Bank Study

What is working capital? Importance and different types of working capital

What is working capital? Working capital is calculated by subtracting current liabilities from current assets, as listed on the company’s balance sheet. Current assets include cash, accounts receivable and inventory. Current liabilities include accounts payable, taxes, wages and interest.

What is working capital importance?

Liquidity perspective:
By properly analyzing the expenses payable the financial team of an enterprise would easily plan for their funds accordingly.
Out of Cash: In-appropriate prepared plans of day to day expenses may result in enterprise liquidity crisis which give a bad impression of an enterprise at the party.
Helps in Decision Making:
By correctly analyzing the requirement of funds for day to day operations the finance team can appropriately manage the funds and can decide accordingly .
Helps in the Situation of Cash Crises: By properly managing the liquid funds the organization not to affect the situation of crises.
Perfect Investments Plans: Correctly managing the funds or working capital one can choose or plan for their investments accordingly and invest the funds to maximize the return as per their availability.
Strengthening the Work Culture of Entity: Timely payment of all the day to day expenses mainly focused on the salary of the employees creates a good environment and a sort of motivation amongst employees to work harder and strengthening the good working environment.
Improves Creditworthiness of Entity: When the enterprise has adequately planned their working capital requirements, they will surely pay the payments to vendors and other creditors timely which improves their creditworthiness .
 working capital calculation is important so that the further decisions could be taken accordingly as per the availability.

What is working capital types:

Cash Credit/Bank Overdraft:
These cash facilities are provided by the commercial banks by which the borrower is approved a specific amount of cash that he can use for making business payments.
Trade Credit: This is a type of working capital financing that is extended by the present or potential supplier of a business.
Working Capital Loans: Working capital loans are used by small businesses to finance their day by day operations or raise their cash flow.
Bank Guarantee: This is a non-fund based working capital financing. Bank guarantee is acquired by the client or seller to decrease the risk of loss to the other party due to non- performance of agreed undertaking which may be paying back the money or offering some services and so on.
Letter of Credit
This form is also known as non-fund based working capital financing. a buyer would purchase a letter of credit and send it to the seller. As soon as the seller sends the products according to the agreement, the bank would pay the amount to the seller and collects that cash from the buyer.

Industrial unit turn into sick due to Inadequate working capital

To run the business normally It is important to have a working capital level. Working capital keeps business activities moving. Business without working capital. Like a car without an engine. The effects of deficit working capital problems are as follows.

1. Failure in paying Current Liabilities; Deficit is the main problem of working capital and as a result current liabilities cannot be paid in time.
2. Lack of Raw Materials: The scarcity of raw materials is evident when the opportunity to purchase on credit is limited. The suppliers are reluctant to supply the borrowed raw material if the current liabilities are not paid in time.
3. Interruption in Production: Adequate working capital is essential to ensure supply of other materials of production including purchase of raw materials.

4. Loss of Sale: As the products are not produced on time, the products cannot be supplied as per the demand of the buyers, as a result the organization is deprived of potential sales.
5. Loss of Goodwill; Lack of required working capital  they do not pay their dues on time as the buyers cannot trust the company and they do not get the product as per the demand.
6, Reduction in Profit (Reduction in Profit): As the production and sales activities are disrupted, the amount of operating profit or operating profit of the organization decreases. This is why it is said that “Current assets do not directly generate profit but help to make it.” That is, it does not make a profit directly from working capital, but it does make a profit. Plays an important role.
7. Fall in Credit Rating: When an organization is unable to meet its current liabilities due to lack of working capital, its credit rating is downgraded.
8, Institutional Efficiency Decreases: If the lack of working capital is prolonged. Efficiency decreases at all levels of the organization.

See more:

What are good borrower qualities? Points  to be taken into consideration.

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