- Meaning of working capital:-
Working capital can be defined in simple words as, that part of the total capital, which is required for daily working of the business. It is the capital, which is required for daily working of the business. It is the capital with which the business is worked over. Funds needed for short term purpose for the purchase of raw material, payment of wages & other day to day expenses etc. these funds are known as working capital.
In simple words working capital refers to that part of the firm’s capital which is required for financing short term or current assets such as cash, marketable securities, debtors & inventories. Funds thus invested in current assets keep revolving fast & are being constantly converted into cash. Hence, it is also known as revolving or circulating capital or short term capital because it starts with cash & ultimately results in cash after completing the cycle. Cash is converted into stock of goods, later the goods are sold, sale of goods created debtors & bills receivables & finally they are turned into cash.
- In the words of Shubin, “Working capital is the amount of funds necessary to cover the cost of the operating the enterprise.”
- According to Genestenberg, “Circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another, as for example from cash to inventories, inventories to receivables, receivables into cash.”
- Concepts of working capital:-
There are two concepts of working capital:
- Gross working capital
- Net working capital
In the broad sense, the term working capital refers to the gross working capital & represents the amount of funds invested in current assets. Thus, the gross working capital is the capital invested in the total current assets of the enterprise. Current assets are those assets which in the ordinary course of business can be converted into cash within short period of normally one accounting year.
In the narrow sense, the term working capital refers to the net working. Net working capital is the excess of current assets over current liabilities or say:
Net working capital = Current assets – Current liabilities
Net working capital may be positive or negative. When the current assets exceed the current liabilities the working capital is positive & the negative working capital results when the current liabilities are more than the current assets. Current liabilities are those liabilities which are intended to be paid in the ordinary course of business within a short period of normally one accounting year out of current assets or the income of the business.
The gross working capital concept is financial or going concern concept whereas net working is an accounting concept of working capital. These two concepts of working capital are not exclusive; rather both have their own merits.
- Importance or Advantages of adequate working capital:-
Working capital is the life blood & nerve centre of a business. Just as circulation of blood is essential in the human body for maintaining life, working capital is very essential to maintain the smooth running of a business. No business can run successfully without an adequate amount of working capital. The main advantages of maintaining adequate amount of working capital are as follows:
- Solvency of the business: – Adequate working capital helps in maintaining solvency of the business by providing uninterrupted flow of production.
- Goodwill: – Sufficient working capital enables a business concern to make prompt payments & hence helps in creating & maintaining goodwill.
- Easy loans: – A concern having adequate working capital , high solvency & good credit standing can arrange loans from banks & others on easy & favourable terms.
- Cash discount: – Adequate working capital also enables a concern to avail cash discounts on the purchases & hence it reduces costs.
- Regular supply of raw materials: – Sufficient working capital ensures regular supply of raw materials & continuous production.
- Regular payments of salaries, wages & other day to day commitments: – A company which has ample working capital can make regularly payment of salaries, wages & other day to day commitments which raises the morale of its employees, increases their efficiency, reduces wastages & cost & enhances production & profit.
- Exploitation of favourable market conditions:- Only concerns with adequate working capital can exploit favourable market conditions such as purchasing its requirements in bulk when the prices are lower & by holding its inventories for higher prices.
- Ability to face crisis: – Adequate working capital enables a concern to face business crisis in emergencies such as depression because during such periods, generally there is much pressure on working capital.
- Quick & regular return on investment:- Every investors wants a quick & regular return on his investments. Sufficiency of working capital enables a concern to pay quick & regular dividends to its investors as there may not be much pressure to plough back profit. This gains the confidence of its investors & creates a favourable market to raise additional funds in the future.
- High morale: – Adequate working capital creates an environment of security, confidence, and high morale & creates overall efficiency in a business.