Page 25 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes Sweat Equity

There is also a form of capital known as sweat equity which can be explained as equity acquired
by a company’s executives on favorable terms, to reflect the value the executives have added and
will continue to add to the company. This type of equity results when an owner bootstraps
operations by putting in long hours at a low rate of pay per hour making up for the lack of
capital necessary to hire sufficient employees to do the job well and let them work an ordinarily
forty hour workweek.
Although it is largely intangible and does not count as financial capital, it can be estimated as the
cost of payroll saved as a result of excess hours worked by the owners. The hope is that the
business will grow fast enough to compensate the owner for the low-pay, long-hour sweat
equity infused into the enterprise.

Self Assessment

Fill in the blanks:
1. ................................. is the invested money not repaid to the investors in the normal course
of business.
2. Debt capital ranks ................................. than equity capital for the repayment of annual
returns.

3. ………………..is largely intangible and does not count as financial capital, it can be estimated
as the cost of payroll saved as a result of excess hours worked by the owners.

2.2 Operating Cycle

The extent to which profits can be earned will naturally depend, among other things, upon the
magnitude of the sales. A successful sales programme is, in other words, necessary for earning
profits by any business enterprise. However, sales do not convert into cash instantly: there is
invariably a time-lag between the sale of goods and the receipt of cash. There is, therefore, a
need for working capital in the form of current assets to deal with the problem arising out of the
lack of immediate realisation of cash against goods sold. Therefore, sufficient working capital is
necessary to sustain sales activity. Technically, this is referred to as the operating or cash cycle.
2.2.1 Meaning of Operating Cycle

The simplest definition of the term operating cycle is, “The average time between purchasing or
acquiring inventory and receiving cash proceeds from its sale.”

The operating cycle can be said to be at the heart of the need for working capital. The continuing
flow from cash to suppliers, to inventory, to accounts receivable and back into cash is what is
called the operating cycle. In other words, the term cash cycle refers to the length of time
necessary to complete the following cycle of events:
1. Conversion of cash into inventory
2. Conversion of inventory into receivables

3. Conversion of receivables into cash.
The operating cycle, which is a continuous process, is shown in Figure 2.1.

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