Knowledge about working capital is important for all business owners. Working capital is an essential tool that will help you ascertain the short-term financial standing of your business. It will help you identify problem areas and blind spots you need to address. This kind of information enables you to improve the effectiveness of your operations and impacts your business' bottom line.
What is working capital?
Working capital is defined as the difference between your business's current assets and current liabilities. Once you obtain this ratio, it becomes easier to understand whether your company is capable of meeting its short-term debts or not.
In simpler terms, it is the amount of money available in your organisation to keep daily operations running smoothly. Working capital includes cash, inventory, accounts receivable and payable, and short-term debt.
The formula to calculate working capital is as follows:
Working capital = current assets – current liabilities.
Do note that a sharp increase in working capital usually indicates the rising costs of a business. On the other hand, not meeting the working capital requirements is considered to be one of the primary reasons for the lack of resources.
How many types of working capital are there?
Working capital in India can be divided into the following types based on periodicity:
Permanent working capital: Also known as fixed working capital, it consists of the minimum current assets needed to ensure that business operations stay afloat. Do note that the size of fixed working capital is dependent on the production scale and growth.
Variable working capital:It refers to the amount that is invested in a business for the short term. It is also understood as the additional working capital used to account for production and sales changes. Variable working capital is also commonly known as temporary working capital.
Reserve margin working capital: It comprises short-term financial arrangements made by business entities to manage unforeseen expenses. Also known as cushion working capital, it helps reduce unwarranted risks and get through a crisis.
Seasonal working capital: It is the working capital procured to meet rising customer demands during peak seasons. Financial assistance obtained to meet such requirements is known as seasonal working capital.
Regular working capital: This type is described as the minimum working capital that a company has to maintain under normal circumstances.
Special working capital: It is described as the additional working capital that a business requires to meet unique circumstances.
Gross working capital: As far as the question "what is gross working capital" is concerned, it is the funds invested in a firm's current assets and serves as an indicator of the same. Components of gross working capital include inventory, short-term investments, account receivables, cash and marketable securities.
Net working capital: An essential type of working capital, this one signifies the amount by which a company's current assets surpass its current liabilities. Thus, it is the difference between a business' total current assets and current liabilities.
How does working capital help your business?
Regardless of the size and scale of your operations, working capital serves as an essential component that provides the following benefits:
Enables production to run smoothly.
Allows for a boost in liquidity.
Ensures that your business uses fixed assets in the most optimal manner.
Helps build a positive image of the business.
Assists the business in availing financial assistance like loans.
Makes meeting contingencies more effective.
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Read more on how financial reporting helps support your business by clicking here.
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