Components of Working Capital
Working capital is required for an entity so that the organization operates effectively and efficiently by monitoring and deploying its current assets and current liabilities to the best possible extent. It is important to take into account the two terms, current assets, and current liabilities, as we will be talking about this frequently in our discussion.
- Current Assets: Those assets that are easily converted into cash or have high liquidity are called current assets, and these assets are held by businesses to be converted into cash within 12 months or one normal operating cycle. Examples: cash, marketable securities, debtors, bills receivable, bank balance, short-term investments, inventory, etc. The holding of capital assets suggests the healthy financial well-being of a business, as it helps to finance the day-to-day business functions. Current assets are normally used to pay out current liabilities.
- Current Liabilities: Those liabilities or financial obligations that are required to be paid or due within 12 months or within one normal operating cycle of a business are known as current liabilities. Examples: creditors, bank overdrafts, bills payable, loans to be paid within 12 months, etc. Current liabilities are incurred to maintain regular business operations, like purchasing goods on credit, which creates a creditor. When a business is facing a cash crunch, it takes a bank overdraft to finance its operations.
What is Working Capital? – Formula, Components, Limitations
Working Capital represents the firm’s holdings of assets like cash, marketable securities, receivables, etc. Funds, being the backbone of any efficient business, are the most important aspect to be managed. Careful maintenance of the working capital and fund mix to acquire are key areas of decision-making and are important as they help to meet any business contingencies.
From an accounting perspective working capital is the difference between the short-term sources of funds, i.e., the current assets, and the short-term financial obligations, i.e., the current liabilities. In this article, we are providing you with all the information regarding working capital and its formula, components, and limitations.
What is Working Capital?
Table of Content
- Working Capital
- Components of Working Capital
- Formula for Working Capital
- Significance of Working Capital
- Advantages of Working Capital
- Limitations of Working Capital
- FAQs on Working Capital