What is Working Capital?


Working Capital

First of all, let's thanks to the person 'Hema Sai' who contributes his time and knowledge to simplify this topic.

Meaning of working capital:

            Working capital means the amount available for day-to-day operations or activities of the business.

             It is also known as revolving capital to meet the day-to-day requirements of the business.

       It is also an indicator of a company's ability to meet its short-term obligation.

        The process of managing activities and procedures that relate to working capital is called working capital management.

       This management helps the company to maintain stability in the company's cash flow in a short-term period.

         The formula for working capital=current assets -current liabilities.

    The items that are covered in current assets are 
A. Inventory
B. Raw materials
C. Work in progress
D .Debtors
E .cash and bank balance etc 

    The items that are covered in current liabilities are 
A. Commercial banks
B. Creditors
C. Advances etc

Types of working capital:

1. Gross working capital
2.Net working capital

Gross working capital:

   The assets that are converted or turned into cash within one accounting year are known as gross working capital.

        Gross working capital= Total amount of current assets.

Net working capital:

       It is the difference between current assets and current liabilities. It represents the company's liquidity position. It is for the long term. 

Sources of working capital 
1. Permanent source
2. Temporary source

Permanent source

         A permanent source of working capital is to provide long-term financial stability. some of the long-term sources are 
a. Shares
b. Debentures
c. Public deposit
d. Retain of profits
e. Loans from financial institutions.

Temporary source

        A temporary source of working capital is for short-term plans. some sources are 

b. Commercial banks
c. Trade credits
d. Commercial paper

         Working capital management is mainly dependent on three factors. They are 

1. Profitability
2. Liquidity
3. Structure of the business

          If the working capital is less than the requirement then the company assets are insufficient to meet its short-term obligation which may lead to disturbances in the business. Also if the company maintains more than the required amount of working capital then the company can't invest more in its fixed assets.

      The management of working capital policies is connected with some conditions such as 

A. Connected with profitability, liquidity, and firm risk.
B. Connected with current assets
C. Connected with current liabilities.

The objective of working capital

A. To know the operating cycle period of the company.
B. To know the current assets investment policy of the company
C. To know the increase and decrease in current assets

    To know the turnover in working capital there is also a formula i;e 
Working capital turnover ratio=sales/net current assets.

 Similarly to know the liquidity of a company there are some ratios such as:

A. Current ratio =current assets/current liabilities
It measures the liquidity of a company.
       The conventional rule of the current ratio is 2:1

B. Quick ratio=Current assets-inventory /current liabilities
It is the proportion of quick assets to quick current liabilities of the company.
         The conventional ratio of quick ratio is 1:1

C . Total assets turnover ratio=sales/total assets
It measures the efficiency of a company's assets in generating revenue.

D.Inventory turnover ratio =Net sales/inventory.

It determines the number of times inventory is purchased and sold in a financial year.

     Approaches to working capital
There are three types of approaches in working capital. They are 

1. Matching approach  
         In this approach, long-term financing is used to fund fixed assets and permanent current assets.

2. Conservative approach
        In this approach, long-term financing can be placed in tradable securities to save liquidity and also some portion in funding permanent assets.

3. Aggressive approach 
       In this approach short-term financing is utilized to place some portion in the company's long-term current liabilities.

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