Working Capital

Working Capital- Definition, Factors determining Working Capital

Working Capital- Meaning & Definition

Working Capital means capital required for day to day working or operations of the enterprises. Hence, it is known as Working capital. It is required for purchasing raw materials. For payment of wages, salaries, rent, advertisement expenses etc. Working capital is invested in current assets such as cash in hand, debtors, bills receivables, stock of goods or raw materials. These assets change their form from time-to-time, i.e., these assets keep on revolving or circulating. For example, if stock of goods is sold on credit, the person to whom such goods are sold are called debtors. If the debtors accept bills receivable, the amount of such sales will be represented by the amount of bills receivables. When the debtors pay cash, or bills receivables are realized on maturity, the amount of debtors and bills receivable is reduced to that extent. In this manner, the amount of cash, debtors, bills receivables etc. goes on changing, i.e., increasing or decreasing. Working capital is also called circulating or revolving capital because the amount invested in debtors, bills receivables stock etc. keeps on circulating or revolving. For example, cash is used to purchase raw materials. The amount of cash is reduced and the amount of stock is increased. After the goods are manufactured these are sold, the amount of stock is reduced and the amount of sale realized will increase the cash (if goods are sold for cash) or debtors and bills receivables (if the goods are sold on credit). Thus, working capital is invested, recovered and reinvested time and again. This process goes on repeating continuously during the life time of the enterprise.

Working capital requirements will change from firm to firm and from time-to-time depending upon the demand of goods. For example, during festival season the demand of goods will be more. To produce larger volume of goods larger amount of working capital will be needed.

Working capital requirements are of short term nature and keep on fluctuating from time-to-time.

It should be remembered that certain minimum amount of working capital is always needed. Such part of the working capital will be fixed capital.

Factors Determining Working Capital

Requirements working capital will depend upon number of factors, such as proportion of cost of raw materials, cost of labour, length of period of manufacture, nature of industry etc. These factors differ from industry to industry and so much so from firm to firm in the same industry. Working capital requirements depend upon the following important factors:

  1. Proportion of cost of raw materials :

    Larger the proportion of cost of raw materials in the total cost of production, the larger will be the need for working capital and vice versa. For example, in jewellery manufacture, larger amount of working capital will have to be invested in the purchase of gold as compared to the manufacture of cold drinks where cost of raw materials (mostly water) is negligible or much less in comparison to Jewellery

  2. Cost of Labour :

    If the process of production is labour-intensive, large number of workers will be required. Hence, larger amount of working capital will be needed to pay wages to the workers. On the contrary if the process of production is capital intensive, huge amount of capital will be needed to purchase the machines, Needless to say that in such a case less working capital will be needed as lesser number of workers will be needed to produce the goods.

  3. Length of Manufacture :

    Longer the time required for manufacturing goods, the larger will be the requirement for working capital as capital will remain invested till such times the goods are ready for sale. For example, in ship building industry it takes a very long time, say 3 years to 5 years to build a ship. For the period of building the ship, the working capital will be blocked. On the other hand, in case of bakery, the breads will be ready over night and sold the next morning. Hence, a small amount of working capital will be needed in this case.

  4. Sales Turnover :

    Sales turnover means the speed with which the goods produced are sold. Larger the sales turnover the larger will be the speed of recovery of the working capital invested in the production of goods. For example, in the case of a jewellery, the jewellery may remain in the showcase for sometime before it attracts the prospective customer. As such the working capital will remain blocked in the stock of jewellery. On the other hand, in the case of a bakery, breads will be sold the next morning. Hence a small amount of working capital will be blocked in the stock breads.

  5. Terms of Purchase and Sales :

    If the terms of purchase and sales are favourable, lesser amount of working capital will be needed and vice versa. For example, if purchases are on credit basis and sales on cash basis the stock of raw materials can be purchased on credit and the payment made when the goods are sold. In this case little or very little working capital will be required. On the other hand, if the purchases are on cash basis and sales on credit basis, double the amount of working capital will be needed. First, cash will be needed to pay for raw material or stocks. Second, capital will be needed to give credit to the buyers who have purchased goods on credit. Needless to say that working capital will be blocked till the payment against the sales is realized.

  6. Requirements of Cash :

    Cash is needed for day to day operations. Larger the amount of cash needed, the larger will be the working capital requirement and vice versa. For example, cash is needed to pay wages, salaries, rent, taxes, advertisement expenses etc. A concern requiring larger cash for such payments will need more working capital.

  7. Seasonal Variations :

    In cash of seasonal industries such as sugar industry the production is confined to certain seasons when crop of sugarcane is ready. In such cases working capital requirements will be larger in peak seasons and smaller in off seasons.

  8. Tax Liability:

    Higher the Tax liability, the higher will be the need for working capital. Provision for returns has to be made adequately and at proper time.

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