEFINITION OF WORKING

CAPITALCAPITAL


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There are two concept of working capital

Net working

Gross working capital

CONCEPT OF WORKINGCAPITAL


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Working capital is the excess of current assets overcurrent liabilities.

In the form of equation as follows. Working capital = current assets current

liabilities

Components of working capital

according to net concept working capital has twocomponents viz.

a. Current assets

b. Current liabilities

NET WORKING CAPITALNET WORKING CAPITAL


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Current assets : those assets which are convertedinto cash within a period not exceeding one year

normally, such assets are called current assets. Example of current assets:-

Cash in hand

Cash at bank

Bills receivable Sundry assets

Prepared expenses

Outstanding income

NET WORKING CAPITAL


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Those liabilities are to be paid within a period of oneyear, such liabilities are called current liabilities.Generally current liabilities are paid out of current

assets or the income from the business. Example of current liabilities:-

Trade creditors

Outstanding expenses

NET WORKING CAPITAL


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Short-term borrowings

Taxes and dividend payable

Bank overdraft Outstanding liabilities

Advances received from parties against goods to besold.

So net working capital is an accounting concept. Networking capital may be positive or negative.

NET WORKING


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The gross working capital refers to firms investmentin all the current assets taken together.

The total of investment in all the current assets is the

gross working capital.This concept is supported by the authorizes like mean

banker etc.

According to them the working capital concept is

financial or going concern concept.

GROSS WORKING CAPITAL


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The working capital needs of a firm aredetermined and influenced by variousfactors.

A wide variety of considerations may effectthe quantum of working capital requiredand these considerations may vary from

time to time.The working capital needed at one point of

time may not be good enough for someother situation.

The determination of working capital

FACTORS DETERMININGWORKING CAPITAL

REQUIREMENT


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Following are some of the factor which are relevant indetermining the working capital needs of the firm:

1. Basic nature of business.

2. Business cycle fluctuations.

3. Seasonal operations.

4. Market competitiveness.

5. Credit policy.

6. Supply conditions.

7. Inventory policy.

8. Accessibility to credit.

9. Growth of business.

10. Environment factor.

11.


REQUIREMENT


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BASIC NATURE OF BUSINESS :

The working requirement is closely related to the nature of thebusiness of the firm.

In case of retail shop or a trading firm, the amount of workingcapital required is small enough. Most of the transaction areundertaken in cash and the length of the operating cycle isgenerally small.

The trading concerns usually have smaller needs of workingcapital, however in certain cases, large inventories of goodsmay be required and consequently the working capital maybe large.

In case of manufacturing concerns, different types ofproduction process are performed. One unit of raw materialintroduced in the production schedule may take a long periodbefore it is available as finished goods for sale. Funds are


REQUIREMENT


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BUSINESS CYCLE FLUCTUATIONS:

Different phases of business cycle i.e., Boom, Recession,Recovery etc., also effect the working capital requirement.

Incase of Boom condition, inflationary pressure appears andbusiness activities expand.

As a result, the overall need for cash , inventories etc. increaseresulting in more and more funds blocked in these currentassets.

In case of recession period however, there is usually a dullnessin business activities and there will be an opposite effect onthe level of working capital requirement. There will be a fallin inventories and cash requirement etc.


REQUIREMENT


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SEASONAL OPERATIONS:

o If a firm is operating in good and services having seasonalfluctuating in demand, then the working capital requirementwill also fluctuate with every change.

o In a cold drink factory, the demand will certainly be higherduring summer season and therefore, more working capitalis required to maintain higher production, in the form oflarger inventories and bigger receivables.

o On other hand, if the operations are smooth and eventhroughout the year then the working capital requirement willbe constant and will not be affected by seasonal factors.


REQUIREMENT


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MARKET COMPETITIVENESS:

The market competitiveness has an important bearing on theworking capital needs of a firm.

In view of the competitive conditions prevailing in the market,the firm may have to offer liberal credit terms to thecustomers resulting in higher debtors.

Even larger inventories may be maintained to serve an order asand when received; otherwise the customer may go to someother supplier.

Thus, working capital tends to be high as a result of greaterinvestment in inventories and receivables.

On other hand, a monopolistic firm may not require largerworking capital.

It may ask the customers to pay in advance or to wait for sometime after placing the order.


REQUIREMENT


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CREDIT POLICY :

The credit policy means the totality of terms and conditions onwhich goods are sold and purchased.

A firm has to interact with two types of credit policies at atime.

One, the credit policy of the supplier of raw materials, goodsetc., and two, the credit policy relating to credit which itextends to its customers.

In both the cases, however, the firm while deciding its creditpolicy, has to take care of the credit policy of the market.

Example : A firm might be purchasing goods and services oncredit terms but selling goods only for cash. The workingcapital requirement of this firm will be lower than that of a

firm which is purchasing cash but has to sell on credit basis.


REQUIREMENT


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SUPPLY CONDITIONS:

The time taken by a supplier of raw materials, goods etc.

After placing an order, also determines the working capitalrequirement. If goods are received as soon as or in a shortperiod after placing an order, then the purchaser will not liketo maintain a high level of inventory of that goods .

Otherwise, larger inventories should kept.


REQUIREMENT


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INVENTORY POLICY:

The traditional production systems generate more stock of finishedgoods and high levels of raw materials and WIP stock aremaintained and stock holding period is also more working capital

is needed.

ACCESSIBILITY TO CREDIT :

Creditworthiness is the precondition for assured accessibility tocredit.

Accessibility in banks depends on the flow of credit i.e., level ofworking capital.

GROWTH OF BUSINESS:

Growth and diversification of business call for larger volume ofworking funds.

The need for increased working capital does not follow the growthof business o erations but recedes it.


REQUIREMENT


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ENVIRONMENT FACTORS:

Political stability brings in stability in money market andtrading world.

Things mostly go smooth. Risk ventures are possible with enhanced need for

working capital finance.

Similarly, avaibility of local infrastructure facilities like

road, transport, storage and market etc., influencebusiness and working capital need as well.


REQUIREMENT

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Working Capital Management m.com 3