WORKING CAPITAL

1. WORKING CAPITAL

2. WORKING CAPITAL • Working Capital represents operating liquidity available to a business. • This is short term capital or finance that a business keeps. • Working capital is the money used to meet day to day working in business concern such as salary, rent, energy bills, purchases etc.

3. Working Capital • Working capital is defined as • Working Capital = Current Assets – Current Liabilities.

4. Balance Sheet of Company X

5. Current Assets • Current assets are short term source of finance such as • Stocks / Inventories • Debtors • Cash • Cash Equivalent – these are short term and highly liquid investments which are easily and immediately convertible in to cash.

6. Current Liabilities • Current liabilities are short term requirements for cash. • trade creditors • Bills payable • Bank credit • Taxes • dividend

7. Working capital management • Task of the finance manager in managing working capital efficiently is to ensure sufficient liquidity in the operations of the business. • The liquidity of the firm is measured by its ability to satisfy short term obligations as they become due.

8. Measures of liquidity • The three basic measure of a firm’s overall liquidity are • 1) Current Ratio • 2) Acid Test Ratio • 3) Net Working Capital

9. Current Ratio • The current ratio is the ratio of total current assets to total current liabilities. Current Assets • Current Ratio = --------------------------- Current Liabilities

10. CURRENT RATIO • Its measurement of short term solvency. • It indicates the rupee of current assets available for each rupee of current liability. • Conventionally a current ratio of 2 : 1 is considered satisfactory.

11. Current ratio Firm A Firm B • Current Assets 1,80,000 30,000 ----------------------- = --------------- ------------ Current Liabilities 1,20,0000 10,000 = 3 : 2 3 : 1

12. Current Ratio • In case of company A, the current ratio is 3 : 2. • It implies that for every two rupees of current liabilities, three rupees of current assets are available to meet them. • In case of company B, the current ratio is 3:1. • It implies that for every rupees of current liabilities, three rupees of current assets are available to meet them.

13. Current ratio • The liquidity position, as measured by current ratio, is better in company B as compared to company A. • In inter firm comparison, the firm with higher current ratio has better liquidity / short term solvency.

14. Acid Test Ratio • The acid test ratio is the ratio of quick current assets to total current liabilities. Quick Assets • Current Ratio = --------------------------- Current Liabilities

15. Acid test ratio • Quick asset refers to current assets which can be converted into cash immediately or at a short notice without diminution of value. • It is a rigorous measure of a firm’s ability to serve short term liabilities. • An acid test ratio of 1:1 is considered satisfactory.

16. Net Working Capital • Net working capital represents the excess of current assets over current liabilities. • Although NWC is really not a ratio, it is frequently employed as measure of a company’s liquidity position. • An enterprise should have sufficient working capital in order to be able to meet the claims of the creditors as well as daily needs of the business.

17. Need for working capital • Need for working capital arises because sales do not convert into cash immediately. • There is invariably a time lag between the sale of goods and the receipt of cash. • Therefore, sufficient working capital is necessary to sustain sales activity. • Technically, this is refereed to as operating cycle.

18. Operating Cycle • The operating cycle consists of three phases. • Phase 1- cash get converted into inventory • Phase 2 – the inventory is converted into receivables as credit sales are made to customers. • Phase 3 – Receivables are collected.

19. Permanent & Temporary Working Capital • To carry on business, a certain minimum level of working capital is necessary on a continuous basis. • This requirement will have to be met permanently. • Any amount above the permanent level of working capital is temporary, fluctuating or variable working capital. • Temporary working capital requirement arises due to seasonal fluctuation of business activity.

20. Permanent & Temporary Working Capital Figure shows that permanent level is fairly constant, while temporary working capital is fluctuating in accordance with seasonal demand. Temporary Permanent Time

21. Permanent & Temporary Working Capital • In case of expanding firm, the permanent working capital line may be horizontal. Temporary Permanent Time

22. Financing of W.C. • The source of finance for working capital are mainly as under. • 1) Trade Credit • 2) Bank Credit • 3) Current provisions and non bank short term borrowings • 4) Long term source comprising equity capital and long term borrowings.

23. Financing of W.C. • In India the primary source for financing working capital are trade credit and short term bank credit.

24. Bank Credit • The bank credit is the primary institutional source of working capital finance. • To obtain short term bank credit, working capital requirement is estimated by borrowers and then banks are approached with necessary supporting data. • The bank determine the maximum credit based on the margin requirement of the security.

25. Bank Credit • The margin represents a percentage of the value of the asset offered as security by the borrower. • For ex, if the margin requirement on a particular item is 50%, the bank will provide credit upto Rs. 50,000 against the security of an asset worth Rs. 1,00,000.

26. Forms of Credit • After getting the overall credit limit sanctioned by the banker, the borrower draws fund periodically. The following forms of credit area available to him: • 1) Loan Arrangement • 2) Overdraft Arrangement • 3) Cash Credit Arrangement • 4) Term Loan for working capital