Working capital is a important outcome location (KRA) for firms operating in manufacturing and trading sectors. Therefore, it is prudent to know how to calculate working capital for target firms for investment.
Hypothetical illustration
Let us assume the following figures (quantity in Rs crore) for Sharad Tejas Ltd (ST) for its newest monetary year: Current assets 600 Trade receivables 200 inventories 300 money and money equivalent 50 other existing assets 50 existing liabilities 400 trade payables 140 accrued expenditures 60 existing portion of lengthy-term debt one hundred quick-term bank loan 50 other existing liabilities 50 total assets 700 lengthy term debt 200 shareholders’ funds one hundred sales income 1,000.
Working capital refers to the requirement of funds for meeting the operating activities of an entity.
Conventional working capital
Working capital is defined as the excess of total existing assets more than the total existing liabilities of a firm. For ST, it is Rs 200 crore. As a percentage of total assets, WC for ST is 28.57% and it is 20% of sales.
This definition is not rational as it considers money and money equivalent in the working capital computation. Cash and money equivalents are currently in the liquid type with the firm and therefore it need to not be regarded in the computation of the requirement of funds. Further, WC is dealing with requirement of funds invested in unproductive assets. For instance, ST has blocked capital of Rs 500 crore in trade receivables and inventories which are however to be realized in money and the firm pays the expense of this Rs 500 crore till the time it is realised in money. However, money and money equivalents are productive assets as the firm invests it in avenues that are anticipated to earn the essential price of return. Therefore, we need to exclude money and money equivalent in the computation of WC.
Further, standard practice of contemplating the whole quantity of existing liabilities in the computation of WC is not suitable as it considers interest bearing existing liabilities such as quick term borrowings and existing portion of lengthy term debt (i.e., principal quantity of lengthy term borrowings which are due for payment in the next 12 months). These are currently incorporated in the computation of expense of capital. Therefore, to steer clear of double counting, we need to exclude interest bearing existing liabilities in computing WC.
Non-money working capital
It is the excess of non-money existing assets more than the non-interest-bearing existing liabilities. For ST, it is Rs 300 crore. As a per cent of total assets, non-money WC for ST is 42.86%, and it is 30% of sales.
One could compute the non-money WC of a firm for the previous 5 years to comprehend the trend and use it for predicting the WC for its future.
The writer is associate professor of Finance at XLRI – Xavier School of Management, Jamshedpur