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Gross Working Capital Concept (2) Net Working Capital Concept

(1) Gross working capital refers to a firm's total current assets, including cash, receivables, inventory. It represents the firm's total investment in current assets. (2) Net working capital is calculated as current assets minus current liabilities. It indicates whether a firm has enough short-term assets to cover its short-term debts. A positive net working capital means current assets exceed current liabilities. (3) There are arguments for both gross and net working capital concepts. Gross working capital simply looks at current assets, while net working capital provides more information about a firm's liquidity and ability to meet short-term obligations.

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142 views3 pages

Gross Working Capital Concept (2) Net Working Capital Concept

(1) Gross working capital refers to a firm's total current assets, including cash, receivables, inventory. It represents the firm's total investment in current assets. (2) Net working capital is calculated as current assets minus current liabilities. It indicates whether a firm has enough short-term assets to cover its short-term debts. A positive net working capital means current assets exceed current liabilities. (3) There are arguments for both gross and net working capital concepts. Gross working capital simply looks at current assets, while net working capital provides more information about a firm's liquidity and ability to meet short-term obligations.

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We take content rights seriously. If you suspect this is your content, claim it here.
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AFN0001: Explain Working Capital.

What do you mean by Gross Working Capital and


Net Working Capital?

Ans. Introduction:- Working capital plays the same role in the business as the role of heart in
the human body. Just like heart gets blood and circulates the same in the body, in the same way
in working capital, funds are generated and then circulated in the business. As and when this
circulation stops the business becomes lifeless. Thus, prudent management of Working capital is
necessary for the success of a business.

Meaning of Working Capital:-Working capital management is an important aspect of financial


management. In business, money is required for fixed assets and working capital. Fixed assets
include land and building, plant and machinery, furniture and fittings etc. Fixed assets are
acquired to be retained in the business for a long period and yield returns over the life of such
assets. The main objective of working capital management is to determine the optimum amount
of working capital required. Generally, management of working capital means management of
current assets.

Concepts of Working Capital:-There are two concepts of working capital-

(1) Gross Working Capital Concept

(2) Net Working Capital Concept.

(1) Gross working capital: Gross working capital; refers to firm's investment in current
assets. Current assets are the assets which can be converted into cash within an
accounting year and include cash, short-term securities, debtors, bill receivables and
stock. According to this concept, working capital means Gross working Capital which is
the total of all current assets of a business. It can be represented by the following
equation:
Gross Working Capital = Total Current Assets

Definitions favoring this concept are:-


According to Mead, Mallot and Field: "Working Capital means total of Current Assets".

According to Bonneville and Dewey


"Any acquisition of funds which increases the current assets increases working capital, for they
are one and the same".
Arguments in favour of Gross Working Capital Concept:- Persons acknowledging the total
of current assets as working capital give the following arguments in their favour:-

(i) Just as fixed assets are considered as the symbol of fixed capital, current assets must also
be considered as symbol of working capital.
(ii) Any acquisition of funds increases the working capital. This statement proves true
according to this concept whereas it does not hold true according to the second concept.
(iii) Most of the managers plan their business operations according to the current assets
concept because these are the assets used in day-to-day business operations.

(2) Net Working Capital Concept: Net working capital refers to the difference between
current assets and current liabilities. Current liabilities are those claims of outsiders
which are expected to mature for payment within an accounting year and include
creditors, bills payables, and outstanding expenses. Net working capital can be positive or
negative. A positive net working capital will arise when current assets exceed current
liabilities. A negative Net working capital occurs when current liabilities are in excess of
current assets.

Net Working Capital = Current Assets - Current Liabilities

Definitions Favouring Net Working Capital Concept:-

According to C.W.Gestenbergh

"It has ordinarily been defined as the excess of current assets over current liabilities".

According to Lawrence. J. Gitmen

“The most common definition of net working capital is the difference of firm's current assets and
current liabilities".

Arguments in Favour of Net Working Capital Concept:-

(i) This concept gives the true information about the liquidity of a concern. According to
first concept, the working capital appears to be increased merely by taking a short-term
loan whereas in the second concept working capital remains unchanged by doing so.
Thus, the second concept looks more logical.

(ii) Excess of current assets over current liabilities will indicate whether or not the concern
will be able to meet its current liabilities when they fall due. First concept does not
disclose this fact.

(iii) It is on the basis of this concept that the short-term lenders, bankers etc. calculate the
safety margin regarding the timely payment of their debt.

(iv) Excess of current assets over current liabilities will determine whether or not the concern
will be able to face the depression or any other contingent need of the business.

(v) According to this concept a comparison can be made between the financial position of
two firms whose current assets are equal. As discussed, net working capital is the excess
of current assets over current liabilities. There are three conditions:-
(i) When Current assets are equal to current liabilities, then working capital will be
zero.
(ii) When current assets are more than current liabilities, then working capital will be
positive.
(iii) When current assets are less than current liabilities, then working capital will be
Negative.

Current Assets:- Current assets mean those assets which are converted into cash within a short
period of time not exceeding one year e.g. Cash, Bank balance, Debtors, Bills Receivables,
Stock, Accrued Income etc.

Current Liabilities:- Current liabilities means those liabilities which have to be paid within a
short period of time in no case exceeding one year, e.g. Creditors, Bills payable, Outstanding
Expenses, Shot-term loans etc.

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