Concept of working Capital by V S RAMA RAO on FEBRUARY 7, 2009 There are two definitions of working capital (1) Gross

working capital (2) Net working capital Gross working capital refers to working capital as the total of current assets, whereas the net working capital refers to working capital as excess of current assets over current liabilities. In other words net working capital refers to current assets financed by long term funds. Accordingly, Gross working capital = Total current assets Net working capital = Current assets Current liabilities The net working capital position of the firm is an important consideration, as this will determine the firms profitability and risk. Here the profitability refers to profits after expenses and risk refers to the probability that a firm will become technically insolvent where it will be unable to meet obligations when they become due for payment. A finance manager has to make an appropriate financing mix, which will limit the risk and increase the profitability. Financing mix refers to the proportion of current assets financed by current liabilities and long term funds. There are two approaches which determine the financing mix (1) Aggressive approach (2) Conservative approach. According to aggressive approach the long term funds are used to finance only the core or fixed portion of current assets (e.g., minimum level of finished goods inventory, raw material etc) and the other portion i.e. temporary and seasonal requirements are financed by short term funds. This is of high risk and high profit financing mix. According to conservative approach the total current assets are financed from long term sources and short term sources are used only in emergency situation i.e. when there is an unexpected cash outflow. This is of low-risk and low-profit financing mix.

As we observed two methods of financing mix, one method is of high risk high profit and other is of risk low profit. A finance manager has to trade off between these two extremes. Operating Cycle: The objective of financial management is to maximize the shareholders wealth. So it is needed to generate sufficient profits. The profits generated depend mainly on sales volume. When the goods are being sold on credit as is the normal practice of business firms today to cope with increased competition the sale of goods cannot be converted into cash instantly because of time lag between sales and realization of cash. As there is a time lag between sales and realization of receivables there is a need for sufficient working capital to deal with the problem which arises due to lack of immediate realization of cash against goods sold. The operating cycle is the length of time required for conversion of noncash assets into cash. This operating cycle refers to the time taken for the conversion of cash into raw material, raw materials into work-in-progress, work-in-progress into finished goods, finished into receivables into cash and this cycle repeats. The operating cycle length differs from firm to firm. If a firm has lengthy production process or a firm has liberal credit policy the length of operating cycle will be more. On the other hand, if a firm does not extent credit or the firm is not a manufacturing concern i.e. where cash will be converted into inventory directly then the length of operating cycle will be reduced to a greater extent. The length of operating cycle can be calculated by calculating periods of raw material storage, work in process, finished gods storage and debtors collection period. 1. Raw materials storage period = Average stock of raw materials and stores/ Average daily consumption of raw material and stores 2. Work in process period = Average work in process inventory /Average cost of production per day 3. Finished goods storage period

= Average finished goods inventory / Average cost of goods sold per day 4. Debtors collection period = Average book debts / Average credit sales per day Length of operating cycle = 1+2+ 3+4

Definition of working capital:

Current assets minus current liabilities. Working capital measures how much in liquid assets a company has available to build its business. The number can be positive or negative, depending on how much debt the company is carrying. In general, companies that have a lot of working capital will be more successful since they can expand and improve their operations. Companies with negative working capital may lack the funds necessary for growth. also called net current assets or current capital.

Concept of working capital:

Concept of working capital includes meaning of working capital and its nature. Working capital is the investment in current assets. Without this investment, we can not operate our fixed assets properly. For getting good profits from fixed assets, we need to buy some current assets or pay some expenses or invest our money in current assets. For example, we keep some of cash which is the one of major part of working capital. At any time, our machines may need repair. Repair is revenue expense but without cash, we can not repair our machines and without machines, our production may delay. Like this, we need inventory or to invest in debtors and other short term securities. On the basis of Concept, we can divide our working capital into two parts: 1. Gross Working Capital In this concept of working capital, we study gross working capital. We do not deduct current liabilities in this concept but we use current liabilities as source of fund. Suppose, if we buy goods on credit, it means our save our cash and we can use this as working capital for paying other expenses.

2. Net Working Capital Under this concept we use net working capital. For this, we first deduct all our current liabilities from our current assets. Excess of current assets over current liabilities will be current assets. We have to maintain minimum level of working capital in our business for operation of business activities. This concept is also used for preparation of balance sheet. In the vertical form of balance sheet, we show excess of current assets over current liabilities. Operating Cycle Concept of Working Capital In this concept of working capital, we make the operating cycle. In this cycle, we calculate inventory conversion period. To know this, we can estimate when we need cash for buying our inventory. We also calculate debtor or receivable conversion period. To know this, we can estimate when we receive cash from our debtors. If inventory conversion period is less than debtor conversion period, we have to manage other sources for buying our inventories. If we buy good on credit, we also take care creditors' conversion period.

