Concept of Working Capital: Gross and Net Working Capital

One of the key determinants of short-term financial stability, working capital refers to the ability of an organisation to pay off all the current liabilities. Therefore, the working capital ratio (also referred to as current ratio) calculated as Current Assets / Current Liabilities – indicates if the organisation’s short-term assets are sufficient to cover all short-term debt; that is finance regular business operations such as paying off creditors, purchasing and maintaining inventory and the like. Working capital can be classified into primarily two categories – gross working capital and net working capital.

Putting it down to a simple equation:

Working capital = Current assets – Current liabilities

While current assets include cash, inventories, accounts receivables, sundry debtors and other investments made over the short term, current liabilities include bills payables, sundry creditors and accrued expenses.

A current ratio of 2:1 is considered to be good as it hints at the organisation’s financial soundness. While a ratio less than 1 (negative working capital) would mean potential liquidity issues, a current ratio exceeding 2 suggests that a firm may not be optimally leveraging its current assets to generate increased revenue. A working capital ratio that’s on the lower side (usually less than 1) is an obvious red flag as it could be hinting at possible bankruptcy.

Types of working capital

According to value, working capital can be classified into:

• Gross working capital: It refers to the sum of current assets lying with the organisation. However, arriving at the gross ratio is not a standard indicator of an organisation’s financial health. This is because while short term borrowing would register an increase in the current assets, it would simultaneously pull up the current liabilities as well.

Therefore, Gross working capital = Sum of all current assets

• Net working capital: It refers to a concept of accounting wherein current assets exceed current liabilities. This is the better indicator of an organisation’s liquidity and financial soundness.

Therefore, Net working capital = Current assets – Current liabilities

Considering a fictitious balance sheet of XYZ Ltd:

According to the table, gross working capital will be calculated as under:

And, net working capital will be calculated as under:

Managing working capital matters since it an important metric that outlines the three most crucial aspects of an organisation’s operations – liquidity, profitability and the overall financial standing. Select lenders and NBFCs offer working capital loans in order to aid businesses in meeting their regular operational expenses, without any hassle.

For instance, Bajaj Finserv Working Capital Loan sanctions up to as much as Rs.30 lakhs on an unsecured basis, at competitive interest rates that can be repaid over a flexible tenor ranging from 12-60 months. You can avail this loan to finance short-term debt and other routine expenditure such as paying off creditors on time, making vital additions to your inventory, recruiting and training new people on the job, paying their salaries/wages, and ramping up organisational presence by investing in marketing and advertising campaigns. In addition to this, its Flexi Loan facility allows you to withdraw from within a predetermined limit (as per the requirements) and pay interest only on what you borrow and not the entire loan amount. There are no extra charges are levied on partial prepayment of the loan and you can also pay only interest as EMIs with the principal payable at the end of the tenor.

You can share a few basic details about yourself and get pre-approved offers, exclusively for you, on a range of loans from Bajaj Finserv.

Read Also: Types of Working Capital

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Anuj Joined: January 5th, 2018