Dimensions of Working Capital Management

7/23/2019 Dimensions of Working Capital Management

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DIMENSIONS OF WORKING CAPITAL MANAGEMENT

There exists two concepts of worin! c"pit"#$ n"%e#& !ross concept "n' netconcept( Accor'in! to !ross concept$ worin! c"pit"# refers to c)rrent "ssets$ *i+( c"sh$

%"ret",#e sec)rities$ in*entories of r"w %"teri"#$ wor-in-process$ finishe' !oo's "n'

recei*",#es( Accor'in! to net concept$ worin! c"pit"# refers to the 'ifference ,etweenc)rrent "ssets "n' c)rrent #i",i#ities( Worin! c"pit"# c"n ,e c#"ssifie' into fixe' or

per%"nent "n' *"ri",#e or f#)ct)"tin! p"rts( The %ini%)% #e*e# of in*est%ent in c)rrent

"ssets re!)#"r#& e%p#o&e' in ,)siness is c"##e' fixe' or per%"nent worin! c"pit"# "n'the extr" worin! c"pit"# nee'e' to s)pport the ch"n!in! ,)siness "cti*ities is c"##e'

*"ri",#e or f#)ct)"tin! worin! c"pit"#( Worin! c"pit"# %"n"!e%ent is concerne' with

"## "spects of %"n"!in! c)rrent "ssets "n' c)rrent #i",i#ities(

.i/ M"n"!in! In*est%ent in c)rrent "ssets0 Deter%in"tion of "ppropri"te #e*e# of

in*est%ent in c)rrent "ssets is the first "n' fore%ost responsi,i#it& of worin! c"pit"#

%"n"!er( A#tho)!h the "%o)nt of in*est%ent in "n& c)rrent "sset or'in"ri#& *"ries fro%

'"&-to-'"&$ the "*er"!e "%o)nt or #e*e# o*er " perio' of ti%e c"n ,e )se' in 'eter%inin!the f#)ct)"tin! "n' per%"nent in*est%ent in c)rrent "ssets( This 'istinction is of !re"t

i%port"nce in 'e*isin! "ppropri"te fin"ncin! str"te!ies( 1esi'es the #e*e# of in*est%ent$the t&pe of c)rrent "ssets to ,e he#' "re e2)"##& i%port"nt 'ecision *"ri",#es( There is "

*er& #"r!e n)%,er of "#tern"ti*e #e*e#s of in*est%ent in e"ch t&pe of c)rrent "sset(

Therefore$ in princip#e$ c)rrent "sset in*est%ent is " pro,#e% of e*"#)"tin! " #"r!en)%,er of %)t)"##& exc#)si*e in*est%ent opport)nities(

.ii/ Fin"ncin! of worin! c"pit"#0 Another i%port"nt 'i%ension of worin! c"pit"#

%"n"!e%ent is 'eter%inin! the %ix of fin"nce for worin! c"pit"# which %"& ,e "co%,in"tion of spont"neo)s$ short-ter% "n' #on! ter% so)rces( Spont"neo)s so)rces of

fin"ncin! consist of tr"'e cre'it "n' other "cco)nts p"&",#e th"t "rise spont"neo)s#& inthe fir%3s '"&-to-'"& oper"tions$ s)ch "s p)rch"se of r"w %"teri"#s "n' s)pp#ies( In"''ition to tr"'e cre'it$ w"!es "n' s"#"ries p"&",#e$ "ccr)e' interest "n' "ccr)e' t"xes

"#so pro*i'e the fir% with *"#)",#e so)rces of spont"neo)s fin"ncin!( Th)s the cre'it

which "rises in con4)nction with the '"&-to-'"& oper"tions of the fir% pro*i'espont"neo)s so)rce of fin"ncin! of worin! c"pit"#( 1i##s p"&",#e$ short ter% ,"n #o"ns$

inter corpor"te #o"ns$ co%%erci"# p"per "re the %ost co%%on ex"%p#es of short ter%

so)rces of worin! c"pit"# fin"nce( Ter% #o"ns$ 'e,ent)res$ e2)it& "n' ret"ine' e"rnin!sconstit)te #on!-ter% so)rces of worin! c"pit"# fin"nce(

.iii/ Inter-re#"te'ness 0 Inter-re#"te'ness is the %ost 'istin!)ishin! ch"r"cteristic of

worin! c"pit"# 'ecisions( The 'esire' #e*e# of in*entor& o*er " perio' "n' s"#es co)#'not ,e %"'e witho)t consi'erin! the i%p#ic"tions for "cco)nts recei*",#e( Moreo*er

incre"se' s"#es "n' co##ections for the fir% is #ie#& to %e"n th"t #ower "*er"!e c"sh

,"#"nces wi## ,e nee'e' or th"t " new c"sh %"n"!e%ent s&ste% wo)#' ,e 'esir",#e(If s"#es incre"se$ "n incre"se in in*entor& wi## ,e fin"nce' spont"neo)s#& with tr"'e

cre'it( The "%o)nt of tr"'e cre'it fin"ncin! wi## 'epen' on 'ecisions re!"r'in!

p"&%ents( In*entor& 'ecisions "re th)s #ine' to tr"'e cre'it 'ecisions( Th)s worin!c"pit"# %"n"!ers h"*e to p"& "ttention to the inter re#"te' n"t)re of c)rrent "ssets "n'


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c)rrent #i",i#ities "n' t"e into "cco)nt %"4or inter"ctions th"t inf#)ence the worin!

c"pit"# in*est%ent "n' fin"ncin! 'ecisions(

.i*/ 5o#"ti#it& "n' Re*ersi,i#it&0 Another si!nific"nt fe"t)re of the worin! c"pit"#

%"n"!e%ent is th"t the "%o)nt of %one& in*este' in c)rrent "ssets c"n ch"n!e r"pi'#&$

"n' so 'oes the fin"ncin! re2)ire'( The #e*e# of in*est%ent in c)rrent "ssets is inf#)ence',& " *"riet& of f"ctors$ which %"& ,e "s err"tic "s #",or )nrest or f#oo'in! of the p#"nt(

Se"son"# "n' c&c#ic"# f#)ct)"tions in 'e%"n' "re " co%%on c")se of r"pi' ch"n!es in

in*est%ent in c)rrent "ssets "n' the fin"ncin! re2)ire'( Re#"te' to *o#"ti#it& is there*ersi,i#it& fe"t)re of c)rrent "ssets "n' c)rrent #i",i#ities$ which %e"ns th"t the c"sh

f#ow re#"te' to these co)#' ,e re"'i#& re*erse'(

RISK RET6RN TRADE OFF IN WORKING CAPITAL MANAGEMENT

Worin! c"pit"# 'ecisions of the fin"nce %"n"!er %)st ,e !e"re' to %"xi%i+"tion

of sh"reho#'ers we"#th( Accor'in!#&$ ris ret)rn tr"'e-off ch"r"cteri+es e"ch of theworin! c"pit"# 'ecision( There "re two t&pes of riss inherent in worin! c"pit"#

