WORKING CAPITAL – AN OVERVIEW:
Finance being the life blood for an organization, every organization needs it both for short term purpose as well as long term purpose.
Long term purpose includes funds used to create production facilities such as purchasing plant, building or other fixed assets. It represents the fixed capital of a business. Whereas Short term needs on the other hand includes funds required to finance the current assets such as cash, bank receivables, debtors etc.
Thus the capital utilized to meet the short term or current asset requirements of an organization are also termed as working capital requirements. According to Hoagland, working capital is a descriptive of that capital which is not fixed. It is defined as a difference between book value of current assets and current liabilities.
CONCEPTS OF WORKING CAPITAL:
There are basically two main concepts of working capital.
Balance sheet concept:
Under balance sheet concept the working capital is classified into following two broad categories.
GROSS WORKING CAPITAL
The term working when used in a broader sense is also termed as gross working capital. Gross working capital is defined as total amount of capital to be invested in the current assets.
Current assets are the assets which can be easily converted into cash within a short period of time say one accounting year. The main constituents of current assets includes
- Cash in hand
- Cash receivables
- Short term loans and advances
- Prepaid expenses
- Accrued income
Benefits of gross working capital:
- It helps in arranging correct amount of capital required for working capital requirement.
- It is also helpful in determining the actual rate of return on working capital invested.
NET WORKING CAPITAL
In narrower sense, the working capital is referred as net working capital. It may be defined as an excess of current assets over current liabilities.
Net working capital = current assets – current liabilities
It can be positive or negative. If the total current assets exceeds the total current liabilities, the working capital is positive on the other hand when the current liabilities exceeds current assets, the working capital is said to be negative.
Benefits of net working capital:
- It is the great indicator of how much financially sound a business is.
- It also indicates the firm’s ability to meet short term capital needs whenever the need arises.
Operating cycle concept
When it comes to a manufacturing concern, operating cycle may be defined as the average time intervening between the acquisition of material or services entering the process and the final cash realization from the sale of finished goods.
Working capital is basically that part of capital which is used to finance the current asset requirements. Funds invested in current assets thus, revolve in very fast manner. Funds convert are into current assets and then gain converted into cash and that cash is utilized to invest in other current assets. This circular flow of capital is totally based upon the operating cycle.