Working capital = current assets - current liabilities
This calculation indicates whether the company possesses sufficient assets to cover its short-term financial needs.
Sources of working capital
Thesources for working capitalcan be long-term, short-term, or spontaneous.Long-term working capital sources include long-term loans, provision for depreciation, retained profits, debentures, and share capital.Short-term working capital sources include dividend or tax provisions, cash credit, public deposits, and others. Spontaneous working capital comes from trade credit, including notes payable and bills payable.
Types of working capital
There are severaltypes of working capitalbased on the balance sheet or operating cycle view. A balance sheet view classifies working capital into two types of working capital:
- Net (current liabilities subtracted from current assets featuring in the balance sheet)
- Gross working capital (current assets in the balance sheet)
The operating cycle view classifies working capital into temporary (difference between net working capital and permanent working capital) and permanent (fixed assets) working capital.
Working capital cycle
Working capital cycle refers to the time taken to convert net current liabilities and assets into cash by a business. The shorter theworking capital cycle, the swifter the company will free up its blocked cash. Businesses strive to lower this working capital cycle to enhance liquidity in the short term. Bajaj Finserv offers working capital loans to address any deficits in working capital and ensure optimal operations.
Components of working capital
The components of working capital include current assets (such as cash, inventory, accounts receivable), and current liabilities (such as accounts payable, short-term loans, accrued expenses). The current assets are used to finance the company’s short-term expenses, while the current liabilities represent the company’s payments that are due within a year. The working capital ratio (current assets divided by current liabilities) is frequently used to assess a company’s liquidity and its ability to meet its short-term obligations.
Current assets
Current assets are the assets of a company that are expected to be converted into cash or consumed within a year. The most common types of current assets include cash and cash equivalents, accounts receivable, inventory, and short-term investments.
These assets are important because they help the company to fund its daily operations, pay current liabilities, and make necessary investments in the short term. Additionally, a company's ability to manage its current assets efficiently is a critical factor in maintaining its working capital and liquidity.
Current liabilities
Current liabilities refer to the company's obligations that are due within one year or the operating cycle, whichever is longer. Common examples of current liabilities include accounts payable, short-term loans, accrued expenses, and taxes payable.
Managing current liabilities is essential because it impacts the company's working capital, cash flow, and overall financial performance. A company with strong current liability management practices can better finance its short-term obligations, achieve profitability, and create long-term financial stability.
Additional Read: Importance of capital budgeting
