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A Study on Working Capital

A Study on Working Capital

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12/15/2010

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A STUDY ON WORKING CAPITAL
Introduction: 
working capital is of vital significance. It has been observed by Schall and Haley that“managing current assets requires more attention than managing plant and equipmentexpenditure mismanagement of current assets can be costly. Too large an investment incurrent assets means typing up capital that can be used productively else where on theother hand too little investment can be also be expensive”.
Meaning of working capital:
Capital required for a business can be classified two main categories viz., (i ) Fixed Capital and (ii) Working CapitalEvery business needs funds for two purposes for its establishment and to carry out itsday-to-day operations. Long-term funds are required to create production facilitiesthrough purchase of fixed assets such as plant and machinery, land, building, furniture,etc. Investments in theses assets represent that part of firm’s capital which is blocked on a permanent of fixed basis and is called fixed capital. Funds are also needed for short-term purposes for the purchase of raw materials, payment of wages and other day-to-dayexpenses etc. These funds are known as working capital. working capital refers to partof the firm’s capital which is required for financing short term or current assets such ascash, marketable securities, debtors and inventories. Funds, thus invested in current assetskeep revolving fast and are being constantly converted in to cash and this cash flows outagain in exchange for other current assets. Hence, it is also known as resolving or circulating capital or short-term capital.In the words of Shubin, “working capital is the amount of funds necessary to cover thecost of operating the enterprise”.According to Genesten berg, “circulating capital means current assets of a companythat are changed in the ordinary course of business from one from to another, as for example, from cash to inventories, inventories to receivables, receivables in to cash”.
Working capital definitions:
The following are the some of the definitions given for working capital by experts inthe area of financeJ.S.Mill: “The sum of the current assets is the working capital of a business”.
 
Bonneville and Dewey: “Any acquisition of funds which increases the current assets,increased working capital, for they are one and the same”.C.W.Gerstenberg: “working capital has ordinarily been defined as the excess of currentassets over current liabilities”.
Concepts of working capital: 
There are two concepts of working capital:(A)Balance sheet concept.(B)Operating cycle or circular flow concept.(A)Balance sheet concept.There are two interpretations of working capital under the balance sheet concept:(i) Gross working capital.(ii) Net working capital.The term working capital refers to the gross working capital and represents theamount of funds invested in current assets. Thus, the gross working capital is the capitalinvested in total current assets of the enterprise. Current assets are those assets are thoseassets which in the ordinary course of business can be converted into cash with in a short period of normally one accounting year.Examples of current assets are:1. Cash in hand and bank balance2. Bills receivables3. Sundry debtors(less provision for bad debts)4. Short-term loans and advances5. Inventories of stocks, as:(a) Raw materials,(b) Work-in-process(c) Stores and spares(d) Finished goods6. Temporary investments of surplus funds7. Prepaid expenses8. Accrued incomes.In a narrow sense, the term working capital refers to the net working capital. Networking capital is the excess of current assets over current liabilities or say:Net working capital = Current Assets
 _ 
Current Liabilities.Net working capital may be positive or negative when the current assets exceed thecurrent liabilities the working the working capital is positive and the negative working
 
capital results when the current liabilities are more than the current assets. Currentliabilities are those liabilities which are intended to be paid in the ordinary course of  business.Examples of current liabilities are1. Bills payable2. Sundry creditors or accounts payable3. Accrued or outstanding expenses4. Short-term loans, advances and deposits5. Dividends payable6. Bank overdraft7. Provision for taxation, if it does not amount to appropriation of profits.In the words of Hog land, “working capital is descriptive of that capital which is notfixed. But the more common use of the working capital is to consider it as the difference between the book value of the current assets and capital liabilities”.
Positive or negative working capital: 
The net working capital of a firm may be positive or negative. When the total currentassets exceed the current liabilities, the working capital is positive and the negativeworking capital results when the current liabilities are more than current assets. The position of negative working capital does not allow a firm to utilize efficiently the fixedassets due to non-availability of liquid funds and it adversely affects its profitability or the rate of return. In fact, no firm can continue business for long-term with a negativeworking capital. The business of the firm may have to be closed due to technicalinsolvency.
Types of working capital:
Working capital can be divided into two categories on the basis of time.1. Permanent working capital2. Temporary or variable working capital
Permanent working capital:
This refers to that minimum amount of investment in all current assets which isrequired at all times to carry out minimum level of business activities. In other words, itrepresents the currents assets required on a continuing basis over the entire year. Tandoncommittee has reffered to this type of working capital as “core current assets”. 

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