MGT601 SME MANAGEMENT

Lesson 25 Working Capital

Chapter Learning Objectives This lecture deals with; Meaning of Working Capital Different Senses of “Working Capital” Significance of Working Capital Factors Affecting Working Capital Requirements Determination of Working Capital Needs Ingredients of Working Capital Management in Small Enterprise

Working Capital Working capital management or current asset management is one of the most important aspects of overall financial management in an enterprise. It is basically concerned with the management of current assets and current liabilities and inter relationship between them.

Meaning of Working Capital Working capital is the amount of funds needed by an enterprise to finance its day to day operation. It is the part of capital employed in short-term operation such as raw materials, semi finished products, sundry debtors. Because of its variable nature, the working capital is also referred to as circulating capital.

Continued… The total working capital is composed of two parts. 1) Regular Capital 2) Variable Capital

1. Regular Capital Regular Working capital is required for permanent investment in any business for holing certain minimum quantity of raw material, finished product or cash. Such investment is irreducible minimum and remains permanently sunk into business.

2. Variable Capital The variable portion first gets tied up into raw materials which are then converted into finished goods. On the sale of goods it gets converted into account receivables or cash and circle is then completed.

Different Senses of “Working Capital” Gross Working Capital Net Working Capital

1. Gross Working Capital It represents total value of current assets. In other words, it is the sum total of net working capital and current liabilities. It is a quantities concept showing the total amount available for financing the current assets. It cannot reveal the true position of the company. For instance, every increase in borrowings will increase the gross working capital but net working capital will remain the same.

2. Net Working Capital It represents excess of current assets over current liabilities. Current assets include cash, debtors, stock, and bills receivable, Current liabilities include bills payable, accounts payable, expenses payable. It indicates the liquidity position of an enterprise i.e. the soundness or otherwise of the current financial position.

Continued… The ratio of 2:1 between current assets and current liabilities is considered sound. The concept of net working capital is quantitative concept indicating firm’s capacity to meet operating expenses and current liabilities. Net working capital is increased only when there is an increase in current assets without corresponding increase in current liabilities. Net Working Capital = Current assets – Current liabilities.

Significance of Working Capital Conversion of cash into inventory. Conversion of inventory into receivable. Conversion of receivable into cash.

Factors Affecting Working Capital Requirements Size of Business Nature of Process Proportion of Raw Materials and Total Cost Terms of Sale & Purchase Turnover of Inventories

Factors Affecting Working Capital Requirements…. Labour Vs. Capital Intensive Cash Requirements Banking Facilities Seasonal Requirements Contingencies

Determination of Working Capital Needs Working capital requirements of a small enterprise vary from unit to unit and in accordance with the difference on the nature of the enterprise. Broadly speaking, working capital should be adequate to meet operating expenses like raw materials, labour, factory and other overheads etc. Operating expenses can be ascertained from the final accounts of the firm. But the working capital requirements needs not be equal to the level of expenses.

Working Capital Requirement Formula Operating Expense in previous year = _____________________________ number of operating Cycles in year

Ingredients of Working Capital Management in Small Enterprise Budget the Material Requirements Production Goes on Uninterrupted Realize Cash Fast Follow the Bills Identify Surplus Cash Working Capital Sources

Thanks you Happy Learning, Keep Learning