Ineffective Utilization of Working Caital

Topics: Inventory, Working capital, Investment Pages: 6 (1920 words) Published: April 19, 2013
Ineffective Utilization of Working Capital
Meaning of Working Capital
Business organization requires adequate capital to establish business and operate their activities. The total capital of a business can be classified as fixed capital and working capital. Fixed capital is required for the purchase of fixed assets like building, land, machinery, furniture etc. Fixed capital is invested for long period, therefore it is known as long-term capital. Similarly, the capital, which is needed for investing in current assets, is called working capital. Capital required for a business can be classified under two main categories via 1. Fixed Capital

2. Working Capital
Every business needs funds for two purposes
* For its establishment
* To carry out its day- to-day operations
Long terms funds are required to create production facilities through purchase of fixed assets such as P&M, land, building, furniture, etc. Investments in these assets represent that part of firm’s capital which is blocked on permanent or fixed basis and is called Fixed Capital. Funds are also needed for short-term purposes for the purchase of raw material, payment of ages and other day–to-day expenses etc. These funds are known as Working Capital. In simple words, working capital refers to that part of the firm’s capital which is required for financing short- term or current assets such as cash, marketable securities, debtors & inventories. Funds, thus, invested in current assts keep revolving fast and are being constantly converted in to cash and this cash flows out again in exchange for other current assets. Hence, it is also known as revolving or circulating capital or short term capital. Classification of Working Capital

 Working capital may be classified in two ways:
On the basis of concept.
On the basis of time.
There are two concepts of working capital
* Gross working capital
* Net working capital
Gross Working Capital
The gross working capital is the capital invested in the total current assets of the enterprise. Current assets are those Assets which can convert into cash within a short period normally one accounting year. Net Working Capital

The term working capital refers to the net working. Net working capital is the excess of current assets over current liability. It can be positive or negative. When the current assets exceeds the current liabilities are more than the current assets. Net Working Capital = Current Assets – Current Liabilities

On the basis of time, working capital may be classified as:
* Permanent or fixed working capital
* Temporary or variable working capital
Permanent or Fixed Working Capital 
Permanent or fixed working capital is minimum amount which is required to ensure effective utilization of fixed facilities and for maintaining the circulation of current assets. Every firm has to maintain a minimum level of raw material, work- in-process, finished goods and cash balance. This minimum level of current assets is called permanent or fixed working capital as this part of working is permanently blocked in current assets. As the business grow the requirements of working capital also increases due to increase in current assets. Temporary or Variable Working Capital

Temporary or variable working capital is the amount of working capital which is required to meet the seasonal demands and some special exigencies. Variable working capital can further be classified as seasonal working capital and special working capital. The capital required to meet the seasonal need of the enterprise is called seasonal working capital. Special working capital is that part of working capital which is required to meet special exigencies such as launching of extensive marketing for conducting research, etc. Temporary working capital differs from permanent working capital in the sense that is required for short periods and cannot be permanently employed gainfully in the business.

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