Components of Working Capital
The components of working capital refer to the elements that make up a company's short-term operating liquidity. These components typically include cash, accounts receivable, inventory, and accounts payable. Managing these components effectively is crucial for ensuring a company has enough resources to cover its short-term financial obligations and maintain smooth operations.
8 Key excerpts on "Components of Working Capital"
eBook - ePub- David Horner(Author)
- 2020(Publication Date)
- Kogan Page(Publisher)
...12 Working capital management Introduction A business has two types of capital: fixed capital in the form of non-current assets, such as premises, machinery and equipment; working capital to fund the business operations over the short term. Working capital consists of the current assets and the current liabilities of the business and is calculated as follows: Working capital = Current assets (inventory, trade receivables and cash) − Current liabilities (trade payables and bank overdraft) Expenses will need settling in cash. If a business has insufficient cash holdings (either in the business or in the bank account) then it can utilise the liquid assets of the business. It is clearly important that a business manages its working capital carefully. The working capital cycle The firm will not simply hold cash ready to pay suppliers and other expenses. Cash will be tied up in various categories as working capital, which will be in a state of constant flux and will be constantly moving between different categories in a cyclical matter. This working capital cycle is shown in Figure 12.1. Figure 12.1 The working capital cycle The working capital cycle works (at least in theory) as follows: a firm will purchase inventory (either as finished goods or as raw materials) on credit from its suppliers (appearing as trade payables in the working capital). After production has taken place the finished goods will be sold on to customers as either cash or credit sales (now appearing as trade receivables in the working capital). The firm will eventually receive the cash from these credit customers, which in turn can then be used to settle the amounts owing to the credit suppliers as well as any other obligations it has run up during this period, such as wages and other expenses. A firm will wish to minimize the length of its working capital cycle...
eBook - ePubCorporate Finance
A Practical Approach
- Michelle R. Clayman, Martin S. Fridson, George H. Troughton(Authors)
- 2012(Publication Date)
- Wiley(Publisher)
...Achieving this goal requires a balancing of concerns. Insufficient access to cash could ultimately lead to severe restructuring of a company by selling off assets, reorganization via bankruptcy proceedings, or final liquidation of the company. On the other hand, excessive investment in cash and liquid assets may not be the best use of company resources. Effective working capital management encompasses several aspects of short-term finance: maintaining adequate levels of cash, converting short-term assets (i.e., accounts receivable and inventory) into cash, and controlling outgoing payments to vendors, employees, and others. To do this successfully, companies invest short-term funds in working capital portfolios of short-dated, highly liquid securities, or they maintain credit reserves in the form of bank lines of credit or access to financing by issuing commercial paper or other money market instruments. Working capital management is a broad-based function. Effective execution requires managing and coordinating several tasks within the company, including managing short-term investments, granting credit to customers and collecting on this credit, managing inventory, and managing payables...
eBook - ePub- Vibrant Publishers, Kalpesh Ashar(Authors)
- 2019(Publication Date)
- Vibrant Publishers(Publisher)
...Working Capital Management The term,“working capital”, can have several different meanings. One common aspect of all these is that it refers to current assets and liabilities. Below are the most commonly used terms related to working capital: Working Capital (or Gross Working Capital) This term simply refers to the current assets of a company, like inventory, accounts receivable, cash, marketable securities etc. Net Working Capital The difference between current assets and current liabilities is termed as net working capital. Net Operating Working Capital This is the current assets minus non-interest-bearing current liabilities. The interest-bearing current liabilities signify the money borrowed by the company as a short-term loan. Non-interest-bearing current liabilities are the ones that come out of regular business, like accounts payable and accruals. Working capital is required by every company as it provides the cash needed to pay for loan interests and other day-to-day operations of the company. Depending upon the kind of business that a company is in, it decides how much working capital to carry. Too much working capital leads to reduction in profitability and too less could lead to bankruptcy. In the sections below we see how a company calculates how much working capital it needs to carry. Cash Conversion Cycle The length of time a dollar is tied up in current assets is called the cash conversion cycle. By calculating this length, a company gets an idea of how much working capital it would need and also how the company can improve its operations to reduce the length of this cycle. Companies buy raw materials, convert them into finished products and sell them. This is the business cycle of a typical company. Companies also get a credit period to pay for their raw materials, called Payables Deferral Period. Similarly, companies also extend credit to their customers, called DSO (this term was seen in chapter 2 earlier) or Receivables Collection Period...
