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MEANING
Working capital refers to short term funds to meet operating expenses. It refers to the funds which a company must possess to finance its day to day operations. It is concerned with the management of the firms current assets and current liabilities.
Current AssetsInventories (Raw materials , Work - in process, Finished goods), Trade debtors, Loans and advances, Investments, Cash and bank balances Current LiabilitiesSundry creditors, Trade advances, short term Borrowings, etc
Significance of Gross Working Capital Optimum investment in Current Assets Financing of Current Assets
Any additional working capital apart from permanent working capital required to support the change in production and sales activities is referred to as temporary or Variable Working capital. In other words an amount over and above the permanent working capital is variable working capital.
For maximization of profit or minimization of working capital cost or to maintain balance between liquidity and profitability there is a need to maintain a balance in working capital. It should not be Excessive or Inadequate
It results in unnecessary accumulation of inventories which leads to mishandling of inventories, waste, theft and losses. It is an indication of defective credit policy and increase in collection period. It leads to managerial inefficiency.
It stagnates growth. Difficult to implement production It leads to inefficient utilization of fixed assets. It hampers the firms goodwill in the market.
Problem
From the following information of XYZ ltd estimate the working capital needed to finance a level of production of 110000 units after adding 10% safety contingencies. The cost per unit Particulars Amount (Rs.) Raw Materials 78 Direct Labour 29 Overheads 58 Total Costs 165 Profit 24 Selling Price 189 Additional Information Average Raw material in stock (one month), Average materials in process (50% completion- month), Average Finished goods in stock (one month), Credit allowed by supplier (one month), Credit allowed to customers (two month(, Time lag in payment of wages ( one& weeks ), Time lag in payment of Overheads expenses (one month). of the sales is on cash basis. Cash balance is expected to be Rs.215000/-.
if the firm follows a highly aggressive current asset policy, it will carry a low level of current assets in relation to sales. An aggressive current asset policy, seeking to minimize the investment in current assets, exposes the firm to greater risk. The firm may not be able to cope with unanticipated changes in the market place and operating conditions. The compensation for higher risk, of course, is higher expected profitability.
If the firm adopts a moderate current asset policy, a moderate level of current assets in relation to sales will exist. The moderate level of investment in current assets helps keeping a sufficient amount of resources available for investment in business and maintain adequate liquidity. It results moderate level of risk
Conservative approach
In this approach the firm depends more on long term sources of finance. The firm finances its permanent working capital and also a part of its fluctuating working capital with long term financing. Only a small portion of the temporary working capital financed trough short term sources.
Conservative approach
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Marketable securities
Perm C.A.
Fixed Assets
Years
Aggressive approach
In this approach a firm uses more short term sources of financing. Here the temporary as well as a part of the permanent working capital is financed through short term sources.
Perm C.A.
Fixed Assets
Years
An aggressive overall working capital policy consists of an aggressive current asset policy and an aggressive current asset financing policy. An overall conservative working capital policy reduces risk and offers low return. An overall moderate working capital policy offers moderate return accompanied by moderate risk. An overall aggressive working capital policy provides a package of high risk and high return. The choice of an overall working capital policy will depend on the risk disposition of management.
Trade credit
Trade credit represents the credit extended by the suppliers of gods and services. It is a very important source of financing. The cost of trade credit depends on the terms of credit offered by the supplier. When the supplier offers discount for prompt payment, trade credit availed beyond the discount period is quite costly
Public deposites
Many firms, large and small, have received deposits from the public. The maximum maturity period allowed for public deposits is three years for manufacturing companies and five years for finance companies.
Commercial paper
Represents short-term unsecured promissory note issued by firms, which enjoy a fairly high credit rating.
Factoring
involves sale of accounts receivable to a factor who charges a commission on it.
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