USA: +1-585-535-1023

UK: +44-208-133-5697

AUS: +61-280-07-5697

Concepts of working capital

The first and foremost objective of the financial management is to maximise the wealth of shareholders. It is possible only when the company earns sufficient profit. The profitability of the organisation fully depends upon the magnitude of sales. However, sales are not converted  into cash immediately. Because there is a time gap between the sala of goods and receipt of cash. During the time gap a certain amount is required to sustain the sales volume on a regular basis. That amount is known as working capital. Suppose adequate working capital is not available, the company will not be in a position to maintain the sales volume at an expected level.

 

Simply, working capital means circulating capital or revolving capital. In other words, working capital means amount required for the day-to-day expenses of the business activities.

 

According to J.S.Mill, the sum of current assets is the working capital of a business. (Working capital is the amount of funds necessary to cover the cost of operating the

enterprise” says Shubin.

 

Gesterrberg defines, Working capital is the excess of current assets over current

liabilities.

 

Simply, Net Working Capital = Current Assets – Current Liabilities.

 

CONCEPTS OF WORKING CAPITAL

 

(i) Gross Working Capital (ii) Net Working Capital

 

(i) Gross Working Capital

 

The Gross working capital refers to working capital which represents investment in current assets such as marketable securities, inventories and bills receivables.

 

(ii) Net Working Capital

 

Net working capital refers to working capital. It is the excess of current assets over current Liabilities. This is the most commonly accepted definition.

 

TYPES OF WORKING CAPITAL

 

Working capital can be divided into two categories on the basis of time.

(i) Permanent working capital or core current assets

(ii) Temporary or variable working capital

 

(i) Permanent Working Capital

 

Permanent working capital refers to that minimum amount of investment in all current assets which is required to carry out minimum level of business activities on a permanent basis. In other words, certain current assets which are retained by the organisation on a continuous basis is called permanent working capital or core current assets.

 

(ii) Temporary or Variable Working Capital

 

Temporary working capital is an investment in current assets which are fluctuating from time to time on the basis of the operations of the business. The capital, required to meet the seasonal needs of a firm, is called seasonal working capital or temporary working capita . In other words, the amount of working capital which will vary from time to time depending upon the level of business activities, is known as variable working capital.

 

 

OPERATING CYCLE

 

Modern business enterprises face severe competitions. They produce goods based upon the demand. In this respect, all manufactured goods are not sold immediately. And at the same time, cash for sales is also not realised immediately. From the purchase of raw material to the conversion of cash, certain time gap is taken. This time gap is technically known as operating cycle of the business.

 

Stages of Operating Cycle

 

(i) Conversion of cash into raw materials

(ii) Conversion of raw materials into work in progress

(iii) Conversion of work in progress into finished goods

(iv) Conversion of finished goods into debtors

(v) Conversion of debtors into cash