accounting glossaory-6

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Working Capital: There are two types of working capital: gross working capital and net working capital. Gross working capital is the total of current assets. Net working capital is the difference between the total of current assets and the total of current liabilities.

Working Capital Cycle:

                                                It refers to the length of time between the firms paying cash for materials, etc.., entering into the production process/ stock and the inflow of cash from debtors (sales)

  

Capital Budgeting: Process of analyzing, appraising, deciding investment on long term projects is known as capital budgeting.

Methods of Capital Budgeting:

1.            Traditional Methods

                              Payback period method

                             Average rate of return (ARR)

2.            Discounted Cash Flow Methods or Sophisticated methods

                              Net present value (NPV)

                              Internal rate of return (IRR)

                              Profitability index

Pay back period: Required time to reach actual investment is known as payback period.

                    = Investment / Cash flow

ARR: It means the average annual yield on the project.

                = avg. income / avg. investment

                               Or

       = (Sum of income / no. of years) / (Total investment + Scrap value) / 2)

NPV: The best method for the evaluation of an investment proposal is the NPV or discounted cash flow technique. This method takes into account the time value of money.

              The sum of the present values of all the cash inflows less the sum of the present value of all the cash outflows associated with the proposal.

NPV = Sum of present value of future cash flows – Investment

IRR: It is that rate at which the sum total of cash inflows aftrer discounting equals to the discounted cash outflows. The internal rate of return of a project is the discount rate which makes net present value of the project equal to zero.

Profitability Index: One of the methods comparing such proposals is to workout what is known as the ‘Desirability Factor’ or ‘Profitability Index’.

In general terms a project is acceptable if its profitability index value is greater than 1.