Page 7 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes other funds must be raised judiciously. Short-term or current assets constitute a part of the asset-
investment decision and require diligent review by the firm’s executives.
Further, since there exists a close correlation between sales fluctuations and invested amounts in
current assets, a careful maintenance of the proper asset and funds should be ensured.

1.1 Concept of Working Capital

Working capital typically means the firm’s holdings of current, or short-term, assets such as
cash, receivables, inventory, and marketable securities. Working capital refers to that part of
firm’s capital which is required for financing short-term or current assets such as cash, marketable
securities, debtors, and inventories. In other words working capital is the amount of funds
necessary to cover the cost of operating the enterprise.

Working capital means the funds (i.e.; capital) available and used for day-to-day operations
(i.e.; working) of an enterprise. It consists broadly of that portion of assets of a business which
are used in or related to its current operations. It refers to funds which are used during an
accounting period to generate a current income of a type which is consistent with major purpose
of a firm existence.
Working Capital is the money used to make goods and attract sales. The less Working Capital
used to attract sales, the higher is likely to be the return on investment. Working Capital
management is about the commercial and financial aspects of Inventory, credit, purchasing,
marketing, and royalty and investment policy. The higher the profit margin, the lower is likely to
be the level of Working Capital tied up in creating and selling titles. The faster that we create and
sell the books the higher is likely to be the return on investment. Thus, when we have been using.

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Caution The larger the percentage of funds obtained from short-term funds, the more
aggressive (and risky) in firm’s working capital policy and vice-versa.
There are two possible interpretations of working capital concept:

l. Balance Sheet Concept
2. Operating Cycle Concept
It goes without saying that the pattern of management will be very largely influenced by the
approach taken in defining it. Therefore, the two concepts are discussed separately in a nutshell.

1.1.1 Balance Sheet Concept

There are two interpretations of working capital under the balance sheet concept. It is represented
by the excess of current assets over current liabilities and is the amount normally available to
finance current operations. But, sometimes working capital is also used as a synonym for gross
or total current assets. In that case, the excess of current assets over current liabilities is called the
net working capital or net current assets. Economists like Mead, Malott, Baket and Field support
the latter view of working capital. They feel that current assets should be considered as working
capital as the whole of it helps to earn profits; and the management is more concerned with the
total current assets as they constitute the total funds available for operational purposes. On the
other hand, economists like Lincoln and Salvers uphold the former view. They argue that
1. In the long run what matters is the surplus of current asserts over current liabilities;

2. It is this concept which helps creditors and investors to judge the financial soundness of
the enterprise;

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