eBook - ePub- James S. Sagner(Author)
- 2010(Publication Date)
- Wiley(Publisher)
...CHAPTER 1 Concepts in Working Capital Management After reading this material you will be able to: Understand the concept of working capital. Appreciate the components used in managing working capital. Determine how ratio analysis is used in understanding working capital. Consider traditional and modern ideas of working capital management. Working capital is the arithmetic difference between two balance-sheet-aggregated accounts: current assets and current liabilities. This calculation is done in a currency, such as U.S. dollars, which is the convention we will be using in this book. Working Capital Concepts Both current assets and current liabilities are comprised of several ledger accounts as shown in italics in Exhibit 1.1. For the company presented in this balance sheet—we’ll call it the Rengas Company—the amount of working capital is $425,000, calculated as current assets ($650,000) less current liabilities ($225,000). Concepts in Working Capital Management EXHIBIT 1. 1 Description of Working Capital Accounts The accounts noted in italics are briefly explained below, with chapters of this book devoted to appropriate management procedures. Cash accounts and short-term investments. These account categories include cash on hand and in bank accounts, and any short-term investments that are expected to be turned into cash within one year. We’ll review the management of cash in Chapters 2 and 3, and of banking relationships in Chapter 4. Accounts receivable. This category of current assets includes all credit sales where the customer is expected to pay by a future date specified on an invoice. Most companies have small amounts of uncollectible credit sales, and an account called ‘‘allowance for doubtful accounts’’ may be deducted from accounts receivable to reflect this experience. We’ll examine receivables in Chapter 5. Inventory. Most companies hold some combination of raw materials, work in process (that is, partially manufactured and assembled), and finished goods...
eBook - ePubWorking Capital Management
Applications and Case Studies
- James S. Sagner(Author)
- 2014(Publication Date)
- Wiley(Publisher)
...CHAPTER 1 Concepts in Working Capital Management This chapter covers these topics: Explanation of the basic concepts of working capital. Appreciation for the problems in assigning management responsibility for working capital. Consideration of traditional and modern ideas of working capital management. Understanding the essential focus of cost in working capital management. Applying working capital concepts to a successful company (Best Buy). WORKING CAPITAL is the arithmetic difference between two balance sheet aggregated accounts: current assets and current liabilities. This calculation is done in a currency, such as U.S. dollars, which is the convention we will be using in this book. WORKING CAPITAL CONCEPTS Both current assets and current liabilities are composed of several ledger accounts, as shown in italics in the Exhibit 1.1 balance sheet. For the company presented in this balance sheet—we'll call it the Rengas Company—the amount of working capital in 2013 was $42.5 million, calculated as current assets ($65 million) less current liabilities ($22.5 million). Description of Working Capital Accounts The accounts noted in italics in Exhibit 1.1 are briefly explained next, with chapters of this book devoted to appropriate management procedures. Cash accounts and short-term investments. These account categories include cash on hand and in bank accounts, and any short-term investments that are expected to be turned into cash within one year. We'll review the management of cash in Chapters 3 and 4, and of short-term investments in Chapter 5. Accounts receivable. This category of current assets includes all credit sales where the customer is expected to pay by a future date specified on an invoice. Most companies have small amounts of uncollectible credit sales, and an account called “allowance for doubtful accounts” may be deducted from accounts receivable to reflect this experience...