%"n"!e%ent n"%e#&$ #i2)i'it& ris "n' opport)nit& #oss ris( Li2)i'it& ris is the non-"*"i#",i#it& of c"sh to p"& " #i",i#it& th"t f"##s ')e( It c"n c")se not on#& " #oss of

rep)t"tion ,)t "#so %"e the wor con'ition )nf"*o)r",#e for !ettin! the ,est ter%s on

tr"ns"ction with the tr"'e cre'itors( The other ris in*o#*e' in worin! c"pit"#%"n"!e%ent is the ris of opport)nit& #oss i(e ris of h"*in! too #itt#e in*entor& to

%"int"in pro')ction "n' s"#es$ or the ris of not !r"ntin! "'e2)"te cre'it for re"#i+in! the

"chie*",#e #e*e# of s"#es( In other wor's$ it is the ris of not ,ein! ",#e to pro')ce %ore

or se## %ore or ,oth "n' therefore not ,ein! ",#e to e"rn the potenti"# profit$ ,ec")se therewere not eno)!h f)n's to s)pport hi!her in*entor& "n' ,oo 'e,ts( Th)s it is on#&

theoretic"# th"t the c)rrent "ssets co)#' "## t"e +ero *"#)es( In'ee'$ it is neitherpr"ctic",#e nor "'*is",#e( In pr"ctice$ "## c)rrent "ssets t"e positi*e *"#)es$ ,ec")sefir%s see to re')ce worin! c"pit"# riss( 7owe*er$ !re"ter the f)n's #oce' )p or

'ep#o&e' in c)rrent "ssets$ the hi!her is the cost of f)n' e%p#o&e'$ "n' therefore #esser

the profit(

The ris ret)rn tr"'e off in %"n"!in! the fir%3s #i2)i'it& ,& in*estin! in

%"ret",#e sec)rities$ 'oes h"*e " f"*o)r",#e effect on fir%3s #i2)i'it&$ ,)t it "#so h"s "n)nf"*o)r",#e effect on the fir%3s r"te of ret)rn e"rne' on in*este' f)n's( The ris ret)rn

tr"'e off in*o#*e' in ho#'in! %ore c"sh "n' %"ret",#e sec)rities$ therefore$ is one of

"''e' #i2)i'it& *ers)s re')ce' profit",i#it&( In the )se of c)rrent *ers)s #on! ter% 'e,t

for fin"ncin! worin! c"pit"# nee's "#so the fir% f"ces " ris-ret)rn tr"'e off( Otherthin!s re%"inin! the s"%e$ the !re"ter its re#i"nce )pon short ter% 'e,t or c)rrent

#i",i#ities in fin"ncin! its c)rrent "sset in*est%ents the #ower wi## ,e its #i2)i'it&( On the

other h"n'$ the )se of c)rrent #i",i#ities offers so%e *er& re"# "'*"nt"!es to the )ser inth"t the& c"n ,e #ess cost#& th"n #on!-ter% fin"ncin! "s the& pro*i'e the fir% with "

f#exi,#e %e"ns o fin"ncin! its f#)ct)"tin! nee's for c)rrent "ssets( Th)s " fir% c"n re')ce

its ris of i##i2)i'it& thro)!h the )se of #on! ter% 'e,t "t the expense of " re')ction of its


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ret)rn on in*este' f)n's( The ris ret)rn tr"'e off in*o#*es "n incre"se' ris of i##i2)i'it&

*ers)s incre"se' profit",i#it&(

Theor"tic"##&$ NP5 r)#es 'e*e#ope' for the fir%3s in*est%ent 'ecisions wo)#'

"pp#& to in*est%ent in c)rrent "ssets( 1)t in pr"ctice$ in *iew of cert"in )ni2)ech"r"cteristics of c)rrent "ssets$ two )sef)# %o'ific"tions of NP5 "re fo##owe' "s

'ecision criteri" in worin! c"pit"# 'ecisions( The& "re A*er"!e Net Profit per perio' "n'

Tot"# cost( We c"n )se net profit per perio' "s " criterion for choosin! "%on! "#tern"ti*ere*ersi,#e in*est%ents( The in*est%ent with the hi!hest *"#)e of net profit per perio' is

"#so the in*est%ent with the hi!hest net present *"#)e$ re!"r'#ess of when the in*est%ent

is re*erse'( In*est%ents with positi*e NP5s wi## h"*e positi*e net profits$ in*est%ents

with +ero NP5s wi## h"*e +ero net profits "n' in*est%ents with ne!"ti*e NP5s wi## h"*ene!"ti*e profit( Th)s$ net profit per perio' inste"' of NP5 c"n ,e )se' "s " 'ecision

criterion for worin! c"pit"# %"n"!e%ent(

M"n& c)rrent "sset 'ecisions$ p"rtic)#"r#& in*entor& 'ecisions c"n ,e %"'e on the,"sis of %ini%i+in! cost( There "#so inste"' of %ini%i+in! the net present *"#)e of costs$

one %"& %ini%i+e the tot"# "nn)"# cost where the "nn)"# c"pit"# cost of the in*est%ent isthe 'isco)nt r"te ti%es the "%o)nt in*este'( In s)%$ the c)rrent "ssets %"& ,e tre"te' "s

re*ersi,#e "n' in*est%ent po#icies %"& ,e se#ecte' th"t %"xi%i+e net profit or %ini%i+e

tot"# cost per perio'( The choice ,etween the profit or cost criterion wi## of co)rse 'epen'on the p"rtic)#"r pro,#e% ,ein! "n"#&se'(

7EDGING PRINCIPLE

A princip#e which c"n ,e )se' "s " !)i'e to fir%3s worin! c"pit"# fin"ncin!'ecisions is the he'!in! princip#e or %"tchin! princip#e( Si%p#& spe"in!$ the he'!in!princip#e in*o#*es %"tchin! the c"sh f#ow !ener"tin! ch"r"cteristics of "n "sset with the

%"t)rit& of the so)rce of fin"ncin! )se' to fin"nce its "c2)isition( For ex"%p#e$ "

se"son"# exp"nsion in in*entories$ "ccor'in! to the he'!in! princip#e sho)#' ,e fin"nce'with " short ter% #o"n or c)rrent #i",i#it&( The r"tion"#e )n'er#&in! the r)#e is str"i!ht

forw"r'( F)n's "re nee'e' for " #i%ite' perio' of ti%e$ "n' when th"t ti%e h"s p"sse'$

the c"sh nee'e' to rep"& the #o"n wi## ,e !ener"te' ,& the s"#e of extr" in*entor& ite%s(O,t"inin! the nee'e' f)n's fro% " #on! ter% so)rce .#on!er th"n one &e"r/ wo)#' %e"n

th"t the fir% wo)#' sti## h"*e the f)n's "fter the in*entories .the& he#pe' fin"nce/ h"*e

,een so#'( In this c"se the fir% wo)#' h"*e excess #i2)i'it& which the& either ho#' in c"sh

or in*est in #ow &ie#'in! %"ret",#e sec)rities )nti# the se"son"# incre"se in in*entoriesocc)rs "!"in "n' the f)n's "re nee'e'( This wo)#' res)#t in "n o*er "## #owerin! of fir%

profits(

To p)t it *er& s)ccinct#&$ the he'!in! princip#e st"tes th"t the fir%3s "ssets not

fin"nce' ,& spont"neo)s so)rces sho)#' ,e fin"nce' in "ccor'"nce with the r)#e0

per%"nent "ssets .inc#)'in! per%"nent worin! c"pit"# nee's/ fin"nce' with #on! ter%so)rces "n' te%por"r& "ssets .*i+( f#)ct)"tin! worin! c"pit"# nee'/ with short ter%


