WORKING CAPITAL MANAGEMENT
Concept of Working Capital
Working capital refers to short-term funds, need to meet operating expenses. It refers to the funds; to finance its day-to-day operations. It is concerned with current assets and current liabilities. If a firm can’t maintain a satisfactory level of working capital, it may become insolvent or bankrupt. Broadly there are 2 concepts of working capital, such as: 1. Gross Working Capital (Quantitative Concept)
2. Net working Capital (Qualitative Concept)
Both these concepts of working capital have operational significance. The two concepts are not mutually exclusive. The ‘gross concept’ emphasizing the ‘use’ and the ‘net concept’ emphasizes the ‘source’.
1. Gross Working Capital
The total current assets are termed as the gross working capital. It is also known as quantitative or circulating capital. It refers to firm’s investment in short term assets such as cash, marketable securities, accounts receivables, prepaid expenses, inventories etc. Significance
a. Optimum investment in current assets.-: Inadequate working capital leads to insolvency and excessive will lead to less profitability. b. Financing of current assets.-: If funds arise it should be invested in short term securities, don’t keep it idle. 2. Net Working Capital
The excess of current assets over current liabilities represents net working capital. It may be positive or negative. Net working capital indicates the liquidity of the business. Significance
a. Maintaining Liquidity Position-: Current assets help in meeting financial obligations. Generally for every one rupee of current asset there should be one rupee of current liability. b. Extent of long term capital in financing current assets-: If there are Rs 100000 current assets and Rs 75000 current liabilities then NWC is Rs 25000, and it supposed to be financed from long term funds.
KINDS OF WORKING CAPITAL
1. PERMENT WORKING CAPITAL
The minimum level of current assets maintained in a firm is known as permanent or regular working capital. It is kept in form of raw material, work-in-process, finished goods, stores & spares and book debts to have uninterrupted operation of a firm. 2. TEMPORARY WORKING CAPITAL
Any additional working capital over and above the permanent working capital is called temporary working capital. It is needed to meet events like floods, strike, seasonal production, price-hikes and contingencies.
DISTINCTION BETWEEN PERMANENT AND TEMPORARY WORKING CAPITAL
COMPONENTS OF WORKING CAPITAL
Efficient management of working capital involves control over the current assets and current liabilities, which are the main components of working capital.
1. Components of current assets: Currents assets are those, can be converted into cash within a year. It consists of cash, marketable securities, inventories, debtors, prepaid expenses. 2. Components of current Liabilities: Current liabilities are those to be paid in a year. It consists of creditors, short-term borrowings, taxes and proposed dividends.
• To ensure optimum investment in current assets.
• To ensure adequate flow of funds for current operations. • To speed up the flow of funds.
• Maintain liquidity and profitability.
NEED OF WORKING CAPITAL
• Maximize shareholders’ wealth possible only when there is sufficient return. • Discharge day-to-day liabilities.
• Protect the business from adverse effects in emergencies. • Determines the relevant levels of current assets and their efficient use. • To sustain sales activity. Sales don’t convert into cash immediately. It needs time to collection of cash. BALANCED WORKING CAPITAL
For maximization profits or minimize working capital cost and...