DIFFERENCES BETWEEN WORKING CAPITAL AND CAPITAL EMPLOYED

Working Capital is an amount of money borrowed from a bank or other lender and used by a
new business for money to keep operations going and pay business bills during the startup
period, when income is usually less than expenses. For many new businesses, having enough
working capital means the difference between the success and failure of the business.

Working capital is a liquidity (cash) concept. A business might show a "profit," but if it cannot
maintain a positive cash position (that is, having money in the bank to pay bills each month),
the business cannot continue to operate. (Murray, 2014)

One the other hand Capital employed is the value of the company assets that belongs to the
shareholders and is equal to all the assets less all the liabilities.

Capital Employed

1. The total amount of capital used for the acquisition of profits.

2. The value of all the assets employed in a business.

3. Fixed assets plus working capital.

4. Total assets less current liabilities.

The term Capital Employed is frequently used, but very difficult to define because there are so
many contexts it can be used in. All definitions generally refer to the investment required for a
business to function. By "employing capital" you are making an investment. (Investopedia,
2014)
Assignment

 The managing director of a construction company, after carrying out a thorough market
investigation of the opportunities for work in a development area, decides to set up a
division in the region. The work will be obtained by tender only, and a small
management organisation is to be set up in an establishment purchased for Gh₵45000.
as an approximate rule, the estimate for tenders is built upon the following figures:

 Labour, 15%; plant, 20%; materials, 35%; overheads, 20%; profit, 10%.

 All materials purchased and plant hired are given one month’s credit by suppliers and
three month’s stock of materials is held on sites at all times

 The average time between starting a section of work and receipt of the interim payment
is two months. The working capital is Gh₵200000.

 Calculate the annual turnover required to justify the director’s decision to go ahead if
the working capital is to be fully utilised, and give a summary of the new capital
requirements.
Solution

Working capital required Time factor

1. Material (35% of turnover)

Material hold on site …………………………………………………………………………....3months
Work in progress ………………………………………………………………………………...2months
5months
Less credit from supplier …………………………………………………………………….… 1 month
4 months

2. Plant (20% of turn over)

Work in progress…………………………………………….……………………………….…….2months
Less credit from supplier………………………………………………………………….……..1month
1 month

3. Labour ( 15% of turnover)

Work in progress ……………………………………………………………………………………2months

4. Overhead (20% of turnover)

Work in progress ………………………………………………………………………….…….… 2months

Let y = turn over

Such that

 Material (ym) = 35/100*y

 Plant (yp) = 20/100*y
 Labour (yl) = 15/100*y
 Overheads (yo) = 20/100*y

Now finding annual turnover….

Working capital = (time factor/12months)*ym + (t.f/12m)*yp + (t.f/12m)*yl + (t.f/12m)*yo

But working capital (w.c ) = 200,000

Therefore

200000 = 4/12*(ym) + 1/12*(yp) + 2/12*(yl) + 2/12(yo)

But from above

 Material (ym) = 35/100*y

 Plant (yp) = 20/100*y
 Labour (yl) = 15/100*y
 Overheads (yo) = 20/100*y

Therefor

200000 = (4/12*35/100)*y +(1/12*20/100)*y+(2/12*15/100)*y+(2/12*20/100)*y

200000 = (0.117y) + (0.017y) + (0.025y) + (0.033y)

0.192y = 200000

Y = 200000/0.192

Y = 1041666.667

 Turn over =1041666.667 + 10%

= 1041666.667 + 104166.6667

= 1145833.328

 Summary of New Capital Required

Established cost = 45,000.00 add

Working capital = 200,000.00

245,000.00
REFERENCE

 Murray. J (2014) Working Capital [WWW] biztaxlaw.about.com, Available from:

http://biztaxlaw.about.com/od/glossaryw/a/workingcapital.htm [Accessed 05/02/15].

 Investopedia (2014) capitalemployed [WWW] investopedia.com, Available from:

http://www.investopedia.com/terms/c/capitalemployed.asp [Accessed 05/02/15].