Posted in Accounting, Business Management, Financial Accounting
on Jul 2nd, 2014 | 0 comments
“Working capital means #current assets” –Mead, Malott and Field.
“Any acquisition of funds which the current asset increases working capital, for, they are one and the same.” – J.S.mill
Working Capital Cycle
Understanding Working Capital:
It is the life blood of business. Funds needed for the purchase of raw materials, payment of wages and other day-to-day expenses are known as working capital. It is part of the firm’s capital, which is being used for financing short-term operations. Hence, it may also be termed as Circulating Capital or Short-Term capital.
Financial troubles and issues arise only when this entity called ‘working capital’ is not properly managed. Every successful company will hire a financial manger to deal with issues relating to #finance while the CEO can look into matters relating to promotion of the product or service and the position of the company in the market.
The ‘#Sales Turnover or Sales Volume’ is the key issue you have to look into to gauge whether you have sufficient working capital to manage that big a volume for that particular period. You have to rotate your funds wisely keeping in mind the #credit policies your company offers and the credits you may enjoy with your supplier, bank interest for the short-term loans etc.
Concept of WC:
Working capital implies excess of current assets over #current liabilities. Funds invested in current assets is known as “#Gross Working Capital.” The difference between current assets and current liabilities is known as “#Net Working Capital.”
What are the two types?
- Permanent or fixed: It is the minimum amount of current assets required for conducting the business operation. This capital will remain permanent in current assets and should be financed out of long-term funds. The amount varies from year to year, depending upon the growth of a company.
- Temporary or Variable: It is the amount of additional current assets required for a short period. It is needed to meet the seasonal demands at different times during a year. The capital can be temporary and should be financed out of short-term funds. The working capital starts decreasing when the peak season is over.
Various Factors Influencing Working Capital:
- Nature of business: Service oriented concerns like electricity; water supplies need limited working capital while a manufacturing concern requires sufficient working capital, since they have to maintain stock and debtors.
- Credit Policies: A company which allows credit to its customers shall need more amount while a company enjoying credit facilities from its suppliers will need lower amount of working capital.
- Manufacturing Process: Conversion of raw materials into finished goods is called manufacturing or production. Longer the process, higher the requirement of working capital.
- Rapidity of turnover: High rate of turnover requires low amount and lower and slow moving stocks need a larger amount of working capital. Say, jewelry shops have to maintain different types of designs calling for high working capital. Fast moving goods like grocery requires low working capital.
- #Business cycle: Changes in economy has a say over the requirement of working capital. When a business is prosperous, it requires huge amount of capital; also during depression huge amount is needed for unsold stock and uncollected debts.
- Seasonal variation: Industries which are manufacturing and selling goods seasonally require large amount of working capital.
- Fluctuation of supply: Firms have to maintain large reserves of raw material in stores, to avoid uninterrupted production which needs large amount of working capital.
- Dividend policy: If a conservative dividend policy is followed by the management, the need for working capital can be met with the retained earnings, it consequently drains off large amounts from working capital pool.