To run a business, one requires funds to meet its daily operational commitments. This fund is called working capital. Also called net working capital, it is the difference between current assets (e.g. cash receivables, bills receivables, inventories – both raw material and finished goods) and current liabilities (e.g. bills payable, debts, etc.).
In short, working capital is a fund that is essential to take care of the company’s cost of operations.
To ensure the business operations run smoothly and unhindered, the company needs to have a minimum quantum of current assets. That money is called permanent working capital or fixed working capital.
There are few significant components in working capital. They are as under:
1. Stock/Inventories
Inventory management is the key element in handling the current assets of a business.
2. Cash/Bills Receivables
This is the amount outstanding in the market. Hence, collection of the same decides the cash inflow of the company.
3. Debts
Like receivables, companies need to manage their own outstanding in the market. This is to ensure unobstructed availability of resources and build on the business goodwill.
In addition to the above, the company must have liquid cash and liquid assets ready in hand. Despite being vigilant in every aspect, a situation may come when a sudden cash requirement may arise.
As is evident from the matters mentioned above, working capital is an integral part of any business operation. Working capital ensures unhindered operations.
Therefore, it is a matter of utmost importance. It may not be possible for the promoter to maintain liquidity from self-generated fund sources. This is a situation when one may look at working capital loans or working capital finance.
Working capital loans come in different variations. They are as under:
- Short Term Loans
These loans usually are offered as short-term loans for 12 months. If the promoter has proven creditworthiness, the loan may be given even without collateral.
2. Overdraft
Under this arrangement, the bank offers a pre-fixed credit line to the entrepreneur. The borrower needs to pay interest only on the amount of money withdrawn and on the sanctioned limit. Any prudent borrower would like to replenish the withdrawal to avoid paying interest.
3. Trade Credit
These are offered by the suppliers, both existing and new to the borrower. However, these are provided only after a supplier applies due diligence and does an in-depth study of the company’s credit history, earnings, and liquidity position.
Summary
A few essential takeaways are as under:
- Working Capital is the fund covering the short-term expenses of a company.
- The difference between current assets and current liabilities denotes the working capital of a company.
- It is the fund that takes care of the daily operating expenses of the company.
- It is a significant contributor to a company’s liquidity position, which is crucial to meeting the business’s short-term needs.
- Fixed assets of the company may be used optimally by managing working capital efficiently.
Working Capital is termed as the all-important grease that keeps the company’s wheels moving seamlessly.
One may safely state that working capital characterizes operational liquidity to a business entity. Like a business that owns fixed assets like plants, machinery, and equipment, working capital is also a part of operating capital.
