Capital
Capital
refers to the value of the things owned by a business.
Capital = Assets – liabilities
1. Fixed Capital
This
consists of the durable (long lasting) assets of a business which are used over
a long period of time and are tied up in permanent use, for example, land,
buildings, machinery, furniture, motor vehicle etc.
2. Working Capital
Working Capital is the amount of
capital, which is available to the day to day running of the business. It is
the excess of current assets over current liabilities.
Working Capital = Current Assets –
Current Liabilities
WC = CA – CL
Current Assets
Current assets are those assets,
which can be converted into cash within a short period of time, generally one
year period. E.g. stock of goods, debtors, cash at bank, cash in hand etc.
Current Liability
Current liabilities are those
liabilities of the business which has to be paid within a short period of time,
generally one year. E.g. Creditors, Bank O/D, short term loans etc.
Working capital is also known as
circulating capital or Revolving Capital. For example, cash is used to buy raw
material, which is transferred into finished goods. Then the finished goods are
sold in the market and realize the cash. This process goes on in business.
Advantages of
working capital
Sufficient working
capital enables a firm to:
- Make prompt payment to the creditors and be able to enjoy cash discounts.
- Take advantage of change in price of raw materials by making bulk purchase of seasonal goods.
- Obtain loans from banks and other financial institutions.
- Make prompt payment of expenses like wages, salaries, rent, interest etc.
- Ensure smooth working of the business.
Ways of increasing
the working capital.
- Investing more cash capital by the owner.
- Obtaining loans and advances from banks or other sorces of finance.
- By making profit on it’s trading.
- By selling some of its fixed assets for cash.
- By issuing new shares and debentures ( in the case of Public Limited Companies)
Reasons for
reduction in working capital
- The owner of the business withdraw cash for his personal use.
- Thew company declaring a dividend, which increases the current liability of the company.
- The company making loss on its trading.
- The purchase of fixed assets for cash.
Working Capital
Ratio (Current Ratio)
It is the ratio of
current assets to current liabilities. It can be calculated by dividing current
assets with current liabilities. This ratio is used to show the extent of the
business financial stability. 2:1 is the generally accepted working capital
ratio.
Working Capital
Ratio = Current Assets
Current
Liabilities
3. Turnover
Turnover is another name for net
sales. Net sales means sales minus sales returns. A business can make profit
only when there is turnover. High turnover results in high profit., but
increase in profits doesn’t have direct proportion to increase in turnover.
Turnover
= Sales – Sales Return
4. Profit
Business is carried on mainly to
make profit. This is done by purchasing goods at lower price and selling them at
high price after charging its condition. Generally profit is calculated by
deducting cost of goods sold and expenses from sales. But profits can be
correctly estimated only after considering the following points:
a. Turnover
Turnover is another name for net
sales. Net sales means sales minus sales returns. A business can make profit
only when there is turnover. High turnover results in high profit., but
increase in profits doesn’t have direct proportion to increase in turnover.
b. Cost of Goods Sold
Cost of Goods Sold includes the
total cost of goods purchased for sales and all direct expenses incurred on the
goods for making them ready for sale.
Cost of goods sold = OP stock + net
purchase + direct expenses = closing stock or Sales – Gross Profit.
c. Gross Profit.
Gross Profit is the difference
between turnover and cost of goods sold. Gross profit is not true profit,
because it is the profit before deducting any expenses incurred in selling the
goods such as rent of premises, wages, interest on capital etc. High gross
profit shows that there is enough profit to meet the expenses and leaves a
certain amount as net profit.
Gross
Profit = Net Sales – Cost of Goods Sold
d. Net Profit
Net Profit is the true profit
obtainable from trading. It is amount remaining after deducting all expenses
from the gross profit.
Net
Profit = Gross Profit + other incomes – expenses.
Percentage of Profit
- Margin
Margin is the gross profit as a
percentage of sales (turnover). Margin
is also known as Gross profit turnover or Gross profit margin.
Margin = Gross Profit X 100
Sales
- Mark- up
Mark – up is the gross profit as a
percentage of cost of goods sold.
Mark-up = Gross profit X 100
Cost of goods sold
- Net Profit Percentage or NP Turnover = Net profit X 100
Turnover
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