- Working capital refers to the funds that a business has available for its day-to-day operations.
- It is calculated by subtracting current liabilities from current assets.
- Current assets:
- Assets that are expected to be converted into cash or used up within one year or one operating cycle, whichever is longer.
- Examples include cash, inventory, accounts receivable, prepaid expenses, and short-term investments.
- Current assets are important for assessing a business’s liquidity and ability to meet its short-term obligations.
- Current liabilities:
- Obligations that are expected to be paid within one year or one operating cycle, whichever is longer.
- Examples include accounts payable, salaries payable, taxes payable, short-term loans, and accrued expenses.
- Current liabilities are important for assessing a business’s ability to meet its short-term financial obligations.
Features of Working Capital:
- Liquid assets: Working capital consists of cash and other assets that can be easily converted to cash.
- Short-term focus: Working capital is used to meet short-term obligations and expenses.
- Cyclical nature: Working capital needs can fluctuate depending on the business cycle and industry.
- Continuous monitoring: Working capital levels need to be monitored regularly to ensure sufficient funds are available.
- Risk management: Adequate working capital can help mitigate financial risks.
- Source of financing: Working capital can be used to finance other operations or investments.
- Inventory management: Efficient inventory management is critical for maintaining adequate working capital.
- Accounts receivable management: Effective accounts receivable management can improve cash flow and working capital.
Importance of Working Capital:
- Operating expenses: Working capital is needed to cover day-to-day operating expenses.
- Seasonal fluctuations: Adequate working capital can help businesses survive seasonal fluctuations in revenue.
- Business growth: Working capital is needed to fund expansion and growth initiatives.
- Vendor relationships: Timely payment of vendors can help maintain good relationships and negotiate favourable terms.
- Creditworthiness: Sufficient working capital can help businesses maintain good creditworthiness and access financing.
- Cash flow management: Efficient working capital management can improve cash flow and reduce the risk of insolvency.
- Flexibility: Adequate working capital provides businesses with the flexibility to respond to unexpected events or opportunities.
- Reputation: Good working capital management can enhance a business’s reputation and attract investment.
- Investor confidence: Adequate working capital can instil confidence in investors and stakeholders.
- Long-term viability: Effective working capital management is critical for the long-term viability and sustainability of a business.