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so)rces of fin"nce to w"r' of the #i2)i'it& ris( In pr"ctice$ se*er"# %o'ific"tions of the

strict he'!in! princip#e s)ch "s conser*"ti*e fin"ncin! str"te!& "n' the "!!ressi*e

fin"ncin! str"te!& "re fo##owe' ,& the fir%s "t 'ifferent ti%es( The he'!in! princip#epro*i'es "n i%port"nt !)i'e re!"r'in! the "ppropri"te )se of short ter% cre'it for

worin! c"pit"# fin"ncin!(

In conser*"ti*e fin"ncin! str"te!&$ the fir% fo##ows " %ore c")tio)s p#"n$ where,&

#on!-ter% so)rces of fin"ncin! excee' per%"nent "ssets in tro)!h perio' s)ch th"t excess

c"sh is "*"i#",#e .which %)st ,e in*este' in %"ret",#e sec)rities/( Note th"t the fir%"ct)"##& h"s excess #i2)i'it& ')rin! the #ow e,, of its "sset c&c#e "n' th)s f"ces " #ower

ris of ,ein! c")!ht short of c"sh th"n " fir% th"t fo##ows the p)re he'!in! "ppro"ch(

7owe*er$ the fir% "#so incre"ses its in*est%ent in re#"ti*e#& #ow-&ie#'in! "ssets s)ch th"t

its ret)rn on in*est%ent is 'i%inishe'(

In "!!ressi*e fin"ncin! str"te!&$ the fir% contin)"##& fin"nces " p"rt of its

per%"nent "sset nee's with short ter% f)n's "n' th)s fo##ows " %ore "!!ressi*e str"te!&

in %"n"!in! its worin! c"pit"#( It c"n ,e seen th"t e*en when its in*est%ent in "sstnee's is #owest the fir% %)st sti## re#& on short ter% fin"ncin!( S)ch " fir% wo)#' ,e

s),4ecte' to incre"se' riss of " c"sh short f"## in th"t it %)st 'epen' on " contin)"#ro##o*er or rep#"ce%ent of its short ter% 'e,t with %ore short ter% 'e,t( The ,enefit

'eri*e' fro% fo##owin! s)ch " po#ic& re#"tes to the possi,#e s"*in!s res)#tin! fro% the )se

of #ower cost short-ter% 'e,t "s oppose' to #on!-ter% 'e,t(


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RATIOS

Working capital management is concerned with maintaining an

adequate amount of working capital by proper balance of current assets vis

!vis non current assets in the asset structure and a reasonable mi" of shotterm and long term sources in the financial structure of the firm# Ratio

analysis can be used by management as a tool to verify the level and

composition of working capital held by management in the business as against

its operations$ the e"tent of liquidity present in its asset structure as well

as financial structure and the efficiency with which working capital is being

used in the business# In the other words$ management can employ ratios to

analy%e three facets of working capital management namely efficiency$

liquidity and its structural health#

RATIOS TO A&'A(S) T*) )++I,I)&,( O+ WOR-I&. ,A/ITA'

The efficiency with which working capital is being used by the

management can be analy%ed in terms of the overall working capital and0or

its constituent parts vi%# cash$ inventory$ receivables# )fficiency ratios

indicate the efficiency with which working capital and its constituent parts

1cash$ inventory$ receivables2 are being utili%ed# Overall working capital and

its elements are generally e"pressed as number of times they are convertedinto sales0 cost of goods sold or number of days they are being held# In this

category the ratios are3 working capital turnover$ inventory turnover$

receivables turnover$ cash turnover$ payables turnover# Inventory turnover

ratio is further classified as raw material turnover ratio$ workinprocess

turnover ratio and finished goods inventory turnover ratio# 'iquidity ratios

indicate the e"tent to which a firm will be able to meet its shot term

obligations# These ratios include current ratio$ acid test ratio and cash

ratio# The set of ratios 3 current assets to total assets$ cash to current

asset$ receivables to current assets$ inventory to current asset and current

liabilities to total liabilities helps to evaluate structural shifts and changes

that have taken place over time and are indicative of structural health of

working capital in the business# Working capital and its various elements

should form a reasonable balance in the asset structure as well as financial

structure#


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)++I,I)&,( O+ O4)RA'' WOR-I&. ,A/ITA'

The efficient use of overall working capital in the firm can be gauged

with the help of working capital turnover ratio#

&et Sales

Working capital turnover ratio 5

Average &et Working ,apital

This ratio indicates the rate of working capital utili%ation in the firm# A

higher ratio of a firm when compared with that of an industry average

indicates that the amount of working capital in this firm is less than that

required by its operations i#e#$ sales# So the firm may have to go for

additional working capital that can be supplied to it by its owners throughreinvestment of earnings or can be obtained by selling additional shares or

debentures# 'ikewise if this ratio is lower than the industry average$ it

indicates that the investment in net working capital is more than what is

required# This calls for either withdrawing e"cess amount or increasing the

sales in the market so that the relationship between the amount of working

capital financed by long term sources and sales is reasonable#

&et working capital turnover ratio can also be analy%ed over a period

of five to seven years# An increasing ratio indicates that working capital has

been used more intensively over a period of time# A decreasing ratio is

indicative of relative inefficiency in the use of working capital# A variant of

this ratio is current asset turnover ratio which is cost of goods sold to

average current asset# .enerally a higher ratio is considered an indicator of

better efficiency and a lower one the opposite(

)++I,I)&,( O+ WOR-I&. ,A/ITA' )')6)&TS

Inventory constitutes an important part of the total working capital#In actual practice$ many firms face serious problems due to slow moving$ out

dated inventory# 7ut if too much amount is invested in this for too long$ it

poses a serious threat to the profitability as well as solvency of the concern#

Inventory turnover ratio reflects the efficiency with which inventory is

being managed in the concern#


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,ost of .oods Sold

Inventory turnover ratio 5

Average Inventory

It shows how rapidly the inventory is being turned into receivables0cashthrough sales# .enerally a higher turnover is considered good and a low

turnover bad# A low turnover implies an e"cessive level of inventory than

warranted by production or sales operations# This may also indicate the

presence of slow moving or obsolete inventory#

R),)I4A7')S )++I,I)&,( RATIO

With the increasing competition in the business$ managementsometimes offers liberal credit terms to its customers$ thereby ma"imi%ing

sales and total profits# Thus the number of times the management is able to

turn the receivables into sales indicates the efficiency with which the

receivables are being managed# This is given by the receivables turnover

ratio#

Total Sales

Receivables turnover ratio 5

Average Receivables

A low turnover ratio is an indicator of the firm8s increased reliance on credit

sales in its marketing efforts# If this is not backed up by timely and

efficient collection of receivables$ it may 9eopardi%e the very solvency of

the firm#

,AS* )++I,I)&,(

,ash is considered an idle asset as it does not earn any return#

Therefore$ a balance has to be struck between too much and too less an

amount of cash that a concern should have# In fact$ it should be 9ust

adequate to the needs of the concern# )fficient management of cash

requires that there should be proper relationship between cash needs of the


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concern to the average balance of cash held by it during the year# This is

e"pressed by cash turnover ratio#

,ash operating e"penses during the year

,ash turnover ratio 5 Average cash balance during the year

*owever no conclusions can be drawn if this ratio deviates from the selected

standards of comparisons#

/A(A7')S )++I,I)&,(

Accounts payable constitute an important source to providespontaneous working capital finance for the firm# To what e"tent

management is able to use it properly is an important area worth probing#

/ayables turnover ratio e"presses the number of times account payables are

converted into purchases by management during the year#

Annual purchases

/ayables turnover ratio 5

Average payables

&ormally$ a higher turnover ratio is preferred# This means that with a

smaller amount of payables$ management could purchase more material

during the year#

Inventory comprises raw material$ workinprocess$ finished goods and

spare parts etc# All the components should form a reasonable part of the

total inventory# Therefore all components should be related individually to

the total inventory to find out the proportion of each of them# Inventory

turnover ratio is further classified as raw material turnover ratio$ workin

process turnover ratio and finished goods inventory turnover ratio#


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Raw materials consumed during the year

