Working capital

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 Working capital refers to the funds required by a business to finance its day-to-day operations, such as purchasing raw materials, paying salaries, and meeting other short-term expenses. It is the amount of money needed to cover the cost of running a business on a daily basis.


Components of Working Capital  ; 


1. Current Assets : These are assets that can be converted into cash within a short period, typically within a year. Examples include:

    - Cash and bank balances

    - Accounts receivable (amounts owed by customers)

    - Inventory (goods and materials held for sale)

    - Prepaid expenses (expenses paid in advance)

2. Current Liabilities : These are liabilities that must be paid within a short period, typically within a year. Examples include:

    - Accounts payable (amounts owed to suppliers)

    - Short-term loans and debt

    - Taxes owed

    - Accrued expenses (expenses incurred but not yet paid)


 Formula to calculate working capital ; 


Working Capital = Current Assets - Current Liabilities


Types of Working Capital ; 


1. Gross Working Capital : This refers to the total amount of current assets.

2. Net Working Capital : This refers to the difference between current assets and current liabilities.

3. Permanent Working Capital : This refers to the minimum amount of working capital required by a business to operate smoothly.

4. Variable Working Capital : This refers to the additional working capital required by a business to meet seasonal or cyclical fluctuations in demand.


Importance of Working Capital ; 


1. Ensures Smooth Operations : Working capital ensures that a business has sufficient funds to meet its day-to-day expenses.

2. Maintains Liquidity : Working capital helps a business to maintain liquidity, which is essential for meeting short-term obligations.

3. Supports Growth : Working capital provides a business with the necessary funds to invest in growth opportunities.

4. Manages Risk : Working capital helps a business to manage risk by providing a cushion against unexpected expenses or revenue shortfalls.


Sources of Working Capital ; 


1. Internal Sources : Retained earnings, dividends, and sale of assets.

2. External Sources : Loans from banks and other financial institutions, issuance of debt and equity, and factoring and invoice discounting.

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