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What is Working Capital? Meaning.
Working Capital is the amount by which current assets exceed current liabilities. It is used to fund the operations of a company or non-profit organization, such as purchases of raw materials, office supplies, salaries, etc.
It can be regarded as the lifeblood of a business, because it is needed to finance the cash conversion cycle of a business: the number of days required to convert raw materials into finished goods, finished goods into sales, and accounts receivables into cash.
Along with fixed assets (such as plant and equipment), working capital is considered a part of operating capital.
Working Capital Deficiency
If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit. A positive working capital is vital to ensure that a firm is able to continue its operations and that it has sufficient funds available to satisfy both maturing short-term debt and upcoming operational expenses.
The Meaning of an Increase or Decrease of Working Capital
An increase in working capital indicates that the business has either increased current assets (that it has increased its receivables, or other current assets) or has decreased current liabilities, for example has paid off some short-term creditors.
How much Working Capital is Needed?
The amount of working capital needed varies with a number of factors, including: type of industry, efficiency of production processes, economies of scale, seasonality, sales success, etc. A (temporary) shortage in the working capital can easily lead to bankruptcy of a small firm, even if it has many profitable orders coming. In debt contracts, the borrower may be obliged to maintain certain levels of working capital. Such clauses are called Affirmative Debt Covenants.
Sources of Working Capital
Internal sources include: retained earnings, savings through achieving operating efficiencies, allocation of cash through depreciation, deferred taxes.
External sources include: short-term borrowings, trade credit, accounts receivables factoring.
Working Capital Management
This involves managing the relationship between a firm's short-term assets and its short-term liabilities via a combination of policies and techniques, such as cash (flow) management, inventory management, debt management and short term financing. The aim of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses.
Compare with: Current Ratio | Working Capital Ratio | Microfinance | EBITDA | Cash Value Added | Return On Net Assets | Just In Time | Accounts Receivables Factoring | Recapitalization | Undercapitalization | 3rd Party Logistics (3PL) | Sale and Leaseback
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