Working Capital Concept & Animation

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1 Working Capital Concept & Animation

2 Meaning A measure of both a company's efficiency and its short-term financial health. The 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.

3 Types Of Working Capital Gross Working Capital Temporary Working Capital Negative Working Capital Net Working Capital Cash Working Capital Estimating Working Capital Permanent Working Capital Positive Working Capital

4 1) Gross Working Capital : Gross Working Capital means the total Current Assets without deducting the Current Liabilities. Gross Working Capital = Current Assets Thus, Gross working Capital is equal to the Cash balance and the amount blocked up in Debtors, stock etc.

5 2) Net Working capital: A part of Gross working Capital is financed Current Liabilities such as Creditors for goods, Bills Payables and creditors for expenses. Net Working Capital = Current Assets Current Liabilities It is also known as Current Assets. It indicates the Liquidity of the concern in the immediate future.

6 Distinction between Gross Working Capital and Net Working Capital Gross Working Capital Gross working capital is the total of all current assets of a business. Current assets include cash, and any assets a business could quickly convert to cash such as equipment, land or buildings. This also includes assets that will convert to cash within a year, such as accounts receivable. Net Working Capital Net working capital is current assets minus current liabilities. Current liabilities are short-term debts owed by a company, such as accounts payable, taxes and dividends payable. Current liabilities either are liabilities a company pays off within one year, or are recurring liabilities that occur at the same time during an accounting Cycle.

7 Permanent Working Capital It is the minimum working capital required for producing predetermined production Permanent working is the minimum investment kept in the form of inventory of raw materials, work in process, finished goods, stores & spare, and book debts to facilitate uninterrupted operation of a firm.

8 Though this investment is stable in the short run, it certainly varies in the long run depending upon the expansion programmers undertaken by a firm. It may increase or decrease over a period of time. The minimum level of current assets maintained in a firm is usually known as permanent or regular working capital.

9 Temporary Working Capital It is the additional current assets required for temporary period, and it is above permanent WC A firm is required to maintain an additional current asset temporarily over and above the permanent working capital to satisfy cyclical demands. Any additional working capital apart from permanent working capital required to support the changing production and sales activities is referred to as temporary or variable working capital.

10 In Other words, an amount over and above the permanent level of working capital is temporary, fluctuating or variable working capital. At times, additional working capital is required to meet the unforeseen events like floods, strikes, seasonal production and price hike tendencies contingencies.

11 Cash Working Capital The actual Cash realized from all Current Assets appearing in the Balance Sheet may be less than the book value because (a) Debtor include Profit Margins (b) Depreciation ( a non-cash charge) may have been included as an overhead in valuation of closing stock of finished goods. The concept of Cash working Capital makes proper adjustments in the Balance Sheet Working Capital for the above items to arrive at the Cash Working Capital.

12 Positive Working Capital When Current Assets exceeds Current Liabilities the Net Current Asset is a Positive figure and hence it is called Positive Working Capital. Positive Working Capital indicates favorable Liquidity and Solvency position of a concern.

13 Negative Working Capital When Current Assets are less than Current Liabilities the Net Current Assets is negative figure and hence is called Negative Working Capital. Negative Working Capital indicates lack of Liquidity and adverse solvency position of a concern.

14 Factors affecting Working Capital 1. Operating Cycle of a Manufacturing Concern

15 2. Operating Cycle of a Trading Concern

16 3. Operating Cycle of a Service Concern Cash Accounts Receivable

17 How Long each item remain in the Operating Cycle

18 CASH Purchase of Raw materials Start Production Finished Goods Produced Sale on Credit Receipt from Debtors March 1 March 4 March 6 March 12 March 18 RM in Stock WIP in Stock FG in Stock Debtors 3 Days 2 Days 6 Days 7 Days Inventory Cycle Credit Cycle 11 Days 7 Days

19 Statement of Estimating Working Capital Particulars Calculation Amount I. CURRENT ASSETS 1. Closing Stock a) Raw Material (RM) R.M.Cost x Credit Period 12/52/365 b) Work-in-Progress i. Material R.M.Cost x Credit Period 12/52/365 ii. Labour iii. Overheads Wage Cost x Credit Period 12/52/365 Overhead Cost x Credit Period 12/52/365 c) Finished Goods (FG) Total Cost x Credit Period 12/52/365 Continue.

20 Particulars Calculation Amount 2. Debtors Sales Cost x Credit Period 12/52/ Pre-paid Expenses Expenses x Credit Period 12/52/ Cash and Bank Balance Amount Given TOTAL CURRENT ASSETS II. CURRENT LIABILITIES 1. Creditors R.M.Cost x Credit Period 12/52/ Outstanding Expenses Expenses x Credit Period 12/52/ Advance From Customers Amount Given TOTAL CURRENT LIABILITIES Continue.

21 Particulars Calculation Amount Net Working Capital (I II) Add: Margin of safety/ Provision for Contingency Estimating Working Capital/ Required Working Capital

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