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India is dealing with high commodity prices and borrowing costs along with a low rupee value. Also, Russia-Ukraine war conditions have impacted the economy. As a result, the working capital need for Indian firms might rise by 28% in FY23.
Working capital helps meet daily expenses. So, a firm should have sufficient working capital. Moreover, business owners must know about it to survive and succeed.
In this blog, we’ll help you understand working capital and how to calculate it. To begin with, let’s discuss what working capital is and why it’s vital for firms.
Working capital is the money a firm has to meet its current, short-term obligations. In other words, a firm needs this money for its daily expenses. So, it is a type of short-term funding for firms.
There are four types of working capital:
The table given below explains the types of working capital:
Basis of Categorisation | Type | Meaning |
Concept | Gross working capital | Total current assets |
Concept | Net working capital | Difference between current assets and current liabilities |
Time | Permanent working capital | Business’s minimal operating capital. The firm begins with little working capital and must maintain it to sustain operations. Except for company growth or contraction, it intends to stay steady from year to year. |
Time | Temporary working capital | Working capital exceeding the permanent level that usually fluctuates and is not fixed at any rate. |
Having enough working capital is vital for firms. There are many reasons for it:
Make sure your business has enough working capital. To do this, firstly, check how much working capital you have now. Second, estimate how much you’ll need in the future. And finally, plan how you can always have enough cash on hand.
You should also learn how to calculate a firm’s working capital. As a result, you can plan for your firm’s growth. Also, you can maintain your firm’s financial health.
The formula to find out working capital is easy. And here it is:
Working Capital = Current Assets – Current Liabilities
Let’s put this in words: working capital is the difference between current assets and current liabilities. To clarify, you have to subtract current liabilities from current assets to find out the working capital. Now, let’s define current assets and current liabilities:
A firm expects to turn these assets into cash in a year. For instance:
A firm expects to pay these obligations in a year. For example:
Let’s say a firm has a positive working capital. In general, it means that the firm has enough money to pay for its short-term expenses.
But there may be other reasons too. For example, the firm perhaps doesn’t invest its excess cash in a wise way. Plus, it aims to boost liquidity. So, it skips the chances of growth. Also, it may invest a lot in inventory.
On the other hand, let’s say a firm’s working capital is negative. Then, it means that the firm lacks enough working capital. As a result, it may be hard for the firm to meet its short-term obligations.
But it also has another meaning. For example, the firm might have used excess cash to create investment income. Plus, it funds growth projects with its surplus cash.
So, working capital can have many meanings. An example can help you know this better.
Tata Steel is a leading steel manufacturing firm in India. In March 2022, its current liabilities were ₹53,664.83 crores, and its current assets were ₹31,289.57 crores.
As per the formula:
WC = 31,289.57 – 53,664.83
WC = (–22375.26)
So, the working capital is negative. Thus, you may think that Tata Steel lacks the money to pay off its short-term debts. However, it may also be so that it has used the cash for other business objectives and also has the creditworthiness to establish longer repayment timelines with its operational creditors.
But note that not all big firms have a lot of working capital. In fact, some even have negative working capital. So, Tata Steel might be such a firm.
Then, how do these firms pay their short-term debts? Actually, low working capital isn’t the sole criterion to determine if a firm is a solvent. Indeed, many factors come into play. For example, the firm should also have strong:
As a result, these firms may make more money in less time. For instance, they can shuffle money from other operational silos. Also, they can take out long-term loans.
To sum up, if your firm has proper working capital, it’s vital for its overall success. For instance, it makes sure the firm has enough money to pay for day-to-day expenses. Also, it allows the firm to invest in growth avenues. Plus, it helps with financial issues.
It is easy to calculate working capital. Just subtract total current liabilities from total current assets. Moreover, when you learn to make sense of working capital, you’ll know better about your firm’s finances.
If you have questions about financing, you can seek guidance from GJM & Co. Our experienced professionals can assist you. Furthermore, we will also help you calculate your firm’s working capital with other necessary data and reports to help you understand and improve your business’s financial health.
Should you have any queries or need consultation, Schedule a Call today or write to us at info@gjmco.in.