A brief overview on Working Capital

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Working CapitalWorking Capital
Presented by Xavier Prakash atPresented by Xavier Prakash at
JBIMSJBIMS
University of MumbaiUniversity of Mumbai

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MeaningMeaning
• Accounting Principles Board of the American Institute ofAccounting Principles Board of the American Institute of
Certified Public Accountants has defined Working Capital asCertified Public Accountants has defined Working Capital as
“the excess of Current Assets over Current Liabilities... which“the excess of Current Assets over Current Liabilities... which
is the liquid portion of the total capital... a margin a buffer foris the liquid portion of the total capital... a margin a buffer for
liabilities payable within the ordinary operating cycle of theliabilities payable within the ordinary operating cycle of the
business.”business.”
• Funds required for carrying day to day operationsFunds required for carrying day to day operations
• Working Capital=Current Assets – Current LiabilitiesWorking Capital=Current Assets – Current Liabilities

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Types of Working CapitalTypes of Working Capital
• Gross and Net Working CapitalGross and Net Working Capital
• Permanent and Temporary Working CapitalPermanent and Temporary Working Capital
• Balance Sheet Capital and Cash Working CapitalBalance Sheet Capital and Cash Working Capital
• Positive and Negative Working CapitalPositive and Negative Working Capital

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Importance of Working CapitalImportance of Working Capital
• Continuity in Business OperationContinuity in Business Operation
• Increase Credit WorthinessIncrease Credit Worthiness
• GoodwillGoodwill
• Repayment of Long Term LoansRepayment of Long Term Loans
• Regular Dividend PaymentRegular Dividend Payment
• Easy Availability of Bank LoansEasy Availability of Bank Loans
• Increase Efficiency and ProductivityIncrease Efficiency and Productivity
• Enable to face competitionEnable to face competition

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Current Assets Current Liabilities
Components of Working CapitalComponents of Working Capital
Stock Debtors
Prepaid
Expenses
Cash &
Bank Balance
Raw Material
Work in Progress
Finished Goods
Creditors
Outstanding
Expenses
Advance from
Customers

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Working Capital CycleWorking Capital Cycle
Cash
OutflowInflow
Purchase of
Raw Material for
cash or credit
Payment of
Direct Expenses
for cash or
credit
Work in
Progress
Production of
Finished
Goods
Sale for cash or
credit
(Including
Profit)
Payment of
Overheads for
cash or credit

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Factors Influencing Working CapitalFactors Influencing Working Capital
RequirementRequirement
• Nature of BusinessNature of Business
• Seasonality of OperationSeasonality of Operation
• Production PolicyProduction Policy
• Market ConditionsMarket Conditions
• Condition of SupplyCondition of Supply

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Sources of Working CapitalSources of Working Capital
• Trade CreditTrade Credit
• Bank OverdraftBank Overdraft
• Cash CreditCash Credit
• Bill DiscountingBill Discounting
• Self – FinancingSelf – Financing
• Packing credit facility for ExportersPacking credit facility for Exporters
• Dealers AdvanceDealers Advance
• Commercial PaperCommercial Paper

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Excess of Working CapitalExcess of Working Capital
• Over CapitalizationOver Capitalization
• Under tradingUnder trading
• E.g. Due to Heavy BorrowingsE.g. Due to Heavy Borrowings
Consequences of over assessmentConsequences of over assessment
• Unnecessary Accumulation of InventoriesUnnecessary Accumulation of Inventories
• Liberal Credit Terms to BuyersLiberal Credit Terms to Buyers
• Poor Recovery System and Cash ManagementPoor Recovery System and Cash Management
• InefficiencyInefficiency
• Reduce Return on Investment.Reduce Return on Investment.

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Shortage of Working CapitalShortage of Working Capital
• Sickness in businessSickness in business
• Under CapitalizationUnder Capitalization
• Causes –Causes –
1.1. Operating LossesOperating Losses
2.2. Extra Ordinary LossesExtra Ordinary Losses
3.3. Liberal Dividend PolicyLiberal Dividend Policy
4.4. Payment of Interest before due datePayment of Interest before due date
5.5. Redemption of Preference Capital before bringing in newRedemption of Preference Capital before bringing in new
capital or debenturescapital or debentures
6.6. Purchase of Fixed Assets without raising Long Term FundsPurchase of Fixed Assets without raising Long Term Funds

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Consequences of InadequateConsequences of Inadequate
Working CapitalWorking Capital
• Production of sales Schedule can’t be achievedProduction of sales Schedule can’t be achieved
• Late Payment to CreditorsLate Payment to Creditors
• No stable Dividend PolicyNo stable Dividend Policy
• Late Payment to WorkersLate Payment to Workers
• Low ProfitabilityLow Profitability
• Less scope for expansionLess scope for expansion

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Case StudyCase Study
Mahesh Hockey Shop, a hypothetical business with currentMahesh Hockey Shop, a hypothetical business with current
assets of Rs50,000 and current liabilities of Rs25000, hasassets of Rs50,000 and current liabilities of Rs25000, has
working capital of Rs25000 (Rs50,000-Rs25000).The businessworking capital of Rs25000 (Rs50,000-Rs25000).The business
has Rs2 of current assets for every Rs1 of current liabilities.has Rs2 of current assets for every Rs1 of current liabilities.
Mahesh’s working capital or current ratio is expressed as 2:1.Mahesh’s working capital or current ratio is expressed as 2:1.

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Situation 1Situation 1
Current assets CurrentCurrent assets Current
LiabilitiesLiabilities
Rs50,000Rs50,000 Rs25,000Rs25,000
22 11

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Situation 2Situation 2
Current assets CurrentCurrent assets Current
LiabilitiesLiabilities
Rs50,000Rs50,000 Rs50,000Rs50,000
11 11

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Situation 3Situation 3
Current assets CurrentCurrent assets Current
LiabilitiesLiabilities
Rs20,000Rs20,000 Rs25,000Rs25,000
0.80.8 11

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Thank youThank you