Concept of Working Capital

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Concept of working capital includes meaning of working capital and its nature. Working capital is the investment in current assets. Without this investment, we can not operate our fixed assets properly. For getting good profits from fixed assets, we need to buy some current assets or pay some expenses or invest our money in current assets. For example, we keep some of cash which is the one of major part of working capital. At any time, our machines may need repair. Repair is revenue expense but without cash, we can not repair our machines and without machines, our production may delay. Like this, we need inventory or to invest in debtors and other short term securities.

On the basis of Concept, we can divide our working capital into two parts:

1. Gross Working Capital

In this concept of working capital, we study gross working capital. We do not deduct current liabilities in this concept but we use current liabilities as source of fund. Suppose, if we buy goods on credit, it means our save our cash and we can use this as working capital for paying other expenses.

2. Net Working Capital

Under this concept we use net working capital. For this, we first deduct all our current liabilities from our current assets. Excess of current assets over current liabilities will be current assets. We have to maintain minimum level of working capital in our business for operation of business activities. This concept is also used for preparation of balance sheet. In the vertical form of balance sheet, we show excess of current assets over current liabilities.

Operating Cycle Concept of Working Capital

In this concept of working capital, we make the operating cycle. In this cycle, we calculate inventory conversion period. To know this, we can estimate when we need cash for buying our inventory. We also calculate debtor or receivable conversion period. To know this, we can estimate when we receive cash from our debtors.

If inventory conversion period is less than debtor conversion period, we have to manage other sources for buying our inventories. If we buy good on credit, we also take care creditors' conversion period.

Related : Working Capital Management