Tip:
Highlight text to annotate it
X
The wide known formula defines the working capital as the difference between current
assets and current liabilities.
That is the definition from a creditor standpoint.
Here, we turn to the management approach in understanding of the working capital.
Company purchases materials,
put them into the process,
transfers finished goods to the warehouse
until those delivered to clients.
Finally, it collects money from clients
and put them back into procurement,
framing the cycle, which is known as operating cycle.
Now, what is happened with money within the operating cycle?
Company invests money at the procurement stage
and recovers those at the collections.
The period between the investment and the recovery points is called a cash conversion
cycle, and is measured usually in days.
Is that the only money company invests into the operating cycle?
Let us see.
Company finances the raw materials purchase.
After materials move to the processing area,
company purchases another portion of materials to keep wheals running.
Then, when the first portion of material is converted to finished goods and transferred
to the warehouse,
the second portion of materials moves to the processing,
and company purchases the third one.
When goods are delivered to clients,
inventory makes another move through the cycle,
and company purchase the fourth portion of the materials.
Finally, the collected money finance further procurement.
So, in our case, company finances four procurement cycles with its own money.
The total amount of all money invested into the operating cycle is the working capital
of the company.
That is the definition of the working capital from the management,
operations,
and equity investor standpoint.