Raw material inventory 5

turnover Average raw material inventory

This ratio indicates the rate of utili%ation of raw material# A higher turnoverratio over a period of time indicates its increasing utili%ation# 7ut too high a

ratio may indicate that proportionately less raw materials were held in order

to carry out the production which may be quite risky#

,ost of goods manufactured

Workinprocess inventory 5

turnover Average W#I#/ inventory

This ratio establishes a relationship between the value of goods produced

and the value of average workinprocess# A higher turnover ratio indicates$

lower inventory accumulation and lesser tiedup working capital# A falling

turnover means either management has become la" in controlling the

productive processes or some e"ternal factors have retarded the production

movement at its final runup#

,ost of goods sold

+inished goods inventory 5

turnover Average finished goods inventory

If the finished goods are turned over faster$ the amount of locked up funds

would be less: otherwise$ it will be more# +inished goods inventory turnover

ratio attempts to capture this aspect#

RATIOS TO A&A'(S) 'I;


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,


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,AS* or A7SO'


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F6ND FLOW 8 CAS7 FLOW ANAL9SIS

F)n's f#ow is )se' to refer to ch"n!es in or %o*e%ent of c)rrent "ssets "n'c)rrent #i",i#ities( Worin! c"pit"# %e"ns tot"# c)rrent "ssets #ess c)rrent #i",i#ities(

Worin! c"pit"# i%p#ies "%o)nt of reso)rces in*este' in c)rrent "ssets fro% so)rces of

fin"nce other th"n c)rrent #i",i#ities( This net "%o)nt is "#so the "%o)nt "*"i#",#e for )sein the ,)siness in the for% of f)n'( D)rin! "n "cco)ntin! perio'$ worin! c"pit"# or

f)n's f#ow fro% one e#e%ent of ,"#"nce sheet to "nother "n' "ccor'in! to net worin!

c"pit"# "ppro"ch $ worin! c"pit"# is the "%o)nt which is "*"i#",#e to the fir% "s "#i2)i' reso)rce( A st"te%ent th"t )ses net worin! c"pit"# "s " %e"s)re of #i2)i'it&

position is referre' to "s f)n' f#ow st"te%ent$ "n' its "n"#&sis "s f)n' f#ow "n"#&sis(

C"sh "n' c"sh e2)i*"#ent ,"sis is "nother w"& in which #i2)i'it& position of the

fir% is concei*e'( M"ret",#e sec)rities "re consi'ere' "s c"sh e2)i*"#ent )n'er this

"ppro"ch( The ch"n!e in the "%o)nt of c"sh "n' its e2)i*"#ents ')rin! the "cco)ntin!

perio' ref#ects #i2)i'it& position( This i%p#ies th"t %"n& of the ite%s which 'o not

ch"n!e NWC position ,)t "ffect c"sh position of the fir% "re "n"#&+e'( The st"te%entprep"re' on c"sh ,"sis is c"##e' c"sh f#ow st"te%ent "n' its "n"#&sis is referre' to "s c"sh

f#ow "n"#&sis(

In or'er to )n'ert"e f)n' f#ow "n"#&sis$ it re2)ires "n )n'erst"n'in! of the

fo##owin!0

?# The concept of so)rces "n' )ses of f)n's(

># The effect of ch"n!es in *"rio)s ,"#"nce sheet ite%s on the NWC position of thefir% i(e($ how *"rio)s "cco)nts "ffect worin! c"pit"# position(

@# The re"rr"n!e%ent "n' conso#i'"tion of infor%"tion t"en fro% ,"#"nce sheet "sin'ic"te' ",o*e "n' re#e*"nt infor%"tion fro% profit "n' #oss "cco)nt in the for%of F)n' f#ow st"te%ent(

The first step in the "n"#&sis f)n' f#ows is to c#"ssif& the ,)siness tr"ns"ctions intoso)rces "n' )ses of f)n's( Nor%"##&$ "n incre"se in #i",i#ities or " 'ecre"se in "ssets of

the fir% is consi'ere' "s so)rces of f)n's( On the other h"n'$ "n incre"se in "ssets or "

'ecre"se in #i",i#ities$ is consi'ere' "s )se of f)n's( An incre"se in worin! c"pit"# %e"nsits "%o)nt "t the en' of the perio' is !re"ter th"n its "%o)nt "t the ,e!innin! of the

perio'$ "n' it 'enotes the 'ep#o&%ent of f)n's ,& the "%o)nt of the incre"se "n' hence it

is consi'ere' " )se of f)n's( On the other h"n'$ " 'ecre"se in net worin! c"pit"# ,"#"nce')rin! the "cco)ntin! perio' 'enotes the "*"i#",i#it& of f)n's with the ,)siness$ hence it

is " so)rce of f)n's(

An "n"#&sis of the f#)ct)"tions of c)rrent "ssets "n' c)rrent #i",i#ities i(e($ worin!c"pit"# te##s )s how the worin! c"pit"# h"s incre"se' or 'ecre"se'( We w"nt to now

where the incre"se' worin! c"pit"# is "pp#ie' if it h"s incre"se'$ "n' fro% where f)n's

h"*e ,een re#e"se' if it h"s 'ecre"se'( The profit "n' #oss "cco)nt !i*es so%e in'ic"tionof the res)#ts of the oper"tions "n' its i%p"ct on the f)n's position( We tr& to inte!r"te

the i%p"ct of oper"tions reporte' in the profit "n' #oss "cco)nt "n' ,"#"nce sheet ,&


13/22

prep"rin! " st"te%ent of ch"n!es in fin"nci"# position( It 'escri,es the so)rces fro%

which f)n's were recei*e' "n' the )ses to which f)n's were p)t( This st"te%ent of

ch"n!es in fin"nci"# position is )s)"##& referre' to "s f)n' f#ow st"te%ent or st"te%ent ofso)rces "n' "pp#ic"tion of f)n's( It tr"ces the f#ow of f)n's thro)!h the or!"ni+"tion(

The st"te%ent of f)n's f#ow is )s)"##& ,if)rc"te' into two #o!ic"# 'i*isions0 so)rcesof f)n's or inf#ows ')rin! the perio's "n' )ses of f)n's or "pp#ic"tions of f)n's ')rin!

