Let us first understand what working capital is. Working capital means the funds available for the day-to-day operations of an enterprise. It is a measure of a company’s liquidity and short term financial health. They are cash or mere cash resources of a business concern. It also represents the exceRead more
Let us first understand what working capital is.
Working capital means the funds available for the day-to-day operations of an enterprise. It is a measure of a company’s liquidity and short term financial health. They are cash or mere cash resources of a business concern.
It also represents the excess of current assets, such as cash, accounts receivable and inventories, over current liabilities, such as accounts payable and bank overdraft.
Sources of Working Capital
Any transaction that increases the amount of working capital for a company is a source of working capital.
Suppose, Amazon sells its goods for $1,000 when the cost is only $700. Then, the difference of $300 is the source of working capital as the increase in cash is greater than the decrease in inventory.
Sources of working capital can be classified as follows:
Short Term Sources
- Trade credit: Credit given by one business firm to the other arising from credit sales. It is a spontaneous source of finance representing credit extended by the supplier of goods and services.
- Bills/Note payable: The purchaser gives a written promise to pay the amount of bill or invoice either on-demand or at a fixed future date to the seller or the bearer of the note.
- Accrued expenses: It refers to the services availed by the firm, but the payment for which is yet to be done. It represents an interest-free source of finance.
- Tax/Dividend provisions: It is a provision made out of current profits to meet the tax/dividend obligation. The time gap between provision made and payment of actual payment serves as a source of short-term finance during the intermediate period.
- Cash Credit/Overdraft: Under this arrangement, the bank specifies a pre-determined limit for borrowings. The borrower can withdraw as required up to the specified limits.
- Public deposit: These are unsecured deposits invited by the company from the public for a period of six months to 3 years.
- Bills discounting: It refers to an activity wherein a discounted amount is released by the bank to the seller on purchase of the bill drawn by the borrower on their customers.
- Short term loans: These loans are granted for a period of less than a year to fulfil a short term liquidity crunch.
- Inter-corporate loans/deposits: Organizations having surplus funds invest with other organizations for up to six months at rates higher than that of banks.
- Commercial paper: These are short term unsecured promissory notes sold at discount and redeemed at face value. These are issued for periods ranging from 7 to 360 days.
- Debt factoring: It is an arrangement between the firm (the client) and a financial institution (the factor) whereby the factor collects dues of his client for a certain fee. In other words, the factor purchases its client’s trade debts at a discount.
Long Term Sources
- Retained profits: These are profits earned by a business in a financial year and set aside for further usage and investments.
- Share Capital: It is the money invested by the shareholders in the company via purchase of shares floated by the company in the market.
- Long term loans: These loans are disbursed for a period greater than 1 year to the borrower in his account in cash. Interest is charged on the full amount irrespective of the amount in use. These shareholders receive annual dividends against the money invested.
- Debentures: These are issued by companies to obtain funds from the public in form of debt. They are not backed by any collateral but carry a fixed rate of interest to be paid by the company to the debenture holders.
Another point I would like to add is that, although depreciation is recorded in expense and fixed assets accounts and does not affect working capital, it still needs to be accounted for when calculating working capital.
See less
Trading A/c is a nominal account which follows the rule "Debit all expenses and losses, Credit all incomes and gains". So, all expenses relating to the purchase or manufacturing of goods are shown on the debit side of the Trading A/c. It includes Opening Stock, Purchases, Wages, Carriage Inward, ManRead more
Trading A/c is a nominal account which follows the rule “Debit all expenses and losses, Credit all incomes and gains”.
So, all expenses relating to the purchase or manufacturing of goods are shown on the debit side of the Trading A/c. It includes Opening Stock, Purchases, Wages, Carriage Inward, Manufacturing Expenses, Dock charges, and other direct expenses that are directly related to the manufacturing or purchase.
TRADING ACCOUNT
Trading A/c is prepared for calculating the Gross Profit or Gross Loss arising from the trading activities of a business.
Trading activities are mostly related to buying and selling of goods. However, in between buying and selling, a lot of activities are involved like transportation, warehousing, etc. So, all the expenses that are directly related to manufacturing or purchase of goods are also recorded in the Trading A/c.
