Working capital (WC) forms the lifeblood of a business organization as it keeps the operation running smoothly. Whether it is paying off creditors, providing salaries or upgrading inventories, an enterprise can never achieve its full potential without adequate working capital.
However, as a business owner, merely facilitating working capital is not enough. One must understand the different types of working capital to gain a complete perception. Broadly, it consists of 2 types – WC under the balance sheet view and WC under the operating cycle view.
Balance sheet view
Under the balance sheet view, working capital is of 2 types:
Gross working capital
It is denoted as the money/capital that you have invested in your company’s current assets. These assets have high liquidity; hence, you can convert them into cash within a short time-span. Examples of these current assets include prepaid expenses, debtors and stock.
It is the difference between your company’s current assets and liabilities as per the balance sheet. It is further segregated into positive and negative working capital. The former denotes your firm’s current assets have exceeded its current liabilities. On the other hand, the latter is when current liabilities outperform the current assets.
Between these two, net working capital is more widely used as it indicates your firm’s ability to meet the current liabilities and also shows whether your enterprise is financially sound or not.
Operating cycle view
Under this type of working capital, there are two classifications based on the time it takes for converting stocks into cash for your business.
Permanent/Fixed working capital
Permanent working capital varies from one firm to another. Primarily, it is based upon the networking capital amount in one financial year. This type of WC signifies the minimum investment that is required for your company to maintain its day-to-day expenses. If your business falls short of this fixed capital, applying for business loans can help you overcome this cash crunch.
Variable/Temporary working capital
This is the difference between net WC and permanent WC of your firm. Temporary working capital is required to meet your company’s extra cash necessities due to fluctuations in production and variable seasonal sales.
For instance, if your company manufactures umbrella, you will naturally increase your stock as the season commences, by anticipating the demand. Therefore, you will require additional funds to meet this temporary capital vacuum. A WC loan can be a viable financial aid in such circumstances.
Besides these, there are other types of working capital like reserve/cushion working capital. It denotes the short-term financial arrangement made by a firm to tackle uncertain changes. An enterprise always operates with certain risks. Reserve working capital cushions the impact in cases of uncontrollable risks and sustains them.
There is also special working capital, which is used to conduct special programs for business expansion and development. The applications can include advertisement campaigns, sales promotion, and market research, product development, launching new products or services and the like.
Now that you know the various types of working capital, it is essential to monitor them. This is to ensure that there are any signs of depletion; you can meet that deficiency before it impacts your firm’s productivity.