Financial needs of modern business enterprise may be classified into two categories
(a) Fixed capital, and
(b) Working capital.
Modern Industries and capital intensive by nature and its Fixed Capital includes lands and building, Plant
and Machinery, and tools and implements.
The requirement of finance to purchase fixed capital is essentially long term in nature.
The working capital, short term in nature, is required to purchase raw materials and meet day to day
administrative and other such expenses.
There are various sources of finance for a modern industrial unit. These sources are of two types
(a) Internal sources and (b) External Sources
Internal sources include paid up capital in the form of share subscription, ploughing back of profits and
reserves.
The external sources include debenture issue, public deposits, loans from Commercial banks and other
specialized institutions.
Lending operation of the commercial banks to the Industrial Units and other Business Enterprises are
governed by the guidelines issued by the Reserve bank of India.
As mentioned above, Banks finance is largely divided into two categories , i.e Term Credit and working
capital.
Term Credit refers to the funds required for investment in fixed or permanent assets like land, building,
plants, machineries, other fixed assets etc,. Fixed Capital in the nature of Term Credit is required for the
establishment of business. Tem Credit facilities generally is allowed for longer term in nature.
Working Capital refers to the capital which is required to meet day to day expenses of the organization and
which is required to meet day to day expenses of the organization and which is employed in the current
assets like raw materials, debtors, bill-receivables etc. Thus working capital is required to utilize fixed
assets.
Working capital plays a very important role in business. It acts as a lubricant to run the wheels of fixed
assets. The effective provision and efficient utilization of working capital can lead to success of the
business.
Overview of Working Capital Assessment
Meaning of Working capital
Working capital is the amount of funds necessary to cover the cost of operating the business cycle of the
entrepreneur. This refers to the investment of the business unit in short term assets, cash, short term
securities, account receivables and inventories. It is the level of fund which a company must possess to
finance its day to day operation.
Definition: Working Capital, in banking perspective, is defined as:
❖ Funds required for acquisition of build up Current Assets generally for a period of one operating
cycle.
❖ Funds required for financing short term assets or Current Assets such as cash, Debtors and
inventories to enable business/industry to operate at the expected level.
❖ Funds required for meeting day-to-day operations like purchase of raw materials, spares & stores,
meeting manufacturing expenses like wages, power & fuel and storage & selling expenses of
finished goods etc. These expenses generally form part of Working capital or that capital of fund
which is required for keeping the wheels of production going on.
❖ Thus working capital represents the total funds required for running the operating cycle and
finance manufacturing, production and sales. Therefore it is called operating Capital or Short term
capital. Total funds required for the continuous operations of the business on a going basis.
❖ Financed as Cash Credit, Overdraft, Short Term Working Capital Loan etc,.
❖ Assessed for one year and renewed annually.
Basic Financial Concepts
1. Gross Working capital
2. Net Working Capital:
3. Working Capital Gap
A. Commercial Banks have traditionally been assessing working capital credit requirements on the
basis of the various components of chargeable assets held by a unit (i.e raw material, stocks in
process, finished goods , receivables, other current assets viz advance payments to suppliers
etc).
➢ Concept of Operating Cycle in working capital assessment
Assets which are part of the operating cycle or which get converted into cash within the operating
cycle or within one year are as:
1. Cash & Bank balance
2. Raw Material, Stock-in-Trade, Work in Progress (SIP), Stores & Spares, Finished goods.
3. Trade receivables ( Book Debts ,Sundry Debtors)
4. Advance Paid to suppliers of RM/Stock In Trade
5. Advances recoverable in cash or receivables
6. Balance with customs, Tax Authorities, port authorities, municipal authorities etc
7. Other current assets required in operations for manufacturing and trading process activity.
Operating Cycle Concept of Working Capital
The operating cycle concept of working capital envisages measurement of the average time taken by an
enterprise in manufacturing the goods and selling them for cash so that the funds can be deployed for
starting another batch of production. In other words, the operating cycle commences when cash is
initially injected into the system for purchase of the basic raw material components required for
production. The system completes one cycle when cash is realized out of the sale proceeds of finished
goods.
