Working capital

Current assets turn into cash within a year: cash, inventory, receivables. Working capital is the money tied up in them. Net working capital = current assets − current liabilities. For example, current assets of ₹12 lakh and current liabilities of ₹7 lakh give a net working capital of ₹5 lakh.

Current assets give liquidity (the ability to pay bills), but they earn a low return. So a firm must balance liquidity and profitability: enough working capital to run smoothly, but not so much that money sits idle.

Factors that decide how much working capital is needed:

• Nature of business: trading and service firms need less than manufacturers.
• Scale of operations: larger firms need more.
• Business cycle: more in a boom, less in a slump.
• Seasonal factors: more in the peak season.
• Production cycle: a longer cycle needs more.
• Credit allowed to customers: a liberal credit policy raises the need.
• Credit availed from suppliers: it reduces the need.
• Operating efficiency: efficient firms need less.
• Availability of raw material: a longer lead time means more stock must be held, so more working capital.
• Growth prospects, the level of competition, and inflation all tend to raise it.