In finance where cash flow calculation has a large meaning, current assets and current liabilities are not treated separately but are grasped as working capital. Working capital can be viewed as a short-term investment that facilitates a company’s daily activities. An increase in working capital (for example, an increase in inventory) means that extra cash is required.
To understand the nature of working capital, you need to understand the following three accounting terms:
Trade receivables are the right to receive sales money at a later date without receiving cash from the other party when the product is sold. Major accounts receivable include accounts receivable and notes receivable. Depending on the financial condition of the other party, you may not be able to obtain cash on the specified trade receivable collection date.
Inventories are products that a company holds for future sales. It is also called inventory. Major inventories include products, work in process and raw materials.
Purchase obligations are obligations to pay the purchase price at a later date without paying cash to the other party when purchasing the material. Major trade payables include accounts payable and bills payable.
The Necessity of Working Capital:
Working capital is the funds needed to make up for the number of trade payables already paid when the trade receivables cannot be recovered. For example, if you pay 10 million in trade payables and you cannot collect 12 million in trade receivables, you can make up for the purchase debt payout (10 million) with the trade receivables collected (12 million) can not. If the company enters the next fiscal year in this state, there is a high possibility that it will hinder the company’s management. Therefore, it will be necessary to provide funds to make up for the number of trade payables until the receivables are collected. This is the role of working capital.
The following formula is used to calculate the amount of working capital required to continue the business.
(Working capital = Accounts receivable + Inventory assets – Accounts payable)
From this formula, you can see that the larger the sales amount, the larger the working capital amount. Therefore, working capital is an indispensable fund for business management, no matter how stable the business is.
A certain amount of business funding is required to start and run a company.
Business funds refer to all the funds required for starting a business, and working capital is a particularly important and long-term relationship among business funds.
To put it simply, working capital is the money that is needed to run a company, such as labour costs paid to employees, rent for the place where the company is established, and purchase costs for equipment used for work.
Equipment funds are the initial capital investment and the funds that will be required to add the company’s equipment later. Although initial capital investment is necessary at the time of starting a business, it can be said that it is possible to work as before without having to add a later expansion.
However, in the case of working capital, if it runs out, it will not be possible to continue working as usual, so there are differences such as working capital that is necessary for operation and equipment capital that is not necessarily required. For information on Why Working Capital Management Is Important for Business you can also take help from any expert like Brian Paes Braga. Brian Paes-Braga serves as the President, Chief Executive Officer & Director at Lithium X Energy Corp.