The process of manufacturing unit has to pass through the following stages to complete its operating
cycle.
(i) Conversion of cash into raw material –
(ii) Conversion of raw material into stock in process and to finished goods.
(iii) Conversion of finished goods into receivables/debtors or cash.
How to Measure Operating Cycle: The operating cycle is measured in terms of days of average
inventory need to be held for every major category of working capital components.
Computation of Important Concepts on the basis of Analysis of Financial Statements ( CMA)
Annual Consumption of Raw Material = Annual Purchases of Raw Material + Opening Stock of
Raw Material- Closing Stock of Raw Material.
Cost of production = Consumption of Raw Material ( Imported & Indigenous) + Consumables Spares
& Stores+ Power& Fuel+ Direct Labor+ Repairs & Maintenance+ Other manufacturing Expenses +
Depreciation+ Opening stock of SIP- Closing Stock of SIP.
Cost of production is treated as the denominator in computing the Holding Period in respect of stock
in process, while assessing working capital requirements of a manufacturing unit.
Cost of Sales (Cost of Goods Sold during an accounting year ) = Cost of production + Opening Stock of
Finished Goods- Closing Stock of Finished Goods. This is taken as denominator in the computation of
holding level of the stock of Finished Goods in the course of assessment of working capital
requirement.
Gross Sales: Gross Sales include excise component ( tax levied on manufacture of goods ).
There are various factors that need to be considered while accepting estimated Holding levels of
the various components of Working capital.
Though there are various methods used for assessing the quantum of Working
Capital Requirement for a Business Enterprise, the following are commonly used.
Broadly there are two types
(i) Balance Sheet Based (Working capital Cycle)
Under Balance Sheet Method comes, Traditional Method, Turnover method & PBS
(ii) Cash Budget Based
(a) Fixed capital, and
(b) Working capital.
Modern Industries and capital intensive by nature and its Fixed Capital includes lands and building, Plant
and Machinery, and tools and implements.
The requirement of finance to purchase fixed capital is essentially long term in nature.
The working capital, short term in nature, is required to purchase raw materials and meet day to day
administrative and other such expenses.
There are various sources of finance for a modern industrial unit. These sources are of two types
(a) Internal sources and (b) External Sources
Internal sources include paid up capital in the form of share subscription, ploughing back of profits and
reserves.
The external sources include debenture issue, public deposits, loans from Commercial banks and other
specialized institutions.
Lending operation of the commercial banks to the Industrial Units and other Business Enterprises are
governed by the guidelines issued by the Reserve bank of India.
As mentioned above, Banks finance is largely divided into two categories , i.e Term Credit and working
capital.
Term Credit refers to the funds required for investment in fixed or permanent assets like land, building,
plants, machineries, other fixed assets etc,. Fixed Capital in the nature of Term Credit is required for the
establishment of business. Tem Credit facilities generally is allowed for longer term in nature.
Working Capital refers to the capital which is required to meet day to day expenses of the organization and
which is required to meet day to day expenses of the organization and which is employed in the current
assets like raw materials, debtors, bill-receivables etc. Thus working capital is required to utilize fixed
assets.
Working capital plays a very important role in business. It acts as a lubricant to run the wheels of fixed
assets. The effective provision and efficient utilization of working capital can lead to success of the
business.
Overview of Working Capital Assessment
Meaning of Working capital
Working capital is the amount of funds necessary to cover the cost of operating the business cycle of the
entrepreneur. This refers to the investment of the business unit in short term assets, cash, short term
securities, account receivables and inventories. It is the level of fund which a company must possess to
finance its day to day operation.
Definition: Working Capital, in banking perspective, is defined as:
❖ Funds required for acquisition of build up Current Assets generally for a period of one operating
cycle.
