Working Capital, Current Assets, Current Liabilities

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Therefore, in an equation form, working capital is: Working capital = current assets – current liabilities The quantity can be positive or negative, depending on the amount of debt the company is carrying. If a company has a lot of working capital, it will be more successful. Companies with negative working capital may be short of the funds necessary for growth. (C) Working capital is important to a business. It can maximize growth, can help minimize future financial shortcomings, and it’s an indicator of potential financial problems. However, various problems can be faced if there is not enough working capital in an organization.

Too little working capital is recognized as over-trading and is frequent when a business is starting up or going through a period of quick growth. This can result in cash flow problems beyond its agreed overdraft limit, flawing to pay suppliers on time and being incapable to claim discounts for punctual payment. A business with inadequate working capital will be incapable to meet its current obligations. Poor management of working capital will also result in unnecessary amounts tied up in current assets. Such a circumstance will lead to a business earning a lower than expected return. (D) There are different ways in which a sole trader can increase their working capital. One way to do so is by increasing the net profit.

This can be done by reducing expenses. This involves you to evaluate your expenses.

Increasing sales is an additional way to increase net profit therefore increasing working capital. This requires knowledge about the connection your sales have to your expenses. Eliminating certain services or products that are too expensive and unsuccessful can also create additional profit for your company. Owners adding capital to their business can also increase working capital. This can be done through providing a cash loan to your company or buying additional supply in exchange for cash. Another way to increase working capital is by selling unwanted assets. A business must know what assets are needed, wanted and unwanted for it to determine if it will generate additional capital. Increasing long-term debt can also increase working capital. A long term loan enables small and medium sized enterprises to breathe easily and pay for assets at a set pace.

Collecting payments from customers faster is a route to keeping more capital in a company. Entrepreneurs can also consider refinancing fixed assets such as equipment in order to increase working capital. This is done by controlling one’s assets and turning them into the cash that they need. Another option to increase working capital is to make personal investments. In order to do this, one needs to first do a cost/benefit analysis to see what return they will get on their investments. This is an important method if a sole trader see’s that the payoff in their business outweighs person losses. Question 2: (A) The difference between cash and accrual basis accounting has to do with the time structure in which revenues and expenses are recorded and reported. Accrual basis accounting matches revenues to the time phase in which they are earned and matches expenses to the time period in which they are incurred. This means that sales are recorded straight away, expenses are posted at once, and any other sort of operation goes to the books at the time the event takes place.

Also a receivable is recorded when payments is not received at the moment of sale. Payables are also recorded when payments is not made at the time of purchase. Cash basis accounting is a very simple and quick form of accounting. It records only cash spending and cash receipts. It is a method of bookkeeping that is centered on the inflow of cash received and the outflow of cash. Expenses in cash basis are recorded when they are paid, which may be before or after they are incurred. Unlike accrual basis, in cash basis, no receivables, payables or methods of tracking partial payments are recorded. Accrual basis accounting is more complicated than cash basis accounting; however, it provides much more information about one’s business.

Cash basis accounting will suffice if one’s business is a simple one. However, the accrual basis will give a more accurate picture of the results of business procedures. (B) Businesses have to make adjustments in their concluding accounts to give a more realistic portrayal of how the business is doing. One of these adjustments involves appropriately signifying the expenses and income of the business in the accounts using accruals and prepayments. Accruals are adjustments for revenues that have been earned but not yet recorded in the accounts and expenses that have been incurred but not yet recorded in the financial records. They are those items which have already been taken by company but the payments are not yet paid or services of which already provided but amounts are not yet received. Prepayments are the reverse of accruals as these are payments which have been made already but are not yet taken by the company. It is early repayments of a loan by a borrower. Accruals decrease the net profit of a firm as expenses are increased while prepayments show a greater net profit as expenses are reduced. An example of accruals is rent accrued for previous 6 months but has not yet been paid for. And an example of prepayments is prepaid rent for the next 6 months.

Another example of accruals is bills that straddle and accounting period end, such as utility bill or a phone bill. (C) The matching concept is a concept is to ensure that the expenditure incurred in earning must be matched to it, in calculating profit. For example, if a business bought 30 buckets but only sold 27, it would be wrong to charge the profit and loss account with the cost of all 30 buckets, as there are still 3 in stock. The historical cost concept requires transactions to be recorded at the original cost.

The changes in prices or values will be ignored. It states that all assets in the financial statement should be reported based on their original cost. An example of this is as followed: Fred buys an apartment for 4,000,000 eight years ago. The value of the building is now 5,000,000. But in Fred’s accounting records, the building is still recorded as 4,000,000. No account is taken of the increase in value. (D) Monetary concept: Accounting uses money to express certain facts of a firm and in a way that they can be a useful expression of the wealth of the firm. For example, it might be a fact that a firm owns $40,000 of cash: 8000 pounds of raw material, 10 trucks, 60,000 square feet of premises, and so on, these quantities cannot be added together to construct a significant total of what the firm owns. However, expressing these pieces in monetary terms makes it simpler: $30,000 of cash, 10,000 of raw material, $180,000 on trucks, and 5,000,000 on premises makes such an addition possible. Prudence Concept: Profits are not documented until a sale has been completed.

Also, a cautious view is taken for future problems and costs of the business. For example, if a loss is foreseen, it should be taken into account right away. If a business purchases stick for $1400 but then can only be sold for $1200, then the stick should be valued at $1200 in the accounts. (E) Objectivity: This means that accounting information is prepared and reported in an unbiased way. It is not biased towards a particular user or interest. For example, supply of goods lying unsold should be valued as its cost price not at a higher price at the end of the year even if is likely to be sold at a higher price in the future. Consistency Concept: The consistency concept simply means that you treat comparable items in a similar way and that the same treatment should be applied from one period to another. While changes of methods may be made, they should not be made frequently. For instance, if a firm is charging depreciation using the straight line method, then they must follow through with the straight line method. Read more:’historical_cost_accounting’

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Working capital, current assets, current liabilities. (2017, Jun 26). Retrieved July 12, 2024 , from

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