What is working capital ?

Funds required by a unit for its day to day working.

working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses.
Every business needs funds for two purposes. * Long term funds are required to create production facilities through purchase of fixed assets such as plants, machineries, lands, buildings & etc * Short term funds are required for the purchase of raw materials, payment of wages, and other day-to-day expenses. . It is other wise known as revolving or circulating capital It is nothing but the difference between current assets and current liabilities. i.e. Working Capital = Current Asset Current Liability. Working capital is essential for any business to succeed.

Net Working Capital =Current Asset Current Liabilities

Current Assets Cash in hand / at bank Bills Receivable Sundry Debtors Short term loans Investors/ stock Temporary investment Prepaid expenses Accrued incomes

Current Liabilities Bills Payable Sundry Creditors Outstanding expenses Accrued expenses Bank Over draft

Working capital in terms of five components: 1. Cash and equivalents. This most liquid form of working capital requires constant supervision. A good cash budgeting and forecasting system provides answers to key questions such as: Is the cash level adequate to meet current expenses as they come due? What is the timing relationship between cash inflow and outflow? When will peak cash needs occur? When and how much bank borrowing will be needed to meet any cash shortfalls? When will repayment be expected and will the cash flow cover it? 2. Accounts receivable. Many businesses extend credit to their customers. If you do, is the amount of accounts receivable reasonable relative to sales? How rapidly are

receivables being collected? Which customers are slow to pay and what should be done about them? 3. Inventory. Inventory is often as much as 50 percent of a firm's current assets, so naturally it requires continual scrutiny. Is the inventory level reasonable compared with sales and the nature of your business? What's the rate of inventory turnover compared with other companies in your type of business? 4. Accounts payable. Financing by suppliers is common in small business; it is one of the major sources of funds for entrepreneurs. Is the amount of money owed suppliers reasonable relative to what you purchase? What is your firm's payment policy doing to enhance or detract from your credit rating? 5. Accrued expenses and taxes payable. These are obligations of your company at any given time and represent a future outflow of cash.

Need for Working Capital

Working capital is just like the heart of business. If it becomes weak, the
business can hardly prosper and survive. No business can run successfully without an adequate amount of working capital.

Every business needs adequate liquid resources in order to maintain dayto-day cash flow. Eg. To give salaries, purchasing raw material etc. It is required to run business smoothly. Maintaining adequate working capital is also important to ensure the survival of the business in the long-term as well. Need for working capital arises from cash or operating cycle of a firm. As profits earned depend upon magnitude of sales and they do not convert into cash instantly, thus there is a need for working capital in the form of CA so as to deal with the problem arising from lack of immediate realization of cash against goods sold. This is referred to as Operating or Cash Cycle which refers to length of time required to complete the sequence of events. Thus operating cycle creates the need for working capital & its length in terms of time span required to complete the cycle is the major determinant of the firms working capital needs. Working Capital can maximize growth. It can help minimize future financial shortcomings.

Factors influencing the working capital needs of a firm

1. Nature of business 2. Seasonality of operations 3. Production conditions 4. Market conditions 5. Conditions of supply Nature of business: The working capital requirement of a firm is closely related to the nature of its business. A service firm, like an electricity undertaking or a transport corporation, which has a short operating cycle and which sells predominantly on cash basis, has a modest working capital requirement. On the other hand, a manufacturing concern like a machine tools unit, which has a long operating cycle and which sells largely on credit, has a very substantial working capital requirement. Seasonality of Operations: Firms which have marketed seasonally in their operations usually have highly fluctuating working capital requirements. To illustrate, consider a firm manufacturing ceiling fans. The sale of ceiling fans reaches a peak during the summer months and drops sharply during the winter period. The working capital need of such a firm is likely to increase considerably in summer months and decrease significantly during the winter months. Electric bulbs, tubes and CFL lamps have fairly even sales round the year, tends to have stable working capital needs. Production Policy: A firm marketed by pronounced seasonal fluctuations in its sales may pursue a production policy which may reduce the sharp variations in working capital requirements. For example, a manufacturer of ceiling fans may maintain a steady production throughout the year rather than intensify the production activity during the peak business season. Such a production policy may dampen the fluctuations in working capital requirements. Market conditions: The degree of competition prevailing in the market-place has an important bearing on working capital needs. When competition is intense, a larger inventory of finished goods is required to promptly serve customers who may be inclined to wait because other manufacturers are ready to meet their needs. Further, generous credit terms may have to be offered to attract customers in a highly competitive market. Thus, working capital needs tend it be high because of greater investment in finished goods inventory and accounts receivable. If the market is strong and competition is weak, a firm can manage with smaller inventory of finished goods, because customers can be supplied with some delay. Further, in such a situation the firm can insist on cash payment and avoid lock-up of funds in accounts receivable it can even ask for advance, partial or total. Conditions of Supply: The inventory of raw materials, spares and stores depends on the conditions of supply. If the supply is prompt and adequate, the firm can manage with small inventory. However, if the supply is unpredictable and scant, then the firm, to ensure continuity of production would have to acquire stocks as and when they are available and carry larger inventory on an average. A similar policy may have to be followed when the raw material is available only seasonally and production operations are carried out round the year.
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Types of Working Capital

1.On the basis of concept (a) Gross working capital The firm's investment in current assets. (b) Net working capital Current assents - current liabilities

2.On the basis of Requirement (a) Permanent There is always a minimum level of ca which is continuously required by a firm to carry on its business operations. thus, the minimum level of investment in current assets that is required to continue the business without interruption is referred as permanent working capital.

(b) Variable or Seasonal THIS IS THE AMOUNT OF INVESTMENT REQUIRED TO TAKE CARE OF FLUCTUATIONS IN BUSINESS ACTIVITY OR NEEDED TO MEET FLUCTUATIONS IN DEMAND CONSEQUENT UPON CHANGES IN PRODUCTION & SALES AS A RESULT OF SEASONAL CHANGES. Difference between Permanent is stable over time whereas variable is fluctuating according to seasonal demands. Investment in permanent portion can be predicted with some profitability whereas investment in variable cannot be predicted easily. While permanent is minimum investment in various ca , variable is expected to take care for peak in business activity. While permanent component reflects the need for a certain irreducible level of current assets on a continuous and uninterrupted basis , the temporary portion is needed to meet seasonal & other temporary requirements.

Also permanent capital requirements should be financed from l-t sources , stfunds should be used to finance temporary working capital needs of a firm,