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52900646.Pdf WORKING CAPITAL AT A GLANCE INTRODUCTION TYPES FEATURES DETERMINANTS COMPONENTS WORKING CAPITAL CYCLE INTRODUCTION A successful sales program is necessary for earning profits by any business enterprise. Sales don’t convert into cash instantly. There is a time lag between the sale of goods and receipt of cash. Therefore, there is a need for working capital in the form of current assets to deal with the problem arising out of the lack of immediate realization of cash against goods sold. Therefore sufficient working capital is necessary to sustain sales activity. Defination of Working Capital:- According to C.W. Gestenbergh- “Working capital is ordinarily defined as the excess of the current assets over current liabilities”. According to Lawrence. J. Gitmen “The most common defination of working capital is the difference of the firm’s current assets and current liabilities.” Defination of working capital management:- “Working capital management involves the relationship between a firm's short-term assets and its short-term liabilities. The goal of working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable, and cash.” -From WWW.STUDYFINANCE.COM Management of working capital Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital. These require managing the current assets - generally cash and cash equivalents, inventories and debtors. There are also a variety of short term financing options which are considered. • Cash management – identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs • Inventory management - identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials and hence increases cash flow; see Just In Time (JIT) and Economic order quantity (EOQ). • Debtors management - identify the appropriate credit policy, i.e. credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa); see Discounts and allowances. • Short term financing - inventory is ideally financed by credit granted by the supplier; dependent on the cash conversion cycle, it may be necessary to utilize a bank loan (or overdraft), or to "convert debtors to cash" through "factoring". TYPES Working capital can be classified either on the basis of concept or on the basis of periodicity of its requirement. 1) ON THE BASIS OF CONCEPT On the basis of concept working capital is of 2 types. A) Gross working capital - Gross working capital is represented by the total Current assets. Gross working capital = Total current assets B) Net working capital - Net working capital is the excess of current assets over current liabilities. Net working capital = Current assets – Current liabilities 2) ON THE BASIS OF REQUIREMENT On the basis of requirement working capital is also of 2 types. A) Permanent working capital - It is that amount of investment which should always be there in the fixes or minimum current assets like inventory, accounts receivables or cash balance etc. to carry out business smoothly. Such an amount cant be reduced if the firms wants to carry on business operations without interruption. B) Variable working capital - The excess the amount of working capital over permanent working capital is known as variable working capital. It may also be subdivided into two parts. a) Seasonal working capital - Such capital is required to meet out the seasonal demands of busy periods occurring at stated intervals. b) Special working capital - Such capital is required to meet out the extra-ordinary needs for contingencies. Events like strike, fire, unexpected competition, rising price tendencies, or initiating a big advertisement campaign require such capital. FEATURES 1) Working capital is regarded as the excess of current assets over current liabilities. 2) Working capital indicates circular flow of funds in the day-to-day activities of business. That’s why it is also called circulating capital. 3) Working capital represents the minimum amount of investment in raw materials, work-in progress, finished goods, stores and spares, accounts receivables and cash balance. DETERMINANTS 1) Nature of business – The effect of the general nature of the business on working capital requirements can’t be exaggerated. Rail, roads and other public utility services have large fixes investment so they have the lower requirements of current assets. Industrial and manufacturing enterprises, on the other hand, generally require a large amount of working capital. 2) Production policies – if the production is evenly spread over the entire year, working capital requirements are greater, because the inventories will be unnecessarily accumulated during of season period. But if the production schedule favours a varying production plan as per the seasonal requirements, working capital is required to a greater extent during a specified season only. The production policies are affected by so many factors availability of raw materials, labour, stocking facility etc & therefore, whatever the productions policies are, the firm has to arrange its working capital requirements accordingly. 3) Proportion of the cost of raw materials to total cost - In those industries where cost of proportion is a large proportion of total cost of the goods produced, reqirements of working capital will be comparatively large. 4) Length of period of manufacturing – The time which elapses between the commencement and end of the manufacturing process has an important bearing upon the requirements of working capital. The manufacturing cycle may be shorter for certain concerns & longer for others- it depends on the type of the product to be manufactured, work to be done through machine labour & hand labour, degree of rationalization of manufacturing procedures through times, motion & fatigue studies etc. 5) Terms of purchase - If suppliers allow continuous credit, payment can be postponed for some time and can be made out of the sale proceeds of the goods produced. In such a case, the requirements of working capital will be reduced. 6) Dynamic Attitudes – As a company grows, it is logical to expect the large amount of working capital will be required. 7) Business cycles – Requirement of working capital also varies with the business. When the price level is up due to boom conditions, the inflationary conditions create demand for more working capital. During depression also a heavy amount of working capital is needed due to the inventories being locked unsold and book debts uncollected. 8) Requirement of cash - The working capital requirements of a company are also influenced by the amount of cash required by it for various purposes. The greater the requirement of cash, the higher will be the working capital needs of the company. 9) Dividend policy of concern – If the management follows a conservative dividend policy the needs of working capital can be met with the retained earnings. The relationship between dividend policy and working capital is well established and mostly companies declare dividend after a careful study of their cash requirements 10) Other Factors - Other factors, which affect the requirement of working capital, are lack of co-operation in production and distribution policies, transport and communication facilities, the fiscal and tariff policies of the government etc. COMPONENTS Main components of working capital are as follows: 1) Cash – Cash is the most liquid and important component of working capital. Holding cash involves cash in the sense that the present worth of cash held for a year is less than the value of cash on today. During inflationary situations as exist today the cost of holding includes the deterioration in the value of the cash due to inflation. Cash, therefore, results in enhanced liquidity, but lower profitability. Despite in the cost involved it is pertinent to hold cash because it facilitates the attainment of some important motives. 2) Marketable Securities – Though marketable securities provides a such lower yield that the firm’s operation assets. They serve two useful functions. Firstly, they act as a substitute for cash, and secondly, are used as temporary investment. Where these securities are held in lieu of the cash balance, they act as a substitute for transactional or precautionary balances. Normally, these aren’t used as speculative balances, but only as a guard against the possible shortage of bank credit. Marketable securities (as temporary investment) may be held for one of the following reasons: • Seasonal or cyclical operations • To meet known financial requirements. Construction of an additional plant. • Immediately after the sale of long-term securities. 3) Account Receivable - Though accounts receivable are a vital investment of any business organization, little analytical work as been done to determine credit policies. Maintaining account receivable has its cost implications in that the firm’s monetary resources are tied up. This is of greater significance in the inflationary economy, because of the depreciation in the value of money. Basically, this is a two-step account. When goods are shipped, inventories are reduced and accounts receivable is created. When payment is made, this account is reduced and the cash level increases. Accounts receivables are, therefore a function of the volume of credit sales and the average length of time between sales and collections. 4) Inventory – Inventories represent a substantial amount of a firm’s current assets. Management of inventories should be efficiently carried out so that this investment doesn’t become too large, as it would result in blocked capital which could put to productive use elsewhere. On the other hand, having too small an inventory could result in loss of sale or loss of customer goodwill. An optimum level of inventory should therefore be maintained.
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