Management Accounting II
CH. 1 WORKING CAPITAL MANAGEMENT
Flashcards
Working capital is an indicator of the short-term financial position that measures
the overall efficiency of an organization. It is calculated by subtracting current
liabilities from current assets and listed directly in its balance sheet.
Current assets mean the money kept in a bank and assets that can be converted
into cash in case if any situation arises. Current liabilities represent debt that an
individual will pay within the prescribed year. Finally, working capital is the money
left after subtracting liabilities from an individual's money in the bank.
Current assets consist of cash, accounts receivable, and inventory. Current
liabilities include wages, taxes, interest owed.
In broader terms, working capital is also used to measure the company’s financial
health. If there is a larger difference between what a company owns and what an
individual owns for the short-term, the business will be healthier.
If the company owes more than they own, they will have negative working capital,
and their business might get closed.
Types of Working Capital
The types of working capital are mainly divided into different parts:
Gross Working Capital
Gross working capital is the total value of the company’s current assets. Current
assets include cash, receivables, short-term investments, and especially market
securities.
The Gross working capital does not showcase the current liabilities. Gross
working capital can be executed by calculating the difference between the
existing assets and current liabilities.
Management Accounting II 1
, The difference remaining is the actual working capital that the company has to
meet its obligations.
Net Working Capital
Networking capital is the difference between the current assets and current
liabilities of the company. If the company’s assets are more than current liabilities,
it indicates a positive working capital, and the company is in a financial position to
meet its obligations.
However, if the company’s assets are less than current liabilities, it indicates a
negative working capital, and the company is facing financial distress.
The key difference between gross and net working capital is that gross working
capital will always be a positive value. In contrast, networking capital can either be
a negative or positive value.
Permanent Working Capital
Permanent working capital is the minimum amount of capital required to carry on
the operations without interruption or difficulty.
For example, a company will need minimum cash to keep the operations smooth
and running; here, the minimum amount of money required will act as permanent
working capital.
Regular Working Capital
Regular working capital is the amount of funds businesses require to fund its day
to day operations. For example, cash needed for making payment of wages, raw
materials, salaries comes under regular working capital.
Reserve Margin Working Capital
Apart from conducting day-to-day activities, a business may need some amount
of capital to face unforeseen circumstances. Reserve margin working capital is
nothing, but the money kept aside apart from the regular working capital. These
funds are held separately against unexpected events like floods, natural
calamities, storms, etc.
Variable Working Capital
Variable working capital can be defined as the capital invested for a temporary
period in the business. Variable working capital is also called fluctuating working
Management Accounting II 2
, capital.
Such capital differs with respect to changes in the business assets or the size of
the business. Furthermore, variable capital is subdivided into two parts:
1) Seasonable Variable Working Capital
Seasonable variable working capital is the amount of capital kept aside to meet
the seasonal demand if the business is running seasonally.
2) Special Variable Working Capital
Special variable working capital is the temporary rise in the working capital due to
any unforeseen or occurrence of a special event.
Sources of working Capital
A company has various sources of working capital. Depending upon its condition
and requirements, a company may use any of these sources of working capital.
These sources may be spontaneous, short-term, or long-term.
Spontaneous Sources: The sources of capital created during normal business
activity are called spontaneous sources of working capital. The amount and
credit terms vary from industry to industry and depend on the business
relationship between the buyer and seller. The main characteristic of
spontaneous sources is ‘zero-effort’ and ‘negligible cost’ compared to
traditional financing methods. The primary sources of spontaneous working
capital are trade credit and outstanding expenses.
Short-term Sources: The sources of capital available to a business for less
than one year are called short-term sources of working capital.
Long-term Sources: The sources of capital available to a business for a
longer period, usually more than one year, are called long-term sources of
working capital.
Short-Term Sources of Working Capital
1. Short-Term Capital Sources:
Short-term capital sources can be categorized into Internal Sources and
External Sources.
