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Working Capital and its Importance

>> March 15, 2009

Definition of Working Capital

" Working capital is an excess of current assets over current liabilities. In other words, The amount of current assets which is more than current liabilities is known as Working Capital. If current liabilities are nil then, working capital will equal to current assets. Working capital shows strength of business in short period of time . If a company have some amount in the form of working capital , it means Company have liquid assets, with this money company can face every crises position in market. "

Formula of Calculating Working Capital

Working Capital = Current Assets - Current Liabilities

Current Assets

Current assets are those assets which can be converted into cash within One year or less then one year . In current assets, we includes cash, bank, debtors, bill receivables, prepaid expenses, outstanding incomes .

Current Liabilities

Current Liabilities are those liabilities which can be paid to respective parties within one year or less than one year at their maturity. In current liabilities, we includes creditors, outstanding bills, bank overdraft, bills payable and short term loans, outstanding expenses, advance incomes .

Other names of Working Capital

Some Professional accountants know working capital as operating capital, operating liquidity, positive working capital.

Important things about Working Capital

1. Working Capital can be negative. At that time, We add one word " deficiency" in the back of working capital . It means if Current Liabilities are more than current assets, it is known as working capital deficiency or inverse working capital or negative working capital.

2. Working capital can be easily adjusted, if Accounts manager knows different techniques of managing working capital . He can try to get short term loan or he can increase working capital by proper management of inventory and outstanding incomes and debtors .

3. Working capital can also change by Changing in Cash Conversion period. Cash conversion period is a period in which company changes current assets into cash or bank.

4. Working capital can also positive by increasing growth rate of company. If company does not invest more money and increase profit, the same amount will increase in the cash position of company and with cash company can increase their working capital position.

Importance of Working Capital

Some time, If creditors demands their money from company, at this time company's high working capital saves company from this situation . You know that selling of current assets are easy in small period of time but Company can not sell their fixed assets with in small period of time. So, If Company have sufficient working capital , Company can easily pay off the creditors and create his reputation in market . But If a company have zero working capital and then company can not pay creditors in emergency time and either company becomes bankrupt or takes loan at higher rate of Interest . In both condition , it is very dangerous and always Company's Account Manager tries to keep some amount of working capital for creating goodwill in market .
Positive working capital enables also to pay day to day expenses like wages, salaries, overheads and other operating expenses. Because sufficient working capital can not only pay maturity liabilities but also outstanding liabilities without any more delay.
One of advantages of positive working capital that Company can do every risky work without any tension of self security.

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