Working capital indicates the liquidity of business for the short term. The working capital is the difference between the company’s current assets and its current liabilities.
What are current assets?
Current assets are the assets that can be efficiently sold or consumed during the financial year.
Current assets include:
1. Cash
2. Account Receivable
3. Stock inventories
4. Prepaid liabilities
5. Stocks, mutual funds, bonds
The current liabilities can be debts, accounts payable or inventory cost.
If a company’s current asset is Rs. 2,000,000 and the current liability is Rs. 1.25 lakh. Its working capital is Rs. 750,000.
What does working capital indicate?
A high working capital shows that a company s functioning. A high net working capital means that the company has the resources required to meet its financial obligations.
A very high net capital can also mean that the company is not using its resources to maintain high liquidity.
What happens if the working capital is low?
If the working capital is low, it can be a sign that the company has low current assets and more liabilities. A low net capital does not always mean that the company is at a loss. Working capital reflects short term financial health; a lower working capital can also mean that the company has heavily invested in something that may give good returns. If a company has completed its financial obligations with inadequate working capital, it can mean that the company is reliable and can manage finance optimally.
Negative working capital means that the current assets are lesser than the current liabilities. Negative net capital for extended periods can lead to bankruptcy.
What are the types of working capital?
Types of working capital are classified into two main types: Balance sheet view and Operating Cycle View.
Balance sheet view:
1. Gross Working Capital – The current assets of a company are called the Gross Working Capital. Assets in the balance sheet that can be converted into cash within a year are the current assets.
2. Net Working Capital – This is the capital used for effective capital management. It is the surplus of current assets after paying liabilities.
Operating Cycle View:
1. Fixed Working Capital – Also known as permanent working capital, this is the fixed value of an asset. It is the lowest value of investment towards the company’s working capital.
This is further divided into:
- Regular working Capital: It is the capital required for the company to run smoothly.
- Reserve working capital: It is the capital kept in case of contingencies.
- It is exclusive of the regular working capital
2. Variable Working Capital – This is the difference between the net working capital and fixed working capital.
This is further divided into:
- Seasonal Working Capital: It is a temporary increase in the working capital due to seasonal requirements.
- Special Working Capital: It is a temporary rise in the working capital due to the occurrence of a special event.
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