Working Capital

Introduction

​Working Capital is a part of the capital that is needed for meeting the day-to-day requirements of the business concern. For example, payment to creditors, salary paid to workers, purchase of raw materials, etc., normally these expenses are recurring in nature. W.C. can be easily converted into cash. Hence, it is also known as short-term capital.​

Working capital, also known as net working capital (NWC), is the difference between a company’s current assets—such as cash, accounts receivable/customers’ unpaid bills, and inventories of raw materials and finished goods—and its current liabilities, such as accounts payable and debts.​

TYPES OF WORKING CAPITAL​

  1. Gross Working Capital: is the general concept which determines the working capital concept. Thus, the gross working capital is the capital invested in total current assets of the business concern. Gross Working Capital is simply called as the total current assets of the concern. GWC = CA
  2. Net Working Capital: is the specific concept, which, considers both current assets and current liability of the concern. Net Working Capital is the excess of current assets over the current liability of the concern during a particular period. If the current assets exceed the current liabilities it is said to be positive working capital; it is reverse, it is said to be Negative working capital. NWC = C A – CL

COMPONENTS OF WORKING CAPITAL​

  1. Current Assets: Current assets are all of a company’s assets that are likely to be sold or converted into cash within a year or within the operational cycle, whichever comes first. On the balance sheet, they are typically listed in order of liquidity and include cash and cash equivalents, accounts receivable, inventory, prepaid, and other short-term assets.​
  2. Current Liabilities: Current liabilities are a company’s short-term financial commitments that must be paid within a year or within a regular operational cycle. An operational cycle, also known as the cash conversion cycle, is the amount of time it takes for a corporation to acquire inventory and convert it to cash from sales. ​

NEEDS OF WORKING CAPITAL​

  • Purchase of raw materials and spares: The basic part of the manufacturing process is, raw materials. It should be purchased frequently according to the needs of the business concern.​
  • Payment of wages and salary: The next part of Working Capital is the payment of wages and salaries to labor and employees.​
  • Day-to-day expenses: A business concern has to meet various expenditures regarding the operations on a daily basis like fuel, power, office expenses, etc.​
  • Provide credit obligations: A business concern is responsible for providing credit facilities to the customer and meeting the short-term obligation​
  • Working capital is important for an organization because it is necessary for an organization to remain solvent. There should be sufficient funds available with an organization to meet its day-to-day obligations e.g., rent, taxes, salaries, other expenses​

​ CAUSES AND EFFECTS OF EXCESSIVE WORKING CAPITAL​

  • Excessive Working Capital means idle funds which results in the locking up of excess funds earning no profits.​
  • Excessive Working Capital leads to unnecessary purchasing and accumulation of raw materials, components, and spares causing more chances of theft, waste, and losses. ​
  • Excessive working capital implies excessive debtors and defective credit policy which may cause a higher incidence of bad debts.​
  • It may result in overall inefficiency in the organization.​
  • When there is excessive working capital, relations with banks and other financial institutions may not be maintained.

CAUSES AND EFFECTS OF INADEQUATE WORKING CAPITAL​

  • Inadequate working capital cannot buy its requirements in bulk order.
  • It becomes impossible to utilize efficiently the fixed assets.
  • It hampers the overall operation of the business.
  •  A concern that has inadequate working capital cannot pay its short-term liabilities in time. Thus, it will lose its reputation and will not be able to get good credit facilities.
  •  It becomes difficult for the firm to exploit favorable market conditions and undertake profitable projects due to lack of working capital.

​ WORKING CAPITAL RATIO​ ​

​The working capital ratio is a measure of liquidity, revealing whether a business can pay its obligations The ratio is the relative proportion of an entity’s current assets to its current liabilities and shows the ability of a business to pay for its current liabilities with its current assets. A working capital ratio of less than 1.0 is a strong indicator that there will be liquidity problems in the future, while a ratio of 2.0 is considered to represent good short-term liquidity.​

       Working capital ratio = Current assets / Current liabilities​

Conclusion

Working capital indicates the liquidity levels of businesses for managing day-to-day expenses and covers inventory, cash, accounts payable, accounts receivable, and short-term debt. It is an indicator of the financial position of an organization and is also a measure of its overall efficiency. 

Working capital is used to fund operations and meet short-term obligations. If a company has enough working capital, it can continue to pay its employees and suppliers and meet other obligations, such as interest payments and taxes, even if it runs into cash flow challenges.

Bibliography

https://en.wikipedia.org/wiki/Working_capital

https://www.bankofamerica.com/smallbusiness/business-financing/learn/what-is-working-capital/

https://www.investopedia.com/terms/w/workingcapitalmanagement.asp

Thank You

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