Write short notes on ‘Working Capital’.
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Working Capital:
Working capital represents the funds available for the day-to-day operations of a business. It is the difference between a company's current assets and current liabilities. Current assets include cash, accounts receivable, and inventory, while current liabilities consist of short-term obligations like accounts payable and short-term debt.
Significance:
Liquidity Management: Working capital measures a company's ability to meet its short-term obligations. Maintaining an optimal level ensures liquidity for daily operations and flexibility to seize opportunities or weather financial downturns.
Operational Efficiency: Efficient working capital management ensures that a company has the right amount of resources to support its production and sales cycles. It prevents overstocking or stockouts, optimizing production and sales processes.
Cash Flow Stability: Adequate working capital contributes to stable cash flows, reducing the risk of financial distress. It allows a business to pay its bills, meet payroll, and cover other operational expenses in a timely manner.
Creditworthiness: Lenders and suppliers often assess a company's working capital position to evaluate its creditworthiness. A healthy working capital position signals a company's ability to meet its financial obligations.
Formula:
[ \text{Working Capital} = \text{Current Assets} – \text{Current Liabilities} ]
Types:
Positive Working Capital: When current assets exceed current liabilities, indicating a healthy financial position.
Negative Working Capital: When current liabilities surpass current assets, suggesting potential liquidity challenges. Some industries, like retail, may intentionally operate with negative working capital.
In summary, working capital is a critical financial metric that reflects a company's short-term financial health. Effective management of working capital is essential for sustaining operations, managing cash flows, and supporting overall business stability and growth.