Meaning of Working Capital Firstly, let’s understand the meaning of the working capital. Working capital is the factor which demonstrates the liquidity position of the business to carry out day to day operations. It majorly includes cash & bank balances and liquid assets. Managing working capitaRead more
Meaning of Working Capital
Firstly, let’s understand the meaning of the working capital. Working capital is the factor which demonstrates the liquidity position of the business to carry out day to day operations. It majorly includes cash & bank balances and liquid assets.
Managing working capital is a crucial process to maintain short term liquidity and so ultimately resulting into achieving long term objectives efficiently. Working capital can be calculated by deducting business’s current liabilities from current assets.
To achieve the ideal working capital requirement for any business, it is important to understand various types of working capital and various ways to manage it.
Coming to Permanent Working Capital, also called as Fixed Working Capital, it is the minimum working capital required or maintained by businesses. Such type of working capital is maintained to take care of regular financial obligations like creditors, inventory, salaries etc.
Irrespective of scale of operations carried out in business, Permanent Capital is maintained by businesses which can be in form of Net Working Capital.
There is no specific formula for calculating Fixed Working Capital, it completely depends upon the business’s assets and liabilities. So accordingly, it can be estimated through the balance sheet of the business.
For calculating Permanent Working Capital, you can follow below steps:
- Calculate Net Working Capital for each day for a whole month
- Find the smallest value among them
- That will be Permanent Working Capital for the month
- Follow the above steps for every month
- There you have the annual figure for Permanent Working Capital
The requirement of Permanent Working Capital changes as the business expands. It is crucial to make sure that the working capital level does not fall below the Permanent Working Capital requirement.
Types of Permanent Working Capital:
Permanent working capital is further divided into two types:
- Regular working capital – This refers to capital required to maintain healthy cashflow for purchases of raw materials, payment of wages etc.
- Reserve working capital – This refers to amount which is more than regular working capital to take care of unexpected business expenses due to contingent events.
Interest on drawings Drawings refer to the money withdrawn by owners/partners for personal use from the business. The drawings, in accounting terms, can be of any type. It can be cash withdrawn from business or furniture or car etc. Drawings are money or assets that are withdrawn from a company by iRead more
Interest on drawings
Drawings refer to the money withdrawn by owners/partners for personal use from the business. The drawings, in accounting terms, can be of any type. It can be cash withdrawn from business or furniture or car etc. Drawings are money or assets that are withdrawn from a company by its owners for personal use and must be recorded as a reduction of assets. It’s paid back to the business with some interest.
Interest on drawings is an income for the business and reduces the capital of the owner. Interest on drawings is the amount of interest paid by the partners, calculated concerning the period for which the money was withdrawn.
Formulae for Interest on drawings
There are three formulae used for calculating the interest on drawings. They are:
1. Simple Method: In this method, as the name suggests, the amount of interest on drawings is calculated simply for the time the amount has been utilized.
Interest on Drawings = Amount of drawings × Rate/100 × No. of Months/12Â
2. Product Method: This method is used when-
Interest on Drawings = Total of Products × Rate/100 × 1/12
Interest on Drawings= Total amount of drawings × Rate/ 100 × Average Period/12
Also, note-
Average Period = (No. of months left after first drawings+ No. of months left after last drawings)/2
Example:
Harish withdrew equal amounts at the beginning of every month for 9 months. Total drawings amounted to ₹6,000. Calculate the interest on drawings charged if the rate was 6% p.a.
Solution:
Average period = (No. of months left after first drawings+ No. of months left after last drawings)/2 = (9+1)/2 = 5 monthsÂ
Interest on Drawings = Total of drawings × Rate/100 × 5/12
Journal entry for interest on drawings:Â
Interest transferred to Profit & Loss A/c:
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