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Basic ideas on appraisal of working capital limits

Basic ideas on appraisal of working capital limits


[The working capital requirement of industrial and trading establishments means the sum of the funds invested by them in various current assets (like raw material (RM), work in process (WIP), finished goods (FG), and the outstanding receivables on goods sold.  The working capital facility is extended to a borrower  by the banks will depend upon on the nature of current assets less suitable margin to be provided by the borrower within the overall permissible bank finance.Let us understand the various terms used in working capital appraisal.]

What are the items classified as current Assets in the balance sheet?

Current assets reflected in the balance sheet are the assets of the company like Cash or Cash equivalent assets which can be converted into cash within one year from the date of balance sheet. Examples of current assets are raw material (RM), work in process (WIP), finished goods (FG), and receivables.

What are the items classified as current liabilities in the balance sheet?

The Current liabilities shown on the balance sheet signifies all -term liabilities or debts of the company which are payable by the company within the next twelve months of balance sheet date. The example of Current liabilities are accounts payable to sundry creditors, pay- roll liabilities, current portion of long- term loans payable within next twelve months,  Dividend payable etc.

What is the  meaning of working capital?

Working capital means the total amount of capital that a company has invested in operating cycle.

What is the difference between Gross Working Capital and Net Working Capital?

The net working capital is an accounting concept which represents the excess of current assets over current liabilities which sometimes simply referred as ‘working capital’.  The working capital can be divided into two categories viz. gross working capital and net working capital.

The gross working capital means the total current assets, whereas net working capital is defined as current asset minus current liabilities. The changes in the total amount of current assets change the amount of gross working capital. However, the changes in current assets do not automatically change the amount of working capital (NWC).  For example, when the identical amount of changes takes place both in current assets and current liabilities there won’t be any change in NWC. The changes in net working capital take place only when the amount of change in current assets and current liabilities are not identical.

What is the meaning of working capital gap?

A manufacturing unit needs to purchase raw material, labour and other overheads in the production process. The portion of current assets which are not financed by current liabilities is known as the working capital gap. The working capital gap would be financed either by own source or from borrowings.

What is the significance of working capital gap?

Working capital gap is to be filled in by the  contribution from long-term sources (Known as Net Working Capital) available with the entity and Working capital finance from the bank, wherever necessary. Therefore, it is important for the bank, to first appraise the gross working capital, net- working capital and working capital gap for assessment of working capital limits.

What does operating cycle mean?

Operating cycle means the length of time required to convert ‘Non-Cash current assets’, (like raw material (RM), work in process (WIP), finished goods (FG), and receivables) into cash.

What is the difference between gross working capital and net working capital?

The sum of all the current assets is called Gross Working Capital (GWC), whereas the excess of current assets over current liabilities (current assets minus current liabilities) is known as Net Working Capital (NWC).

Net working capital’ can also be defined as “Long term source of funds that is available for financing current asset” which means the surplus of the  long-term sources (LTS) minus long term uses(LTU) is net-working capital (NWC).

What is the meaning of Net-worth  (NW) of the company?

Net-worth can be defined as total assets minus total outside liabilities of the company.  Normally, share capital and retained profit represent the net-worth of the company.

 

 

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