Working capital

“Working capital is the amount of funds

necessary to cover the cost of operating the
enterprise.”

Concepts of working capital

1. Balance sheet concept

2. Operating cycle concept
Balance Sheet Concept

There are two interpretations of working capital

under the balance sheet concept:

1. Gross Working Capital

2. Net Working Capital

Gross working capital represents the amount of

funds invested in current assets. Thus, gross
working capital is the capital invested in total
current assets of the enterprise.
Net Working Capital

Net working capital is the excess of current

assets over current liabilities.

Net working capital = Current assets – current

liabilities.

It may be positive or negative.

Meaning of fund

Fund means net working capital, i.e., the excess

of total current assets over total current
liabilities.

Flow of fund

Flow of funds takes place when a transaction

results in increase or decrease in net working
capital.
Treatment of provision of Taxation

1. As a current Liability
When provision for taxation is treated as a
current liability, it appears in statement of
changes in working capital.

It will not appears on application side of

the fund flow statement on account of
taxation.
Treatment of proposed dividend

As a current Liability

It appears in the statement of changes in

working capital and no adjustment is made in
the calculation of funds from operation.
As a non-current Liability

It is added back in profit to calculate the

funds from operations and dividend actually
paid ( or payable ) is shown as an application
of funds in the fund flow statement.

It does not appear in the statement of

changes in working capital.
 Difference between Fund Flow Statement &
Balance Sheet

1. Legal Requirements

Preparation of balance sheet of a company is

compulsory , as per schedule IV of the
Companies Act.

Preparation of Funds Flow Statement is not

compulsory under law.
2. Purpose

Purpose of preparing Balance sheet is to show

the Financial position of a business as on a
particular date.

The purpose of Fund flow statement is to

show net increase or decrease in working
capital.
3. Basis of preparations

Balance sheet is prepared on the basis of trial

balance and additional information .

Fund flow statement is prepared on the basis

of two consecutive balance sheets and
additional information.
4. Type of information

Balance sheet shows assets, liabilities and

capital at a point of time.

Fund flow statement reveals flow of funds

during a period of time.
5. Types of accounts

Balance sheet contains balance of personnel

and real accounts.

Fund flow statement deals with those

accounts which affect working capital, i.e.
non-current accounts.
Marginal Cost

The IMA OF UK the define marginal cost ‘ as

the amount at any given volume off output
by which aggregate costs are changed, if
volume of output is increased or decreased
by one unit’.

An important point is that marginal cost per

unit remains unchanged irrespective off the
level of activity.
Marginal Costing
Marginal costing is the ascertainment of
marginal cost and the effect on profit of
changes in volume or type of output by
differentiating between fixed costs and
variable costs .
The accounting system in which variable costs
are charged to cost units and fixed costs of the
period are written off in full against the
aggregate contribution.
 Break Even Analysis

Narrow Meaning - Break even analysis is

concerned with determining break even
point, i.e, that level of production and sales
which there is no profit and no loss. At this
point total cost is equal to total sales
revenue.
Broad Meaning : Break even analysis is used to
determine probable profit / loss at any given
level of production/sales. It also helps to
determine the amount of volume of sales to
earn a desired amount of profit.
Margin of Safety
It may be defined as the difference between
actual sales and sales at break even point. In
other words, it is the amount by which actual
volume of sales exceeds the break even point.
Difference between Fund Flow and Cash Flow
statement

1. Cash position and working capital position

Cash flow statement is mainly concerned

with changes in cash position while a fund
flow statement is concerned with changes in
working capital.
2. Usefulness in short term financial analysis

For short term financial analysis, cash flow

statement is considered to be more useful to
management as compared to funs flow
statement.
3. Method of Preparation

Techniques of preparing cash flow statement

and funds flow statement are different.

In funds flow statement, an increase in a

current liability or decrease in current asset
result in decrease in net working capital and
vice –versa.
But the cash flow statement, an increase in
a current liability or decrease in a current
asset might result in increase in cash and
vice-versa.
4. Schedule of Changes in Working Capital

A fund flow statement is generally followed

by a schedule of changes in working capital.

But a cash flow statement is not followed by

any other such statement.
5. Opening and closing balances

In cash flow statement opening and closing

balances of cash and cash equivalents are
given.

But a fund flow statement does not

contain any opening and cash balances.
6. Legal Requirements

There is no legal requirement to prepare

funds flow statement.

But cash flow statement is to be prepared by

every listed company as per AS-3 as required
by SEBI .
Advantage and Uses of Funds flow Statement

1. Guides proper use of available funds

For the continued financial health or well –

being of a firm, it is necessary to use available
working capital carefully and properly.

The fund flow statement shows up boldly how

the funds made available in a year were used.
2. Acts as a basis for financial plan and budgeting

It can be easily as a basis for preparing financial

plans for the coming period.
On an estimated basis, it becomes the financial
budget for the next year.
In fact, when large sums are borrowed and
repayment is made by annual installments,
fund flow statement prepared in anticipation
for future years will determine the amount that
can be paid each year.