Working Capital refers to the reserve of liquid cash, for using at the time of financial emergencies and uncertainties. Working Capital represents the amount of operating liquidity required by a business house on a regular basis. It also measures the temporary financial status and efficiency of a company simultaneously, and is calculated as:
Together with the fixed assets of a company, Working Capital is also considered to be an important part of the operating capital of the company.
Categories of Working Capital:
Working capital is normally segregated into two different categories, namely:
Positive Working Capital: indicates the capability of a company to repay all its temporary liabilities.
Negative Working Capital: denotes the inefficiency and inability of a commercial organization for paying-off its temporary liabilities, along with the current assets which include account receivables, cash and inventory.
Working Capital Management:
Working capital management forms a significant part of corporate finance. It refers to the decisions taken with respect to the short-term financing and working capital. Working capital management includes effective handling of the association between short-term liabilities and short-term assets of a commercial firm.
Role of Working Capital:
The working capital plays a major role in financial reports and statements. Analysis of working capital is always important and critical for both creditors and lenders on the following grounds:
Cash Conversion Cycle: It is the measurement of the working capital efficiency of a commercial entity, rendering useful hints about the basic conditions of its business firm. This cycle calculates the average number of days required for the investment of working capital in the operating cycle. Such calculation begins with the addition of ‘Days Inventory Outstanding’ (DIO) to the ‘Days Sales Outstanding’ (DOS). This is because a company makes cash investment for building or obtaining inventory and not for accumulating cash, until the inventory is sold and there is a final collection of the account receivable.
Equity Valuation: With respect to the equity valuation and the growth prospects of a company, working capital is essential to detect whether the company is an asset or capital intensive or people or service intensive, when it is at the risk of oversimplifying.
Inventory Balances: Working capital is important for calculating the inventory balances, which affects the reported gross profit margins of a company, in the form of inventory cost accounting. Gross profit margin measures the value offered by the customers or the pricing power of the company in the industrial sector, and under the constant vigilance of the investors.
|Concepts in Financial Report||Earning Statement||Basics in Financial Statement|
|Long Term Assets||Long Term Liabilities||Pension Plan|
|Working Capital Statement||Financial Statement :Revenue||Stock Holder Statement|
Last Updated on : 2nd July 2013