Working capital is the fuel of your business and keeps your operational gears running smoothly. Be it paying creditors while you await payment from clients, paying salaries and utilities on time, or holding inventory in your warehouse without sufficient working capital. Your firm won’t be able to function at its full potential.
However, simply facilitating working capital isn’t enough. Understanding the various ways in which it gets calculated will facilitate working capital management. Broadly, there are two views of working capital, the balance sheet view and operating cycle view. Let’s take a look at what the two include.
1. Balance sheet view of working capital
With Under the balance sheet view, there are two types of working capital.
Gross working capital
Simply put, gross working capital is defined as the amount of money you have invested in the company’s current assets. These are assets with high liquidity, and so you can convert them into cash in a short period, usually a year. Examples of such current assets include debtors, prepaid expenses and stock.
Net working capital
Net working capital is the difference between your company’s current assets and current liabilities as per its balance sheet. It can be further divided into positive net working capital and negative net working capital. The former is when your company’s current assets exceed its current liabilities. On the other hand, negative net working capital is when the liabilities outdo the assets.
In such a situation, seeking a working capital loan will help you restore balance. You can avail of a working capital loan from Bajaj Finserv in a Flexi format, which allows you to withdraw as and when there’s a shortage of liquidity and prepay when your blocked payments from debtors get cleared. Here, you can pay interest on what you use. You can lower your EMI by up to 45%.
Between the two, net working capital is used more widely. This is because it indicates your company’s ability to meet its current liabilities, shows whether your business is financially sound, and is a measure of the margin available to short-term creditors.
2. Operating cycle view of working capital
Here, working capital is classified according to its time to convert stock into cash for your company.
Additional Read: A complete guide for working capital cycle
Permanent or fixed working capital
Fixed working capital varies from firm to firm. Essentially, based on the lowest amount of net working capital as per one financial year. This level is considered the permanent or fixed working capital and signifies the minimum investment you must make towards your company’s working capital. If you notice a shortfall, you can finance it using funds from a working capital loan.
Temporary or variable working capital
The difference between any company’s net working capital and permanent working capital is its temporary or variable working capital. This is needed to meet the additional cash requirements due to annual fluctuations in production and sales caused by seasonality. For example, if you’re an umbrella manufacturer, you will manufacture stock before the season commences, anticipating demand. Hence you will require extra funds to meet this temporary working capital need.
Besides these, other kinds of working capital are reserve or cushion working capital and special working capital. As the name suggests, reserve working capital acts as a cash reserve to tackle uncontrollable risks and uncertainties. Special working capital is set aside to finance certain activities such as running an advertisement campaign, conducting marketing research or diversifying into a new market.
No matter what method of working capital calculation you adopt for your business, it is vital to monitor it. If there are any gaps or signs of distress, you can meet the deficiency at the earliest, before it impacts your business’ productivity.
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