Understanding Different Types of Working Capital

The day-to-day expenses for business operations need a working capital that reflects the short-term finances of the company. There are different types of working capital based on the value of the amount and the utility time frame.

What is Working Capital?

Working capital reflects the company’s immediate financial status and the comprehensive efficiency of its business operations. This can be determined from the balance sheet by subtracting the current liabilities from the current company assets. The current assets indicate the capital in the bank account and the company assets that can be easily liquidated to cash as and when required. This comprises cash, inventory, and accounts receivables. The current liabilities could be salaries of the employees, tax deductions, and the interest owed.

In simpler terms, working capital indicates the financial health of the company. When the company has more debts over assets, it's representative of negative working capital. The goal is to have a healthy balance of assets and liabilities and have a regular working capital streamlined for smooth business operations.

Types of Working Capital

Generally, the working capital is leveraged to support the business operations, fulfill any short-term immediate requirements or obligations, and support the salaries of the employees, taxes, and any debt or interest payments in the event of crises related to cash flow. Let’s explore different types of working capital and understand its impact on the company's operations.

Permanent working capital

The minimum capital required for managing the business operations and covering any liabilities is called the permanent working capital. This is indicative of the minimum current assets held by the company for normal operations and the exact amount varies according to the growth of the business. When the business is growing aggressively, the liabilities will amplify and require a higher working capital for business continuity. The permanent capital can be further categorized as follows:

- Regular working capital: This comprises the fundamental capital to support the daily operations that include salaries, maintenance, rent, and other overhead expenses. Companies need to have a regular working capital that suffices the operational requirements and ensures financial stability.

- Reserve margin working capital: This is the additional working capital required alongside the regular working capital. The reserve margin funds can be considered as the emergency fund in the event of any unexpected circumstances like market fluctuations, natural calamities, etc.

Variable or Temporary working capital

Variable or temporary working capital is generally used by companies as a short-term investment, with the amount of capital varying according to the growth and size of the company. The temporary working capital can be further classified into two types:

- Seasonal working capital: It is one of the types of working capital that helps with the increased demand for working capital according to seasonal fluctuations for business requirements. Businesses need higher working capital temporarily to complete their seasonal needs, which can be met through borrowing funds or taking loans.

- Special working capital: When businesses focus on expansion or face any unexpected crisis, they need funds for risk management and implementing novel growth strategies. The special working capital helps with these temporary requirements and streamlines the launch of new products or campaigns.

Net Working Capital

One of the most important types of working capital, net working capital is calculated through the figurative differences between the net current assets and net current liabilities. When companies have adequate net working capital, it is a positive sign indicating the company’s business structure is aligned to meet the futuristic vision through big targets. When companies lack the net working capital, there is a higher chance of bankruptcy when cash flow challenges persist.

Gross Working Capital

The gross working capital represents the overall current assets of the company such as cash receivables, short-term or liquid investments, particularly market securities. The gross working capital does not indicate the current liabilities and can be determined by calculating the difference between existing assets and current liabilities. This amount is the inherent working capital required by the company to fulfill all its obligations.

Negative working capital

Negative working capital is required for business operations when the current liabilities are higher than the current assets owned by the company. This signifies the weak financial health of the company and indicates the company needs more working capital to pay off the short-term debts that cannot be settled with the currently available assets. Businesses with the need for negative working capital have a higher chance of bankruptcy if the same working capital cycle continues for a longer period. When companies leverage negative working capital, this is the moment of awareness to proceed further with careful monitoring and taking proactive steps to primarily focus on financial stability.

Difference Between Permanent and Temporary Working Capital

The permanent working capital is the minimum amount required for the company to ensure operational continuity, which could be the regular working capital to meet the salary, utility, and overhead expenses whereas reserve gain for any unexpected emergency. On the other hand, temporary working capital is one of the types of working capital used to meet temporary or seasonal requirements. Let's understand more about the difference between permanent and temporary working capital based on the following attributes:

What is Working Capital loan?

When businesses focus on growth, the requirement for operational funds can increase, which might require a working capital loan. This is especially required when the company has consumed all the other funding options and needs operational costs like salaries of employees, rent, and other overhead expenses. The working capital loan also offers flexibility to ensure business continuity when income is less. Unlike investor funding, this type of loan gives the business owner complete ownership of the funds and have control of its utility for business needs.

Conclusion

Working capital refers to the operational funds required by the companies to ensure business continuity. The operational funds refer to employee salaries, rent, overhead expenses, etc., ensuring a streamlined workflow. The different types of working capital support the company during day-to-day expenses, unexpected emergency situations or to meet the seasonal market demands. Alongside managing the funds adequately for working capital, it is important to have business insurance to shield the business from any unprecedented crises like fire, theft, or natural calamities. Explore personalized business insurance solutions by Covrzy here!