the perio'( The 'i*ision showin! so)rces of f)n's s)%%"ri+es "## those tr"ns"ctions

which h"' the net effect of 'ecre"sin! the worin! c"pit"#( 6ses of f)n's on the otherh"n' 'e"# with "## those tr"ns"ctions which h"' the effect of incre"sin! the worin!

c"pit"#( To s)%%"ri+e$ "n incre"se in net worin! c"pit"# is possi,#e ')e to incre"se in

non-c)rrent #i",i#ities "n' owners3 e2)it& or 'ecre"se in non-c)rrent "ssets( Whi#e

'ecre"se in net worin! c"pit"# res)#ts fro% "n incre"se in non-c)rrent "ssets or 'ecre"sein non-c)rrent #i",i#ities "n' 8 or owners3 e2)it&( Worin! c"pit"# 'oes not !et "ffecte'0 if

tr"ns"ctions "ffect on#& c)rrent ite%s i(e($ c)rrent "ssets "n' c)rrent #i",i#ities or if

tr"ns"ctions "ffect on#& non-c)rrent "ssets( The f#ow of f)n's st"te%ent !i*es " s)%%"r&

of the i%p"cts of %"n"!eri"# 'ecisions( As s)ch it ref#ects the po#icies of fin"ncin!$in*est%ent$ "c2)isition "n' retire%ent of fixe' "ssets$ 'istri,)tion of profits "n' the

s)ccess of oper"tions(

SOURCES OF FUNDS

Worin! c"pit"# is re2)ire' to fin"nce th"t portion of c)rrent "ssets which is notfin"nce' ,& c)rrent #i",i#ities( The in*est%ents represente' ,& c)rrent "ssets "re

con*erte' into c"sh ')rin! the oper"tin! c&c#e( This i%p#ies th"t o)r nee' for fin"ncin! is

for one s)ch c&c#e( 6n'er nor%"# circ)%st"nces e*er& )nit of in*est%ent in worin!

c"pit"# is con*erte' into c"sh "t the en' of the c&c#e "t "n "''e' *"#)e$ to the extent ofprofits(

Intern"# So)rces 0 E*er& profit",#e s"#e ,rin!s with it f)n's in excess of wh"t w"sexpen'e' on the !oo's so#'( In other wor's$ profits !ener"te' ,& the ,)siness contri,)te

tow"r's "''ition"# worin! c"pit"#( Whene*er we %e"s)re profits$ we %"tch the re*en)e

"!"inst "## expenses re#"tin! to the re*en)e$ whether it in*o#*es )se of f)n's in thec)rrent perio' or not( Th)s the profits %e"s)re' 'o not ref#ect the "ct)"# "%o)nt of f)n's

"*"i#",#e( In or'er to "ssess the "ct)"# f)n's !ener"te' fro% c)rrent oper"tions we sho)#'

"'' ,"c to the profits "## those ite%s of expenses not in*o#*in! )se of f)n's ')rin! the

c)rrent perio'( One %"4or ex"%p#e of s)ch "n ite% is 'epreci"tion( Th)s we co)#'s)%%"ri+e the i%port"nt possi,#e so)rces of f)n's "s0 F)n's !ener"te' fro% oper"tions$

i(e($ profit p#)s 'epreci"tion "n' other "%orti+"tions "n' s"#e of non-c)rrent "ssets$ "n&

s)rp#)s worin! c"pit"#(

F)n's fro% Oper"tions 0 F)n's fro% oper"tions represent the s"#e procee's of !oo's "n'

ser*ices ,& the co%p"n&( P"rt of these f)n's is )ti#i+e' for %eetin! the cost of inp)tss)ch "s %"teri"#$ personne# "n' other oper"tin! costs( Ap"rt fro% these we h"*e "#so to

%eet the interest co%%it%ents "n' costs expir"tion of the %"chiner& "n' e2)ip%ent(

7owe*er$ expir"tion of costs of the %"chiner& "n' e2)ip%ent .'epreci"tion/ is one ite%

which 'oes not re2)ire )se of f)n's in the c)rrent perio'( Th)s the f)n's pro*i'e' fro%


14/22

the oper"tions "re in f"ct the re*en)es e"rne' fro% oper"tions ."s "#so non-oper"tin!

inco%es/ #ess "## i%%e'i"te costs of !oo's so#' re2)irin! )se of f)n's( In other wor's$ it

is net inco%e or profit "fter t"xes p#)s "## the non-c"sh expenses$ s)ch "s 'epreci"tion "n'"%ortis"tion(

Extern"# So)rces 0 Extern"# so)rces of f)n's "re reso)rces r"ise' for% o)tsi'e theor!"ni+"tion to ")!%ent f)n's "*"i#",i#it& for "n& of the )ses( Nor%"##& there "re two

w"&s of 'oin! this0 ,& contri,)tin! or r"isin! "''ition"# c"pit"# "n' ,& incre"se' #on!

ter% ,orrowin!( Short-ter% cre'itors "re not inc#)'e' "s " so)rce of f)n's since we h"*e"#re"'& 'efine' f)n's "s : c)rrent "ssets #ess c)rrent #i",i#ities;( Th)s worin! c"pit"#

represents #on! ter% in*est%ent in c)rrent "ssets "n' hence short ter% ,orrowin! wi## not

incre"se worin! c"pit"#( The so)rces of f)n's$ "s )s)"##& presente' in the f)n' f#ow

st"te%ent "re !i*en ,e#ow0

So)rces of F)n's

Oper"tions0

Net Profit "fter t"xes -----------A''0 Depreci"tion -----------

Other "%orti+"tions -----------F)n's pro*i'e' ,& oper"tions ----------------

New iss)e of sh"re c"pit"# ----------------

New iss)e of 'e,ent)res8,on's ----------------A''ition"# #on!-ter% ,orrowin! ----------------

S"#e procee's of fixe' "ssets ----------------

S"#e of #on! ter% in*est%ents ----------------

USES (APPLICATIONS) OF FUNDS

A ,)siness wo)#' re2)ire "''ition"# c"pit"# for two p)rposes0


15/22

If the tr"'in! or ,)siness oper"tions "re )ns)ccessf)#$ the& %"& )se f)n's r"ther th"n

pro*i'e f)n's( The )ses of f)n's$ "s the& "re )s)"##& presente' in the f)n' f#ow

st"te%ent$ "re !i*en ,e#ow0

6ses of F)n's

Di*i'en's -------------Non-oper"tin! #osses not p"sse' thro)!h P L "cco)nt -------------

Re'e%ption of re'ee%",#e preference sh"re c"pit"# -------------

Rep"&%ent of 'e,ent)res8,on's -------------Rep"&%ent of #on! ter% #o"ns -------------

P)rch"se of fixe' "ssets -------------

P)rch"se of #on!-ter%-in*est%ent -------------

Incre"se in worin! c"pit"# -------------

FACTORS AFFECTING F6ND REB6IREMENTS

F)n' re2)ire%ents *"r& with the n"t)re "n' t&pe of ,)siness( Worin! c"pit"#

re2)ire%ents "re 'irect#& inf#)ence' ,& s"#es *o#)%e( F)n' re2)ire%ents for the ,)siness%"& ,e se"son"#( An i%port"nt "spect which %"& con'ition f)n' re2)ire%ent is the

