Working Capital

Working capital is the money available to fund a company’s day-to-day operations. In financial speak, working capital is the difference between current assets and current liabilities. Current assets is the money you have in the bank as well as any assets you can quickly convert to cash if you needed it. Current liabilities are debts that you will repay within the year. So, working capital is what’s left over when you subtract your current liabilities from what you have in the bank.

In broader terms, working capital is also a gauge of a company’s financial health. The larger the difference between what you own and what you owe short-term, the healthier the business.

Positive v/s Negative Working Capital

Having positive working capital can be a good sign of the short-term financial health of a company because it has enough liquid assets remaining to pay off short-term bills and to internally finance the growth of its business. With a working capital deficit, a company may have to borrow additional funds from a bank or turn to investment bankers to raise more money.

Negative working capital means assets aren’t being used effectively and a company may face a liquidity crisis. Even if a company has a lot invested in fixed assets, it will face financial and operating challenges if liabilities are due. This may lead to more borrowing, late payments to creditors and suppliers, and, as a result, a lower corporate credit rating for the company.

When Negative Working Capital Is Ok

Depending on the type of business, companies can have negative working capital and still do well. Examples are grocery stores like Walmart or fast-food chains like McDonald’s that can generate cash very quickly due to high inventory turnover rates and by receiving payment from customers in a matter of a few days. These companies need little working capital being kept on hand, as they can generate more in short order.

Products that are bought from suppliers are immediately sold to customers before the company has to pay the vendor or supplier. In contrast, capital-intensive companies that manufacture heavy equipment and machinery usually can’t raise cash quickly, as they sell their products on a long-term payment basis. If they can’t sell fast enough, cash won’t be available immediately during tough financial times, so having adequate working capital is essential.

Sources Of Working Capital

The sources, from where working capital can be derived, can be classified under three categories – short-term, long-term or spontaneous. Short-term capital comes from tax provisions or dividends, public deposits, cash credit, short-term loans, trade deposits, inter-corporate loans, commercial paper and also bill discounting. Under the category long term, working capital falls long term loans, retained profits, provisions for depreciation, share capital and debentures, etc. On the other hand, spontaneous working capital is mainly obtained from trade credit that includes bills payable and notes payable.

The Cycle Of Working Capital

The WCC or the Working Capital Cycle is defined as the span of time which is required for converting the current net liabilities and also needs to convert the different assets into some cash by any company. It acts as an indicator that can be used to determine organizational efficiency for effectively managing the liquidity position for the short-term and also the cycle, that is calculated using days. It is actually the time span that lies in between the revenue generation using cash by selling products and material buying for producing various products.

The shorter will be the working capital cycle, the faster the company would free up the cash that is blocked. If the working cycle is much longer, the capital would get stuck in between without getting the returns for this operational cycle. Such businesses are always striving to lower the working capital cycle for viewing towards enhancing this liquidity for the short-term.