Chapter 14
Estimation of Working Capital
OBJECTIVES
Know the components of working capital.
Be able to measure working capital requirement and the length of operating cycle.
Know the link between operating cycle and sustainable growth.
The impact of working capital investment and shareholder value.
Know the determinants of working capital.
Know the different approaches to working capital lending adopted by banks.A firm requires funds to acquire two types of assets: fixed assets and current assets. Fixed assets include
land, building, plant and machinery, vehicles, equipment, etc. These assets are relatively permanent in nature
and are necessary for carrying on the business. Current assets, on the other hand, are kept for supporting day-
to-day operations and keep changing during the course of the business. They are liquidated within a short
period of time during the operating cycle of the industry and not normally exceeding one year. Current assets
include cash, debtors, inventory of raw material and finished goods, etc. Current assets constitute gross
working capital.
The excess of current assets over current liabilities is called net working capital or, simply, working cap-
ital. Current liabilities, as you know, are to be paid in the ordinary course of business, (normally within one
year) out of the income generated by the company or from the proceeds from sale of current assets. Fixed
assets are to be financed by owners’ equity and long-term liabilities while current assets are partly financed
by long-term sources and partly by current liabilities and short-term loans given by banks. The concept of
working capital is shown as a diagram:
Liabilities Assets
Share capital
Reserves and surplus Net fixed assets
Long-term liabilities
Working Capital
Current liabilities Current assets