*e#ocit& of circ)#"tion of c)rrent "ssets( In other wor's the #en!th of the oper"tin! c&c#e

wi## inf#)ence the nee' for f)n's( Shorter the ')r"tion of oper"tin! c&c#e f"ster is thecon*ersion of %one& in*este' in c)rrent "ssets into c"sh "n' hence #esser the nee' for net

worin! c"pit"#( Net worin! c"pit"# re2)ire%ent is "#so inf#)ence' ,& the ter%s

"*"i#",#e fro% the s)pp#iers( The cre'it ter%s exten'e' ,& the s)pp#iers wi## 'eter%ine

the "%o)nt of "''ition"# f)n's re2)ire'( We c"n s)%%"rise the nee' for worin! c"pit"#,& s"&in! th"t the ",i#it& of the fir% to circ)#"te the :c"sh-r"w %"teri"# in*entor& -

wor-in process - finishe' !oo's in*entor& - recei*",#es - c"sh; is the %ost *it"# "n'

i%port"nt f"ctor in 'eter%inin! the "%o)nt of worin! c"pit"#( 7owe*er the ex"ct"%o)nt nee'e' to ,e in*este' in "## these wi## ,e 'eter%ine' ,& the perio' "n' 2)"nt)%

of ho#'in! of e"ch of these e#e%ents(

ANAL9SING C7ANGES IN WORKING CAPITAL

In )n'erst"n'in! the fin"nci"# st"te%ents of " co%p"n&$ one of the first steps

in*o#*e' is the st)'& of the ch"n!es in c)rrent fin"nci"# position of the co%p"n& "n' there"sons for the ch"n!es( We c"n "tte%pt "t st)'&in! these ch"n!es "n' their c")ses ,&

)sin! the '"t" cont"ine' in the s)%%"ri+e' co%p"r"ti*e ,"#"nce sheet "n' profit #oss

"cco)nt of " co%p"n&( A st"te%ent of ch"n!es in worin! c"pit"# he#ps )s in #oc"tin!where these ch"n!es too p#"ce( In the first inst"nce we tr& to show the incre"se

.'ecre"se/ in in'i*i')"# ite%s "n' tr& to c#"ssif& the% in ter%s of incre"se "n' 'ecre"se

in worin! c"pit"#( Since worin! c"pit"# is %e"s)re' ,& s),tr"ctin! c)rrent #i",i#itiesfro% c)rrent "ssets$ "n& incre"se in c)rrent "ssets "n' 'ecre"se in c)rrent #i",i#ities shows

"n incre"se in worin! c"pit"#( Si%i#"r#&$ " 'ecre"se in c)rrent "ssets "n' "n incre"se in

c)rrent #i",i#ities represent " 'ecre"se in worin! c"pit"#(


16/22

1ALANCE S7EET

1"#"nce sheet is the %ost si!nific"nt fin"nci"# st"te%ent( It in'ic"tes the fin"nci"#con'ition or the st"te of "ff"irs of " ,)siness "t " p"rtic)#"r %o%ent of ti%e( In the

#"n!)"!e of "cco)ntin!$ ,"#"nce sheet co%%)nic"tes infor%"tion ",o)t "ssets$ #i",i#ities

"n' owner3s e2)it& for " ,)siness fir% "s on " specific '"te( It pro*i'es " sn"pshot of thefin"nci"# position of the fir% "t the c#ose of the fir%3s "cco)ntin! perio'(

ASSETSAssets$ representin! econo%ic reso)rces "re the *"#)",#e possessions owne' ,& the fir%(

Assets "re the f)t)re ,enefits( The& represent0 ."/ store' p)rch"sin! power .e(!( c"sh/$ .,/

%one& c#"i%s .e(!( recei*",#es$ stoc/ "n' .c/ t"n!i,#e "n' int"n!i,#e ite%s th"t c"n ,e

so#' or )se' in the ,)siness to !ener"te e"rnin!s( T"n!i,#e ite%s inc#)'e #"n'$ ,)i#'in!$p#"nt$ e2)ip%ent or stocs of %"teri"#s "n' finishe' !oo's "n' "## s)ch ite%s which h"*e

ph&sic"# s),st"nce( Int"n!i,#e ite%s 'o not h"*e "n& ph&sic"# existence$ ,)t the& h"*e

*"#)e to " fir%( The& inc#)'e p"tents$ cop& ri!hts$ tr"'e n"%e or !oo'wi##(

Assets %"& ,e c#"ssifie' "s0 .


17/22

with " ,"n "n' re"#i+e c"sh i%%e'i"te#&( The "%o)nt of 'isco)nt is the ,"n3s

co%%ission(

STOCK .or IN5ENTOR9/

Stoc or in*entor& inc#)'es r"w %"teri"#s$ wor-in-process "n' finishe' !oo's in c"se of

%"n)f"ct)rin! fir%s( A %erch"n'ise ,)siness %"& not h"*e r"w %"teri"# "n' wor-in-process in*entories "s it h"s no %"n)f"ct)rin! "cti*it&(

PREPAID EPENSES AND ACCR6ED INCOMESPrep"i' expenses "n' "ccr)e' inco%es "re "#so inc#)'e' inc)rrent "ssets( Prep"i'

expenses "re the expenses of f)t)re perio' p"i' in "'*"nce( Ex"%p#es of prep"i'

expenses "re prep"i' ins)r"nce$ prep"i' rent or t"xes p"i' in "'*"nce( The& "re c)rrent

"ssets ,ec")se their ,enefits wi## ,e recei*e' within the "cco)ntin! perio'( Accr)e'inco%es "re the ,enefits which the fir% h"s e"rne'$ ,)t the& h"*e not ,een recei*e' in

c"sh &et( The& inc#)'e ite%s s)ch "s "ccr)e' 'i*i'en'$ "ccr)e' co%%ission$ or "ccr)e'

interest(

LOANS AND AD5ANCES

Lo"ns "n' A'*"nces "re "#so inc#)'e' in c)rrent "ssets in In'i"( The& inc#)'e ')es fro%e%p#o&ees or "ssoci"tes$ "'*"nces for c)rrent s)pp#ies "n' "'*"nces "!"inst "c2)isition

of c"pit"# "ssets(

FIED ASSETS

Fixe' or #on!-ter% "ssets "re he#' for perio's #on!er th"n the "cco)ntin! perio'( The& "re

he#' for )se in ,)siness$ "n' not for the p)rpose of s"#e( Fixe' "ssets wo)#' inc#)'e #on!-

ter% in*est%ent "n' "## non-c)rrent "ssets(

T"n!i,#e fixe' "ssets

T"n!i,#e fixe' "ssets inc#)'e #"n'$ ,)i#'in!$ %"chiner&$ e2)ip%ent$ f)rnit)re etc( These"re nor%"##& recor'e' "t cost( Costs of t"n!i,#e fixe' "ssets "re "##oc"te' o*er their )sef)#

#i*es( The "%o)nt so "##oc"te' e"ch &e"r is c"##e' 'epreci"tion( Costs of t"n!i,#e fixe'

"ssets "re re')ce' e*er& &e"r ,& the "%o)nt of 'epreci"tion( Depreci"tin! "n "sset is "process of "##oc"tin! cost "n' 'oes not in*o#*e "n& c"sh o)t#"&(

