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Working Capital Entry Working Capital Grzegorz Zimon Department of Finance, Banking, and Accountancy, The Faculty of Management, Rzeszow University of Technology, 35-959 Rzeszow, Poland; [email protected] Definition: The simplest net working capital can be defined as the difference between the value of current assets and short-term liabilities together with other short-term accruals. It is equivalent to the part of the current assets financed with equity, provisions for liabilities, long-term liabilities, and the remaining part of accruals. Therefore, it is the capital that finances only that part of the current assets that are not financed with short-term liabilities. This amount is financed with fixed capital. Summing up, net working capital is the fixed capital that finances the company’s current assets. Keywords: working capital; strategy; financial liquidity; financial security 1. Introduction There are many definitions of net working capital in the literature. It is often referred to as working capital, net working capital (NWC), or circulating capital. In the literature, the concept of working capital is most often considered in net or gross terms [1–3]. On the other hand, gross working capital are current assets used in the normal operating cycle [3–7]. The term “working capital” is derived from an old Yankee travelling merchant who loaded goods onto his cart and was on the way to sell them. These commodities were referred to as “working capital” as he had to circulate them in order to make a profit. The Citation: Zimon, G. Working Capital. cart and horse were his fixed assets [4]. The merchant owned the cart and the horse, so Encyclopedia 2021, 1, 764–772. https:// they were financed with equity. However, he had to borrow funds to buy the goods that he doi.org/10.3390/encyclopedia1030058 wanted to sell. These were called working-capital loans and had to be paid off after each trip to prove the merchant’s creditworthiness. When the merchant was able to pay off the Academic Editors: Chia-Lin Chang loan, the bank was willing to give him another [3,4]. The example of this definition clearly and Philip Hans Franses shows that working-capital management includes a number of key elements related to company finances, i.e., short-term receivables, inventories, cash, and short-term liabilities. Received: 2 July 2021 Authors usually present current assets and liabilities as two basic elements that Accepted: 3 August 2021 influence the level of net working capital. Apart from current assets and current liabilities, Published: 6 August 2021 profits that generate sales revenue are the third most important element that significantly influences the level of net working capital. Several studies showed that the length of the Publisher’s Note: MDPI stays neutral production process and other technological characteristics are important determinants of with regard to jurisdictional claims in working-capital demand [8,9]. published maps and institutional affil- However, current assets are the most relevant areas that affect the level of working iations. capital. The entire current asset management process generally focuses on two elements, i.e., inventories and receivables from customers. Inventories are the component of current assets that generates high costs. By analyzing small and medium-sized enterprises in this area, one can find many places where unnecessary costs are incurred. Therefore, in order Copyright: © 2021 by the author. to create an optimal working-capital management strategy, it is necessary to introduce Licensee MDPI, Basel, Switzerland. various methods, inventory-management tools derived from logistics, which optimize the This article is an open access article level of inventories and the costs of their management. distributed under the terms and In turn, receivables from customers are a component that directly impacts creating a conditions of the Creative Commons policy of managing liabilities towards suppliers. Establishing a receivables-management Attribution (CC BY) license (https:// creativecommons.org/licenses/by/ strategy very often determines the policy of managing liabilities towards suppliers. 4.0/). Encyclopedia 2021, 1, 764–772. https://doi.org/10.3390/encyclopedia1030058 https://www.mdpi.com/journal/encyclopedia Encyclopedia 2021, 1, FOR PEER REVIEW 2 Encyclopedia 2021, 1, FOR PEER REVIEW 2 In turn, receivables from customers are a component that directly impacts creating a policy of managing liabilities towards suppliers. Establishing a receivables-management Encyclopedia 2021, 1 strategyIn turn, very receivables often determines from customers the policy are ofa co managingmponent liabilitiesthat directly towards impacts suppliers. creating a 765 policyDecisions of managing made liabilities by managers towards in suppliers.the area of Establishing current assets a receivables-management should aim at determining strategythe appropriate very often levels determines and structure the policy of ofindivi managingdual elements liabilities that towards make suppliers. up the current as- Decisions made by managers in the area of current assets should aim at determining sets [5].Decisions Inventories made and by managersshort-term in receivable the area ofs are current such assets elements should of current aim at determiningassets in the the appropriate levels and structure of individual elements that make up the current as- thecase appropriate that the selection levels andof an structure appropriate of individual management elements strategy that determines make up thethe currentlevel of sets [5]. Inventories and short-term receivables are such elements of current assets in the assetscosts incurred [5]. Inventories by an andenterprise. short-term Is it receivables high or low are suchcost? elements The prerequisite of current assetsfor effective in the casemanagement that the selection in this placeof an isappropriate a continuous management control of strategy the risks determines associated the with level holding of casecosts thatincurred the selection by an enterprise. of an appropriate Is it high management or low cost? strategy The prerequisite determines thefor leveleffective of costs incurredassets [10]. by an enterprise. Is it high or low cost? The prerequisite for effective management managementThe second in this area place that isstrongly a continuous influences control working of the capitalrisks associated is the management with holding of cur- inassets this [10]. place is a continuous control of the risks associated with holding assets [10]. rent liabilities. Managing this area mainly involves managing liabilities towards suppli- TheThe second second area area that that strongly strongly influences influences working working capital capital is is the the management management of of cur- current ers whose share in the structure of short-term liabilities is generally very high. liabilities.rent liabilities. Managing Managing this this area area mainly mainly involves involves managingmanaging liabilities liabilities towards towards suppli- suppliers whoseers whose share share in thein the structure structure of of short-term short-term liabilities liabilities is is generally generally veryvery high.high. 2. Working-Capital Level 2. Working-Capital When calculating Level Level net working capital, one can use the capital and property ap- proaches:WhenWhen the calculating first approach netnet workingworking is referred capital,capital, to one ason e canequity, can use use theas thethe capital capitalstarting and and propertypoint property of approaches:the ap-calcula- theproaches:tions first includes approach the first the approach iscompany’s referred is to referredfixed as equity, capital. to as as equity, the starting as the point starting of the point calculations of the calcula- includes thetions company’s Netincludes working the fixed company’s capital capital. = fixed fixed capitalcapital. − fixed assets NetNetThe working workingsecond waycapital capital is the= =fixed fixedproperty capital capital approach, − fixed− fixed assets as assets it starts from current assets [4,6,9–11]. TheTheNet second secondworking way way capital is is the the =property propertycurrent approach,assets approach, − short-term as asit starts it starts liabilities from from current current assets assets [4,6,9–11]. [4,6,9– 11]. NetNetThe working workingvalue of capital capitalworking = =current currentcapital assets assetscan −also short-term− short-term be calculated liabilities liabilities using the short- or long-term approach.TheThe value value In the of of shortworking working term, capital capital so called can can alsoon also th bee bebalancecalculated calculated sheet, using using net the working theshort- short- orcapital long-term or long-term (NWC) is approach.the surplus In In ofthe the current short short term, assets term, so socalled(CA) called overon th on curree thebalance balancent liabilities sheet, sheet, net (CL). working net The working capitalnet working capital (NWC) (NWC) capitalis isthecalculated the surplus surplus onof ofacurrent short-term current assets assets basis (CA) (CA) is over shown over curre currentinnt Figure liabilities liabilities 1. (CL). (CL). The Thenet networking working capital capital calculated on on a a short-term short-term basis basis is isshown shown in inFigure Figure 1. 1. FigureFigure 1. 1.1. Net Net working working capital capital on onon a balance-sheetaa balance-sheetbalance-sheet basis. basis.basis. Source: Source:Source: own own research. research. InInIn long-term, long-term,long-term, i.e.,
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