MEANING AND

COMPOSITION OF
WORKING CAPITAL
• What Is Working Capital?
-Working capital, also known as net working capital (NWC), is the difference
between a company’s current assets—such as cash, accounts
receivable/customers’ unpaid bills, and inventories of raw materials and finished
goods—and its current liabilities, such as accounts payable and debts. It's a
commonly used measurement to gauge the short-term health of an organization.
Understanding Working Capital
•Working capital estimates are derived from the array of assets and
liabilities on a corporate balance sheet. By only looking at immediate debts
and offsetting them with the most liquid of assets, a company can better
understand what sort of liquidity it has in the near future.
•Working capital is also a measure of a company’s operational efficiency
and short-term financial health. If a company has substantial positive NWC,
then it could have the potential to invest in expansion and grow the
company. If a company’s current assets do not exceed its current liabilities,
then it may have trouble growing or paying back creditors. It might even go
bankrupt.
•Working Capital Formula

•To calculate working capital, subtract a company's current liabilities from its current assets.
Both figures can be found in the publicly disclosed financial statements for public companies,
though this information may not be readily available for private companies.

•Working Capital = Current Assets - Current Liabilities

•Why Is Working Capital Important?

•Working capital is important because it is necessary for businesses to remain solvent. In

theory, a business could become bankrupt even if it is profitable. After all, a business cannot
rely on paper profits to pay its bills—those bills need to be paid in cash readily in hand. Say a
company has accumulated $1 million in cash due to its previous years’ retained earnings. If the
company were to invest all $1 million at once, it could find itself with insufficient current assets
to pay for its current liabilities.
•
What are the Components of Working
Capital?
• Major components of working capital are its current assets and current liabilities, and
the difference between them makes up the working capital of a business. Current
assets comprise trade receivables, inventory, and cash & bank balances, and current
liabilities majorly comprise trade payables. The efficient management of these
components ensures the profitability of the business and ensures the smooth running
of the business.
•4 Main Components of Working Capital
• Trade Receivables
• Inventory
• Cash and Bank Balances
• Trade Payables
•1 – Trade Receivables- Trade receivable is the amount the company has billed to its customer for
selling its goods or supplying the services for which the amount has not been paid yet by the customers and
is shown as an asset on its balance sheet.

• 2 – Inventory- Inventory is another significant part of current assets and, without a doubt, forms an integral
component of working capital management. Good Inventory Management is essential since it is responsible for
proper control over inventory from the raw material stage to the finished goods stage.
•3 – Cash and Bank Balances
•It is said that cash is the king and an essential component of current assets, and cash involves not just cash only
but all liquid securities that can be readily converted into cash. Proper Cash Management goes a long way in
keeping the working capital cycle in order and enables the business to manage its operating cycle. Also, business
efficiency is determined by the amount of free cash flow to the firm (FCFF) it generates. Also, proper utilization of
cash ensures business to garner trade discounts and improve the cash conversion cycle, which is a critical
yardstick for analyzing the working capital cycle of any business.
•4 – Trade Payables
 Trade Payables forms a significant part of current liabilities. It also includes the amount due to the bills of
exchange payables. These are the amounts the business has to pay for credit purchases made by it. A crafted
payables management policy goes a long way in ensuring timely payment and cordial business relations with
vendors and creditors.
THE NEEDS/ IMPORTANCE FOR
WORKING CAPITAL
• Working capital is the life blood and nerve center of business. Working
capital is very essential to maintain smooth running of a business. No
business can run successfully without an adequate amount of working
capital. The main advantages or importance of working capital are as
follows:

•Strengthen the solvency

• Working capital helps to operate the business smoothly without any
financial problem for making the payment of short-term liabilities.
Purchase of raw materials and payment of salary, wages and overhead can
be made without any delay. Adequate working capital helps in maintaining
solvency of the business by providing uninterrupted flow of production.
• Enhance Goodwill
•Sufficient working capital enables a business concern to make prompt
payments and hence helps in creating and maintaining goodwill.
Goodwill is enhanced because all current liabilities and operating
expenses are paid on time.

• Easy obtaining loan

• A firm having adequate working capital, high solvency and good credit
rating can arrange loans from banks and financial institutions in easy
and favorable terms.
• Regular supply of raw material

• Quick payment of credit purchase of raw materials ensures the regular supply
of raw materials fro suppliers. Suppliers are satisfied by the payment on time.
It ensures regular supply of raw materials and continuous production.

• Smooth Business Operation

• Working capital is really a life blood of any business organization which

maintains the firm in well condition. Any day to day financial requirement
can be met without any shortage of fund. All expenses and current liabilities
are paid on time.
• Ability to face Crisis

• Adequate working capital enables a firm to face business crisis in

emergencies such as depression.
 WORKING
CAPITAL
MANAGEMENT
 WORKING CAPITAL MANAGEMENT
• MEANING
-Working capital is part of the capital which is needed for meeting day to day
requirement of the business concern . For example , payment to creditors salary paid to
workers , purchase of raw materials etc ,,normally it consists of recurring in nature . It can
be easily converted into cash . Hence, it is also known as short-term capital.
DEFINITIONS:
According to the definition of Mead Baker and Mallot,
“Working capital means Current Assets” .

According to the definition of J.S. Mill,

“The sum of the current asset is the working capital of a business”
WORKING CAPITAL MANAGEMENT
• Concept of Working Capital
• A)Gross Working Capital
-Gross Working Capital is the general which determines the working capital
concept. Thus , the gross working capital is the capital invested in total current
assets of the business concern. Gross Working Capital is simply called as the total
current assets of the concern.

Gross Working Capital = Current Assets

WORKING CAPITAL MANAGEMENT
• B . Net Working Capital
• Networking Capital is the specific concept which consider both
current assets and current liability of the concern.

• Networking Capital is the excess of current assets over the current

liability of the concern during a particular period.

Net Working Capital = Current assets – Current Liabilities

WORKING CAPITAL MANAGEMENT
• Nature of Working Capital
1. It is used for purchases of raw materials, payment of wages and
expenses.
2. It changes from constantly to keep the wheels of business moving.
3. Working capital enhances liquidity, solvency, creditworthiness and
reputation of the enterprise.
4. It generates the element of cost namely: Materials, wages and
expenses.
5. It enables the enterprise to avail the cash discount facilities offered
by its suppliers.