Types of Financial Needs: Working Capital Requirements

While fixed capital finances the permanent assets of a business, working capital finances its day-to-day, short-term operations. Working capital is the fund needed to buy raw material, pay wages and other operating expenses, hold stocks of finished goods, and extend credit to customers (debtors) until cash is finally collected back from sales.

Commerce students preparing for AP Intermediate exams should be familiar with two related ideas here. Gross working capital refers to the total investment a firm makes in its current assets — cash, stock of raw material and finished goods, and amounts receivable from debtors. Net working capital, in contrast, is the excess of current assets over current liabilities (amounts the firm itself owes for a short period, such as creditors and short-term loans); it shows the cushion a firm has to meet its short-term obligations comfortably.

The working capital a firm needs is not fixed once and for all — it depends on a number of factors. The nature of the business is a major influence: a trading firm, which mainly buys and sells finished goods, needs comparatively less working capital than a manufacturing firm, which must fund raw material, work-in-progress and finished stock all at once. The scale of operations matters too, since a larger volume of production and sales naturally needs more funds tied up in stock and debtors. …