Working capital is a company’s most liquid asset to finance day-to-day operations. It includes cash and short-term investments, accounts receivable, and inventory.
The purpose of working capital is to ensure that a business can continue to operate. At the same time, it waits for long-term payments from customers or clients.
It’s an important term to understand. It is the lifeblood of a company and can be used to finance growth, new opportunities, and more.
This blog post will discuss working capital, the different types, and everything you should know about it!
What is Business Capital, and What Role Does it Have in Business and Companies?
Capital is the resources (money, property, assets) used to produce goods and services. Capital can include physical assets such as buildings or equipment, including intangible factors like intellectual property rights (patents).
The term has many different meanings depending on context. Capital refers to economic capital when referring specifically to financial transactions involving money – such as loans, investments, and shares.
Capital is one of the essential factors in determining success or failure in a business context. A company’s ability to generate profits depends on its ability to generate more revenue than it spends – and this requires adequate levels of operational and financial capital.
When it comes to business, there are two main types of capital that you can use:
Debt and Equity. Debt refers to the repayment of a loan or other form of credit with interest. At the same time, equities generally do not require direct obligations. Instead, owners will receive shares representing their ownership position in your company – thus “stock” equity.
#1. Debt Capital
Debt capital is a loan or other form of credit that must be repaid-with interest. It’s one of the most common types of financing for businesses. It can come from various sources, such as banks, angel investors, venture capitalists, and more.
The advantage of debt capital is that it’s often less expensive than equity capital. Debt capital means you don’t have to give up ownership rights in your company when seeking funding through debt financing.
One downside is that it can be riskier than equity financing because there’s no guaranteeing how well the business will perform. If the company fails, creditors may come after personal assets (like houses and cars) or even liquidate assets.
Bonus Read: Types of GST in India- CGST, SGST, and IGST Explained
#2. Equity Capital
Equity capital refers to a stock offering in which shares are sold at an initial price of Rs. 100/- per share, and then investors can buy more or less depending on how well they think it will perform over time-and, whether they believe that price should go up or down based on that.
The advantage of equity capital is that it gives business owners the chance to raise large sums of money. And under equity capital, the owner shall keep control of their company; they don’t have to pay back debt with interest.
One downside is that it can be more expensive than debt financing. There’s also the risk that the company will not perform as well as expected or even fail altogether-which could mean huge losses for those who invested their money.
What is Working Capital?
Working Capital is also termed Net Working Capital and is the company’s liquidity. It is determined by subtracting current liabilities from current assets.
For Example:
If a firm’s balance sheet shows total current assets of Rs. 600,000 lakhs and total current liabilities of Rs. 500,000 lakhs, then the firm’s working capital is Rs. 100,000 lakhs (Current Assets-Current Liabilities).
Current Assets are Cash, Accounts receivables, unpaid bills from customers, finished goods, raw materials, etc., that can be converted into cash within one year. In comparison, Current Liabilities are summed up by accounts payable and debts of the company that needs to be paid within one year.
Types of Current Assets and Current Liabilities in a nut-shell:
Working capital is vital for two reasons:
- A company needs to have enough cash on hand to pay its short-term liabilities;
- To finance the day-to-day operations of the business.
Importance of Working Capital
A lack of working capital can lead to cash flow problems for a business. Impacting companies ability to pay its bills and employees and purchase new inventory or invest in new equipment.
Working capital management is a crucial component of any company’s operations. It can help maintain smooth business functioning and improve profitability by ensuring that the right resources are available when needed most.
Also Check: Top 10 Government Loan Schemes for Small Businesses in India
Types of Working Capital
India has an important place in the international arena. It is not surprising that there are many ways for businesses and investors to invest their money here! One such way would be through working capital financing. Banks provide short-term loans with interest rates higher than traditional borrowing costs so you can buy equipment or inventory. Depending upon the frequency and credit needs of the company, working capital has been bifurcated into the following types:
#1. Permanent Working Capital
Permanent working capital is a type of financing that a company can use to fund long-term assets. This type of financing is typically used to purchase equipment, property, and manufacturing facilities.
