In an ordinary sense, working capital denotes the amount of funds needed for meeting day-to-day operations of a concern. This is related to short-term assets and short-term sources of financing. Hence it deals with both, assets and liabilities—in the sense of managing working capital it is the excess of current assets over current liabilities. In this article we will discuss about the various aspects of working capital.
Concept of Working Capital:
The funds invested in current assets are termed as working capital. It is the fund that is needed to run the day-to-day operations. It circulates in the business like the blood circulates in a living body. Generally, working capital refers to the current assets of a company that are changed from one form to another in the ordinary course of business, i.e. from cash to inventory, inventory to work in progress (WIP), WIP to finished goods, finished goods to receivables and from receivables to cash.
There are two concepts in respect of working capital:
(i) Gross working capital and
(ii) Networking capital.
Gross Working Capital:
Gross working capital refers to a company’s overall current asset amount at any particular moment within an accounting year. It includes any assets that can be converted into cash quickly within an accounting period. In other words, it’s the amount of money a company has on hand to meet its current asset-related needs. A company’s gross working capital will always be negative in any given condition. Working capital does not, however, provide a complete picture of a company’s liquidity. This is due to the fact that a company’s liabilities are not factored into the calculation of this sort of working capital.
Calculation of Gross Working Capital
The calculation for gross working capital used by business owners and financial analysts is –
Gross Working Capital = Total Value of Current Assets
Net working capital is the aggregate amount of all current assets and current liabilities. It is used to measure the short-term liquidity of a business, and can also be used to obtain a general impression of the ability of company management to utilize assets in an efficient manner.
Net Working Capital Formula
Net Working Capital = Current Assets – Current Liabilities