Working capital is an important metric for all business, regardless of their size. It is defined as the excess of current assets over current liabilities. It is also known as circulatory capital, fluctuating capital or revolving capital.
W.C. = Current Assets – Current Liabilities
Types of Working Capital:
Working Capital can be classified based on:
- Concept Factor – Based upon concept factor, there are two sub categories of working capital. They are,
- Gross Working Capital = Current Assets only
- Net Working Capital = Current Assets less Current Liabilities
- Time Factor – Based upon Time factor, there are also two sub categories. They are,
- Permanent Working Capital. = It is the minimum level of investment required in the business at all points of time. It is also called fixed or hard core working capital.
- Temporary Working Capital. = It represents working capital requirements over and above permanent working capital. and is dependent of factors like peak season, trade cycle, boom etc. It is also called fluctuating or variable working capital.
Importance of Working Capital:
Working capital is the life blood and nerve center of business. Working capital is very essential to maintain smooth running of a business. No business can run successfully without an adequate amount of working capital. The further importance of working capital are as follows:-
- Strengthen the solvency
Working capital helps to operate the business smoothly without any financial problem for making the payment of short term liabilities. Purchase of raw materials and payment of salary, wages and overhead can be made without any delay. Adequate working capital helps in maintaining solvency of the business by providing uninterrupted flow of production.
- Enhance Goodwill
Sufficient working capital enables a business concern to make prompt payments and hence helps in creating and maintaining goodwill. Goodwill is enhanced because all current liabilities and operating expenses are paid on time.
- Easy obtaining Loan
A firm having adequate working capital, high solvency and good credit rating can arrange loans from bank and financial institution in easy and favorable terms.
- Regular Supply of Raw Material
Quick payment of credit purchase of raw material ensures the regular supply of raw materials for suppliers. Suppliers are satisfied by the payment on time. It ensures regular supply of raw materials and continues induction.
- Smooth Business Operation
Working capital is really a life blood of any organization which maintains the firm in well condition. Any day to day financial requirement can be met without any shortage of fund.
- Ability to Face Crisis
Adequate working capital enables a firm to face business crisis in emergencies such as depression.
Uses of Working Capital
Working capital is used to cover all of a company’s short term expenses, including inventory, payments on short term debt and operating expenses. Basically working capital is used to keep a business operating smoothly and meet all its financial obligations within the coming year.
Besides this, working capital has main three 3 uses:-
- Unforeseen Circumstances – Sometimes things break, it doesn’t matter if it’s a vehicle, network server or a table saw. A working capital loan can help your business quickly recover from the loss and replace your broken equipment.
- Inventory– Another beneficial way you can use working capital is taking advantage of bulk pricing on inventory. Usually with these purchases, a large upfront payment is needed for the special pricing. And this is often not something you want to miss out on.
- Expenses – With short term business loan, you are able to pay for things you might otherwise find unaffordable or out of your budget. This can range from marketing, getting ready for a conference, hiring new employees, or even a new location.
Working capital is mainly for the minimization of cost to the firm whether managing cash, receivables or inventory or miscellaneous current assets. It facilitates in minimizing risk to the company on receivables and ensures just level of inventory to operate full level of capacity with minimum inventory.