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What are the different types of working capital?

  • Highlights

  • The two views of working capital

  • Balance sheet view

  • Operating cycle view

  • Choosing the right type of working capital

Working capital is the fuel of your business that keeps your operational gears running smoothly. Be it paying creditors while you await payment from clients or 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 is 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.

I. 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 span of time, usually a year. Examples of such current assets include debtors, prepaid expenses and stock.

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Net working capital

Net working capital is the difference between current assets and current liabilities of your company as per its balance sheet. This 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. A Bajaj Finserv Bajaj Finserv Working Capital Loan can be availed in flexi format which helps you to withdraw as and when there’s a liquidity shortfall and prepay when your blocked payments from debtors get cleared. As you pay interest on only what you use, you pay up to 45% lower EMIs here.

Between the two, net working capital is more widely used. 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.

II. Operating cycle view of working capital

Here, working capital is classified as per the time it takes 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, it is set based on the lowest amount of net working capital as per one financial year. It is this level that is considered to be the permanent or fixed working capital and signifies the minimum investment that you must make towards your company’s working capital. If you notice a shortfall in this, you can finance it using funds from a working capital loan.

Temporary or variable working capital

The difference between the net working capital and permanent working capital of your company is its temporary or variable working capital. This is needed to meet the extra 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, in anticipation of demand. Hence you will require extra funds to meet this temporary working capital need.

Besides these, some other kinds of working capital are reserve or cushion working capital and special working capital. Reserve working capital, as the name suggests, acts as a cash reserve to tackle uncontrollable risks and uncertainties. Special working capital is set aside to specifically finance certain activities such as running an advertisement campaign, carrying out 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 so that 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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