Working Capital

Those involved in the world of accounts will tell you that a business is as strong as its working capital, and then there others in the same field who would beg to differ. But whatever the consensus on that may be, we know that in a business, working capital is essential. But what exactly is working capital?

Simply put, working capital is the difference between current assets and current liabilities and it is the amount of liquefiable capital available to a company to build itself. It doesn’t mean that working capital will always be positive, there are times when it can be negative and this happens when the current assets are more than the current liabilities. More importantly a company needs working capital for its day-to-day activities like those of paying wages, paying for raw material and bills. When a company finds itself short of working capital it uses its current assets to get money.

We have already understood the fact that working capital is essential for a business, in fact in some cases, working capital is the essence on the basis of which the business functions. But why is working capital so essential? Basically it is needed for the smooth functioning of the business. A business in fact requires just the right amount of working capital, too much and too little working capital is detrimental to the business.

Elements of Working Capital

Working capital has certain elements and for a business to function smoothly, it needs to be aware of these elements of working capital. These are:

• Cash – this is probably the most essential element or component of working capital. Without cash a business cannot run smoothly. But cash in the business needs to be monitored careful along with proper budgeting and forecasting. Cash inflow and cash outflow need to be monitored properly.
• Accounts receivable – every business has some debtors, people or other businesses that owe them money, these in accounts lingo are called accounts receivable. Simply put these are amounts that are yet to be received from debtors. Accounts receivable have to be monitored properly and checked.
• Inventory or Stock - the inventory in a company is half of its currents assets and hence needs more monitoring than everything else. The level of the inventory or stock needs to be at a particular level, the rate of turnover also needs to be monitored closely. All this is an important aspect of the working capital.
• Accounts payable – like every company has debtors, people who owe you money, similarly every company has creditors to whom they owe money. Its normal for businesses to owe money to their suppliers and other businesses, this is because sometimes the amounts to be paid are large and will need some time to be paid off. It is important to track these payable amounts also called accounts payable for the purpose of working capital but also for goodwill reasons.
• Outstanding expenses and payable taxes – these are certain outstanding that the company has and that will reflect on the working capital.

Each company has different working capital requirements, this requirement depends on different factors, and these are:

• Type of Business.
• Size of business.
• Production policy.
• Process of manufacturing.
• Changes in seasons.
• Working capital cycle.
• Turnover rate of inventory.
• Policy for credit.
• Business cycles.
• Rate at which business grows.
• Changes in pricing.
• Dividend policy and capacity of earning.

We now know how important working policy is, but what happens to the business when there isn’t sufficient working capital? Immediately affected will be the fixed assets that wont be able to function properly because of lack of working capital. There is always the risk of dissolving the company because it cannot sustain on the lack of working capital. The credibility of the company will also be affected; all these will just result in bad losses and like mentioned before the liquidation of the business to cope with these losses.