Cover Image
close this bookFinancial Management of a Small Handicraft Business (Oxfam, 1988, 43 p.)
View the documentAcknowledgements
View the documentIntroduction
close this folderI. Cost calculations in the handicraft industry
View the document(introduction...)
View the documentI. 1. Production costs
View the documentI.2. Overhead apportionment
View the documentI.3. Selling and distribution costs
View the documentI.4. Ways to reduce costs
close this folderII. Pricing
View the document(introduction...)
View the documentII. 1. Value in the market
View the documentII.2. Costs and pricing
View the documentII.3. Contribution analysis
close this folderIII. The concept of working capital
View the documentIII.1. Defining working capital
View the documentIII.2. The role of working capital
View the documentIII.3. Performance measurement
View the documentIII.4. Profits
close this folderIV. Financial planning and decision making
View the documentIV. 1. Management Accounting
View the documentIV.2. Planning for working capital requirements
View the documentIV.3. Releasing cash from other assets
View the documentIV.4. Working capital decisions
View the documentConclusion
View the documentA manual of credit & savings for the poor of developing countries

III.1. Defining working capital

The balance sheet of a business shows its overall financial position at a particular point in time. Specifically, it records three things:

Assets: what the business owns, and has value

Liabilities: what it owes to other parties

Capital: the value of the proprietor's stake.

(i) Assests and liabilities

A separation is made in the balance sheet between those assets and liabilities which are part of the permanent structure of the business, and those which rather represent its day to day operations.

Assets: Fixed assets, deemed to be retained in ownership for a long period—e.g. land, buildings, machinery, equipment, vehicles—are separated from other assets which are owned for short-term purposes, such as stock.

Liabilities: Long-term liabilities, i.e. those not needing to be paid for perhaps one year or more, and the capital of the business, are separated from short-term liabilities, i.e. those needing to be paid in, say, 3-6 months, but definitely less than one year.

Working capital is concerned only with short-term assets and liabilities, called current assets and current liabilities. By current assets is meant assets which can be converted into cash in the short-term future. Similarly, current liabilities are liabilities which must be paid in cash in the short-term future. Working capital can be defined as the net difference between the current assets and current liabilities.

The term working capital is sometimes used erroneously as a synonym for cash. It does mean cash, but it means more than that. From the above, it follows that it means the difference between cash on hand, plus assets which can be converted quickly into cash, and liabilities which must be settled quickly in cash.

(ii) Components of working capital

Consider the balance sheet of a handicrafts production unit (Figure 8). It can be seen that the components of working capital are as follows:

Assets:
Cash—on hand and in the bank
Debtors—(also called accounts receivable)—money owed to the business
Stock—of raw materials and partly and fully finished products
Liabilities:

Deferred wages—money due to people within the business Creditors—money owed to outside parties

Advance payments—money received in advance for products still to be supplied

Overdraft or loan—money borrowed from the bank, due for repayment in the short term.

Figure 8. Fibre Mat Society—Balance Sheet at 30 September 1986

Assets
Current assets

Cash



5.000


Debtors



45,000


Stock:

raw materials

4,000




work in progress

6,000




finished goods

30.000

40.000

90.000

Fixed assets (at cost less depreciation)





Vehicle


21,600



Tools & equipment


3,400

25,000





Total assets

115,000

Liabilities
Current liabilities

Wages


6,600


Creditors:

raw materials

13.200



indirect supplies

2,700

15.900

Advance payments received


12,500


Bank overdraft


35,000

70,000

Long-term liabilities




Loan from voluntary agency



15,000

Share capital and reserves



30,000




Total liabilities 115,000

Working capital takes account of all current assets and liabilities, not just the cash. It is not concerned with fixed assets or long-term liabilities because these are not held with a view to conversion into cash.