Working capital management is significant in financial management due to the fact that it plays a vital role in keeping the wheel of the business running. Every business requires capital, without which it cannot be promoted. Investment decision is concerned with investment in current asset and fixed asset. There are two assets required to be financed by fixed capital and working capital. In other words, the required capital can be divided into two categories, such as fixed capital and working capital. Fixed capital required for establishment of a business, where as working capital required to utilize fixed asset. Fixed asset cannot be utilized without current asset. It is just like blood in the human body, without which there is no body.
Get Help With Your Essay
If you need assistance with writing your essay, our professional essay writing service is here to help!
Essay Writing Service
Working capital plays a key role in a business enterprise just as the role of heart of heart in human body. It acts as grease to run the wheels of fixed asset. Its effective provision can ensure the success of a business while its inefficient management can lead not only to loss but also unlimited downfall of what otherwise might be considered as a promising concern. In other words, efficiency of a concern depends largely on its ability to manage its working capital. Working capital management is there for one of the important facet of a firm’s over all financial management.
Meaning
Working capital refers to short term fund to meat operating expenses. To quote great Indian financial analyst and scholar Mr. Ramamoorthy, “it refers to the funds, which a company must possess to finance its day to day operations”. It is concerned with the management of the firm’s current asset and current liabilities. It relates to with the problems that arise in attempting to manage current assets, current liabilities and their inter relationship that exist between them. If a firm cannot maintain a satisfactory level of working capital, it is likely to become insolvent and may even be forced into bankruptcy.
Concepts of working capital
The concept of working capital has been a matter of great controversy, among the financial wizards and they view it differently. There is no universally accepted definition of working capital. Broadly there are to concepts of working capital commonly found in the existing literature of finance such as:
Gross Working Capital
Net Working Capital
Gross Working Capital concept
According to this concept, the total current assets are termed as the gross working capital or circulating capital. Total current asset include; cash, marketable securities, account receivables, inventory, prepaid expenses, advanced payment of tax. This concept also called as quantitative or broad approach. To quote Weston and Brigham, ” Gross Working Capital refers to firm’s investment in short term assets such as, cash, short term securities, account receivables and inventories “. The concept helps in making optimum investment in current assets and in their financing.
According to Walker, “use of this concept is helpful in providing for the current amount of working capital at the right time so that the firm is able to realize the greatest return on investment”.
Significance
Gross working capital concept focuses attention on the two aspect of current asset management. They are:
1). Optimum investment in current assets:
Investment in current asset must be just adequate to the needs of the firm. On the other hand excessive investment in current asset should be avoided.
2). Financing of current asset:
Need for working capital arise due to the increasing level of business activity. Therefore, there is a need to provide it quickly. If there is surplus fund arise that should be invested in short term securities.
Net Working Capital Concept
As per this concept the excess of current asst over current liabilities represents net working capital. Similar view is expressed by Guthmann, Gerstenberg, Goel Etc.
Net Working Capital represents the amount of current asset which remain after all the current liabilities were paid. It may be either positive or negative. It will be positive if current asset exceed current liabilities and vice versa.
To quote Roy Chowdry, “Net Working Capital indicates the liquidity of the liquidity of business whilst gross working capital denotes the quantum of working capital with which business has to operate.
Significance
Net Working Capital Concept focuses on two aspects. They are:
1). Maintaining liquidity position:
Excess current assets help in meeting its financial obligation within the operating cycle of the firm. Negative and excess working capitals both are bad to the firm.
2). To decide upon the extent of long term capital in financing current asset:
Net working capital means the portion of current asst that should be financed by long term funds. This concept helps to decide the extent of long term fund required in finance current assets.
Kinds of working capital
The categorization of working capital can be made either based on its concept or the need to maintain current asset either permanently and or temporarily. As per conceptual view it may be classified in to gross and net work in capital. Gestenberg has conveniently classified the working capital in to regular or permanent working capital and temporary or variable working capital.
