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Business Process Management System

Importance of working capital and factors determing IT

The term working capital may be defined as the money invested in current assets such as cash in hand, cash at bank, accounts receivable, debtors etc Two concepts of working capital are as follows-

1. Gross working capital-it refers to the funds invested in total current assets.

2. Net working capital-it means the excess of current assets over current liabilities. It is that portion of current assets which is financed by long-term funds.

On the basis of time, working capital may be divided as follows-

1. Permanent or regular working capital-it represents the minimum amount of investment in current assets required at all times to carry on business process management system activities; it is permanently required for the business it should thus ,be financed out of long-term funds.

2. Temporary or variable working capital-such capital fluctuates from time to time. In other words, it represents additional current assets required at particular periods during operating year. For example extra inventory has to be maintained to support sales during the peak period. On the other hand, investment in inventory and receivables will decrease during the off-season.

Operating cycle of working capital:

Working capital is required to sustain the sales activity during the period of time gap between the sale of goods and receipt of cash. The time gap between sales and realization of cash is called operating cycle of business process management system . In a manufacturing enterprise, the operating cycle is the length of time required to complete following activities-

1. Conversion of cash into raw materials.

2. Conversion of raw materials into work in process.

3. Conversion of work-in-process into finished goods.

4. Conversion of finished goods into accounts receivable.

5. Conversion of accounts receivable into cash.

Changes in working capital can take place due to following reasons-

1. Changes in the level of sales.

2. Changes in operating expenses.

3. Changes in technology.

4. Changes in the policy.

Working capital is financed generally by the following sources-

1. Cash sales.

2. Credit sales (collection from debtors).

3. Bank credit.

4. Short term loans and current provisions.

5. Long term sources.

Factors determining working capital

1. Nature business-in case of cash nature of business process management system , inventories and book debts are lesser, thus small working capital is required. Public utilities and service organizations need less working capital as sales are on cash basis. There is little time gap between production and sales and these enterprises do not maintain large stock of goods. On the other hand, in trading and manufacturing concerns large amount of capital is needed to maintain large stocks and book debts.

2. Size of the enterprize-volume of business has a direct influence on working capital needs. Large firms need greater working capital for investment in current assets and to pay current liabilities.

3. Length of operating cycle-complex and roundabout process of production requires a long time to prepare the finished product. Greater the time and cost involved in production, higher is the investment in inventories and wage bills. For instance, a firm manufacturing an aircraft requires a larger amount of working capital than a firm producing confectionaries. Where cost of raw materials is a major part of the total cost, working capital requirements are high.

4. Terms of purchase and sale-less investment in working capital will be required in a firm that buys raw material and other services on credit and selling and sells goods on cash basis. While greater working capital will be needed when purchase of raw materials is on a cash basis but selling the finished product is done on credit basis. The period of credit and efficiency in collection of debts also influence the amount of working capital of a firm.

5. Turnover of working capital-turnover means the speed with which the working capital circulates in business. The rate of turnover of working capital is measured by the ratio of sales to current assets. Faster the flow of working capital, lesser is the need for working capital.

6. Dividend policy-a firm following the policy of paying cash and excellent dividends, more working capital is needed. Lesser working capital is needed if sufficient amount of profit is retained in the business.

7. Cyclical and seasonal fluctuations-business cycles and seasonal demand create a need for more working capital. During depression, investment in stock and debtors may be high, business activities slow down, demand for goods decline, low level of inventory is required; while in boom demand for goods increases resulting in the increase of price, sales tend to be quick and stocks are smaller. More working capital is needed to meet the demand and for the modernization of plant.Similarly, a woolen mill may require more working capital during summer to keep stocks of raw materials and finished goods

8. Management attitude towards risk-if management has a risk-bearing attitude it may operate with small amount of working capital. It may maintain regular connections with banks to borrow at short notice.

9. Price level changes-in case of price rise, the cost of raw material and labor cost increases, so more working capital will be required. If the firm is able to increase the price of its commodities, the working capital requirement may not be so severe. Price level changes have different business process management system impact on the working capital of different firms.

10. Market competition-when the market is more competitive, larger working capital is required because the enterprise will be required to follow liberal credit policy, resulting in increased debtors and blocking of working capital. It will require larger inventory and further result in the increase of working capital.

Importance of working capital

* It is essential for the smooth and efficient functioning of a business. No single error in financial planning can cause greater harm than the failure to provide for sufficient working capital.

* An enterprise needs it to pay off its creditors in time. This helps to improve the credit-worthiness of the enterprise.

* It can meet its day-to-day expenses to ensure uninterrupted functioning. It can take care of contingencies and take advantage of business opportunities.

* A satisfactory level of working capital has to be maintained. Excess and shortage both are harmful. Its excess means the firm has idle funds which earn no profits. Inadequate one will result in interruptions in operations and reduced profits. Moreover, there should be a proper balance between different components of working capital.

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