Int"n!i,#e fixe' "ssets

Int"n!i,#e fixe' "ssets represent the fir%3s ri!hts "n' inc#)'e p"tents$ cop&ri!hts$fr"nchises$ tr"'e-%"rs$ tr"'e n"%es "n' !oo'wi##( P"tents "re the exc#)si*e ri!hts

!r"nte' ,& the !o*ern%ent en",#in! the ho#'er to contro# the )se of "n in*ention( Cop&

ri!hts "re the exc#)si*e ri!hts to repro')ce "n' se## #iter"r&$ %)sic"# "n' "rtistic wors(Fr"nchises "re the contr"cts !i*in! exc#)si*e ri!hts to perfor% cert"in f)nctions or to se##

cert"in ser*ices or pro')cts( Tr"'e %"rs "n' tr"'e n"%es "re the exc#)si*e ri!hts !r"nte'

,& the !o*ern%ent to )se cert"in n"%es$ s&%,o#s$ #",e#s$ 'esi!ns etc( Goo'wi##represents the excessi*e e"rnin! power of " fir% ')e to speci"# "'*"nt"!es th"t it

possesses( Costs of int"n!i,#e fixe' "ssets "re "%orti+e' o*er their )sef)# #i*es(


18/22

Gross ,#oc

Gross ,#oc represents the ori!in"# cost of tot"# fixe' "ssets( When "cc)%)#"te'

'epreci"tion is s),tr"cte' fro% the !ross ,#oc$ the 'ifference is c"##e' the net ,#oc(

Lon!-ter% in*est%ents

Lon!-ter% in*est%ents represent the fir%3s in sh"res$ 'e,ent)res "n' ,on's of otherfir%s or !o*ern%ent ,o'ies for profits "n' contro#( These in*est%ents "re he#' for "

perio' of ti%e !re"ter th"n the "cco)ntin! perio'(

Other non-c)rrent "ssets

Other non-c)rrent "ssets inc#)'e "ssets th"t c"nnot ,e inc#)'e' in "n& of the ",o*e

c"te!ories( 6s)"##& the& represent 'eferre' ch"r!es( Prep"&%ents for ser*ices or ,enefits

for " perio' #on!er th"n the "cco)ntin! perio' "re referre' to "s 'eferre' ch"r!es "n'inc#)'e "'*ertisin!$ pre#i%in"r& expenses etc(

LIA1ILITIES

Li",i#ities "re 'e,ts p"&",#e in the f)t)re ,& the fir% to its cre'itors( The& representecono%ic o,#i!"tions to p"& c"sh or to pro*i'e !oo's or ser*ices in so%e f)t)re perio'(

Gener"##&$ #i",i#ities "re cre"te' ,& ,orrowin! %one& or p)rch"sin! !oo's or ser*ices oncre'it( Ex"%p#es of #i",i#ities "re cre'itors$ ,i##s p"&",#e$ w"!es "n' s"#"ries p"&",#e$

interest p"&",#e$ t"xes p"&",#e$ ,on's$ 'e,ent)res$ ,orrowin! fro% ,"ns "n' fin"nci"#

instit)tions$ p),#ic 'eposits etc(Li",i#ities "re of two t&pes0 .


19/22

Pro*isions

Pro*isions "re other t&pes of c)rrent #i",i#ities( The& inc#)'e pro*ision for t"xes "n'

'i*i'en's( Gener"##&$ the "%o)nt of t"x is esti%"te' "n' shown "s pro*ision for t"xes ort"x #i",i#it&( Si%i#"r#&$ pro*ision for p"&in! 'i*i'en's to sh"reho#'ers %"& ,e cre"te' "n'

shown "s c)rrent #i",i#it&(

Expenses p"&",#e or o)tst"n'in! expenses

Expenses p"&",#e or o)tst"n'in! expenses "re "#so c)rrent #i",i#ities( The fir% %"& owe

p"&%ents to its e%p#o&ees "n' others "t the en' of the "cco)ntin! perio' for the ser*icesrecei*e' in the c)rrent &e"r( These p"&%ents "re p"&",#e within " *er& short perio'(

Ex"%p#es of o)tst"n'in! expenses "re w"!es p"&",#e$ rent p"&",#e$ or co%%ission

p"&",#e(

Inco%e recei*e' in "'*"nce

Inco%e recei*e' in "'*"nce is &et "nother ex"%p#e of c)rrent #i",i#it&( A fir% c"n

so%eti%es recei*e inco%e for !oo's or ser*ices to ,e s)pp#ie' in f)t)re( As !oo's or

ser*ices h"*e to ,e pro*i'e' within the "cco)ntin! perio'$ s)ch receipts "re shown "sc)rrent #i",i#ities(

Inst"#%ents of #on!-ter% #o"ns

Inst"#%ents of #on!-ter% #o"ns "re p"&",#e perio'ic"##&( Th"t portion of the #on! ter%

#o"n which is p"&",#e in the c)rrent &e"r wi## for% p"rt of c)rrent #i",i#ities(

Deposits fro% p),#ic

Deposits fro% p),#ic %"& ,e r"ise' ,& " fir% for fin"ncin! its c)rrent "ssets( These %"&

therefore ,e c#"ssifie' )n'er c)rrent #i",i#ities(

LONG-TERM LIA1ILITIES

Lon!-ter% #i",i#ities "re the o,#i!"tions or 'e,ts p"&",#e in " perio' of ti%e !re"ter th"nthe "cco)ntin! perio'( Lon!-ter% #i",i#ities )s)"##& represent ,orrowin! for " #on! perio'

of ti%e( The& inc#)'e 'e,ent)res$ ,on's "n' sec)re' #on! ter% #o"ns fro% ,"ns "n'

fin"nci"# instit)tions(

De,ent)res or ,on's

De,ent)res or ,on's "re iss)e' ,& " fir% to the p),#ic to r"ise 'e,t( A 'e,ent)re or "

,on' is " !ener"# o,#i!"tion of the fir% to p"& interest "n' ret)rn the princip"# s)% "s perthe "!ree%ent( Lo"n r"ise' thro)!h iss)e of 'e,ent)res or ,on's %"& ,e sec)re' or

)nsec)re'(

Sec)re' #o"ns

Sec)re' #o"ns "re the #on!-ter% ,orrowin!s with fixe' "ssets p#e'!e' "s sec)rit&( Ter%

#o"ns fro% fin"nci"# instit)tions "n' co%%erci"# ,"ns "re sec)re' "!"inst the "ssets ofthe fir%(


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The fin"nci"# interests of the owners "re c"##e' owners3 e2)it&( The owners3 interest is

resi')"# in n"t)re$ ref#ectin! the excess of the fir%3s "ssets o*er its #i",i#ities( As#i",i#ities "re the c#"i%s of o)tsi'e p"rties$ e2)it& represents owners3 c#"i% "!"inst the

,)siness entit& "s of the ,"#"nce sheet '"te( 1)t the n"t)re of the owners3 c#"i% is not the

s"%e "s th"t of the cre'itors( Cre'itors3 c#"i%s "re 'efine' "n' h"*e to ,e %et within thespecifie' perio'( The c#"i% of the owners ch"n!e "n' the "%o)nt p"&",#e to the% c"n ,e

'eter%ine' on#& when the fir% is #i2)i'"te'( Since "ssets "re recor'e' "t cost$ there c"n

