Working capital

The capital oI a business that is used in its day-to-day trading operations, calculated as the
current assets minus the current liabilities.
'Working capital is an excess oI current assets over current liabilities. In other words, the
amount oI current assets which is more than current liabilities is known as Working Capital. II
current liabilities are nil then, working capital will equal to current assets. Working capital shows
strength oI business in short period oI time. II a company have some amount in the Iorm oI
working capital, it means Company have liquid assets, with this money company can Iace every
crises position in market. "
Working Capital Current Assets - Current Liabilities
Current Assets

Current assets are those assets which can be converted into cash within One year or less than one
year. In current assets, we include cash, bank, debtors, bill receivables, prepaid expenses,
outstanding incomes.
Current Liabilities

Current Liabilities are those liabilities which can be paid to respective parties within one year or
less than one year at their maturity. In current liabilities, we includes creditors, outstanding bills,
bank overdraIt, bills payable and short term loans, outstanding expenses, advance incomes .

Some ProIessional accountants know working capital as operating capital, operating liquidity,
positive working capital.

Important things about Working Capital

1. Working Capital can be negative. At that time, We add one word 'deIiciency" in the back oI
working capital. It means iI Current Liabilities are more than current assets, it is known as
working capital deIiciency or inverse working capital or negative working capital.

2. Working capital can be easily adjusted, iI Accounts manager knows diIIerent techniques oI
managing working capital. He can try to get short term loan or he can increase working capital
by proper management oI inventory and outstanding incomes and debtors.

3. Working capital can also change by Changing in Cash Conversion period. Cash conversion
period is a period in which company changes current assets into cash or bank.

4. Working capital can also positive by increasing growth rate oI company. II company does not
invest more money and increase proIit, the same amount will increase in the cash position oI
company and with cash company can increase their working capital position.


Estimating working capital needs
There are number oI methods Ior calculating working capital but three methods are appropriate
Ior calculating working capital.
Current asset holding period: - To estimate working capital requirement on the basis oI
current asset and relating them to costs based on the company`s experience in the
previous years. This method is essentially based on the operating cycle concept.

#atio of sales:- To estimate working capital requirements as a ratio oI sales on the
assumption that current asset change with sales.

#atio of fixed investment:- To estimate working capital requirements as a percentage oI
Iixed investment.

TYPES OF WC

ross working capital
Total or gross working capital is that working capital which is used Ior all the current
assets. Total value oI current assets will equal to gross working capital. In simple words,
it is total cash and cash equivalent on hand. But remember, we do not account oI current
liabilities in gross working capital.

et Working Capital
Net working capital is the excess oI current assets over current liabilities.
Net Working Capital Total Current Assets Total Current Liabilities
This amount shows that iI we deduct total current liabilities Irom total current assets, then
balance amount can be used Ior repayment oI long term debts at any time. It also measure
oI both a company's eIIiciency and its short-term Iinancial health.

Permanent Working Capital

Permanent working capital is that amount oI capital which must be in cash or current
assets Ior continuing the activities oI business. It also shows the minimum amount oI all
current assets that is required at all times to ensure a minimum level oI uninterrupted
business operations.

Temporary Working Capital

Sometime, it may possible that we have to pay Iixed liabilities, at that time we need
working capital which is more than permanent working capital, then this excess amount
will be temporary working capital. In normal working oI business, we don`t need such
capital.

egative working capital

The state where a company is basically operating with no capital because the Company`s
liabilities exceed the available assets. A company cannot operate with negative working
capital Ior an extended period oI time because the company will be unable to meet
payment requirements on certain liabilities iI the additional Iunds are not acquired. A
company can quickly identiIy this state by looking at the accounts receivable inIormation
and comparing that to accounts payable inIormation.

