Working capital is the sum of funds a business requires to meet its day-to-day operational expenses. Irrespective of a business’s size or capacity, it needs to maintain a specific amount of working capital to meet its operational financial needs.
A company’s working capital reflects its short-term liquidity, and thus its operational efficiency. Having a shortage in working capital is therefore far from ideal. It also means the business needs immediate capital finance to fulfil the same.
However, it is not enough to finance working capital. One also needs to know how it is calculated and how it should be managed to keep a smooth working capital flow in the business. Let’s take a look at how working capital is calculated according to different concepts.
Concepts of working capital calculation
Working capital in a business can be calculated based on two different concepts.
- Gross working capital
Gross working capital meaning is the total sum of current assets of a business. It includes assets that can be converted into cash in a short period for liquidity. It is calculated as a sum of all current assets and its numerical representation is as follows.
Gross working capital = Receivables + Debtors + Stock + Cash In-Hand
- Net working capital
Net working capital is the difference between a company’s current asset and current liability. The result arrived at can be both positive and negative. A positive net working capital is when the current assets exceed current liabilities. The negative balance is arrived at if the current liabilities exceed current assets.
Its numerical representation is as follows.
Net working capital = (Cash + Stock + Debtors + Receivables) – (Creditors + Payables)
A negative working capital results in a working capital deficit. It implies that the current liabilities of a business are more than current assets. A working capital deficit will create inefficiency in the daily operations and reduce productivity.
It is vital for a business owner to maintain smooth business operations even in situations of a working capital deficit. The necessary financial requirements can be met by availing additional capital finance from lenders.
Uses of working capital
Working capital is used to meet everyday operational requirements of a business.
- Purchase of raw material
- Procurement of stock or inventory
- Payment of overhead costs such as salaries, rent, electricity and other utilities
- Bridging the gap between receivables due from debtors and cash in hand
- Making advance payment to suppliers
Performing all these activities is essential for smooth business operations. Therefore, a business must ensure that it never runs out of working capital. If it does not have an adequate working capital to meet all these requirements, it needs to infuse additional capital finance in the business.
Know how working capital management helps a business:
Proper working capital management combined with capital finance infusion leaves little scope for liquidity shortage. It is essential for a company to have an appropriate working capital management because it strengthens its operational efficiency and brings about several benefits.
- Provides necessary funds for management of sales fluctuations
- Provides cushion during times of cash crunch
- Gives essential financial support for the preparation of bulk orders
- Stabilises cash flow in the business
- Provides financial assistance to leverage new opportunities in the market
Now, when you know the working capital meaning, its use and reasons to have proper working capital management, make sure to maintain healthy liquidity of your business. If you are short of cash, opt for working capital finance to infuse additional capital.
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