Gross working capital or quantitative
Net working capital or qualitative
Temporary or variable working capital
Permanent or regular working capital
Types of working capital
Concept base
Time base
Permanent working capital
This is the minimum investment kept in the form of inventory of raw materials, work in process, finished goods, stores and spares and book debt to facilitate uninterrupted operation in a firm. Though this investment is stable in short run, it certainly varies in long run depending upon the expansion programs undertaken by the firm. It may increase or decrease over a period of time.
Temporary working capital
Any additional working capital apart from permanent working capital required to support the changing production and sales activities is referred to as temporary working capital. A firm required to maintain an additional amount current asset temporarily over and above permanent working capital.
Temporary
Permanent
Components of working capital
1). Current Asset
Current are those assets that in the ordinary course of business can be or will be turned into cash within an accounting period. It includes cash, marketable securities, inventories, sundry debtors, banks and prepaid expenses.
2). Current Liabilities
Current liabilities are those liabilities intent to be paid in the ordinary course of business within a reasonable period. It consist of sundry creditors, loans and advances, bank over draft, short term borrowing, taxes and proposed dividend.
Aspects of Working Capital Management
Management of working capital involves the following four aspects:
Determining the total fund requires to meet the current operations of the firm.
To decide the structure of current assets.
To evolve suitable policies, procedures and reporting system for controlling the individual components of current assets.
To determine the various sources of working capital.
Objectives of Working Capital Management
To ensure optimum investment in current assets.
To strike a balance between the twin objectives of liquidity and profitability in the use of funds.
To ensure adequate flow of funds for current operations.
To speed up the flow of funds or to minimize the stagnation of funds.
Operating cycle
The operating cycle involves the following procedure:
conversion of cash in to raw materials
conversion of raw materials in to work in progress
conversion of work in progress in to finished goods
conversion of finished goods in to sales
conversion of debtors in to cash
Finished goods
Work in process
Raw materials
cash
Sales
Debtor
Factors influencing working capital
Nature of business
Size of business
Production cycle process
Production policy
Credit policy or terms of purchase and sales
Business cycle
Growth and expansion
Scarce availability of raw materials
Profit level
Level of taxes
Dividend policy
Depreciation policy
Price level changes
Operating efficiency
Availability of credit
Need to maintain balanced working capital
For maximization profit or minimization of working capital cost or to maintain balance between liquidity and profitability, there is a need to maintain a balance in working capital. It should not be excessive or inadequate. Excessive working capital means idle funds that can earn no profit but involve cost, and inadequate working capital disturbs production and profitability.
Danger of excessive working capital
It results in unnecessary accumulation of inventories.
It is indication of defective trade policies and slack in collection period.
It makes management complacent which degenerates in to managerial inefficiency.
Accumulation inventories tend to make speculative profits grow.
Danger of inadequate working capital
It stagnate growth.
It becomes difficult to implement operating plans and achieve the firm’s target.
Operating inefficiencies creep in.
It leads to inefficient utilization of fixed assets.
Firm loses its reputation.
Essay Writing Service Features
Our Experience
No matter how complex your assignment is, we can find the right professional for your specific task. Contact Essay is an essay writing company that hires only the smartest minds to help you with your projects. Our expertise allows us to provide students with high-quality academic writing, editing & proofreading services.
Free Features
Free revision policy
$10Free bibliography & reference
$8Free title page
$8Free formatting
$8How Our Essay Writing Service Works
First, you will need to complete an order form. It's not difficult but, in case there is anything you find not to be clear, you may always call us so that we can guide you through it. On the order form, you will need to include some basic information concerning your order: subject, topic, number of pages, etc. We also encourage our clients to upload any relevant information or sources that will help.
Complete the order form
Once we have all the information and instructions that we need, we select the most suitable writer for your assignment. While everything seems to be clear, the writer, who has complete knowledge of the subject, may need clarification from you. It is at that point that you would receive a call or email from us.
Writer’s assignment
As soon as the writer has finished, it will be delivered both to the website and to your email address so that you will not miss it. If your deadline is close at hand, we will place a call to you to make sure that you receive the paper on time.
Completing the order and download