## Working Capital — Meaning, Concepts & Optimum Level
### 1. What is Working Capital?
In accounting terms:
> Working Capital = Current Assets − Current Liabilities
It represents the funds tied up in running the day-to-day operations of the business.
### 2. Current Assets
An asset is current when:
1. It is expected to be realised / sold / consumed in the entity's normal operating cycle OR within 12 months after the reporting period, whichever is longer; and
2. It is held primarily for trading in the ordinary course of business.
For WC purposes, current assets group into:
- a. Inventory — raw material, WIP, finished goods
- b. Receivables — trade receivables & bills receivable
- c. Cash / cash equivalents — including short-term marketable securities
- d. Prepaid expenses
- (also: short-term loans/advances, accrued revenue, etc.)
### 3. Current Liabilities
A liability is current when:
1. It is expected to be settled in the normal operating cycle OR within 12 months, whichever is longer; and
2. It is settled by using current assets or by creating a new current liability.
For WC purposes, current liabilities group into:
- a. Payables — trade payables & bills payable
- b. Outstanding payments — wages & salary, overheads, other expenses
- (also: short-term borrowings, current portion of long-term debt, short-term provisions like tax provision)
### 4. Working Capital Management — what it covers
WCM is concerned with two things:
- a. Maintaining adequate working capital — managing the levels of individual current assets and current liabilities; and
- b. Financing the working capital.
The Finance Manager first computes the WC requirement, then ensures it is properly financed — this whole exercise is WC Management. Its primary objective: keep enough cash flow to meet day-to-day operating expenses and short-term obligations, so the firm runs efficiently.
### 5. Two ways to classify Working Capital
On the basis of VALUE:
- Gross Working Capital = the firm's total investment in Current Assets.
- Net Working Capital = Current Assets − Current Liabilities.
On the basis of TIME:
- Permanent (Fixed) WC = the minimum level of current assets carried at all times to run day-to-day activity; stays invested permanently.
- Fluctuating (Temporary) WC = the part of total WC required over and above permanent WC (seasonal/cyclical needs).
### 6. Optimum Working Capital
- If current assets do not exceed current liabilities, the firm risks failing to pay creditors on time → lost reputation → vendors withdraw.
- The Current Ratio (Current Assets ÷ Current Liabilities), supplemented by the Acid-test (Quick) Ratio, is the traditional indicator of the WC situation.
- A current ratio of 2 for a manufacturing firm is taken to imply an optimum amount of working capital.
- Higher than 2 → may signal inefficient use of funds (idle current assets).
- Lower than 2 → may signal liquidity problems.