Published on Sept 19, 2022Updated on Apr 15, 2025
In a business, there are two financial metrics that owners or businesses keep a close eye on: the working capital levels and the cash flow status. Both financial metrics help businesses to know whether their company will be able to withstand a market downturn or crisis successfully or not.
In this blog, we will understand the working capital meaning, its importance, and its advantages.
Working capital refers to the liquidity level of the business that covers the day-to-day expenses and other short-term expenses. It indicates the short-term financial position or feasibility of the business and how well the company can manage its short-term financial obligations.
The working capital formula is the current assets minus the current liabilities of the business organisation.
Working Capital = Current Asset - Current Liabilities
Current assets include raw materials, inventory, cash at hand and bank, accounts receivable, etc. On the other hand, current liabilities include accounts payable, wages, taxes, short-term debt, interest owed, etc.
A positive working capital indicates the company has enough funds to cover its daily expenses and short-term debt.
Whereas negative working capital is a situation where current liabilities exceed current assets, meaning the business is struggling to finance the day-to-day expenses of the business and indicates a financial crisis.
Positive working capital indicates a company’s ability to cover its short-term liabilities with its short-term assets, signalling financial health and operational efficiency. It allows businesses to seize growth opportunities and manage daily operations effectively.
Negative working capital, on the other hand, suggests potential liquidity issues, where a company might struggle to meet its immediate obligations. While negative working capital can sometimes indicate efficient inventory management in specific industries (e.g., retail or fast-moving consumer goods), prolonged periods of negative working capital might signal risks to long-term financial stability and solvency.
Sources of working capital include short-term loans, trade credit, bank overdrafts, retained earnings, and advances from customers. Additionally, businesses can utilise inventory financing, factoring, and the sale of non-core assets. These options ensure liquidity for daily operations, helping maintain smooth functioning while avoiding disruptions to long-term financial stability.
There are several types of working capital, each serving specific purposes:
The working capital cycle refers to the time it takes for a company to convert its current assets (like inventory and receivables) into cash. It involves purchasing inventory, selling products, collecting payments, and replenishing stock. A shorter cycle improves liquidity, boosts operational efficiency, and enhances profitability.
The following are the top 10 advantages of having adequate working capital:
While working capital is crucial for day-to-day operations, it has limitations. Excessive working capital can indicate inefficient use of resources, leading to low returns on investments. On the other hand, insufficient working capital can result in liquidity problems, affecting a company’s ability to meet short-term obligations. Additionally, working capital does not account for long-term investments or financial stability, and relying solely on it may overlook other critical financial aspects such as profitability and growth potential.
Working capital includes various financial assets that support a company's daily operations. For example, cash provides liquidity for immediate expenses, while accounts receivable represents money owed by customers for goods or services provided. Inventory, including raw materials, work-in-progress, and finished products, ensures that a company can meet demand. Additionally, accounts payable reflect short-term debts to suppliers, and prepaid expenses are payments made in advance for future services. Together, these elements maintain operational efficiency and business stability.
For any business organisation, having adequate working capital is very important for business growth. As discussed above, the primary purpose of working capital is to finance daily operations, meet all short-term debt obligations, and continue to have sufficient working capital using the existing resources.
If a company has sufficient working capital, it can continue to pay its employees and suppliers, pay taxes, and other expenses, even if there are some cash flow challenges.
It helps to improve the creditworthiness of the business, have better bargaining power with suppliers, and improve profitability. In short, having sufficient working capital ensures value creation and plays a vital role in achieving organisational goals and profitability.
Negative working capital occurs when a company's current liabilities exceed its current assets. This situation can indicate potential liquidity issues, as the business may struggle to meet short-term obligations with available resources. It may arise if a company has high levels of debt, slow-moving inventory, or extended credit terms with suppliers.
While negative working capital is typically seen as a red flag, some businesses, particularly in industries with fast inventory turnover or high levels of prepayments, may operate efficiently despite it. However, sustained negative working capital can lead to financial strain and challenges in managing day-to-day operations.
To improve working capital, a company can:
Working capital management is a process of managing a company's current assets and current liabilities in the most effective way to maintain sufficient cash flow and meet all the short-term goals. The goal of effective working capital management is to reduce the operating cycle, free up cash from the balance sheet, maintain liquidity and reduce dependency on external sources for financing working capital needs.
The efficiency of working capital management can be quantified in three ratios - current ratio, collection ratio, and inventory turnover ratio.
A business may experience a drop in working capital due to unexpected market conditions or increased expenses in other areas of business. In such a case, the business needs to take steps to improve working capital to ensure stability and remain competitive in the market. The following are the top 5 ways to increase working capital:
If you are choosing to avail of a business loan to meet working capital requirements with SMFG India Credit, you must check your eligibility for the loan before applying. By using the business loan eligibility calculator, you can check your eligibility for the loan instantly and the amount you can borrow.
You can also use SMFG India Credit’s business loan EMI calculator to choose the right loan tenure and EMI to increase the chances of loan approval.
* Please note that this article is for your knowledge only. Loans are disbursed at the sole discretion of SMFG India Credit. Final approval, loan terms, disbursal process, foreclosure charges and foreclosure process will be subject to SMFG India Credit's policy at the time of loan application. If you wish to know more about our products and services, please contact us
The formula for working capital is:
Working Capital = Current Assets - Current Liabilities
This measures a company's ability to cover its short-term obligations with its short-term assets, indicating financial health and liquidity for day-to-day operations.
The working capital cycle refers to the time it takes for a company to convert its current assets, such as inventory and receivables, into cash. A shorter cycle indicates more efficient management of working capital, enhancing liquidity and operational efficiency.
Working capital refers to the difference between a company's current assets and current liabilities. It measures a business's ability to cover short-term obligations with its short-term assets, ensuring smooth daily operations and indicating financial health and liquidity.
The four common types of working capital are:
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