There are two concepts of working capital namely Gross concepts and Net concepts:
Concepts of Working Capital
There are two concepts of working
capital namely Gross concepts and Net concepts:
Gross Working Capital
According to this concept,
whatever funds are invested are only in the current assets. This concept
expresses that working capital is an aggregate of current assets. The amount of
current liabilities is not deducted from the total current assets. This concept
is also referred to as “Current Capital” or “Circulating Capital”.
Net Working Capital
What is net working capital? The
term net working capital can be defined in two ways: (1) The most common
definition of net working capital is the capital required for running
day-to-day operations of a business. It may be expressed as excess of current
assets over current liabilities. 2) Net working capital can alternatively be
defined as a part of the current assets, which are financed with long-term
funds. For example, if the current asset is Rs. 100 and current liabilities is
Rs. 75, and then it implies Rs. 25 worth of current assets is financed by long-term
funds such as capital, reserves and surplus, term loans, debentures, etc. On
the other hand, if the current liability is Rs. 100 and current assets is Rs.
75, and then it implies Rs. 25 worth of short-terms funds is used for investing
in the fixed assets. This is known as negative working capital situation. This
is not a favourable financial position. When the current assets are equal to
current liabilities, it implies that there is no net working capital. This
means no current asset is being financed by long-term funds.
Working Capital = Current assets – Current liabilities.
Table 1.1 Difference between gross and net working capital
What are Current Assets? Assets, which can normally be
converted into cash within a year or within the operating cycle, are grouped as
current assets. In other words, current assets are resources that are in cash or
will soon be converted into cash in ‘the ordinary course of businesses. The
current asset components are assets like cash, temporary investments, raw
materials, work in progress, accounts receivables (sundry debtors/ trade
receivables/ bills receivables) and prepaid expenses.
What are Current Liabilities? Liabilities, which are due for
payment in the short-run, are classified as current liabilities. In other
words, these liabilities are due within the accounting period or the operating
cycle of the business. Most of such liabilities are incurred in the acquisition
of materials or services forming part of the current assets. Current
liabilities are commitments, which will soon require cash settlement in ‘the
ordinary course of business’. The current liability components are liabilities
like accounts payable (sundry creditors/ bills payables/ trade payables),
accrued liabilities (wages, salary, and rents), and estimated liabilities
(income tax payable and dividend payable).
In order to study in detail about current assets, let us compare it with
Tags : Financial Management - WORKING CAPITAL MANAGEMENT
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