Permanent working capital is a type of financing that a company can use to fund long-term assets. This type of financing is typically used to purchase equipment, property, and manufacturing facilities.
The main benefit of permanent working capital is that company can use it to finance long-term assets. That would otherwise not qualify for traditional bank loans.
Permanent working capital is also known as fixed working capital. The level of investment required to get your company up and running will depend mainly on the size, growth potential, and industry in which you plan for it.
Permanent working capital can be further split into two types, i.e.-
- Perpetual Working Capital
The minimum capital required to maintain regular day-to-day operations is known as perpetual working capital, for example, salaries, wages, and expenses for purchasing raw material.
- Reserve Margin Working Capital
Working Capital is essential for running a business, but it’s not enough.
Reserve Margin Working Capital helps maintain an emergency fund that can be used when needed most. Such as in case of unforeseen circumstances like natural disasters or other emergencies.
This type of working capital is also known as safety net capital or cushioned capital.
#2. Variable Working Capital
Working capital invested for the short-term in business or companies is called variable working capital. This type of capital is directly proportional to the size of the business, i.e. the volume of variable working capital shall change as per the organisation’s assets or business.
Variable working capital is financing that gives companies the ability to respond quickly to changes in the business environment. This type of financing is ideal for businesses with high inventory or accounts receivable levels.
Types of variable working capital:
- Seasonal Working Capital
Variable working capital can be used for short-term financing needs related to seasonal fluctuations. For example, suppose a company sells snow shovels in the winter months and lawnmowers during the summer months. In that case, it will need more money on hand when demand is high, so they do not run out of these items when sales increase.
A business with seasonal working capital needs requires additional funds to increase inventory during peak periods and reduce the size during low periods.
- Fluctuating Working Capital
Variable working capital is also used for businesses with fluctuating revenues or expenses. For example- if you’re running an e-commerce business, it should have enough money to pay employees and buy supplies. When sales drop during the holiday season or if you work as a freelancer, you need more funds than usual months because your income will fluctuate throughout the year.
- Special Variable Working Capital
Sometimes businesses have to face unexpected or surprising expenses. For those circumstances, a provision is kept, which is called a Special Variable Working Capital. The company uses the working capital for marketing drives, unfortunate events like fire, earthquake, or flood.
#3. Gross Working Capital
Gross working capital refers to all the current assets of a business, including inventory, accounts receivable, and cash.
Gross Working Capital is a measurement that shows how well your company would perform in the short term. However, it doesn’t show us anything about their operational efficiency or ability to generate profit until we find out the volume of current liabilities of the company.
Gross Working Capital is a measurement that shows how well your company would perform in the short term. However, it doesn’t show us anything about their operational efficiency or ability to generate profit until we find out the volume of current liabilities of the company.
#4. Net Working Capital
The difference between a company’s current assets and liabilities is net working capital. This figure gives analysts and investors an idea of how quickly a company can repay its short-term debts.
A healthy net working capital means that a company has more short-term assets than liabilities, indicating that it should pay off its debts without taking additional debt.
A negative net working capital means that a company has more liabilities than assets. Indicating that it may have trouble repaying its short-term obligations in the future unless liquidity increases dramatically or decreases significantly.
Conclusion
So, what is working capital? In short, it is the lifeblood of any business. It ensures that your company can continue to operate smoothly and meet its financial obligations. Without it, you may find yourself in a difficult situation. That’s why it’s so important to make sure you have enough working capital in reserve to cover any unexpected costs or expenses. Hopefully, this article must have helped give you a better understanding of what working capital is and why it’s so crucial for businesses of all sizes. Are there any other questions you still have about this topic? Let us know in the comments below, and we would be happy to answer them!
