Dr.

Virendra Swarup Institute of Computer Studies - Kanpur

(ii) Networking capital.
UNIT IV
Working Capital: Meaning, Concept & Nature Gross Working Capital:
Meaning: The sum total of all current assets of a business concern
In an ordinary sense, working capital denotes the amount is termed as gross working capital. So,
of funds needed for meeting day-to-day operations of a
concern. Gross working capital = Stock + Debtors + Receivables
+ Cash.
This is related to short-term assets and short-term
sources of financing. Hence it deals with both, assets and Net Working Capital:

liabilities—in the sense of managing working capital it is The difference between current assets and current

the excess of current assets over current liabilities. In liabilities of a business concern is termed as the Net

this article we will discuss about the various aspects of working capital.

working capital.
Hence,

Concept of Working Capital:

Net Working Capital = Stock + Debtors + Receivables +
The funds invested in current assets are termed as
Cash – Creditors – Payables.
working capital. It is the fund that is needed to run the
day-to-day operations. It circulates in the business like Nature of Working Capital:
the blood circulates in a living body. The nature of working capital is as discussed below:
i. It is used for purchase of raw materials,
Generally, working capital refers to the current assets of
payment of wages and expenses.
a company that are changed from one form to another in
the ordinary course of business, i.e. ii. It changes form constantly to keep the
wheels of business moving.
from cash to inventory,

iii. Working capital enhances liquidity, solvency,

inventory to work in progress (WIP),
creditworthiness and reputation of the enterprise.

WIP to finished goods,

iv. It generates the elements of cost namely: Materials,

finished goods to receivables wages and expenses.

and from receivables to cash. v. It enables the enterprise to avail the cash discount
facilities offered by its suppliers.
There are two concepts in respect of working capital:
(i) Gross working capital and

Instructor – Anuj Srivastava

Accounts - BCA – Second Semester
 Dr. Virendra Swarup Institute of Computer Studies - Kanpur
Need for Working Capital:
the time period involved in production. It starts right
Working capital plays a vital role in business. This
from acquisition of raw material and ends till payment is
capital remains blocked in raw materials, work in
received after sale.
progress, finished products and with customers.

2. Nature of Business:
The needs for working capital are as given below:
The type of business, firm is involved in, is the next
i. Adequate working capital is needed to maintain a
regular supply of raw materials, which in turn facilitates consideration while deciding the working capital. In case

smoother running of production process. of trading concern or retail shop the requirement of

working capital is less because length of operating cycle

ii. Working capital ensures the regular and timely
is small. It is long in case of production or wholesale
payment of wages and salaries, thereby improving the
business.
morale and efficiency of employees.

3. Scale of Operation:
iii. Working capital is needed for the efficient use of
fixed assets. The firms operating at large scale need to maintain more

inventory, debtors, etc. So they generally require large

iv. In order to enhance goodwill a healthy level of
working capital whereas firms operating at small scale
working capital is needed. It is necessary to build a good
require less working capital.
reputation and to make payments to creditors in time.

4. Business Cycle Fluctuation:

Top 13 Factors affecting the Working Capital of a During boom period the market is flourishing so more
Company
demand, more production, more stock, and more debtors
Factors Affecting the Working Capital:
which mean more amount of working capital is required.
The firm must estimate its working capital very
Whereas during depression period low demand less
accurately because excessive working capital results in
inventories to be maintained, less debtors, so less
unnecessary accumulation of inventory and wastage of
working capital will be required.
capital whereas shortage of working capital affects the

smooth flow of operating cycle and business fails to 5. Seasonal Factors:

meet its commitment. The working capital requirement is constant for the

companies which are selling goods throughout the

1. Length of Operating Cycle:
season whereas the companies which are selling seasonal
The amount of working capital directly depends upon
goods require huge amount during season as more
the length of operating cycle. Operating cycle refers to

Instructor – Anuj Srivastava

Accounts - BCA – Second Semester
 Dr. Virendra Swarup Institute of Computer Studies - Kanpur
9. Operating Efficiency:
demand, more stock has to be maintained and fast supply
The firm having high degree of operating efficiency
is needed whereas during off season or slack season
requires less amount of working capital as compared to
demand is very low so less working capital is needed.
firm having low degree of efficiency which requires
6. Technology and Production Cycle:
more working capital.
If a company is using labour intensive technique of
10. Availability of Raw Materials:
production then more working capital is required
If raw materials are easily available and there is ready
because company needs to maintain enough cash flow
supply of raw materials and inputs then firms can
for making payments to labour whereas if company is
manage with less amount of working capital also as they
using machine-intensive technique of production then
need not maintain any stock of raw materials or they can
less working capital is required because investment in
manage with very less stock.
machinery is fixed capital requirement and there will be

less operative expenses. 11. Level of Competition:

If the market is competitive then company will have to

7. Credit Allowed:
adopt liberal credit policy and to supply goods on time.
Credit policy refers to average period for collection of
Higher inventories have to be maintained so more
sale proceeds. It depends on number of factors such as
working capital is required. A business with less
creditworthiness, of clients, industry norms etc. If
competition or with monopoly position will require less
company is following liberal credit policy then it will
working capital as it can dictate terms according to its
require more working capital whereas if company is
own requirements.
following strict or short term credit policy, then it can

manage with less working capital also. 12. Inflation:

If there is increase or rise in price then the price of raw

8. Credit Avail:
materials and cost of labour will rise, it will result in an
Another factor related to credit policy is how much and
increase in working capital requirement.
for how long period company is getting credit from its

suppliers. If suppliers of raw materials are giving long 13. Growth Prospects:
term credit then company can manage with less amount Firms planning to expand their activities will require
of working capital whereas if suppliers are giving only more amount of working capital as for expansion they
short period credit then company will require more need to increase scale of production which means more
working capital to make payments to creditors.

