Working Capital helps in understanding the liquidity of a business. Current assets and current liabilities of a business are considered as the working capital of any business. It is important to have a positive working capital to manage your day-to-day business operations. Read on to understand in detail what working capital is, its types, calculation, advantages, and limitations. Read on!
What is Working Capital?
Working capital is current assets minus current liabilities. Its primary advantage is that it increases operational efficiency and helps businesses finance short-term requirements. In this way, businesses can cover their daily operational expenses and short-term liabilities.
- Current Asset – Any asset that can be converted into cash within 1 year of time. For example, cash in bank, short term inventory, etc.
- Current Liabilities – Any liabilities that can be settled within 1 year of time. For example, income taxes, short-term notes payable, interest payable, accrued interest, rental fees, and other short-term debts.
How To Calculate Working Capital?
The formula for calculating the working capital of a business is subtracting current assets from current liabilities.
Working Capital = Current Assets - Current Liabilities
8 Types of Working Capital
Each type of working capital performs differently depending on its periodicity and concept. Here’s a list of 8 types of working capital you must know:
1. Permanent Working Capital
Permanent working capital is also known as fixed working capital that remains fixed in the current assets of a company. This portion of the working capital helps businesses to carry out business operations seamlessly. For instance, a company may need a minimum amount of cash and cash equivalents to keep its operations smooth.
2. Temporary Working Capital
Temporary working capital refers to the capital that a business needs during a specific time of the year to meet short-term changes. For instance, a business may require such capital during the festive season, to meet the immediate and increased demands of the customers. This requirement is temporary and is subject to change based on business operations and market conditions.
3. Gross and Net Working Capital
Gross working capital refers to the total sum of all current assets owned by a company. These assets are the ones that can be transformed into cash within a year.
Additionally, to express working capital, the preferred method is to calculate the ratio of current assets to current liabilities. Meanwhile, the net working capital of a business is the difference between current assets and current liabilities.
4. Negative Working Capital
Negative working capital occurs when current liabilities exceed current assets. This indicates a surplus of short-term debt over short-term assets.
Upon effective management, negative working capital can serve as a means to increase your inventory turnover as a result of increased demand. This can also help to fund your business's growth in sales by using other people's money, namely your suppliers.
5. Regular Working Capital
Regular working capital is a type of working capital that refers to the minimum amount of funding that a company uses to manage its day-to-day operations, such as paying salaries, purchasing raw materials, and covering overhead expenses. Without sufficient regular working capital, a business may struggle to keep its operations running smoothly.
6. Reserve Working Capital
Reserve working capital refers to an additional amount of funds that a company sets aside beyond its regular working capital requirements. This works as a contingency fund to meet unexpected events and emergencies.
Moreover, the reserve is held separately from the company's day-to-day operational funds to navigate unforeseen challenges, seize growth opportunities, or withstand economic downturns without disrupting its operations or financial health.
7. Seasonal Working Capital
Seasonal working capital is the additional capital required by a business during a peak season. Businesses with seasonal demand need this working capital to maintain a reserve of funds to quickly adapt to changes.
It is a temporary increase in working capital and is mainly applicable to businesses experiencing seasonal fluctuations in demand, such as the manufacturers of raincoats and umbrellas.
8. Special Working Capital
A special working capital is a kind of working capital that provides temporary funding for a specific occasion that is not part of a business's regular operations. These events are mostly infrequent and unpredictable, making it challenging for businesses to plan for them.
For instance, marketing campaigns may require a significant amount of funds, which a special Working Capital Loan can provide.
Also Read: What is Working Capital Term Loan - Meaning, and How It Works?
Why Is Working Capital Essential?
It is important to manage working capital effectively to stay afloat in the dynamic business landscape. Read the following points to learn more about the importance of working capital:
- Seamless Business Operations
Sufficient working capital helps businesses cover their daily business operations. With the funds, businesses can purchase inventory, pay wages, etc., seamlessly.
- Business Growth
With adequate working capital, businesses can invest in expansion initiatives such as introducing new product lines, entering new markets, etc., which can help businesses grow.
- Financial Soundness
A healthy level of working capital offers financial soundness and resilience, helping businesses face unexpected challenges, economic downturns and cash flow crunch undauntingly.
- Flexibility
Additional working capital offers businesses the flexibility to respond quickly to unforeseen situations, dynamic market conditions, etc., helping them remain competitive and profitable.
Benefits of a Business Loan for Working Capital
Here are the 6 benefits of getting a Business Loan from Poonawalla Fincorp for working capital:
- Fast and easy to obtain, helping ventures finance emergency obligations.
- All charges are disclosed, hence there are no hidden charges.
- Borrowers can get a lump sum loan amount of Rs. 50 Lakh.
- With simple eligibility requirements, you can easily qualify for the loan.
- Get access to a flexible repayment tenure of up to 48 months.
- Enjoy competitive interest rates starting from 15% p.a.
Also Read: Working Capital Cycle: Definition & Complete Overview
How to Apply for a Business Loan for Working Capital with Poonawalla Fincorp?
The application process for a Business Loan for working capital is simple and easy with Poonawalla Fincorp. Just follow the steps below:
- Step 1: Click on the ‘Apply Now’ button.
- Step 2: Provide your name, DOB, etc.
- Step 3: Upload the necessary documents and hit the ‘Submit’ button.
Upon successful verification, the loan amount will be instantly disbursed to your bank account.
To Conclude
Different types of working capital help businesses stay afloat in a highly dynamic market by financing their short-term operational expenses and unforeseen costs. With the help of effective working capital management, companies can invest in growth and expansion opportunities. A Business Loan for working capital can help you overcome financial distress in times when you have negative or low working capital. Choose a trustworthy NBFC like Poonawalla Fincorp to get your working capital today. Apply now!
Frequently Asked Questions
- What is working capital management?
Working capital management refers to the management of a company's short-term assets and liabilities to ensure its operational efficiency and liquidity. It involves monitoring and optimizing the levels of cash, accounts receivable, accounts payable, and inventory to maintain a healthy cash flow position.
- What is the working capital cycle?
The working capital cycle refers to the time it takes for a company to convert its resources into cash through its operational activities, covering the period from cash outflows to cash inflows.
- What are the five sources of working capital?
The five resources of working capital are listed below:
- Cash: Represents readily available funds that can be used for day-to-day operations and to meet immediate obligations.
- Accounts receivable: Refers to the outstanding amounts owed to the company by its customers for goods or services given on credit.
- Inventory: Includes the goods or raw materials held by the company for production, sale, or distribution.
- Accounts payable: Refers to the outstanding amounts that a company owes to its suppliers or creditors for goods or services received on credit.
- Short-term loans: Serve as additional financial resources obtained from lenders to support working capital needs during periods of cash flow mismatch or expansion.