What is 'Working Capital'

Working capital is a measure of both a company's efficiency and its short-term financial health. Working
capital is calculated as:

Working Capital = Current Assets - Current Liabilities

The working capital ratio (Current Assets/Current Liabilities) indicates whether a company has
enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C (working
capital). While anything over 2 means that the company is not investing excess assets. Most believe that
a ratio between 1.2 and 2.0 is sufficient. Also known as "net working capital".

BREAKING DOWN 'Working Capital'

If a company's current assets do not exceed its current liabilities, then it may run into trouble paying
back creditors in the short term. The worst-case scenario is bankruptcy. A declining working capital ratio
over a longer time period could also be a red flag that warrants further analysis. For example, it could be
that the company's sales volumes are decreasing and, as a result, its accounts receivables number
continues to get smaller and smaller .Working capital also gives investors an idea of the company's
underlying operational efficiency. Money that is tied up in inventory or money that customers still owe to
the company cannot be used to pay off any of the company's obligations. So, if a company is not operating
in the most efficient manner (slow collection), it will show up as an increase in the working capital. This
can be seen by comparing the working capital from one period to another; slow collection may signal an
underlying problem in the company's operations.

Things to Remember

If the ratio is less than one then they have negative working capital.

A high working capital ratio isn't always a good thing, it could indicate that they have too much
inventory or they are not investing their excess cash

What is 'Petty Cash'

Petty cash is a small fund of cash kept on hand maintained by a custodian for purchases or
reimbursements too small to be worth submitting to the more rigorous purchase and reimbursement
procedures of a company or institution. Periodic reconciliations reveal any shortfall or average in the fund,
as receipts are used to calculate the fund balance.

BREAKING DOWN 'Petty Cash'

A petty cash fund provides convenience for small transactions for which issuing a check is unreasonable.
Some vendors may not accept company checks. In addition, the exact charges may not be known until the
items are purchased, and issuing a check may not be feasible. A petty cash fund replaces the need for
certain employees to have company credit cards. A petty cash fund delivers a quick opportunity to utilize
funds, as opposed to other time-consuming internal processes for funding or reimbursement.

Internal Controls
The use of a petty cash fund circumvents certain internal controls. For example, instead of making
payments in the form of authorized checks that are signed, payments to certain vendors are made with
cash that was secured and withdrawn according to different procedures. The petty cash fund is
safeguarded by a designated individual, and the funds are often kept in a locked location. Funds are
withdrawn upon receipt of a signature from the appropriate employee, who is required to return any
excess change and all receipts or documentation of the transaction.

Reconciliation Process

The petty cash fund is reconciled periodically to ensure the balance of the fund is correct. The remaining
cash in the petty cash fund is counted as well as the charges noted on all receipts. This summation should
equal the original balance in the petty cash fund. If the calculated amount is less than the original balance,
there is a shortage in the petty cash fund. If the calculated amount is more than the original balance, there
is an overage in the petty cash fund.

Petty Cash Accounting Entries

The petty cash fund and petty cash transactions are still recorded on financial statements. When the petty
cash fund is created, a journal entry simply restricts a small amount of money by debiting the petty cash
fund and crediting cash. As transactions occur, no journal entries are made. Then, at the end of the period
or upon the reconciliation of the petty cash fund, the receipts are used to verify the balance in the petty
cash fund and code the transactions. A journal line item is recorded to an over/short account. If the petty
cash fund is over, a credit is entered to represent a gain. If the petty cash fund is short, a debit is entered
to represent a loss. The over/short account is used to force-balance the fund upon reconciliation.

What is 'Inflation'

Inflation is the rate at which the general level of prices for goods and services is rising and, consequently,
the purchasing power of currency is falling. Central banks attempt to limit inflation, and avoid deflation,
in order to keep the economy running smoothly.

BREAKING DOWN 'Inflation'

As a result of inflation, the purchasing power of a unit of currency falls. For example, if the inflation rate
is 2%, then a pack of gum that costs $1 in a given year will cost $1.02 the next year. As goods and services
require more money to purchase, the implicit value of that money falls.

