Different Types of Working Capital-Explained
There are numerous types of working capital. Here is a look at some of the most popular ones:
1. Gross Working Capital
Gross working capital refers to the amount any firm has invested in assets that can turn into cash very quickly. Examples of gross working capital include assets high in liquidity, such as stocks.
2. Net Working Capital
Working capital, which is also referred to as net working capital or NWC, is defined as the difference between any firm or company’s current assets, which includes cash, accounts receivable or unpaid bills, raw materials inventory, etc., and its current liabilities, which includes accounts payable and debts. It can either be positive or negative working capital. It represents a company’s liquidity.
3. Positive Working Capital
Positive working capital is obtained by a business when its current assets outweigh its current liabilities. When a company has positive working capital, it faces lesser risks when paying short-term debts.
4. Negative Working Capital
Negative working capital refers to the condition when a company has more current liabilities than current assets. When this situation happens, it becomes a cause of concern for both lenders and creditors, primarily because the firm may not have sufficient funds to allocate for fulfilling short-term requirements.
5. Special Working Capital
Special working capital refers to the rise in temporary working capital, which happens when a special event takes place. It does not have any basis to forecast and rarely occurs.
For instance, award functions happen annually, for which the hosting company requires ample funds. Acquiring a special working capital loan is one of the most effective ways the company covers the cost of such extravagant events. This is suitable for big companies since acquiring special working capital loans requires them to pledge assets as collateral.
6. Permanent / Fixed Working Capital
Permanent working capital or fixed working capital refers to the basic amount of funds or capital required by a company to ensure that it operates smoothly and efficiently. It is the base investment amount for all variants of current resources, provided for carrying out business-related activities at all times. The overall value of assets fluctuates, i.e., increases or decreases over time. However, a company requires minimum running assets to carry out business operations efficiently.
7. Seasonal Working Capital
Seasonal working capital is the increased amount of working capital that any business or firm requires during its financial year’s peak season.
A business may borrow funds by taking a loan to meet its working capital needs during the peak season. Having a solid working capital facilitates companies to meet financial demands during the peak season.
8. Regular Working Capital
Regular working capital is the least amount of funds any company requires to fund its daily operations. Some examples include salary and wage payments, and overhead expenses for raw material processing.
9. Temporary Working Capital
Temporary working capital or variable working capital refers to the extra amount of funds a business requires besides its permanent counterpart.
It is directly related to a business’ production volume. Since a company’s sales and production are not fixed, working capital requirements also vary throughout the year.
10. Reserve Working Capital
Reserve working capital refers to funds a business maintains besides the required working capital. It is deemed as contingency funds that may come in handy in unexpected situations.
Working Capital Formula
The working capital formula reduces a company’s current liabilities from its current assets. Doing so facilitates them to measure the funds that are available for operations and enhancing growth.
If the positive value comes back as the answer, the company has enough cash to conveniently cover short-term expenditures. On the other hand, if the number is negative, it means that the company is struggling.
Working capital can easily be calculated using the formula = Working capital + Current assets – Current liabilities.
Current assets refer to cash and other forms of assets that are expected to be converted to cash within twelve months. Current assets generally include cash, cash equivalents, stock inventory, etc.
Current liabilities refer to a company’s short-term financial obligations that are due within twelve months or within a regular operating cycle.
Working Capital Management
Working capital management refers to a business plan or strategy designed to ensure that a firm or organisation operates smoothly and efficiently by monitoring and using its current assets and current liabilities in the most efficient way possible.
The primary purpose of working capital management is to enable firms to maintain sufficient cash flow to fulfil short-term funds requirements and debt obligations.
Working Capital Cycle
The working capital cycle, or WCC, refers to the time taken to convert a company’s net current assets and liabilities into cash.
A long-term cycle refers to tying up capital for more extended periods without earning profits. On the other hand, a short-term cycle facilitates businesses to free up funds quicker.
Working Capital Finance
Working capital finance refers to a business borrowing funds to cover day-to-day expenditures and payroll rather than opting for equipment purchases or investing somewhere. Working capital finance is a common practice for companies with inconsistent cash flow.
Operating Cycle View of Working Capital
The operating cycle view of working capital or the cash operating cycle refers to the days between paying suppliers and receiving cash payments from sales. In simpler terms, it can be determined by adding the inventory and receivables days and subtracting the payable days.
Types of Working Capital Loans in India
The three types of working capital loans in India are:
- Short-term or long-term working capital loans.
- Unsecured working capital loans
- Secured working capital loans
Yes, depending on the kind of working capital loan you opt for, i.e., secured or unsecured, you may or may not be required to pledge assets as collateral.
Yes, limited companies can apply for loans.
Yes, partnership firms are eligible for obtaining working capital loans.
The preferred forms of collateral for working capital loans include industrial, residential, or commercial properties.
Yes, sole proprietorship firms are eligible for working capital loans.