Business Studies · Ch 11 — Financial Management
Working Capital
Working Capital
Working capital is the money a business needs to keep its day-to-day operations running smoothly. While fixed assets (like machinery and buildings) are for the long term, every business also has to invest in current assets — things that will be used up or turned into cash within a year. This investment is what keeps the business moving: paying suppliers, holding stock, and meeting immediate expenses.
Current assets are more liquid than fixed assets (you can turn them into cash faster), but they contribute less to profits. The textbook lists them in order of liquidity — from the most liquid to the least:
- Cash in hand / Cash at bank
- Marketable securities
- Bills receivable
- Debtors
- Finished goods inventory
- Work in progress
- Raw materials
- Prepaid expenses
An asset is considered more liquid if it can be converted into cash quickly and without losing its value. Cash itself is perfectly liquid; raw materials take longer to sell and may lose value in the process.
If a business invests too little in current assets, it may struggle to meet its payment obligations — like paying creditors or salaries on time. But current assets also give little or low return. So management must strike a balance between liquidity (having enough cash or near-cash to pay bills) and profitability (earning a good return on investment).
Current liabilities are the opposite side of the coin — these are payment obligations due within one year. Examples include bills payable, creditors, outstanding expenses, and advances received from customers.
Some part of current assets is normally financed through these short-term sources (current liabilities). The remaining part — the portion financed through long-term sources — is called net working capital. …