Working capital refers to the circulating capital required to meet the day to day operations of a business firm. According to Weston & Brigham, “Working capital refers to a firm’s investment in short term assets, such as cash amounts receivables, inventories etc.”
Working capital has been described as the “life blood of any business which is apt because it constitutes a cyclically flowing stream through the business.
Concepts of Working Capital
1. Gross Working Capital: It refers to the firm’s investment in total current or circulating assets.
2. Net Working Capital: The term “Net Working Capital” has been defined in two different ways:
- It is the excess of current assets over current liabilities. This is, as a matter of fact, the most commonly accepted definition. Some people define it as only the difference between current assets and current liabilities. The former seems to be a better definition as compared to the latter.
- It is that portion of a firm’s current assets which is financed by long-term funds.
3. Permanent Working Capital: This refers to that minimum amount of investment in all current assets which is required at all times to carry out minimum level of business activities. In other words, it represents the current assets required on a continuing basis over the entire year. Tandon Committee has referred to this type of working capital as “Core current assets”.
4. Temporary Working Capital: The amount of such working capital keeps on fluctuating from time to time on the basis of business activities. In other words, it represents additional current assets required at different times during the operating year. For example, extra inventory has to be maintained to support sales during peak sales period. Similarly, receivable also increase and must be financed during period of high sales. On the other hand investment in inventories, receivables, etc., will decrease in periods of depression.
Suppliers of temporary working capital can expect its return during off season when it is not required by the firm. Hence, temporary working capital is generally financed from short-term sources of finance such as bank credit.
5. Negative Working Capital: This situation occurs when the current liabilities exceed the current assets. It is an indication of crisis to the firm.