,e consi'er",#e 'ifference ,etween the owners3 ,oo c#"i% "n' the re"# c#"i%(

Initi"##&$ owners3 e2)it& "rises on "cco)nt of the f)n's in*este' ,& the%( 1)t it ch"n!es

')e to the e"rnin!s of the fir% "n' their 'istri,)tion( The fir%s3 e"rnin!s .or #osses/ 'o

not effect the cre'itors3 c#"i%s( Owners3 e2)it& wi## incre"se when the fir% %"ese"rnin!s "n' ret"ins who#e or p"rt( If #osses "re inc)rre' ,& the fir%$ owners3 c#"i% wi##

,e re')ce'(

Sh"re c"pit"#In c"se of " co%p"n&$ owners "re c"##e' sh"reho#'ers .or stocho#'ers/( Therefore$

owners3 e2)it& is referre' to "s sh"reho#'ers3 e2)it& of sh"reho#'ers3 f)n's( Sh"reho#'erse2)it& h"s two p"rts .i/ p"i'-)p sh"re c"pit"# "n' .ii/ reser*es "n' s)rp#)s .ret"ine'

e"rnin!s/ representin! )n'istri,)te' profits( P"i'-)p sh"re c"pit"# is the "%o)nt of f)n's

'irect#& contri,)te' ,& the sh"reho#'ers( If the sh"reho#'ers "re "ct)"##& re2)ire' to p"&%ore th"n the st"te' or p"r *"#)e per sh"re$ the "%o)nt is sep"r"te#& shown "s sh"re

pre%i)%(

Reser*es "n' s)rp#)sThe secon' p"rt of the owners3 e2)it& is referre' to "s ret"ine' e"rnin!s or reser*es "n'

s)rp#)s( The 'ifference ,etween the tot"# e"rnin!s to '"te "n' the tot"# "%o)nt of

'i*i'en's to '"te is reser*es "n' s)rp#)s( It represents tot"# )n'istri,)te' e"rnin!s( .Theter% 'eficit is )se' to represent excess of tot"# 'i*i'en's o*er tot"# e"rnin!s or #osses

inc)rre' ,& the fir%/( 6n'istri,)te' profits .reser*e/ %"& ,e e"r%"re' for so%e specific

p)rpose$ s)ch "s rep#"ce%ent or 'e,ent)re re'e%ption( Reser*es th"t "re not e"r%"re'"re c"##e' free reser*es(

Net worth

The ter% net worth is )se' for the s)% of sh"re c"pit"# "n' reser*es "n' s)rp#)s$ i(e($ theowners3 e2)it&(

Re#"tionship 1etween Assets$ Li",i#ities "n' Owners3 E2)it&Assets "re reso)rces of the fir% th"t "re "c2)ire' fro% f)n's pro*i'e' ,& o)tsi'ers$

nown "s #i",i#ities "n' f)n's pro*i'e' ,& owners$ nown "s owners3 e2)it&( In other

wor's$ "ssets represent the o)tsi'ers3 "n' owners3 in*est%ents( The re#"tionship is0

Tot"# Assets .TA/ Tot"# Li",i#ities .TL/ Owners3 E2)it& .OE/


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Or TA @ TL OE i(e($ owners3 e2)it& is the fir%s3 re%"inin! reso)rces

."ssets/ "fter the o,#i!"tions of o)tsi'ers .#i",i#ities/ h"*e ,een t"en c"re of( Th)s

ch"n!es in "ssets "n' #i",i#ities wi## c")se " ch"n!e in owners3 e2)it&( Ch"n!e in owners3e2)it& in the c"se of co%p"nies$ wi## ,e ref#ecte' in ret"ine' e"rnin!s or reser*es "n'

s)rp#)s( The p"i'-)p sh"re c"pit"# wi## not nor%"##& 'ecre"se in the #ife ti%e of "

co%p"n& ,)t it c"n incre"se whene*er f)n's "re r"ise' ,& iss)in! new sh"res(

Tot"# Assets .TA/ Net fixe' "ssets .NFA/ C)rrent "ssets .CA/

Tot"# Li",i#ities .TL/ Lon!-ter% #i",i#ities .LTL/ C)rrent #i",i#ities .CL/

i(e($ NFA CA LTL CL OE

i(e($ NFA .CA @ CL/ LTL OE

i(e($ NFA NCA LTL OE$ NCA net c)rrent "ssets

Net worin! c"pit"# !"p

The 'ifference ,etween c)rrent "ssets .CA/ "n' c)rrent #i",i#ities .CL/ is c"##e' net

worin! c"pit"# .NWC/ or net c)rrent "ssets .NCA/( NWC or NCA is th"t portion ofc)rrent "ssets th"t is not fin"nce' fro% c)rrent #i",i#ities therefore$ it %)st necess"ri#& ,e

fin"nce' fro% #on!-ter% f)n's( 1"n cre'it is "n i%port"nt co%ponent of c)rrent#i",i#ities th"t fin"nces c)rrent "ssets( 1)t it is " c)rrent #i",i#it& th"t 'oes not "rise

'irect#& fro% the fir%s3 oper"tions( Acco)nts p"&",#e "n' ,i##s p"&",#e "n' *"rio)s t&pes

of "ccr)"#s "rise spont"neo)s#& o)t of the fir%s3 oper"tions "n' "re therefore c"##e'spont"neo)s c)rrent #i",i#ities .SCL/( The 'ifference ,etween c)rrent "ssets "n'

spont"neo)s c)rrent #i",i#ities .th"t is$ c)rrent #i",i#ities #ess ,"n cre'it/ %"& ,e referre'

to "s net worin! c"pit"# !"p .NWCG/$ or oper"tin! c"pit"# .OC/( NWCG %)st of

necessit& ,e fin"nce' ,& ,"n ,orrowin! .11/ "n' #on!-ter% f)n's(

NFA CA @ . SCL 11 / LTL OE

NFA NWCG @ 11 LTL OENFA NWCG 11 LTL OE

Where 11 is ,"n ,orrowin! for fin"ncin! c)rrent "ssets not co*ere' ,& spont"neo)s

c)rrent #i",i#ities .SCL/(

C"pit"# e%p#o&e'

It %"& ,e 'efine' "s " net fixe' "ssets p#)s net c)rrent "ssets

CE NFA NCASince NFA NCA LTL OE$ it i%p#ies th"t c"pit"# e%p#o&e' e2)"#s #on!-ter% f)n's0

CE LTL OE

The "#tern"ti*e 'efinition of c"pit"# e%p#o&e' is tot"# interest ,e"rin! 'e,t or #o"n f)n's

.i(e($ #on!-ter% 'e,t p#)s ,"n ,orrowin!/ p#)s owners3 e2)it& or sh"reho#'ers f)n's .net

worth/( Fro% "sset si'e$ it %e"ns net fixe' "ssets p#)s net worin! c"pit"# !"p0CE NFA NWCG

Since ,"n ,orrowin! 'oes not "rise 'irect#& fro% the oper"tions of the fir%$ "n' th"t it

h"s to ,e r"ise' extern"##& "t " cost$ it is %ore #o!ic"# to )se the secon' 'efinition of

c"pit"# e%p#o&e' for "n"#&tic"# p)rposes(


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Dimensions of Working Capital Management

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