Page 143 - DMGT409Basic Financial Management

Basic Financial Management

Notes
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Caution The concept of working capital has been a matter of great controversy, among the

financial wizards and they view it differently. There is no universally accepted defi nition
of working capital. Broadly, there are two concepts of working capital commonly found in

the existing literature of finance such as:
1. Gross Working Capital (Quantitative Concept), and
2. Net Working Capital (Qualitative Concept).
Both these concepts of working capital have operational significance. The two concepts are

not to be regarded as mutually exclusive. Each has its relevance in specific situations from the
management point of view.

Each concept of working capital has its own significance – the ‘gross concept’ emphasising the
‘use’ and the ‘net concept’ the ‘source’ – an integration of both these concepts is necessary in
order to understand working capital management in the context of risk, return and uncertainty.

8.1.1 Gross Working Capital Concept

According to this concept, the total current assets are termed as the gross working capital or
circulating capital. Total current assets include; cash, marketable securities, accounts receivables,
inventory, prepaid expense, advance payment of tax; etc. This concept also called as ‘quantitative
or broader approach’. To quote Weston and Brigham, “Gross Working Capital refers to fi rm’s
investments in short term assets such as cash, short term securities, accounts receivables and
inventories”. The concept helps in making optimum investment in current assets and their

financing. According to Walker, “Use of this concept is helpful in providing for the current
amount of working capital at the right time so that the firm is able to realise the greatest return

on investment”.The supporters of this concept like Mead,Field, and Baker and Malott, argue that

the management is very much concerned with the total current assets as they constitute the total
funds available for operating process.
Signifi cance

Gross Working Capital Concept focuses attention on the two aspects of current assets management,
they are:
1. Optimum Investment in Current Assets: Investment in current assets must be just adequate

to the needs of the firm. In other words, current assets investment should not be inadequate
or excessive. Inadequate working capital can disturb production and can also threaten the

solvency of the firm, if it fails to meet its current obligations. On the other hand, excessive
investment in current assets should be avoided, since it impairs the fi rm’s profi tability.
2. Financing of Current Assets: Need for working capital arise due to the increasing level of
business activity. Therefore, there is a need to provide/arrange it quickly. Similarly, some
times surplus funds may arise, thus they should be invested in short-term securities. They
should not be kept as idle.

8.1.2 Net Working Capital Concept

As per this concept, the excess of current assets over current liabilities represents net working
capital. Similar view is expressed by Guthmann and Dougall, Gerstenberg, Goel, Park and
Gladson,Kennedy and McMullen,and Myer in their distinguished works. ‘Accounts Hand Book’

has also fully supported this view.The famous economists like, Sailer Lincoln, and Stevens,fully

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