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Understanding Working Capital Essentials

Working capital refers to the capital required for financing short-term operational needs of a business like payrolls, inventories, and short-term liabilities. It is the difference between current assets and current liabilities. Working capital can be classified as gross or net working capital and permanent or temporary working capital. Sources of working capital include long-term sources like equity shares, debentures, retained earnings and term loans as well as short-term sources like bank loans, trade credit, and public deposits. Factors like nature of business, production cycle, and credit policy impact working capital needs.

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12 views17 pages

Understanding Working Capital Essentials

Working capital refers to the capital required for financing short-term operational needs of a business like payrolls, inventories, and short-term liabilities. It is the difference between current assets and current liabilities. Working capital can be classified as gross or net working capital and permanent or temporary working capital. Sources of working capital include long-term sources like equity shares, debentures, retained earnings and term loans as well as short-term sources like bank loans, trade credit, and public deposits. Factors like nature of business, production cycle, and credit policy impact working capital needs.

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rabadiya
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© Attribution Non-Commercial (BY-NC)
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Meaning of working capital (WC)

• Working capital typically means the firm’s


holding of current or short-term assets such as
cash, receivables, inventory and marketable
securities.
• Funds required for short term purposes or day
to day expenses are working capital. WC refers
to part of firm’s capital reqd. for financing short
term or current assets also known as revolving
or short term capital or circulating capital.
Definition of Working Capital
• Working capital is description of that capital
which is not fixed but more common use of
the working capital is to consider it as a
difference between the book value of current
assets &current liabilities
FACTORS DETERMINING
WORKING CAPITAL
1.     Nature & volume of business
2.   length of Manufacturing
3.    Business fluctuation
4.     Production policy
5.     Credit policy of the business
6. Availability of credit
7.    Growth and expansion
8.    Profit and it’s distribution
9.   Price level fluctuation
10. Operating efficiency
TYPES OF WORKING CAPITAL

WORKING CAPITAL

BASIS OF BASIS OF
CONCEPT TIME

Gross Net Permanent Temporary


Working Working / Fixed / Variable
Capital Capital WC WC

Seasonal Special
WC WC
Regular Reserve
WC WC
Sources Of Working Capital

Long term sources Short term sources

 issue of shares
 Issue of debentures Internal External
 Retained profits  Depreciation funds  Trade credit
 Sales of fixed assets Accrued expenses  Credit papers
 Term loans (provision for taxation)  Commercial bank
 Bank credit
 Public deposits
Sources of working capital
Long term sources
Issue of shares
It is the primary and most important sources of
regular or permanent working capital. Issuing
equity shares as it does not create and burden
on the income of the concern. Nor the concern
is obliged to refund capital should preferably
raise permanent working capital.
Share
The Companies Act defines a share as “Share
in the Share Capital of the company, and
includes stock except where a distinction
between stock and share is expressed.”Under
the Companies Act, 1956, a company can issue
two types of shares.
(a) Equity Shares
(b) Preference shares
Issue of debentures

It crates a fixed charge on future earnings of


the company. company is obliged to pay
interest . management should make wise
choice in procuring funds by issue of
debentures.
Debenture
• Debentures are Debt Instruments issued for a
long term by governments and big institutions
for raising funds. The Debenture has some
resemblances to bonds but the securitization
terms and conditions are different for
Debentures compared to a bond.
TYPES OF DEBENTURES
• Secured debentures
• Redeemable debentures
• Perpetual debentures
• Convertible debentures
• Retained earnings
Retain earning accumulated profits are a
permanent sources of regular working capital.
It is regular and cheapest. It creates not charge
on future profits of the enterprises
• Long term debt
• Company can raise fund from accepting public
deposits, debts from financial institutution like
banks, corporations etc. the cost is higher than
the other financial tools.
• Other sources sale of idle fixed assets ,
securities received from employees and
customers are examples of other sources of
finance
• Commercial bank
A commercial bank constitutes a significant sources
for short term or temporary working capital . this will
be in the form of short term loans, cash credit, and
overdraft and though discounting the bills of
exchanges.
• Public deposits
most of the companies in recent years depends on this
sources to meet their short term working capital
requirements ranging fro six month to three years.
• Various credits
• trade credit, business credit papers and
customer credit are other sources of short term
working capital. Credit from suppliers,
advances from customers, bills of exchanges,
promissnotes, etc helps to raise temporary
working capital
Shares
•
Debentures
• Debentures are debt securities a document
which either creates a debt or acknowledges it
issued under the Company's Common Seal.
Debentures holders have no right to vote at the
meetings of the companies.
Term Loans
• Long term debt with a maturity of more
than one year.
• Obtained from banks & financial
institutions
• Mainly to finance company’s capital
expenditure

Common questions

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A company can leverage the sale of idle fixed assets to manage its working capital requirements by converting non-productive assets into cash, thereby increasing its liquidity. This provides additional funds that can be used to finance short-term operational activities without incurring extra debt .

Working capital on the basis of time can be distinguished into permanent or fixed working capital which remains in the business permanently and is required throughout the life of the business, and temporary or variable working capital which fluctuates with the level of business activity, such as seasonal or cyclical needs .

Commercial banks contribute to short-term working capital requirements by offering products such as short-term loans, cash credit, overdraft facilities, and discounting bills of exchanges, which provide temporary liquidity solutions for companies to meet their operational expenses .

The primary factors that determine the working capital requirements of a business include the nature and volume of the business, length of the manufacturing cycle, business fluctuations, production policy, credit policy of the business, availability of credit, growth and expansion, profit and its distribution, price level fluctuations, and operating efficiency .

Issuance of shares as a long-term source of working capital benefits a company by not creating a financial burden on the income of the company since the capital is not required to be repaid. This allows for raising permanent working capital without creating any charge on future profits, providing a stable financial foundation .

A firm's credit policy impacts its working capital requirements by determining the length of time customers have to pay for their purchases. Generous credit terms may increase sales but will also tie up more capital in receivables, requiring the firm to have higher working capital to manage the delayed cash inflows .

Price level fluctuations influence a firm's working capital needs by affecting the cost of raw materials, production, and inventory management. With fluctuations, firms may require more funds to purchase raw materials or to adjust to changes in sales, impacting the liquidity and capital needed to maintain operations smoothly .

To optimize operating efficiency and its impact on working capital, a company might employ strategies such as just-in-time inventory management to minimize stock levels, improve receivables management through stringent credit policies, and streamline production processes to reduce cycle times and lower costs, thereby increasing liquidity and reducing the need for additional working capital .

Retained earnings serve as a source of working capital by providing funds that have been accumulated from past profits. This source of financing is regular and cost-effective as it does not impose any additional financial obligation on the company, unlike debt instruments .

A company might prefer to issue debentures over equity shares for raising long-term capital because debentures create a fixed charge on future earnings, providing tax-deductible interest payments which can be advantageous, while also allowing the company's existing owners to retain control since debenture holders do not have voting rights .

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