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two categories, e.g., (i) Gross Working Capital and (ii) Net Working
Capital. There are also two other types of working capital: (i) Permanent,
(ii) Temporary working capital.
(i) Gross Working Capital-- It refers to the companys total funds
required for maintaining current assets, such as--cash, marketable
securities, bills receivables, inventories, etc., which are normally
converted into cash within an accounting year.
(ii) Net Working Capital-- Net working capital is the excess of
current assets over current liabilities. In other words, it is that
portion of a firms current assets which is financed by long term
funds. It may be either positive or negative.
(iii)
Permanent Working Capital-- It refers the irreducible
minimum amount which is permanently blocked in the business
and that cannot be converted into cash in the normal course of
business. It represents the current assets required on a continuing
basis over the entire year. Since it is permanently needed for the
business operations and financed by long-term funds.
(iv)Temporary Working Capital-- It is also called variable working
capital. Any amount over and above the permanent level of
profit for it while inadequate working capital means that the enterprise
does not have sufficient funds for financing it daily business activities,
which ultimately results in production interruptions and reduced
productivity.
1. Increase in Goodwill and Debt Capacity Rapidity in payments
creates goodwill and increases the debt capacity of the firm. Regular
availability of adequate working capital creates confidence among
investors and lenders that they will get their due interest and principal in
time. Thus, a firm with adequate working capital can raise the requisite
funds from market, borrow short-term credit from banks and purchase
inventories of raw materials for the business.
2. Loans from Financia1 Institutions-- The presence of adequate
working capital and current assets help a company to raise unsecured and
secured loans from financial institutions and arrange loans from the banks
on easy and favourable terms.
3. Increased Efficiency-- If adequate working capital is maintained in
the business, the firm can successfully carry out its operations, research
and development programmes etc., which would lead to increased
production efficiency. Production efficiency, in turn, will increase the
also increases the value of shares. In other hand, a company not having
adequate working capital cannot distribute attractive dividend in spite of
sufficient profits.
8. Confidence and Security -- Adequate working capital creates a
confidence and security not only among the business executives but also
among the customers, creditors.
9. Availing Cash Discount The firm can avail the advantage of cash
discount by making cash payments for to the suppliers of raw material and
merchandise. It will reduce the cost of production and increase the profits
of the firm.
Factors determining working capital
These are the factors which determine the proper amount of working
capital:
1. Nature of Business - An adequate amount of working capital
requirements of an enterprise are basically related to the nature of its
business. Trading concerns require large amount of working capital and
they also have to keep large amounts of cash. Conversely, the public utility
Cash
Finished goods
Cash
(1)
Raw
Materials
Work-inProgress
Operating Cycle
As explained earlier, this is the best technique for estimating future cash
working capital of a firm. Under this method, the computation of total
operating expenses, operating cycle period and number of operating
cycles in the year is essential for estimating the amount of working
capital:
(1)
Operating Expenses - It includes purchase of raw
materials, direct labour cost, fuel and power, administrative and selling
and distribution expenses for a specific period for which estimates can
be obtained from cost records. Depreciation, write off of intangible
assets are not included in these expenses because these are non-cash
items. Similarly, tax and dividend being appropriation of profits are also
excluded from these expenses.
(2)
Operating Cycle Period - It means the total
number of days involved in the different stages of operation
commencing from the purchase of raw materials and ending with
collection of sale proceeds from debtors after adjusting the number of
days credit allowed by suppliers. Thus, the operating cycle is the total
period involved in different stages of operations which may be
calculated by using the following formula-OC = M + W + F + D - C
Here; OC = Operating Cycle Period
M = Material Storage Period
W = Work-in-Process or Conversion Period
F = Finished Goods Storage Period
D = Debtors Collection Period
C = Creditors Payment Period
Material Storage Period (M) =
=
Or,
Or,
Or
Current Assets
Rs.
(c) Overheads
(c) Overheads
....
......
(iv) Sundry debtors or Receivables (formonths sales)
(a) Raw Material
(b)Labour
(c) Overheads
..
(v)
Payments
in
Advance
(if
any)
..
expenses)
...
XXX
(B) Current Liabilities
(i) Creditors (formonths purchase of raw material) *
(ii) Lag in payment of expenses (outstanding expenses) *
(iii) Others (if any)
XXX
Net Working Capital (A) (B)
**
Add: Provision for Contingencies
*
Total Working Capital Required
***
liabilities side is more than the total of assets side, it represents excess
cash which is not required by the firm. But, if the total of assets side is
more than the total of liabilities side, then it indicates the deficiency of
working capital.
(D) Adjusted Profit and Loss Method In this method, estimated profit
is calculated on the basis on transactions of the ensuing period. Thereafter,
increase or decrease in working capital is computed adjusting the
estimated profit by cash inflows and cash outflows. A few banks in India
use the forms for computing working capital under this method.
Computation of Working Capital
Net Income
Add: Non-cash items
Working Capital provided by Operations
Add: Cash Inflow items
Rs.
..
..
..
..
...