eBook - ePub- Debi J Peverill(Author)
- 2018(Publication Date)
- Painless Financial Training Group Inc.(Publisher)
...Chapter 14. Working Capital Management You hear a lot about working capital, but what is it? Working capital is the excess of current assets—such as cash and accounts receivable—over current liabilities—such as accounts payable. If your current liabilities are more than your current assets then you have what is known as a working capital deficiency. This generally means you have more people calling you and asking for payments to be made than you have people to call asking them to pay you. You find out if you have any working capital by looking at the all-important balance sheet for your business. The place to look is the top of the asset section and the top of the liability section of the balance sheet. Table 28. Example of a good balance sheet In table 28, there is working capital of $5,000, which is the difference between the current assets of $15,000 and the current liabilities of $10,000. This is one of the reasons why this balance sheet is known as the good balance sheet. Table 29. Example of a bad balance sheet In table 29, known as the bad balance sheet, there is a working capital deficiency because this company has more current liabilities than it has current assets. Current liabilities are $75,793 and current assets are $56,476 which is a working capital liability. Without working capital, payments cannot be made and your suppliers and employees become annoyed with you. In order to maintain positive working capital, you need to slow down the funds going out of your business and speed up the funds coming in. There are challenges here as every business has the same goal. Your customers are trying not to pay you right away and your suppliers are trying to collect from you as quickly as possible. What follows are some techniques to help you manage your cash flow—ways to collect your money more quickly and slow down the money leaving your business...
- Michael Chibili(Author)
- 2019(Publication Date)
- Routledge(Publisher)
...8 Management of working capital 8.1 The importance of working capital management 8.2 The working capital cycle Cash is the most fundamental business resource through which creditors, suppliers, employees, the state, shareholders and other stakeholders can be satisfied. Sources of cash include those placed in the business by the owners, those borrowed from third parties (individuals, other business establishments or lending institutions), and those generated by the business itself. In Section 8.1 the importance of working capital management is discussed followed by the explanation and illustration of the working capital cycle in Section 8.2. 8.1 The importance of working capital management Working capital is defined as the surplus of current assets over current liabilities and indicates the amounts available to the business to conduct its revenue generating activities. It is expressed in the following formula: Working capital = current assets − current liabilities Decisions related to working capital and short term financing are called working capital management decisions and they are all meant to ensure that the business is able to continue its operations with sufficient cash that will be able to satisfy its current obligations as well as operational expenses. Profitable businesses generally generate cash but some businesses can be profitable but lack sufficient cash during certain periods of the operating cycle...
eBook - ePub- Richard Kotas(Author)
- 2014(Publication Date)
- Routledge(Publisher)
...18 The Management of Working Capital Introduction It is possible to distinguish two kinds of capital in any one business. Firstly, there is fixed or permanent capital, represented by fixed assets such as land, buildings, kitchen plant, furniture, etc. All such assets are purchased with the intention of being retained in the business. Secondly, there is working capital, whose main function is to support the current financial operations of the business. If we divide the balance sheet horizontally, as shown below, we may see that above our line of division we have fixed elements and, below it, variable elements. Balance sheet Proprietors’ capital xxx Fixed assets xxx Long-term liabilities xxx Current liabilities xxx Current assets xxx —— —— xxx xxx —— —— Current assets consist of cash and items which will sooner or later be converted into cash. Thus current assets represent a source of liquid resources; current liabilities represent a claim on such liquid resources. Clearly, therefore, there should be some kind of relationship between current assets and current liabilities. The excess of current assets over current liabilities is described as working capital. Where current assets amount to £5,000 and current liabilities are £4,000, we have a working capital of £1,000. As explained in a previous chapter, the relationship between current assets and current liabilities may be expressed by means of the current ratio. In this particular case the current ratio is 5:4 or, by dividing current assets by current liabilities, 1.25. From the point of view of the liquidity of the business what matters is not only the relationship between current assets and current liabilities, but also the composition of the current assets. Let us look at the balance sheet below. Balance sheet The business has a current ratio of 10:7 and a working capital of £30,000, which in most hotels and restaurants would be considered satisfactory...
