Definition of Working Capital

There is difference of opinion among different authors about the definition of working capital. Considering the objectives and scope of working capital, it can be defined in two ways:

(i) Gross Concept
(ii) Net Concept

(i) Gross Concept:- According to the gross concept, working capital means total of all the current assets of a business. It is also called gross working capital.

Gross Working Capital= Total Current Assets

(ii) Net Concept:- According to the net concept of working capital, net working capital means the excess of current assets over current liabilities. If current assets are equal to current liabilities then according to this concept working capital will be zero and in case current liabilities are more than current assets, the working capital will be called negative working capital.

Net Working Capital= Current Assets-Current Liabilities

Current assets are those assets which are converted into cash within one accounting period, for example, stock, debtors, bills receivables, prepaid expenses, cash and bank balance. Similarly, current liabilities are those liabilities which have to be paid within an accounting year, for example, creditors bills payables, short term loans etc.

Net working capital can also be defined in another manner. Net working capital is the part of current assets which has been financed from long term funds. It is, therefore also called circulating capital.

Gross concept and net concept of working capital have their own significance. When individual current assets are to be managed, gross concept of working capital is used. Net concept of working capital emphasizes on how much current assets have been financed out of long term funds. Under this concept the relationship between current assets and current liabilities is established or their liquidity is determined. The difference between gross working capital and net working capital can be understood with the help of following illustration.

ILLUSTRATION I.

From the following balance sheet, you are required to calculate the amount of Gross Working Capital and Net Working Capital:-

Balance Sheet

Rs

Rs

Share Capital

10,00,000

Land and Building

10,00,000

Reserves

1,00,000

Plant and Machinery

2,90,000

Debentures

4,00,000

Cash and Bank Balance

10,000

Short-term Loan

50,000

Marketable Securities

90,000

Trade Creditors

40,000

Trade Debtors

1,00,000

Bills Payable

10,000

Bills Receivable

40,000

Inventory

70,000

16,00,000

16,00,000

Solution :

Gross Working capital= Cash and Bank Balance+ Marketable Securities+ Trade Debtors+ Bills Receivable+ Inventory

= Rs. 10,000+Rs90,000+Rs1,00,000+Rs40,000+Rs70,000
= Rs. 3,10,000

Net Working Capital= Current Assets- Current Liabilities

= Rs10,000 + Rs 90,000 + 1,00,000 + Rs 40,000 + Rs70,000- Rs50,000 – Rs 40,000 – Rs 10,000
= Rs 3,10,000- rs 1,00,000 = Rs 2,10,000