Define Net Working Capital.

Net Working Capital:

Net working capital represents the excess of Current Assets over current liabilities. When the total value of current assets exceeds the total value of current liabilities, the result represents positive working capital. On the other hand, if current liabilities exceed current assets, the result represents negative working capital.

Current liability includes those liabilities which is to be liquidated within a concise period, generally; within one accounting year.

The followings are the component of current liabilities.

  4. SHORT TERM LOANS, ADVANCES, OR DEPOSIT (To be repaid within one year)

The gross Working Capital concept is important in respect of the following situation:

  • It enables the business concerned to provide the correct amount of Working Capital at the right time.
  • Every management is more interested in the total assets it has to operate than the sources from which it is made available.
  • The gross concept considers that every increase in the fund of the business concern would increase its Working Capital.
  • The gross concept of Working Capital is useful in determining the rate of return on investment in Working Capital.

The concept of Net Working Capital is important in the following situation:

  • It indicates the ability of the business concerned to meet its operating expenses and short-term liabilities.
  • The excess of current assets over current liabilities indicates the margin of protection of short-term liability.
  • It indicates the soundness of the business.
  • It suggests the need for financing a part of Working Capital requirements out of the permanent source of funds.

Need or Objects of Working Capital

Every business needs some amount of Working Capital which varies according to the character and size of the business. The time lag between manufacturing and the receipt of money from sales creates a demand for working capital. There are lags between the acquisition of raw materials and production, sales and cash realization, and production and sales. Consequently, working capital is required for the following things:

  • For purchase of raw materials and components.
  • To pay Wages and Salaries.
  • To incur day-to-day expenses and over-heads costs such as fuel, power, office expenses, etc.
  • To cover selling expenses like packaging, promotion, etc.
  • To provide credit facilities to customers.
  • To maintain the inventories of raw materials and finished goods etc.

The needs of working capital of a business vary according to new concerns and as one which has attained maturity. A new concern requires a lot of liquid funds to meet initial expenses like promotion etc. These expenses are called Preliminary Expenses. The quantity of operating capital required by a new business is mostly influenced by its size and the objectives of its founders. The greater the size of the business, the more prominent will be the requirement of working capital. The quantum of working capital increases with the expansion of the business unit till its attends maturity. At maturity, the amount of working capital needed is known as normal working capital.

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