You must have heard of working capital many times on many occasions, but have you ever stopped to think about the immense usage of working capital. But, have you ever stopped to think about what exactly is working capital? Working capital is the funds available with a company or business for its day-to-day operations.Working capital is a measure or yardstick to measure the company’s liquidity, efficiency, ability, and total health. Working capital is technically defined as the difference between current assets and current liabilities. Current assets are very liquid assets, meaning that they can be converted to cash very quickly. Current liabilities are the borrowings or dues that have to be repaid within a period of one year. The product that you get by subtracting Current Liabilities from Current Assets is called working capital. Working capital represents the funds available with the company for its day-to-day operations. Even though a company has availed long-term funding, it still needs short-term funding for its day-to-day operations. Without short-term funding for its working capital, a company can go bankrupt.
Working capital is needed pay the company’s current debts and it is necessary to meet the operational needs of the company. If the working capital is available, it can meet the commitments of its trade and short-term debts and helps it to stay financially viable. If the current assets does not exceed the current liabilities of your business, your business stands on very dangerous grounds as it cannot meet the liabilities of short-term creditors. Working capital means the amount of funds or money available with the company for its daily operations. If a company exhibits negative working capital it means that the company has no funds to meet its day-to-day activities.
Positive working capital is indicative of a company’s ability to meet its short-term liabilities while a negative working capital shows its inability. One of the most important uses of working capital is inventory – the longer it is in the warehouse, the longer the company’s working capital is tied up. To put in a nutshell, working capital is a company’s ability to pay off its short-term liabilities; it is also the difference between current assets and current liabilities.
Usually, working capital can be used to finance the following activities:
- For Day-to-day operations of the business
- To pay wages of workers
- To pay salaries of employees (except the salary of the owner)
- For construction or renovation of the leased property
- For purchase of furniture and fixtures
- For the purchase of machinery and equipment
- For purchase of inventory items
If the current assets of a business does not exceed its current liabilities, it may find it problematic to pay back short-term creditors and if the situation does not improve, the company would have to file for bankruptcy. Another reason could be its diminishing sales and the resultant decreasing accounts receivables.
Working capital management is the managing the working capital with the aim of meeting the objectives of profitability and maintaining liquidity. Efficient working capital management deals with going on the golden path where you can be profitable and yet you are in a position to pay off your current liabilities when they fall due.
Working capital can be broadly divided into two areas – to provide working capital for meeting business objectives and short-term working capital for carrying out the daily operations. The normal source of funds for working capital could be bank loans, term loans from financial institutions, or credit from suppliers.
Working capital should be managed very carefully and if not done so, businesses can run out of cash and would need more money for their daily operations. This normally happens when a business uses its own cash for making payments, rather than avail finance from any financial institution for meeting such commitments.
Use your working capital judiciously and ensure that your business turns out a profit.
Working capital is a measure or yardstick to measure the company’s liquidity, efficiency, ability, and total health. Working capital is technically defined as the difference between current assets and current liabilities. Current assets are very liquid assets, meaning that they can be converted to cash very quickly. Current liabilities are the borrowings or dues that have to be repaid within a period of one year.