Instructor – Anuj Srivastava

Accounts - BCA – Second Semester
 Dr. Virendra Swarup Institute of Computer Studies - Kanpur
(b) Liquid Ratio:
raw materials, more inputs etc. so more working capital
It is the ratio between total liquid assets to total liquid
also.
liabilities. The normal for such ratio is taken to be 1:1.
Liquidity and Profitability| Working Capital As a tool for assessment of liquidity position of firms, it
is considered to be much better than that of the current
Meaning of Liquidity:
ratio as it eliminates the snags in the same, since it
Liquidity means one’s ability to meet claims and
indicates the relationship between strictly liquid assets
obligations as and when they become due. In the context
whose realizable value is almost certain on the one hand,
of an asset, it implies convertibility of the same
and strictly liquid liabilities on the other.
ultimately into Cash and it has two dimensions in it, viz.,
time and risk. (c) Absolute Liquidity Ratio:
Liquid ratio measures the relationship between cash and
The time dimension of liquidity is concerned the speed
near cash items on the one hand and immediately
with which an asset can be converted into Cash Risk
maturing obligation on the other. But as the composition
dimension is concerned with the degree of certainty with
of cash and near cash items in the calculation of liquid
which an asset can be converted into Cash without any
ratio, comprises accounts receivable also, doubts have
sacrifice in its book value.
been expressed about the efficacy even of this ratio as a
Measurement of Liquidity:
flawless tool for measuring liquidity position of a firm.
The liquidity is normally measured with the help of
the following financial ratios: Meaning of Profitability:
(a) Current Ratio; Profitability of a firm is represented by the rate of return
on its capital employed.
b) Liquid Ratio;

Liquidity-Profitability Tangle:
(c) Absolute Liquidity Ratio;
From what has hitherto been stated, it becomes obvious,
that, a firm in its bid to maximize the rate of return on
(a) Current Ratio:
investment has first to strive for ensuring its most
It is the relation between the amount of current assets
appropriate level of investment for working capital
and the amount of current liabilities. It is essentially a
purposes. That is to say, its investment in working
tool for measuring short-term liquidity and solvency
capital must be optimum.
position of firms. In other words, it may be stated that
this ratio is taken to measure the margin of safety of
current assets over current liabilities that the Neither be in excess nor be in adequate. Secondly, once
management of a firm maintains in obtaining business the most appropriate level of investment in Working
finance from short-term sources.
Capital has been determined, the firm has to concentrate

on the optimum use of the same. Where investment in

Generally, a 2 : 1 ratio is considered as normal (i.e., for
Working Capital is much in excess of requirement, no
every two rupees of current assets there is only one
doubt, it will impair the firm’s profitability.
rupee of current liability)

Instructor – Anuj Srivastava

Accounts - BCA – Second Semester
 Dr. Virendra Swarup Institute of Computer Studies - Kanpur
There term ‘hedging’ is often used in the sense of a
level, i.e., limited investment in current assets. This
risk-reducing
means that the entity holds lower inventory levels,
follows strict credit policies, keeps less cash balance, etc.
investment strategy involving transactions of a
Under this approach, current assets are maintained solely
simultaneous but opposing nature so that the effect of
to just meet the current liabilities without cushioning for
one is likely to counterbalance the effect of the other. any variations in working capital requirements. The
With reference to an appropriate financing- mix, the aggressive approach suggests that the entire estimated

term hedging can be said to refer to the process of requirements of current assets or working capital should
be financed from short-term funding sources. It says that
matching maturities of debt with the maturities of
even a part of fixed assets investments is to be financed
financial needs. This approach to the financing decision
from short-term sources
to determine an appropriate .financing mix is, therefore,
Conservative approach
also called as matching approach

According to this approach, the maturity of the sources Conservative strategy is one of the approaches of
working capital management wherein the organization
of funds should match the nature of the assets to be
follows a strategy to invest a high amount of capital in
financed. For the purpose of analysis, the current assets
current assets. Here, organizations are known to
can be broadly classified maintain a higher inventory level, follow liberal credit
;into two classes. policies, and maintain cash balance as high as possible
so that any existing liabilities can be met immediately.
Conservation approach
A conservative strategy suggests that no risk is taken in
the management of working capital and that high levels
This approach suggest that the estimated requirement of
of current assets should be carried in relation to sales.
total funds should be met from long-term sources; the
Surplus current assets allow the company to handle
use of short-term funds should be restricted to only unexpected fluctuations in revenue, manufacturing
emergency situation or when there is an unexpected schedules, and procurement times without affecting the

outflow of funds. production plans. It requires maintaining a high level of

working capital and should be funded through long-term
Approaches to Working Capital Management
funds, such as share capital or long-term debt.
Aggressive approach
Moderate/Hedging or Matching approach

The aggressive strategy is one of the approaches of

The moderate strategy is one of those approaches of
working capital management wherein the company’s
working capital management which lies in between the
investments in working capital are kept at a minimum
above two approaches, i.e., aggressive and conservative

Instructor – Anuj Srivastava

Accounts - BCA – Second Semester
 Dr. Virendra Swarup Institute of Computer Studies - Kanpur
approach. In this strategy, a balance between risk and
return is maintained in order to benefit more by more
effective use of the funds.

This approach classifies the requirements of total

working capital into permanent and temporary.
Permanent or fixed working capital is the minimum
amount required to perform normal business operations,
whereas temporary or seasonal working capital is
required to satisfy specific requirements. Under this
approach, the core/permanent working capital is
financed from long-term capital sources, and short-term
funding/borrowing is used to meet seasonal variations or
temporary working capital needs.

Instructor – Anuj Srivastava

Accounts - BCA – Second Semester