SIIFICACE OF WO#I CAPITAL
Investment in Iixed assets only is not suIIicient to run the business. Working capital or
investment in current assets, howsoever small it is, is a must Ior purchase oI raw
materials, and Ior meeting the day-to-day expenditure on salaries, wages, rents,
advertising etc., and Ior maintaining the Iixed assets. 'The Iate oI large scale investment
in Iixed capital is oIten determined by a relatively small amount oI current assets.
Working capital is just like a heart oI industry iI it is weak; the business cannot prosper
and survive, although there is a large body (investment) oI Iixed assets. Moreover, not
only the existence oI working capital is a must Ior the industry, but it must be adequate
also. Adequacy oI the working capital is the liIeblood and controlling nerve center oI a
business. Inadequate as well as redundant working capital is dangerous Ior the health oI
industry. It is said, Inadequate working capital is disastrous; whereas redundant working
capital is a criminal waste`. Both situations are not warranted in a sound organization.
The advantages oI working capital or adequate working capital may be enumerated as
below:
It creates a Feeling of Security and Confidence:
The proprietor or oIIicials or management oI a concern are quite careIree, iI they have
proper working capital arrangements because they need not worry Ior the payment oI
business expenditure or creditors. Adequate working capital creates a sense oI security,
conIidence and loyalty, not only throughout the business itselI, but also among its
customers, creditors and business associates.
ust` for aintaining Solvency and Continuing Production:
In order to maintain the solvency oI the business, it is but essential that the suIIicient
amount t oI Iund is available to make all the payments in time as and when they are due.
Without ample working capital, production will suIIer, particularly in the era oI cut throat
competition, and a business can never Ilourish in the absence oI adequate working
capital.
Sound oodwill and Debt Capacity:
It is common experience oI all prudent businessmen that promptness oI payment in
business creates goodwill and increases the debt oI the capacity oI the business. A Iirm
can raise Iunds Irom the market, purchase goods on credit and borrow short-term Iunds
Irom bank, etc. II the investor and borrowers are conIident that they will get their due
interest and payment oI principal in time.
Easy Loans from the Banks:
An adequate working capital i.e. excess oI current assets over current liabilities helps the
company to borrow unsecured loans Irom the bank because the excess provides a good
security to the unsecured loans, Banks Iavor in granting seasonal loans, iI business has a
good credit standing and trade reputation.
Distribution of Dividend:
II company is short oI working capital, it cannot distribute the good dividend to its
shareholders in spite oI suIIicient proIits. ProIits are to be retained in the business to
make up the deIiciency oI working capital. On the other contrary, iI working capital is
suIIicient, ample dividend can be declared and distributed. It increases the market value
oI shares.
Exploitation of ood Opportunity:
In case oI adequacy oI capital in a concern, good opportunities can be exploited e.g.,
company may make oII-season purchases resulting in substantial savings or it can Ietch
big supply orders resulting in good proIits.
eeting Unseen Contingency:
Depression shoots the demand oI working capital because stock piling oI Iinished goods
becomes necessary. Certain other unseen contingencies e.g., Iinancial crisis due to heavy
losses, business oscillations, etc. can easily be overcome, iI company maintains adequate
working capital.
igh orale:
The provision oI adequate working capital improves the morale oI the executive because
they have an environment oI certainty, security and conIidence, which is a great
psychological, Iactor in improving the overall eIIiciency oI the business and oI the person
who is at the hell oI Iairs in the company.
Increased Production Efficiency:
A continuous supply oI raw material, research programme, innovations and technical
development and expansion programmes can successIully be carried out iI adequate
working capital is maintained in the business. It will increase the production eIIiciency,
which will, in turn increases the eIIiciency and morale oI the employees and lower costs
and create image among the community.
Approaches to financing working capital
There are three approaches to Iinancing working capital
Aggressive approach to financing working capital
The aggressive method is where a company predominantly Iinances all its
Fluctuating current assets and most oI its permanent current assets using short term
source oI Iinance and it is only a small proportion oI its permanent current assets that is
Iinanced using long-term source oI Iinance.
A company that uses more short-term source oI Iinance and less long-term Source
oI Iinance will incur less cost but with a corresponding high risk. This has the eIIect oI
increasing its proIitability but with a potential risk oI Iacing liquidity problem should
such short-term source oI Iinance be withdrawn or renewed on unIavorable terms.


Aggressive Iinancing

Conservative approach to financing working capital
The other extreme method oI Iinancing working capital is where a company
decides to use mainly long-term source oI Iinance and very little short-term source oI
Iinance to Iinance its working capital. This option means that the company`s Iinance is
going to be relatively high cost (that is sacriIicing low cost Iinance) but low risk; this will
make the company`s proIit to be low but does not run the risk oI being Iaced with
liquidity problem as a result oI withdrawal oI its source oI Iinance.
The conservative method is where a company predominantly Iinances all its
permanent current assets and most oI its Iluctuation current assets using long term source
oI Iinance and it is only a small proportion oI its Iluctuating current assets that is Iinanced
using short-term source oI Iinance.

oderate approach to financing working capital
Between the two extreme approaches to Iinancing working capital is the Moderate
(or the matching or balancing) approach. This approach makes Distinction between
fluctuating current assets and permanent current assets with the suggestion that to
Iinance working capital; short-term source oI Iinance should be used to Iinance
Iluctuating current assets, whiles long-term source oI Finance should be used to Iinance
permanent current assets. This matches the Source oI Iinance with the character oI the
current assets.