A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price
index, usually the consumer price index, over time.[4] The opposite of inflation is deflation.

Inflation affects economies in various positive and negative ways. The negative effects of inflation include
an increase in the opportunity cost of holding money, uncertainty over future inflation which may
discourage investment and savings, and if inflation were rapid enough, shortages of goods as consumers
begin hoarding out of concern that prices will increase in the future. Positive effects include reducing the
real burden of public and private debt, keeping nominal interest rates above zero so that central banks
can adjust interest rates to stabilize the economy, and reducing unemployment due to nominal wage
rigidity.[5]
Economists generally believe that high rates of inflation and hyperinflation are caused by an excessive
growth of the money supply.

What is 'Capital Gearing'

Capital gearing is the degree to which a company acquires assets or to which it funds its ongoing
operations with long- or short-term debt. Capital gearing will differ between companies and industries,
and will often change over time. Capital gearing is also known as "financial leverage".

BREAKING DOWN 'Capital Gearing'

In the event of a leveraged buyout, the amount of capital gearing a company will employ will dramatically
increase as the company increases its debt in order to finance the acquisition. When analyzing a firm
undergoing a leveraged buyout, it is important to consider the firm's ability to service the additional
interest payments on an after-tax basis, as well as the likelihood of the firm paying off the new debt as it
matures.

What is a 'Cash Book'

A cash book is a financial journal that contains all cash receipts and payments, including bank deposits
and withdrawals. Entries in the cash book are then posted into the general ledger. Larger firms usually
divide the cash book into two parts: the cash disbursement journal that records all cash payments, such
as accounts payable and operating expenses, and the cash receipts journal, which records all cash receipts,
such as accounts receivable and cash sales.

BREAKING DOWN 'Cash Book'

The cash book is set up as a ledger in which all cash transactions are recorded according to date. It is a
book of original entry and final entry. That is, the cash book serves as the general ledger. There is no need,
as in a cash account, to transfer to a general ledger.

Cash Book vs. Cash Account

There are differences between a cash book and a cash account. A cash book is a separate ledger in which
cash transactions are recorded, whereas a cash account is an account within a ledger. A cash book serves
the purpose of both journal and ledger, whereas a cash account is structured like a ledger. Details or
narration are required in a cash book, but not in a cash account. Finally, cash books use a ledger folio,
while cash accounts use a journal folio.

There are numerous reasons why a business might record transactions using a cash book instead of a cash
account. Daily cash balances are easy to access and determine. Mistakes can be detected easily through
verification, and entries are kept up-to-date, since the balance is verified daily.

Cash Book Format

All transactions in the cash book have two sides: debt and credit. All cash receipts are recorded on the left
hand side, and all cash payments are recorded by date on the right hand side. The difference between the
left and right side shows the balance of cash on hand, which always shows a debit balance.

The cash book is set up in columns. The date column is the date of the transaction. In the first line, the
accountant inputs the year, and in the second line, the accountant inputs the name of the month, followed
by the date. In the next column, the accountant inputs the name of the opposite or contra account, along
with a small description or narration of the transaction. In the ledger folio column, the accountant inputs
the number of the ledger that holds the account, and the amount of the transaction. If the transaction
comes with a voucher, that column may be added as well.

Credit purchase:

It is the type of purchase where the buyer does not pay or partly pays for the goods and services he
received at the time of purchasing. The remaining amount has to be paid back at a predetermined later
date. Hence before the amount is paid back the buyer is in debt or is liable to return the credit. The
company providing the goods and services in advance is the creditor. The credit entry is made in the
payable ledger. Credit purchase might be offered in terms of good will or to someone with a good credit
history. A payment by cheque is an example of credit purchase.

Order of permanence

A financial statement that shows assets in order of how permanent they are, with the most permanent
listed first (e.g. land, then buildings, then equipment).