❖ Funds required for financing short term assets or Current Assets such as cash, Debtors and
inventories to enable business/industry to operate at the expected level.
❖ Funds required for meeting day-to-day operations like purchase of raw materials, spares & stores,
meeting manufacturing expenses like wages, power & fuel and storage & selling expenses of
finished goods etc. These expenses generally form part of Working capital or that capital of fund
which is required for keeping the wheels of production going on.
❖ Thus working capital represents the total funds required for running the operating cycle and
finance manufacturing, production and sales. Therefore it is called operating Capital or Short term
capital. Total funds required for the continuous operations of the business on a going basis.
❖ Financed as Cash Credit, Overdraft, Short Term Working Capital Loan etc,.
❖ Assessed for one year and renewed annually.
Basic Financial Concepts
1. Gross Working capital
2. Net Working Capital:
3. Working Capital Gap
A. Commercial Banks have traditionally been assessing working capital credit requirements on the
basis of the various components of chargeable assets held by a unit (i.e raw material, stocks in
process, finished goods , receivables, other current assets viz advance payments to suppliers
etc).
➢ Concept of Operating Cycle in working capital assessment
Assets which are part of the operating cycle or which get converted into cash within the operating
cycle or within one year are as:
1. Cash & Bank balance
2. Raw Material, Stock-in-Trade, Work in Progress (SIP), Stores & Spares, Finished goods.
3. Trade receivables ( Book Debts ,Sundry Debtors)
4. Advance Paid to suppliers of RM/Stock In Trade
5. Advances recoverable in cash or receivables
6. Balance with customs, Tax Authorities, port authorities, municipal authorities etc
7. Other current assets required in operations for manufacturing and trading process activity.
Operating Cycle Concept of Working Capital
The operating cycle concept of working capital envisages measurement of the average time taken by an
enterprise in manufacturing the goods and selling them for cash so that the funds can be deployed for
starting another batch of production. In other words, the operating cycle commences when cash is
initially injected into the system for purchase of the basic raw material components required for
production. The system completes one cycle when cash is realized out of the sale proceeds of finished
goods.
The process of manufacturing unit has to pass through the following stages to complete its operating
cycle.
(i) Conversion of cash into raw material –
(ii) Conversion of raw material into stock in process and to finished goods.
(iii) Conversion of finished goods into receivables/debtors or cash.
How to Measure Operating Cycle: The operating cycle is measured in terms of days of average
inventory need to be held for every major category of working capital components.
Computation of Important Concepts on the basis of Analysis of Financial Statements ( CMA)
Annual Consumption of Raw Material = Annual Purchases of Raw Material + Opening Stock of
Raw Material- Closing Stock of Raw Material.
Cost of production = Consumption of Raw Material ( Imported & Indigenous) + Consumables Spares
& Stores+ Power& Fuel+ Direct Labor+ Repairs & Maintenance+ Other manufacturing Expenses +
Depreciation+ Opening stock of SIP- Closing Stock of SIP.
Cost of production is treated as the denominator in computing the Holding Period in respect of stock
in process, while assessing working capital requirements of a manufacturing unit.
Cost of Sales (Cost of Goods Sold during an accounting year ) = Cost of production + Opening Stock of
Finished Goods- Closing Stock of Finished Goods. This is taken as denominator in the computation of
holding level of the stock of Finished Goods in the course of assessment of working capital
requirement.
Gross Sales: Gross Sales include excise component ( tax levied on manufacture of goods ).
There are various factors that need to be considered while accepting estimated Holding levels of
the various components of Working capital.
Though there are various methods used for assessing the quantum of Working
Capital Requirement for a Business Enterprise, the following are commonly used.
Broadly there are two types
(i) Balance Sheet Based (Working capital Cycle)
Under Balance Sheet Method comes, Traditional Method, Turnover method & PBS
(ii) Cash Budget Based
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