BF 4

• " Working capital is the excess of current assets over current liabilities". Working capital is the difference between current assets and current liabilities.
• TWO TYPES OF WORKING CAPITAL QUALITATIVE / QUANTITATIVE
• Quantitative - amount of working capital refers to ‘the total current assets’.
• Qualitative - gives an idea regarding source of financing capital. It refers to ‘excess of current assets over liabilities’.
• Current Assets

  • assets that have a short term span, it engaged in current operation of a business and normally used for short term or within twelve months.
• Current Liabilities

  • firm creates a current liability towards creditor from whom it has purchased raw materials on credit. Also known as accounts payable.
• TWO TYPES OF WORKING CAPITAL:

  • On the basis of periodicity

  • On the basis of concept
• Periodicity

  
  

  The requirements of working capital are continuous. More working capital is required in a particular season or the peck period of business activity
• Permanent Working Capital This type of working capital is known as Fixed Working Capital.
• Regular Working Capital

  Minimum amount of working capital required to keep the primary circulation.
• Reserve Margin Working

  Capital Is the excess of capital over the needs of the regular working capital is kept aside as reserve for contingencies, such as strike, business depression etc.
• Variable / Temporary Working Capital

  Variable working capital refers to the capital invested temporarily in a business, often seasonal, to meet seasonal demand.
• Seasonal Variable Working Capital

  This is a reference to the extra operating capital that a firm requires during the busiest time of the year.
• Special Variable Working Capital

  These kinds of working capital are used by businesses to cover unique and unforeseen expenses.
• Gross Working Capital

  Refers to total investment in current assets.
• Net Working Capital

  Means current assets minus current liabilities.
• 1. Nature of Companies The composition of an asset is a function of the size of a business and the companies to which it belongs.
• 2. Demand of Creditors

  Creditors are interested in the security of loans. They want their obligations to be

  sufficiently covered.
• 3. Cash Requirements

  Cash is one of the current assets which are essential for the successful operations of the

  production cycle
• 4. Nature and Size of Business

  The working capital requirements of a firm are basically influenced by the nature of its business. Trading and financial firms have a very less investment in fixed assets, but require a large sum of money to be invested in working capital.
• 5. Time

  The level of working capital depends upon the time required to manufacturing goods.

  If the time is longer, the size of working capital is great.
• 6. Volume of Sales

  This is the most important factor affecting the size and components of working capital
• 7. Terms of purchases Sales

  If the credit terms of purchases are more favourable and those of sales liberal, less cash will be invested in inventory.
• 8. Business Cycle

  Business expands during periods of prosperity and declines during the period of depression.
• 9. Production Cycle

  The time taken to convert raw materials into finished products is referred to as the production cycle or operating cycle
• 10. Liquidity and Profitability

  A firm should choose between liquidity and profitability and decide about its working capital requirements accordingly
• 11. Seasonal Fluctuations

  Seasonal fluctuations in sales affect the level of variable working capital.
• OPERATING CYCLE

  The duration of time required to complete the sequence of events right from purchase of raw material / goods for cash to the realization of sales in cash is called the operating cycle, working capital cycle or cash cycle
• LIQUIDITY VS PROFITABILITY: Risk - Return Tangle

  The firm would make just enough investment in current assets, if it were possible to estimate working capital needs exactly.
• Solvency,

  used in the technical sense, refers to the firm’s continuous ability to meet maturing obligations.
• Profitability,

  the firm may sacrifice solvency and maintain a relatively low level of current assets.
• The Cost of Trade - Off

  A different way of looking into the risk-

  return trade of is in terms of the cost of maintaining a particular level of current assets.
• 1. If the firm carries too much liquidity, the firm’s rate of return will be low.
• 2. If the firm carries too little cash, it may not be able to pay bills promptly at they mature. This may force the firm to borrows at high rates of interest and firm into insolvency
• If the firm’s inventory level too low, sales may be lost and customers may shift to competitors.