Working Capita

WORKING CAPITAL AND THE COST OF CAPITAL

The working capital cycle is an accounting period where money that is used in the business for its day to day activities, is needed to continue activities in the next period. Working capital is “concerned with balance between current assets and current liabilities.” (Open University, 2005:31) In general, there must be an excess of current assets over current liabilities so that a firm can still have enough current assets to continue business activities in the next period, after all creditors have been paid.

4. 1 PRIMARY COMPONENTS OF WORKING CAPITAL (642 words)

Open University (2007: 48) describes the 4 primary components of working capital as follows:

• Cash – “includes that held in notes and coins, and in bank balances.”

• Inventory –”the cost of items produced or purchased and available for immediate future use and sales.”

• Accounts receivable – “value of debts owed to an organisation and due for payment within 12 months.”

• Accounts Payable – “value of debts owed by an organisation and due for payment within 12 months.”

Figure 1 below illustrates the working capital cycle with the 4 primary components and how inflows and outflows of cash are influenced by sales, overheads and other expenses.

It is important to keep cash flowing as illustrated in figure 1 above so that it could be used repeatedly to generate profits. That could be achieved through a shorter operating cycle.

Figure 1: The working capital cycle

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The descriptions of the 4 components are as follows:

Cash

This component is the lifeline of any business. Without it and without proper control thereof a business cannot survive. If the cash position of a business weakens, then so does that business’ ability to fund its operations. That business would not be able to meet its capital requirements and fund its day-to-day activities....