Management Accounting II 3
CH. 1 WORKING CAPITAL MANAGEMENT
Flashcards
Working capital is an indicator of the short-term financial position that measures
the overall efficiency of an organization. It is calculated by subtracting current
liabilities from current assets and listed directly in its balance sheet.
Current assets mean the money kept in a bank and assets that can be converted
into cash in case if any situation arises. Current liabilities represent debt that an
individual will pay within the prescribed year. Finally, working capital is the money
left after subtracting liabilities from an individual's money in the bank.
Current assets consist of cash, accounts receivable, and inventory. Current
liabilities include wages, taxes, interest owed.
In broader terms, working capital is also used to measure the company’s financial
health. If there is a larger difference between what a company owns and what an
individual owns for the short-term, the business will be healthier.
If the company owes more than they own, they will have negative working capital,
and their business might get closed.
Types of Working Capital
The types of working capital are mainly divided into different parts:
Gross Working Capital
Gross working capital is the total value of the company’s current assets. Current
assets include cash, receivables, short-term investments, and especially market
securities.
The Gross working capital does not showcase the current liabilities. Gross
working capital can be executed by calculating the difference between the
existing assets and current liabilities.
Management Accounting II 1
, The difference remaining is the actual working capital that the company has to
meet its obligations.
Net Working Capital
Networking capital is the difference between the current assets and current
liabilities of the company. If the company’s assets are more than current liabilities,
it indicates a positive working capital, and the company is in a financial position to
meet its obligations.
However, if the company’s assets are less than current liabilities, it indicates a
negative working capital, and the company is facing financial distress.
The key difference between gross and net working capital is that gross working
capital will always be a positive value. In contrast, networking capital can either be
a negative or positive value.
Permanent Working Capital
Permanent working capital is the minimum amount of capital required to carry on
the operations without interruption or difficulty.
For example, a company will need minimum cash to keep the operations smooth
and running; here, the minimum amount of money required will act as permanent
working capital.
Regular Working Capital
Regular working capital is the amount of funds businesses require to fund its day
to day operations. For example, cash needed for making payment of wages, raw
materials, salaries comes under regular working capital.
Reserve Margin Working Capital
Apart from conducting day-to-day activities, a business may need some amount
of capital to face unforeseen circumstances. Reserve margin working capital is
nothing, but the money kept aside apart from the regular working capital. These
funds are held separately against unexpected events like floods, natural
calamities, storms, etc.
Variable Working Capital
Variable working capital can be defined as the capital invested for a temporary
period in the business. Variable working capital is also called fluctuating working
Management Accounting II 2
, capital.
Such capital differs with respect to changes in the business assets or the size of
the business. Furthermore, variable capital is subdivided into two parts:
1) Seasonable Variable Working Capital
Seasonable variable working capital is the amount of capital kept aside to meet
the seasonal demand if the business is running seasonally.
2) Special Variable Working Capital
Special variable working capital is the temporary rise in the working capital due to
any unforeseen or occurrence of a special event.
Sources of working Capital
A company has various sources of working capital. Depending upon its condition
and requirements, a company may use any of these sources of working capital.
These sources may be spontaneous, short-term, or long-term.
Spontaneous Sources: The sources of capital created during normal business
activity are called spontaneous sources of working capital. The amount and
credit terms vary from industry to industry and depend on the business
relationship between the buyer and seller. The main characteristic of
spontaneous sources is ‘zero-effort’ and ‘negligible cost’ compared to
traditional financing methods. The primary sources of spontaneous working
capital are trade credit and outstanding expenses.
Short-term Sources: The sources of capital available to a business for less
than one year are called short-term sources of working capital.
Long-term Sources: The sources of capital available to a business for a
longer period, usually more than one year, are called long-term sources of
working capital.
Short-Term Sources of Working Capital
1. Short-Term Capital Sources:
Short-term capital sources can be categorized into Internal Sources and
External Sources.
Management Accounting II 3
