Working Capital (WC) in Business
Assessment of Working Capital Requirement
Any business entity requires two types of capital -‘fixed/permanent capital” for purpose of acquisition of fixed assets and other long term investments to run the business and ‘working capital’ for the purpose of carrying out it’s day- to-day operations.
Concept of Working Capital
Working capital is that part of the capital which is required to complete the whole operating cycle of an entity by maintaining certain level of inventories (such as raw materials, work-in-process, finished goods, stores and spares etc.), trade receivables and cash balance for its day-to-day operations. The term working capital is used as a gross as well as a net concept. Gross Working Capital represents the totality of fluctuating funds invested in all current assets in a business. Whereas net working capital refers to the excess of current assets over current liabilities and indicates the margin or buffer for meeting obligations within the ordinary operating cycle of the business. The total value of the current assets which is held by an entity in the balance sheet at any point of time, in crude terms, is called the Gross Working Capital (GWC). In other words, the total current assets which are locked up in the operating cycle of the entity can be defined as Gross Working Capital. Usually, the part of the current assets of an entity is supported by the current liabilities and other short-term sources of funds say bank borrowings, etc. and the gap (or difference)
between current assets and current liabilities is called the net margin of working capital. The sources of net margin of working capital financing are equity/long term funds. Working Capital is an elastic form of borrowing. It is elastic because working capital requirement fluctuate according to the needs of business of the borrower.Working capital is the cash that the business needs to “work.” Therefore, any trade utilised out or gave by WC is incorporated into the “money streams from working exercises”. Any adjustment in the equalisation of each detail of WC starting with one period then onto the next will influence a company’s money streams.
WC= Current Assets – Current Liabilities
WC is required for inventory, receivables and cash Management.
Nature of business, Production policy, Credit policy, Inventory policy, Abnormal factor, Market conditions, Conditions of supply, Business cycle, Taxation policy, Dividend policy, Operating efficiency, Price level changes, Depreciation policy, Availability of raw material are the factors that affects WC.
Amount of WC requirement mainly depends on (a) Size of the firm (b) Activities of the firm (c) Availability of credits
(d) Attitudes towards profit (e) Attitude toward risks (f) Others.
Smooth running of business, Profitability with manage risk, Growth and development possibility, Smooth payment, Increase in good will, Trade relationship better are the main importance of adequate working capital or optimum working capital.
The assurance of WC helps in figure, control& administration of WC. The term of WC may shift contingent on the idea of business.
The term of working cycle (WC cycle) to estimate WC is equivalent to the whole of span of each of above occasions less the credit time frame permitted by the provider.
For Example- A Company. holds Raw material on a normal for 60 days, it gets credit firm provider for 15 days, production process needs 15 days, completed items are hold for 30 days and 30 days is the total WC cycle. In this way, 60+15+30+30-15=120 days.
Purposes of Maintaining Working Capital
A manufacturing organization needs working capital for the following purposes:
(a) For purchase of raw materials,
(b) For purchase of stores and spares
(c)For keeping funds blocked under stock in process,
(d) For keeping funds blocked in finished stocks
(e)For keeping funds blocked in sundry debtors and receivables pending final realisation of the bills.
(f) For making advance payments to their suppliers for ensuring continuous supply of raw materials, stores etc.
(g) For meeting day to day expenses like payment of wages, power bills etc.
Need for Working Capital
It is needed for the smooth operation of the firm. Needed volume of working capital depends on the length of operating cycle. To get cash earlier small length of operating cycle is desired. Length of operating cycle depends on three factors: (a) Conversion of cash into inventory (b) Conversion of inventory into receivables (c) Conversion of receivables into cash.
Factors that influence Working Capital Requirement
The following factors affect the working capital requirement:
- Nature of industry
- The operating cycle
- The manufacturing cycle
- Production policies
- Shift in demand for products
- Competitive conditions
- Growth and expansion programs
- Operating efficiency
- Taxation
- Dividend policy
- Depreciation policy
- Price level changes
- Variation in supply of raw materials
Operating Cycle:
Operating cycle is the length of time between the entering into stock by procuring materials, labor, overheads, etc. and receiving cash from realisation of receivables and cash sales. Operating cycle starts with the cash and bank balances. It uses a part of the cash to acquire raw materials, to meet the various manufacturing costs, etc. Raw materials are converted into finished goods through work-in-process. Finished goods get sold and become receivables. On realization, receivables turn into cash. The cycle will repeat itself as the business goes on.
Cash—-> SRM =Purchase raw material, pay to Suppliers—-> WIP Pay workforce, overhead, other expense—–>Stock of Finished Goods—–> Receivable= Sells goods on Credit
The span of the operating cycle covers: (a) Raw Materials (RM) holding period (b) Processing period (c) Finished Goods (FG) holding period (d) Credit allowed to customers in days (e) Credit obtained from creditors in days.