Order of liquidity is the presentation of assets in the balance sheet in the order of the amount of time it
would usually take to convert them into cash. Thus, cash is always presented first, followed by marketable
securities, then accounts receivable, then inventory, and then fixed assets. Goodwill is listed last. The
approximate amount of time required to convert each type of asset into cash is noted below:

1. Cash. No conversion is needed.

2. Marketable securities. A few days may be required to convert to cash in most cases.

3. Accounts receivable. Will convert to cash in accordance with the company's normal credit terms,
or can be converted to cash immediately by factoring the receivables.

4. Inventory. Could require multiple months to convert to cash, depending on turnover levels and
the proportion of inventory items for which there is not a ready resale market. It may even be
impossible to convert to cash without accepting a significant discount.

5. Fixed assets. Conversion to cash depends entirely on the presence of an active after-market for
these items.

6. Goodwill. This can only be converted to cash upon the sale of the business for an adequate price,
and so should be listed last.

The order of liquidity concept is not used for the revenues or expenses in the income statement, since the
liquidity concept does not apply to them.

Sundry Debtors
A person who owes money to the firm because of credit sales of goods is called a debtor. For example,
when goods are sold to a person on credit that person pays the price in future. He is called a debtor
because he owes the amount to the firm, commonly customers of goods/ services are known as debtors.

Sundry can mean various, miscellaneous, or diverse. Sundry debtors might refer to a company's customers
who rarely make purchases on credit and the amounts they purchase are not significant. I suspect that
the term sundry was more common when bookkeeping was a manual task. In other words, prior to the
low cost of computers and accounting software, a bookkeeper had to add a page to the company's ledger
book for every new customer. If a new page was added for every occasional customer, the ledger book
would become unwieldly. It was more practical to have one page entitled sundry on which those
occasional customers' small transactions were entered.

With the efficiency and low cost of today's accounting systems, I believe the need for classifying customers
and accounts as sundry has been greatly reduced.

What is 'Solvency'

Solvency is the ability of a company to meet its long-term financial obligations. Solvency is essential to
staying in business as it asserts a companys ability to continue operations into the foreseeable future.
While a company also needs liquidity to thrive, liquidity should not be confused with solvency. A company
that is insolvent must often enter bankruptcy.

BREAKING DOWN 'Solvency'

Solvency directly relates to the ability of an individual or business to pay their long-term debts including
any associated interest. To be considered solvent, the value of an entitys assets, whether in reference to
a company or an individual, must be greater than the sum of its debt obligations. Various mathematical
calculations can be performed to help determine the solvency of a business or individual.

Solvency Ratios

Investors can use ratios to analyze a company's solvency. The interest coverage ratio divides operating
income by interest expense to show a company's ability to pay the interest on its debt, with a higher result
indicating a greater solvency. The debt-to-assets ratio divides a company's debt by the value of its assets
to show whether a company has taken on too much debt, with a lower result indicating a greater solvency.
Equity ratios demonstrate the amount of funds that remain after the value of the assets, offset by the
outstanding debt, is divided among eligible investors.

Solvency ratios vary by industry, so it is important to understand what constitutes a good ratio for the
company before drawing conclusions from the ratio calculations. Ratios that suggest a lower solvency
than the industry average may suggest financial problems are on the horizon.

Risks to Solvency

Certain events can create a risk to an entitys solvency. In the case of business, the pending expiration of
a patent may pose risks to solvency as it will allow competitors to produce the product in question, and it
results in a loss of associated royalty payments. Further, changes in certain regulations that directly impact
a companys ability to continue business operations can pose an additional risk. Both businesses and
individuals may experience solvency issues should a large judgement be ordered against them after a
lawsuit.

Solvency Vs. Liquidity

While solvency represents a companys ability to meet long-term obligations, liquidity represents a
company's ability to meet its short-term obligations. In order for funds to be considered liquid, they must
be either immediately accessible or easily converted into usable funds. Cash is considered the most liquid
payment vehicle. A company that lacks liquidity can be forced to enter bankruptcy even if it is solvent if it
cannot convert its assets into funds that can be used to meet financial obligations.