Meaning of Working Capital
Every business needs funds for two purposes for its establishment and to carry out its day-to-day operations. Capital required for a business can be classified under two main categories viz.
(i) Fixed capital
(ii) Working capital.
Long-term funds are required to create production facilities through purchase of fixed assets such as plant and machinery, land, Building etc. Investments in these assets represent that part of firm’s capital which is blocked on permanent basis and is called fixed capital.
Funds are also needed for short-term purposes for purchase of raw materials, payment of wages and other day-to-day expenses etc. These funds are known as working capital which is also known as Revolving or circulating capital or short term capital. According to Shubin, “Working capital is amount of funds necessary to cover the cost of operating the enterprise”.
Working Capital = Current Assets – Current Liabilities
When current assets exceed the current liabilities the working capital is positive and negative working capital results when current liabilities are more than current assets. Examples of current liabilities are Bills Payable, Sunday debtors, accrued expenses, Bank Overdraft, Provision for taxation etc. Net working capital is an accounting concept of working capital.
CONSTITUENTS OF CURRENT ASSETS
1) Cash in hand and cash at bank
2) Bills receivables
3) Sundry debtors
4) Short term loans and advances.
5) Inventories of stock as:
a. Raw material
b. Work in process
c. Stores and spares
d. Finished goods
6. Temporary investment of surplus funds.
7. Prepaid expenses
8. Accrued incomes.
9. Marketable securities.
CONSTITUENTS OF CURRENT LIABILITIES
1. Accrued or outstanding expenses.
2. Short term loans, advances and deposits.
3. Dividends payable.
4. Bank overdraft.
5. Provision for taxation , if it does not amt. to app. Of profit.
6. Bills payable.
7. Sundry creditors.
The Need or Objects or Working Capital
The need for working capital arises due to time gap between production and realisation of cash from sales. There is an operating cycle involved in sales and realisation of cash. There are time gaps in purchase of raw materials and production, production and sales, and sales and realisation of cash. Thus, working capital is needed for following purposes.
- For purchase of raw materials, components and spares.
- To pay wages and salaries.
- To incur day-to-day expenses and overhead costs such as fuel, power etc.
- To meet selling costs as packing, advertisement.
- To provide credit facilities to customers.
- To maintain inventories of raw materials, work in progress, stores and spares and finished stock.
Working Capital Cycle :-
Cash Raw materialwork in progressFinished goods/stocksDebtors
The determination of WC helps in forecast, control& management of WC. The duration of WC may vary depending upon the nature of business. The duration of operating cycle (WC cycle) for the purpose of estimating WC is equal to the sum of duration of each of above events less the credit period allowed by the supplier.