3. Working capital consists of that portion of the net assets which is not tied up in any fixed or permanent form. The chief forms of working capital are: 1. Cash 2. Accounts and bills receivable 3. Finished stock 4. Raw stock and supplies 5. Securities of other companies held for invest ment, not for purposes of control.
Working capital consists essentially of quick assets, such as are convertible into cash within a reasonable time in the ordinary course of business. Such quick assets, like fixed assets, are sub j ect to great shrinkage in value in event of failure, and should always exceed by safe margin the short-time liabilities. The work ing capital is only the difference between the quick assets and the short-time liabilities. Some companies operate on a very narrow margin of working capital; a few, in fact, possess none at all. But many of the larger producing corporations retain as much as hnlf their entire capital in this form.
The volume of working capital depends upon the nature of the business, and it should be determined by taking into consideration: 1. Volume of the business 2. Distribution of purchases and of production and selling expense thruout the year 3. The credit terms upon which purchases are made 4. The credit terms upon which sales are made 5. The length of the period of production during which capital is tied up in work in process.
Most of these factors speak for themselves. A large business obviously requires more working cap ital than a small one. The regularity of purchases is an important factor. In the grape juice business, for instance, the entire stock of grape juice for the year must be purchased in September and October. The bridge-builder may at one time have no stock on hand and at another have large sums tied up in materials, pending the completion of a large contract. It is plain, therefore, that lines of business which purchase seasonally or irregularly, or sell likewise, require a large working capital because of the heavy stocks which they carry at times.
The credit terms, of both purchase and sale, have great influence upon working capital. If the com pany pays for its materials, say, thirty days net, and sells upon sixty days' time, it will require a much larger working capital than a company which buys on sixty days' time and sells on thirty. The writer
knows of several companies which have no working capital of their own, but deal entirely upon the trade credit which is extended to them, by buying on long terms and selling on short.
During the period of production, or pending resale of goods, capital is tied up by work in process. Some companies turn their capital several times each year and require only a small percentage of profit on each transaction, while others—for instance, builders of ships and office buildings—turn it less frequently, and consequently require a larger percentage of profit on each sale and a correspondingly larger working capital.
In this connection, the extreme importance of per petual inventory, careful stockkeeping, avoidance of wasteful methods and the maintenance of minimum stocks need to be emphasized. It is better for the company to carry a somewhat smaller stock and a larger cash balance, under normal conditions, than to carry heavy stocks. The large bank balance improves the credit of the company, while the large stock often increases manufacturing cost and frequently en courages wasteful and careless methods. The larger the stock, other things being equal, the slower will be the turnover and the greater the working capital re quired.
4. Cash requirement—What part of the working capital. should be in cash? The answer differs with different lines of business, and with different corn panies in the same line. But certain well defined principles are observable.
Cash lying in bank is non-productive. That is why the banks are anxious to loan it out at interest. On the other hand, it is important both to the customer and to the bank that a certain reserve of cash be on hand at all times, since neither is able to match recepits against expenditures exactly. An excessive bank balance shows poor management, but a lean one is likely to be regarded as a sign of financial weak ness. As in most other things, moderation is the best policy.