Working Capital

Working Capital’ is the term used basically to indicate the financial condition of a firm or an organization in the short term. In other words, it can be called a scale to measure the overall efficiency of the business entity.

To obtain the working capital of a specific firm or organisations one is required to subtract the current liabilities from the total current assets of the entity. This ratio suggests whether the particular organization has sufficient assets with it to take care of its short-term debt. To put it the other way, working capital is an indicator of the liquidity levels of an organization for taking care of day-to-day expenditure and cash, accounts payable, inventory, accounts receivable and also due short-term debt.

Types of working capital

• Variable Working Capital- The ever-changing working capital or variable is generally that the amount which is invested for a very short term period. This may also be defined as the extra working capital used to account for the various changes in sales activities and production. The changing working capital is known as the working capital of temporary nature.

• Permanent Working Capital- Permanent Working Capital is called the fixed working capital. It comprises the current assets in minimum which is required for keeping the business operations working. This needs to be noted that fixed working capital size always depends on the growth and production scale. Mostly, these long-term sources are used for availing a working capital of fixed type.

• Regular Working Capital- Regular Working Capital is a particular type of working capital that can be defined as the lowest working capital which needs to be checked by a company.

• Gross Working Capital- Gross Working Capital is the fund that is invested by a company’s current assets which serve as an indicator for Gross Working Capital. Below mentioned are the parts of the gross working capital- Cash, inventory, accounts receivables, marketable securities, short span investments

• Net Working Capital- This is an important working capital. The networking capital shows the amount under which the company’s current assets would surpass the then-current liabilities. This is the difference between the current liabilities and a business’s total assets.

Formula

The working capital formula tells us the short-term liquid assets available after short-term liabilities have been paid off.

Working Capital = Current Assets – Current Liabilities

Example–

A company can increase its working capital by selling more of its products. If the price per unit of the product is Rs 10,000 and the cost per unit in inventory is Rs 6,000, then the company’s working capital will increase by Rs 4,000 for every unit sold, because either cash or accounts receivable will increase.

Comparing the working capital of a company against its competitors in the same industry can indicate its competitive position. If Company X has working capital of Rs 50,000, while Companies Y and Z have Rs 20,000 and Rs 15,000, respectively, then Company X can spend more money to grow its business faster than its two competitors.

Benefit of working capital

Working capital is an essential component of the business that doesn’t depend on the size and scale of operation.

• It allows a smooth production flow

• Helps in boosting the liquidity

• Also ensures proper use of the fixed assets

• It aids a project in getting a positive image of the firm

• Also enables the firms for availing benefits for the cash discounts

• Aids in availing financial assistance such as loans easily

• It also allows meeting the contingencies very effectively

Things to know about working capital

• Accounts Receivable- The trade receivables or accounts receivables are the unpaid bills which a company starts while selling and/or delivering the goods on some credit.

• Accounts Payable- The trade payables or accounts payable are an important part of the current liabilities. Additionally, the accounts payable notify this amount which a firm needs to pay against the credit purchases that have been made. Experts also recommend that businesses adopt some well-rounded management strategies to ensure timely payments for a smooth cash flow.

• Inventory- Inventory is a very important component of the company’s current assets, which is a result of the essential for the proper management of the working capital. Generally, the semi-finished raw materials, and also finished goods create the stock or inventory.