Page 22 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 2: Planning of Working Capital

As compared with the gross working capital, net is a qualitative concept. It indicates the liquidity Notes
position of and suggests the extent to which working Capital needs may be financed by permanent
sources of funds. Current Assets should be optimally more than Current Liabilities. It also
covers the point of right combination of long-term and short-term funds for financing current
assets. For every firm a particular amount of net Working Capital is permanent. Therefore it can
be financed with long-term funds.
Thus both concepts, Gross and Net Working Capital, are equally important for the efficient
management of Working Capital. There are no specific rules to determine a firm’s Gross and
Net Working Capital but it depends on the business activity of the firm.

Every business concern should have neither redundant nor cause excess WC nor it should be
short of WC. Both conditions are harmful and unprofitable for any business. But out of these
two, the shortage of WC is more dangerous for the well being of the firms.
Working capital may be of many types, but the most important of them all are equity capital,
debt capital, speciality capital and sweat equity. Each of these is a separate category of financial
and has its own benefits and characteristics.

Equity Capital

Equity capital can be understood as the invested money that is not repaid to the investors in the
normal course of business. It represents the risk capital staked by the owners through purchase
of the firm’s common stock (ordinary shares). Its value is computed by estimating the current
market value of everything owned by the firm from which the total of all liabilities is subtracted.
On the balance sheet of the firm, equity capital is listed as stockholders’ equity or owners’
equity. Equity Capital is also known as equity financing, share capital, net worth and book
value.
There are some businesses that are funded entirely with equity capital (cash written by the
shareholders or owners into the company that have no offsetting liabilities.) Although it is the
favored form for most people because you cannot go bankrupt, it can be extraordinarily expensive
and require massive amounts of work to grow your enterprise.

Example: Microsoft is an example of such an operation because it generates high enough
returns to justify a pure equity capital structure.

Debt Capital

Debt capital is the capital that a business raises by taking out a loan. It is a loan made to a
company that is normally repaid at some future date.

Notes Debt capital differs from equity capital because subscribers to debt capital do not
become part of the owners of the business, but are merely creditors.
Debt capital ranks higher than equity capital for the repayment of annual returns. This means
that legally, the interest on debt capital must be repaid in full before any dividends are paid to
any suppliers of equity.
Debt capital is that type of capital which is infused into a business with the understanding that
it must be paid back at a predetermined future date. In the meantime, the owner of the capital
(typically a bank, bondholders, or a wealthy individual), agree to accept interest in exchange for
you using their money.

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