Know all about Working Capital: Definition, Factors affecting it, Approaches and Classification
by Mashum Mollah Financial Planning 05 November 2019
Presently, managing liquidity and cash effectively has become a priority considering the ballooning corporate balance sheets and a considerable increase in Non-Performing Assets (NPA). Post-implementation of GST, alternative sources of debt funding, and technological advancements are offering corporations an innovative opportunity to retake their approach towards efficiently managing the working capital.
What Is Working Capital?
Working capital is defined as a measure of a company’s short-term financial health and its efficiency. This ratio is indicative of whether an organization holds adequate assets to cover its short-term debts. It also reflects the liquidity level of a brand to cover –
- Day-to-day expenses.
- Accounts receivable.
- Accounts payable.
- Manage inventory.
- Short-term debt is due to be paid.
This ratio is a company’s surplus of current assets over its current liabilities. Knowing what is working capital is vital to run business operations as well as predict any requirement of funds in case of shortage to maintain optimal business operations.
What Is The Factor Affecting The WC?
Estimating the working capital of a firm with precision is imperative. It includes possessing an in-depth idea about the various factors affecting the working capital cycle –
- Nature of business in question.
- Business cycle fluctuations.
- Availability of raw materials.
- The scale of operation.
- Market conditions.
- Rate of turnover.
- Growth and expansion prospects.
- Seasonal factors.
- Allowed credit limit.
- Degree of operating efficiency.
- The existing level of competition.
- Complexity and time of manufacturing procedure and cost.
- Production and technology cycle.
- Terms of sales and purchase.
What Are The Approaches To WC?
Considering the size of investment in current assets, one needs to look into the financing of WC and working capital management. It includes the ways of –
Also called the matching approach, it involves tallying liabilities and assets to maturities. Under this, a firm utilizes long-term sources to fund permanent current assets and fixed assets; and short-term finances to fund current temporary assets.
As per this approach, the organization in question prefers to have a substantial amount of cash in hand. Subsequently, the fixed part of current assets is funded via permanent funds or long-term financing options that lead to the financial status of low risk, low return.
Companies are willing to take higher risks and hence are involved in utilizing short-term funds to a very high degree to finance fixed and current assets.
Therefore multiple companies can enjoy the privilege of having a wide range of choices for their financing option as per their risk-taking capability. Therefore, keeping in mind the convenience of potential borrowers, multiple reputed financial institutions now offer their advances in the form of business loans.
These advances cater to the working capital requirement of entrepreneurs. These advances provide its borrowers with added benefits of –
- High-value credit amount of up to Rs. 30 Lakh.
- Easy loan approval and quick disbursal of the sanctioned sum.
- Convenient online access to the loan account as well as management functions.
Additionally, in the case of reputed lenders like Bajaj Finserv, borrowers also have the benefit of Flexi Loan facilities. With this facility, individuals need to pay interest only on withdrawn credit amounts and repay as per their convenience.
In the case of existing borrowers with this lender, pre-approved offers are also available to ease the application process to avail financial assistance.
Classification Of Working Capital
WC of all companies irrespective of the genre of trade that they are involved in can be broadly classified based on two categories –
- Networking capital: A firm’s margin between current assets and current liabilities.
- Gross working capital: A firm’s total current assets.
- Fixed or permanent working capital: Permanently locked up in current assets and used to carry out the smooth running of a business.
- Variable or temporary WC: Requires altering as per decrease or increase in the volume of production in a business.
Considering the importance that this capital holds in the financial regulation of business operations, having an in-depth understanding of working capital is essential to ensure a positive flow of the same.