Define Working Capital:
Working capital is a financial metric
represents operating liquidity available to a
business, organization or other entity,
including governmental entity.
Net working capital is calculated as current
assets minus current liabilities. Positive
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.
Management of Working Capital:
Management will use a combination of
policies and techniques for the
management of working capital. The
policies aim at managing the current assets
and the short term financing that cash
flows and returns are acceptable:
1. Cash management: Identify the cash
balance which allows for the business to
meet day to day expenses but reduces cash
holding costs.
2. Inventory management: Identify the
level of inventory which allows for
uninterrupted production.
3. Debtors management: Identify the
appropriate credit policy, i.e. credit terms
which will attract customers.
4. Short term financing: Identify the
appropriate source of financing, given the
cash conversion cycle.
Explain the difference between variable
working capital and permanent working
capital.
Working capital is a part of capital
investment is used for running the business
such like money which is used to buy
stock, pay expenses and finance credit.
Considering time as the basic of
classification there are two types of
working capital: 1) Permanent working
capital; 2) Variable working capital;
The difference between variable working
capital and permanent working capital is as
follows:
1) Permanent working capital is referred to
finance to stock of finished goods, debtors
balances etc. Variable working capital is
used to carry out day to day operations.
2) Permanent working capital consists of
stock of raw materials, stock of work-in-
process, stock of finished goods, debtors
balance, etc. Variable working capital
consists of cash, marketable securities,
account receivable, stock etc.
3) Permanent working capital includes
long term financial decisions. Variable
working capital includes short term
financing decisions.
4) Permanent working is mainly required
for operational activities. Variable working
capital is required for trading activities.
Explain the Factors determining the
need for working capital:
The following factors determine the
need/requirement for working capital:
(1) Size of business; (2) Stage of
development; (3) Time of production
(4) Rate of stock turnover ratio; (5)
Buying and selling terms; (6) Seasonal
consumption; (7) Profit level; (9) Growth
and expansion; (10) Production cycle; (11)
General nature of business; (12) Business
cycle
Describe the motives for holding
cash in bank.
Transaction Motive: Transaction
motive refers to the holding of cash to
meet anticipated obligations whose
timing is not perfectly synchronized
with cash receipts.
Precautionary Motive: Precautionary
motive implies the need to hold the
cash to meet unpredictable
obligations.
Speculative Motive: It refers to the
desire of a firm to take advantage of
opportunities which present
themselves at unexpected moments
and which are typically outside the
normal course of business.
Compensation Motive: Customers of
a bank are usually required to
maintain a minimum cash balance at
that bank for providing services to
them. Since this balance cannot be
utilized by the firms for transaction
purposes, the bank themselves can use
the amount to earn a return.
Explain the objectives of inventory
management.
The main objectives of inventory
management is to maintain inventory at
appropriate level to avoid excessive or
shortage of inventory because both the
cases are undesirable for business. Thus,
management is faced with the following
conflicting objectives:
(1) To keep inventory at sufficiently high
level to perform production and sales
activities smoothly. (2) To minimize
investment in inventory at minimum level
to maximize profitability. (3) To ensure
that the supply of raw material & finished
goods will remain continuous so that
production process is not halted and
demands of customers are duly met. (4)
To minimize carrying cost of
inventory. (5) To keep investment in
inventory at optimum level. (6) To
reduce the losses of theft,
obsolescence & wastage etc. (5) To
make arrangement for sale of slow
moving items. (6) To minimize
inventory ordering costs.
Explain the factors affecting working
capital requirement.
Main factors affecting the working
capital are as follows:
1) Nature of Business
2) Scale of Operations
3) Business cycle
4) Production cycle
5) Seasonal Factors
6) Credit allowed
7) Credit availed
8) Operating efficiency
9) Availability of Raw Material
10) Growth Prospects
11) Level of Competition
12) Inflation
Explain different sources of
financing working capital.
Common Sources of Working Capital
Finance:
Loans from Commercial Banks:
Small scale industries can raise loans
from the commercial banks with or
without security. This method of
financing does not require any legal
formality except that of creating a
mortgage on the assets.
Public Deposits: Often companies find
it easy and convenient to raise, short-
term funds by inviting shareholders,
employees and the general public to
deposit their savings with the company.
Trade Credit: Just as the companies
sell goods on credit, they also buy raw
materials, components and other goods
on credit from their suppliers.
Factoring: Factoring is a financial
service designed to help firms in
managing their book debts and
receivables in a better manner.
Discounting Bills of Exchange: When
goods are sold on credit, bills of
exchange are generally drawn for
acceptance by the buyers of goods. The
bills are generally drawn for a period of
3 to 6 months. In practice, the writer of
the bill, instead of holding the bill till
the date of maturity, prefers to discount
them with commercial banks on
payment of a charge known as
discount.
Bank Overdraft and Cash Credit:
Overdraft is a facility extended by the
banks to their current account holders
for a short-period generally a week.
Advances from Customers: One way
of raising funds for short-term
requirement is to demand for advance
from one’s own customers.
Accrual Accounts: Generally, there is
a certain amount of time gap between a
income is earned and is actually
received or expenditure becomes due
and is actually paid. Salaries, wages
and taxes.