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The term working capital refers to Net

working capital, i.e. current assets less current liabilities. The level of net working capital has a bearing on the profitability as well as the risk in the sense of the inability of the company to meet an obligation as & when they become due.

To minimize the amount of capital employed in financing current assets.

To manage the current assets in such a way that

the marginal return on investments in those assets is not less than the cost and capital acquired to finance them. To maintain the proper balance between the amount of current assets and current liabilities in such a way that the firm is also able to meet its financial obligations.

Fixed Capital and Working Capital differ in Discounting and compounding not important
Increases liquidity although affects profitability
Can be adjusted with sales fluctuations in the short run

Current Assets and Current Liabilities:

Represents assets which can be converted into cash

in less than a year Includes cash, short-term securities, debtors, bills receivables and stock Represents claims of outsiders expected to mature for payment within a year Includes creditors, bills payable, bank overdraft and outstanding expenses

Concepts of Working Capital:

Gross Working Capital:
Investments in current assets Net Working Capital: Difference between current assets and current liabilities Can be Positive or Negative

Current Asset Management:

Needs keep fluctuating Optimum investment in current assets Financing current assets

Brings liquidity Generates idle investment.

Threatens solvency of the firm Inability to meet current obligations

The working capital management is created a feeling of security and confidence in the management. By making cash purchase cash discount can be claimed.
It increases goodwill and debt capacity of the business. It will make easy to obtain bank loan from banks.

Operating Cycle:
The time duration required to convert sales, after the conversion of resources into inventories, into cash.

Involves three phases:

Acquisition of Resources

Manufacturing the Product

Sales of the Finished Product

Length of the Operating Cycle:

Influenced by:
Inventory conversion period: (a) Time required to produce and sell the product (b) Includes Raw material conversion period, WIP conversion period and Finished goods conversion period Book debts conversion period: (a) Time required to collect outstanding amount

Types of capital based on operating cycle:

Permanent Working Capital:

(a) Minimum level of current assets continuously required for carrying on business operations Fluctuating Working Capital:

(a) Extra capital needed to support changing production and sales activities

Early warning signs include:

Pressure on existing cash Exceptional cash generating activities e.g. offering high discounts for cash payment Bank overdraft exceeds authorized limit

Seeking greater overdrafts or lines of credit

Contd. 12

Adequacy of Working Capital:

Adequacy implies having the right amount of working capital

Excess funds results in idle capital


Dangers of Inadequate Working Capital:

Difficult to achieve profit targets

Ineffective utilization of fixed assets

Loss of reputation


Determinants of Working Capital:

Nature and size of business Sales Growth Demand Conditions

Production Policy


Operating efficiency and performance

Price level changes Firms credit Policy

Availability of credit