DEBIT SIDE OF TRADING A/C
The items shown on the Dr. side are,
OPENING STOCK – Stock is nothing but goods that are either obtained for resale or manufactured for sale and are yet unsold on any particular date.
The value of stock at the beginning of an accounting year is called Opening stock while the value of the stock at the end of an accounting year is called closing stock.
The closing stock of the last year becomes the opening stock of the current year.
Opening stock includes,
For example – Suppose you are in the business of manufacturing and trading shirts. On 31st March 2023, there was unused raw material worth $10,000 and shirts worth $50,000 remained unsold.
So, we have Closing Stock of Raw material – $10,000
Closing Stock of Finished Goods – $50,000
This closing stock of last year becomes your opening stock during the current year i.e. on 1st April 2023, we have
Opening Stock of raw material – $10,000
Opening Stock of Finished Goods – $50,000
PURCHASES – Goods that have been bought for resale or raw materials purchased for manufacturing the product are terms as Purchases. These goods must be related to the business you are doing.
It includes cash as well as credit Purchases.
Continuing with the above example, suppose you bought raw material worth $ 1,00,000 for manufacturing and shirts worth $50,000 for resale (and not for personal consumption) then both these will be termed as purchases for you. So, your purchases will be $1,50,000 ($1,00,000 + $50,000)
PURCHASES RETURN – When goods bought are returned to the suppliers due to any reason. This is known as Purchase return. Purchase return is deducted from the Purchases.
In the above example, you bought shirts worth $50,000 for resale. Out of which shirts worth $20,000 were defective. So, you returned them to the supplier. This return of $20,000 is your purchase return or return outwards (as goods are going out)
WAGES – Wages are paid to the workers who are directly engaged in the loading, unloading and production of goods.
For example – Paid $10,000 to workers for manufacturing shirts.
However, it would be included in Trading A/c only if the wages are paid for work which is directly related to the manufacturing or purchase of goods otherwise it will be shown in P&L A/c.
Suppose you hired a manager to take care of your business and paid him $20,000 as salary. This salary is indeed an expense for the business but is not directly related to the manufacturing of goods. Since it is an indirect expense, it can only be recorded in P&L A/c and not in the Trading A/c.
CARRIAGE or CARRIAGE INWARDS or FREIGHT – It refers to the cost of transporting goods from the supplier.
Suppose, you ordered raw material in bulk which was transported to you by a van and you paid its fare. This fare is nothing but your carriage inwards.
However, if carriage or freight is paid on bringing an asset, the amount should be added to the asset account and must not be debited to the trading account.
MANUFACTURING EXPENSES – All expenses incurred in the manufacture of goods such as Coal, Gas, Fuel, Water, Power, Factory rent, Factory lighting etc.
DOCK CHARGES – These are charged by port authorities when unloading goods at a dock or wharf. Such charges paid in connection with goods purchased are considered direct expenses and are debited to Trading a/c.
IMPORT DUTY or CUSTOM DUTY – It is a tax collected on imports and specific exports by a country’s customs authorities. If import duty is paid on the import of goods, then they are shown on the Dr. side of the Trading A/c.
For example – Paid $15,000 as import duty for importing shirts for resale.
ROYALTY – Royalty refers to the amount paid for the use of assets belonging to another person. It includes royalty for the use of intangible assets, such as copyrights, trademarks, or franchisee agreements. It is also paid for the use of natural resources, such as mining leases.
Royalty is charged to the Trading A/c as it increases the cost of production.
GROSS PROFIT – When sales exceed the amount of purchases and the expenses directly connected with such purchases i.e. when Credit side> Debit side.
CREDIT SIDE OF TRADING A/C
SALES – When goods are sold to earn a profit, it is called sales. It can be cash sales or credit sales.
SALES RETURN – When the goods sold are returned by the customer, it is known as a sales return. Sales return is deducted from the sales.
CLOSING STOCK – The goods remaining unsold at the end of the year are termed as closing stock. It is valued at cost price or market price whichever is less.
GROSS LOSS – If purchases and direct expenses exceed sales, then it is a Gross loss. In other words, when Debit side > Credit side.
See less