Working Capital

• Every business needs investment in fixed assets and current assets.
• Current assets help in smooth day-to-day operations of the business.
• Current assets are more liquid but provide lower returns than fixed assets.
• Current assets are expected to be converted into cash or cash equivalents within one year.
• Current liabilities are payment obligations due within one year.
• Some part of current assets is financed through current liabilities, while the remaining part financed through long-term sources is called Net Working Capital.

Examples (in order of liquidity):

• Cash in hand / Cash at bank
• Marketable securities
• Bills receivable
• Debtors
• Finished goods inventory
• Work in progress
• Raw materials
• Prepaid expenses

Key Points:

• Current assets provide liquidity to the business.
• An asset is more liquid if it can be converted into cash quickly without losing value.
• Insufficient investment in current assets may make it difficult to meet payment obligations.
• A balance between liquidity and profitability should be maintained.

Current liabilities are obligations payable within one year, such as:

• Bills payable
• Creditors
• Outstanding expenses
• Advances received from customers

NWC = CA - CL

Where:

• NWC = Net Working Capital
• CA = Current Assets
• CL = Current Liabilities

• Part of current assets is financed through current liabilities (short-term sources).
• The remaining part financed through long-term sources is called Net Working Capital.
• Net Working Capital is the excess of current assets over current liabilities.

• Nature of Business: Trading and service firms require less working capital than manufacturing firms.
• Scale of Operations: Larger scale of operations requires more inventory and debtors, leading to higher working capital.
• Business Cycle: Boom → Higher working capital. Depression → Lower working capital.
• Seasonal Factors: Peak season increases working capital requirement, while lean season reduces it.
• Production Cycle: Longer production cycle increases working capital; shorter cycle reduces it.
• Credit Allowed: Liberal credit to customers increases working capital requirement.
• Credit Availed: Credit received from suppliers reduces working capital requirement.
• Operating Efficiency: Better operating efficiency reduces working capital requirement.
• Availability of Raw Material: Easy availability reduces working capital; irregular supply or longer lead time increases it.
• Growth Prospects: Higher growth prospects require more working capital.
• Level of Competition: Higher competition increases working capital due to larger stock and liberal credit.
• Inflation: Rising prices increase working capital requirement.

• Working capital is the investment in current assets needed for smooth day-to-day operations.
• Current assets are more liquid but provide lower returns than fixed assets.
• Current liabilities are short-term obligations payable within one year.
• Net Working Capital = Current Assets − Current Liabilities.
• A business should maintain a balance between liquidity and profitability.
• Working capital requirements depend on factors such as nature of business, scale of operations, business cycle, seasonality, production cycle, credit policy, operating efficiency, raw material availability, growth prospects, competition and inflation.