Question

What is working capital?

Hint:

Effective working capital management is critical for maintaining liquidity, ensuring operational efficiency, and avoiding financial distress.

Answer 1

Working capital is the difference between a company's current assets and current liabilities, representing the funds available for day-to-day operations. It is a measure of a company's liquidity, operational efficiency, and short-term financial health. The formula to calculate working capital is:
\[ \text{Working Capital} = \text{Current Assets} - \text{Current Liabilities} \] Types of Working Capital:
1. Gross Working Capital: Refers to the total current assets of the company, such as cash, receivables, and inventory.
2. Net Working Capital: Represents the surplus of current assets over current liabilities.
Significance:
- Positive working capital indicates the company can meet its short-term obligations, maintain operations, and invest in growth.
- Negative working capital suggests potential liquidity issues, which can impact the company’s ability to operate smoothly.
Factors Affecting Working Capital:
1. Nature of Business: Manufacturing companies require higher working capital than service-oriented firms.
2. Operating Cycle: A longer operating cycle increases the need for working capital.
3. Market Conditions: Economic downturns or inflation can affect the need for working capital.
Working capital ensures the uninterrupted functioning of an organisation by meeting operational expenses such as salaries, raw material purchases, and utility payments.