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What is Working Capital?
Working capital refers to the capital used in the day-to-day operations of a business. It is the difference between a company’s current assets (like cash, accounts receivable, and inventories of raw materials and finished goods) and its current liabilities (like accounts payable and short-term debt). Essentially, working capital measures a company’s short-term financial health and its ability to cover its short-term obligations.
Features of Working Capital
- Liquidity: Working capital ensures that a company has enough liquidity to manage its daily operations smoothly.
- Short-term Nature: It is concerned with short-term assets and liabilities, typically within a year.
- Circulating Nature: Working capital continuously circulates in a business. It gets converted from cash to inventory to receivables and back to cash.
- Impact on Profitability: Effective management of working capital can significantly impact a company’s profitability and operational efficiency.
- Influence on Creditworthiness: Adequate working capital helps maintain a company’s creditworthiness by ensuring it can meet its short-term obligations.
- Risk Management: Proper working capital management helps mitigate risks related to cash flow problems.
Types of Working Capital
Gross Working Capital
The total of all current assets a company holds. It focuses on the total amount of funds invested in current assets.
Net Working Capital
The difference between current assets and current liabilities. It indicates the liquidity position and the short-term financial health of a business.
Permanent Working Capital
The minimum level of current assets required for a business to operate smoothly, regardless of the level of sales or production.
Temporary Working Capital
Also known as fluctuating working capital, it is the additional working capital needed to support seasonal or cyclical demands.
Gross Working Capital
The total of all current assets a company holds. It focuses on the total amount of funds invested in current assets.
Net Working Capital
The difference between current assets and current liabilities. It indicates the liquidity position and the short-term financial health of a business.
Permanent Working Capital
The minimum level of current assets required for a business to operate smoothly, regardless of the level of sales or production.
Temporary Working Capital
Also known as fluctuating working capital, it is the additional working capital needed to support seasonal or cyclical demands.