Business Studies: Working Capital

• Refers to the capital of the business that is used for the day to day running of the business
• Put simply it is the cash available for day-to-day operations of an organization
• Strictly speaking though working capital is more than just cash
• It includes all the assets that can be quickly and conveniently turned into cash or cash equivalence
• Cash equivalent refers to items such as bank balance which can be used to settle debts
• Working capital can be found by subtracting Current Liabilities from Current Assets
• Working Capital = Current Assets-Current Liabilities
• Current Assets are those assets which a business does not expect to hold for more than a year and will be converted back into cash in the normal course of its operations
• Current Assets items often include:
  1. Inventories in the form of stock bought and held for resale, unfinished goods and stocks of raw materials
  2. Debtors
  3. Prepaid expenses
  4. Accrued Income for example rent owed to the business by other parties
  5. Bank Account balance when it’s positive and not an overdraft
  6. Cash in hand
• Meanwhile Current Liabilities are those liabilities which a business expects to settle within the course of a year as part of its normal operations
• Examples would include:
  1. Trade creditors from whom we bought goods
  2. Accrued expenses such as rent owed by the business
  3. Interest on debentures
• If a business’s current assets exceed it’s current liabilities i.e. it has positive working capital then the business is said to have surplus working capital
• Conversely if a business’s current assets exceeded by current liabilities the business is said to have a working capital deficit
• Since cash and it’s equivalent are the primary means of paying liabilities a business with a working capital deficit will find it difficult to meet its obligations when they fall due
• For this reason working capital is seen as a measure of the operational liquidity of a business
• Working capital is often called the lifeblood of a business
• It allows the business:
  1. To pay its creditors
  2. Negotiate discounts for prompt payments
  3. Order supplies such as stationary
  4. Pay for wages and salaries (remember bank is part of working capital)
  5. Pay Interest on debentures (failure to pay interest can lead to liquidation)
  6. Pay taxes to the authorities including Tax to the authorities
  7. To acquire new assets
  8. To purchase raw materials
• The sum of it all is if a business fails to manage it’s working capital carefully it will go out of business even if it is making a profit
• Pay dividends to shareholders
• Popular methods of managing working capital include:
  1. Delaying paying creditors
  2. Shortening debtors’ payment period e.g. through offering cash discounts
  3. Employing just in time stock management techniques
  4. Accepting credit cards as a form of payment
  5. Selling fixed assets
  6. Sale and lease back
  7. Rights issue and new capital infusion
  8. Replacing short term debts such as bank overdraft with long term long term debts
  9. Debt factoring
• Just as a human would not survive without/ with too little blood a business would not survive if it has insufficient working capital

To access more topics go to the O Level Business Notes