PROJECT ON:

               PROBLEMS OF WORKING CAPITAL IN SMALL SCALE INDUSTRIES

Definition
Current assets minus current liabilities. Working capital measures how much in liquid assets
a company has available to build its business. The number can be positive or negative,
depending on how much debt the company is carrying. In general, companies that have a lot
of working capital will be more successful since they can expand and improve their
operations. Companies with negative working capital may lack the funds necessary for
growth. also called net current assets or current capital.

Working capital is a measurement of an entity’s current assets, after subtracting its liabilities.
Sometimes referred to as operating capital, it is a valuation of the amount of liquidity a
business or organization has for the running and building of the business. Generally speaking,
companies with higher amounts of working capital are better positioned for success. They
have the liquid assets needed to expand their business operations as desired.

Sometimes, a company will have a large amount of assets, but have very little with which to
build the business and improve processes. Even a profitable company may have this problem.
This can occur when a company has assets that are not easy to convert into cash.

Working capital can be expressed as a positive or negative number. When a company has
more debts than current assets, it has negative working capital. When current assets outweigh
debts, a company has positive working capital.

Changes in working capital will impact a business’ cash flow. When working capital
increases, the effect on cash flow is negative. This is often caused by the liquidation of
inventory or the drawing of money from accounts that are due to be paid by the business. On
the other hand, a decrease in working capital translates into less money to settle short-term
debts.

Working capital is among the many important things that contribute to the success of a
business. Without it, a business may cease to function properly or at all. Not only does a lack
of working capital render a company unable to build and grow, but it may also leave a
company with too little cash to pay its short-term obligations. Simply put, a company with a
very low amount of working capital may be at risk of running out of money.

When a company has too little working capital, it can face financial difficulties and may even
be forced toward bankruptcy. This is true of both very small companies and billion-dollar
organizations. A company with this problem may pay creditors late or even skip payments. It
may borrow money in an attempt to remain afloat. If late payments have affected the
company’s credit rating, it may have difficulty obtaining a loan at an affordable interest rate.

Working Capital = Current Assets − Current Liabilities

Calculation
Current assets and current liabilities include three accounts which are of special
importance. These accounts represent the areas of the business where managers have the most
direct impact:

 accounts receivable (current asset)

The current portion of debt (payable within 12 months) is critical, because it represents a
short-term claim to current assets and is often secured by long term assets. Common types of
short-term debt are bank loans and lines of credit.

An increase in working capital indicates that the business has either increased current assets
(that is has increased its receivables, or other current assets) or has decreased current
liabilities, for example has paid off some short-term creditors.

Implications on M&A: The common commercial definition of working capital for the
purpose of a working capital adjustment in an M&A transaction (i.e. for a working capital
adjustment mechanism in a sale and purchase agreement) is equal to:

Current Assets – Current Liabilities excluding deferred tax assets/liabilities, excess cash,
surplus assets and/or deposit balances.

Cash balance items often attract a one-for-one purchase price adjustment.

Working capital management

Decisions relating to working capital and short term financing are referred to as working
capital management. These involve managing the relationship between a firm's short-term
assets and its short-term liabilities. The goal of working capital management is to ensure that
the firm is able to continue its operations and that it has sufficient cash flow to satisfy both
maturing short-term debt and upcoming operational expenses.

REQUIREMENT OF WORKING CAPITAL

The working capital requirement is the minimum amount of resources that a company
requires to effectively cover the usual costs and expenses necessary to operate the business.
Since the capital needs of each company will be a little different, there is no ideal working
capital requirement that is universally applicable to all businesses, or even to companies
engaged in the same industry. However, new companies can develop an idea of what type of
working capital requirement they will need to operate at given levels by researching the cost
and expenses associated with other corporations engaged in similar operations.
The basic formula for determining working capital involves only two factors. First, it is
necessary to define the current liquid assets in the possession of the company. This may be
somewhat different from general assets, since the focus is on those resources that can be
converted into cash quickly and easily. Liquid assets may be such resources as the
outstanding current Accounts Receivable balance, property that is not directly used in the
operation of the business, and balances in various operating accounts.

Along with defining the liquid assets of the company, determining the working capital
requirement will also allow for the current liabilities of the corporation. This will include
both short-term liabilities, such as the usual and general monthly operating expenses, as well
as any long-term debt. By deducting the liabilities from the liquid assets, it is possible to
determine the current working capital requirement.

The general idea is to ensure there is enough revenue generated to cover the essential
operations of the corporation and allow for additional revenue to be generated in the future.
Companies may currently operate with a negative working capital requirement, based on
some long-term debt, but this is not necessarily a sign that the company is in financial
trouble. However, calculating the current working capital requirement at least once a quarter
will allow the company to spot trends that may indicate problems. For example, if the
working capital requirement reveals a higher negative ratio from previous periods even
though long-term debt was reduced, this may indicate an issue with decreased sales and
earnings or other factors that are causing a lessening of needed capital.

WHAT IS SMALL SCALE INDUSTRY ?

Small scale industries are differentiated from the former by the technique of production. They
use modern power driven machines and employ labours as well. The raw materials are also
obtained from outside, if not available locally. These industries are larger in size than cottage
industries. Their products are sold through traders beyond local markets. In many developing
countries, the role of these industries are crucial as they provide employment to a large
number of people. In countries like India and China, a large number of goods such as clothes,
toys, furniture, edible oil and leather goods are produced by small scale industries .

Small Scale Industries may sound small but actually plays a very important part in the
overall growth of an economy. Small Scale Industries can be characterized by the unique
feature of labor intensiveness. The total number of people employed in this industry has been
calculated to be near about one crore and ninety lakhs in India, the main proponents of Small
scale industries.

The importance of this industry increases manifold due to the immense employment
generating potential. The countries which are characterized by acute unemployment problem
especially put emphasis on the model of Small Scale Industries. It has been observed that
India along with the countries in the Indian continent have gone long strides in this field.

Advantages associated with Small Scale Industries

 This industry is especially specialized in the production of consumer commodities

 Small scale industries can be characterized with the special feature of adopting the
labor intensive approach for commodity production. As these industries lack capital,
so they utilize the labor power for the production of goods. The main advantage of
such a process lies in the absorption of the surplus amount of labor in the economy
who were not being absorbed by the large and capital intensive industries. This, in
turn, helps the system in scaling down the extent of unemployment as well as poverty.
 It has been empirically proved all over the world that Small Scale Industries are
adept in distributing national income in more efficient and equitable manner among
the various participants in the process of good production than their medium or larger
counterparts.
 Small Scale Industries help the economy in promoting balanced development of
industries across all the regions of the economy.
 This industry helps the various sections of the society to hone their skills required for
entrepreneurship.
 Small Scale Industries act as an essential medium for the efficient utilization of the
skills as well as resources available locally.

Small Scale Industries enjoy a lot of help and encouragement from the government through
protecting these industries from the direct competition of the large scale ones, provision of
subsidies in the form of capital, lenient tax structure for this industry and many more.