Working Capital: Meaning, Types and Financing Sources Management YouTube Lecture Handouts

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Working Capital: Meaning, Types and Financing Sources Management

Meaning

  • The excess of current assets over the current liabilities or simply the difference between current assets and current liabilities is called Net working capital.
  • It is always preferred that current assets are more than current liabilities because and inadequate working capital will lead to inability to pay to the creditors or even buy future stock.

Types of Working Capital

It is divided into two parts i.e.. , Permanent Working Capital and Temporary working Capital.

Permanent Working Capital

It is basically the amount of minimum current assets which are required all the time to ensure a minimum level of uninterrupted business operations

Temporary W. C

It is the additional working capital required from time to time over and above the permanent working capital

Operating Cycle

It refers to the number of days a company takes in converting inventories into cash.

Its formula is:

Operating cycle = Inventory holding period + Receivable collection Period

Or,

Operating Cycle = Raw material holding period + work in Progress period + finished goods period + receivables collection period.

Net Operating Cycle

In this we subtract the period in which we as producers pay back to our creditors from the Operating cycle formula.

The formula is

Cash cycle/Net operating cycle = Inventory holding period + Receivable՚s collection period – Credit payment period

WC Financing Sources

  • Bank Overdraft: The facility is offered by the banks. Here the borrower is sanctioned an amount which can be utilized as per need and the borrower pays the interest only on the used part of amount.
  • Working capital loans: They are issued by banks and NBFC՚s to finance the day-to-day operations of an organization.
  • Trade Credit: When the creditor extends the credit period of the borrower. For example; if a supplier is ok to get a delayed payment.
  • Bank Guarantee: It is basically a guarantee given by the banks to pay the required amount in case the buyer fails to pay the amount.
  • Letter of Credit: When the banks issue a letter of credit, the seller sells the goods and gets the payment by the bank and later the buyer pays the payment to the bank
  • Discounting of bills: When a firm gives goods to debtors on credit, it generates a bill. This bill is shown to the bank and the firm an avail the money at a discount.
  • Factoring: Selling the debtors to the third party on agreed terms is known as the factoring process.

MCQs

When a bank issues letter of credit, which party makes the payment?

1. Buyer

2. Seller

3. Bank

4. None

Answer: 3

When the supplier extends the payment period of goods. It is called?

1. Bank Guarantee

2. Factoring

3. Trade credit

4. All of the above

Answer: 3

Manishika