Question

What is working capital and how do businesses use working capital to manage a business?

Answer 1

Working capital is the capital requirement for the short-term business needs or we can say day to day needs of the businesses. For example, payment to suppliers of raw materials, receivable for the inventory. This is basically related to the short-term capital needs of the company, when we say short-term it normally means one year. The working capital is calculated as the difference between the current asset and current liability.

Businesses use working capital to smoothly run the business and generate revenue for the company. The working capital management is generally done by an accountant or a treasurer who raises short-term capital when required and invest the excess cash lying with him for a short period of time. For example, let’s say an account payable is due in 90 days and company has to make payment of $100,000. Then if the company does not have enough cash then it will have to raise that amount to pay to the supplier and if the company has that much cash available then company can either keep that cash with them or invest in money market securities for 90 day period and at the end of that period pay the supplier. Working capital management is basically managing your fund requirement as well as excess fund lying with the company in an efficient way.