Concept of Working capital In Business

Working Capital and Current Assets, in English Working Capital is a rapidly renewing resource (cash, receivables, inventories, etc) that represents the liquidity available for the operation of the business, organization or other entity, including public bodies. It is an important tool for decision making, as it refers to a firm's operating cycle, comprising the purchase of raw materials to sale and receipt of goods sold. As the fixed assets like plants and equipment, working capital is considered a part of operating capital. Working Capital (CDG) is the resource used to support the day-to-day business, i.e. is the capital available to conduct normal business of the company.

Some important points in the efficient management of working capital are its impact on the company's cash flow. The volume of working capital used by a company depends on its volume of sales, credit policy and the level of inventory held. The CDG needs resources for its financing, i.e., the higher its value, the greater the need for funding, either with their own resources or with funds from third parties. The difficulties associated with CDG in a company are due mainly to the occurrence of the following factors: Reduced sales Growth in default Increase in financial expenses Increased costs The CDG is also a financial-economic concept and not a legal definition, constitute a permanent source of funds used to finance the 'Need for Working Capital. " Net Working Capital The Net Working Capital (CGL) is an indicator of liquidity used by companies to reflect the ability to manage relationships with suppliers and customers. The Net Working Capital (CGL) is calculated by subtracting the current assets (CA) and Liabilities (PC) CGL = AC PC Assets: represents the resources available in the short term (cash, banks, financial investments, accounts receivable, inventories, etc.) Current liabilities: represents the short-term financing of the company (vendors, bills, loans etc.).

The objective of financial management is to manage company assets in order to find the balance between profitability and risk to increase firm value. CGL positive: In this case, we identify that this company with working capital deficit.

CGL negative: In this case, we identified that the company is handicapped in its capital, meaning that part of your assets is not being financed with its liabilities in the short term, denoting a risk framework. The larger the company's CGL, the lower their risk of insolvency, however, a very high CGL means that significant long-term funds are financing part of current assets, the costs of these resources are always higher, this can become a financial problem for the institution. Need for Working Capital The Need for Working Capital (SCN) has a great importance because of information provided by operating activities, decisions taken by top management and how to finance the investment of funds. The SCN is directly connected to the company's cash cycle. When the cash cycle is over, the need for working capital is greater and vice versa. Thus, reducing the cash cycle in short, means to receive early and pay later should be a goal of financial management. However, reducing the cash cycle requires the adoption of an operational nature, involving the shortening of the periods of storage, production, operation and sales. The proper design of the need for working capital is one of the biggest challenges of financial manager. High volume of working capital will divert resources that could be applied to fixed assets of the company. However, very little working capital will restrict the ability of sales and operation of the company. The need for working capital can be estimated in two ways: based on the financial cycle or with the use of financial statements (balance sheet)

Working Capital Management & Cash Forecasting

What do Working Capital Management and Cash Forecasting have to do with Practical Turnaround Management? One of the first steps that turnaround managers undertake is creating the 13-week cash forecast. With this they can see the full picture and then set reasonable expectations for stakeholders such as lenders, vendors and employees. One of the next steps is to evaluate working capital. The calculation is: Operating current assets Operating current liabilities Current assets are Cash, Accounts Receivable and Inventory. Current liabilities are Accounts Payable, other accruals and the current portion of long-term debt. ------------------Reducing working capital is a great example of how the turnaround management toolkit can be used on a daily basis by companies that are not in distress. Reducing working capital liberates cash. Internally generated cash and profits are always an important source of funds, and are managements first choice on the pecking order, especially in an era of tight credit. This cash can be put to more productive uses or returned to shareholders in the form of dividends. These actions create value for shareholders. The Discounted Cash Flow (DCF) model below shows that each additional dollar of Free Cash Flow (FCF) increases firm value, holding other variables constant. WACC is the weighted average cost of capital. The DCF model for calculating a firms value is:

FCFt Value (1

t=1 WACC)t

Heres the practical turnaround thinking: do not wait for a liquidity crisis to occur before addressing these issues. Reducing their working capital needs and improving their cash forecasting abilities are top priorities for management teams who want to maintain or improve performance. 13-week cash forecasts lead to more prudent borrowing and investing decisions. The smart money creates and maintains the forecast even when the firms financial condition is strong. Contact Melissa Craig to have an informal conversation about how your company can unlock value by reducing its working capital needs, and improving its cash forecasting abilities. See the Services and Solutions in the sidebar.