The capital which is required to finance current assets is called working capital. It is the capital of a business that is used to carry out the day-to-day business operations of a firm.
“Working capital may be defined as all the short term assets used in daily operation”—John. J Harpton.
Working Capital =Current assets –Current Liabilities
An asset is classified as current when:
- It is expected to be realized or intends to be sold or consumed in the normal operating cycle of the entity;
- The asset is held primarily for the purpose of trading;
- It is expected to be realized within twelve months after the reporting period;
- It is cash or cash equivalent.
Generally, current assets of an entity, for the purpose of working capital management can be grouped into the following main heads:
- Inventory (raw material, work in process, and finished goods)
- Receivables (trade receivables and bills receivables)
- Cash or cash equivalents (Cash equivalents are short-term marketable securities)
- Prepaid expenses.
A liability is classified as current when:
- It is expected to be settled in the normal operating cycle of the entity
- The liability is held primarily for the purpose of trading
- It is expected to be settled within twelve months after the reporting period.
Generally, the current liabilities of an entity, for the purpose of working capital management can be grouped into the following main heads:
(a) Payable (trade payables and bills receivables)
(b) Outstanding payments (wages & salary etc.)
In general, Working capital management is essentially managing Current Assets, management of working capital arises as a part of the process of such management.
Short term assets of a firm mean cash money, short-term securities, inventory, bill receivable, note receivable, debtors, etc. In operating the daily business, fixed assets are also needed in addition to current assets. Though some fixed assets help on the daily operation of a firm, these can’t be termed as working capital, because these can’t be converted into cash in the current accounting period. So, the assets which can be converted into raw material from cash—R/M—Finished Goods—B/R—Cash and helps in operating daily business of the firm, is called working Capital. Working capital is also called ‘Trading Capital”, Circulating capital/Short term capital /Short /Current Assets management.
Working capital is defined keeping in view the varying objectives and purposes. To businessmen, working capital comprises current assets of business whereas to the accountant/creditors/investment analysts working capital is understood as the difference between current assets and current liabilities. This is also called the Net Working Capital. There are operative aspects of working capital i.e. current assets (which is known as ‘funds’ also) employed in the business process from the gross working capital. Current assets comprise cash, receivables, inventories, marketable securities held as short-term investments, and other items near cash or equivalent to cash. This is also known as the going-concern concept of working capital.