Business Finance · Chapter 8
Study notes aligned to the official NEB syllabus.
While capital budgeting deals with long-term investment, a firm also needs money to run its day-to-day operations, to hold stock, to allow customers time to pay, and to keep cash for daily bills. The funds tied up in these short-term assets, and the way they are managed, are the subject of working capital management. Good management here keeps the firm liquid and efficient at the same time.
Working capital refers to the funds a firm needs to finance its current assets and carry on its everyday operations. In its most common form, called net working capital, it is the excess of current assets over current liabilities:
$$ \text{Net Working Capital} = \text{Current Assets} - \text{Current Liabilities} $$
Gross working capital, by contrast, means simply the firm's total investment in current assets. A positive net working capital shows that the firm can meet its short-term obligations from its short-term assets.
Working capital is classified in two useful ways. By concept it is either gross working capital (total current assets) or net working capital (current assets minus current liabilities). By time it is either permanent (fixed) working capital, the minimum level of current assets the firm must always keep to run without interruption, or temporary (variable) working capital, the extra current assets needed to meet seasonal or fluctuating demand.
Its importance lies in the fact that adequate working capital keeps the firm liquid so it can pay wages and suppliers on time, maintains an uninterrupted flow of production, allows the firm to grant credit to customers and to earn cash discounts from suppliers, and protects it against sudden shocks. Too little working capital threatens solvency, while too much ties up funds that earn nothing, so the aim is a sound balance.
While capital budgeting deals with long-term investment, a firm also needs money to run its day-to-day operations, to hold stock, to allow customers time to pay, and to keep cash for daily bills. The funds tied up in these short-term assets, and the way they are managed, are the subject of working capital management. Good management here keeps the firm liquid and efficient at the same time.
Working capital refers to the funds a firm needs to finance its current assets and carry on its everyday operations. In its most common form, called net working capital, it is the excess of current assets over current liabilities:
Gross working capital, by contrast, means simply the firm's total investment in current assets. A positive net working capital shows that the firm can meet its short-term obligations from its short-term assets.
Working capital is classified in two useful ways. By concept it is either gross working capital (total current assets) or net working capital (current assets minus current liabilities). By time it is either permanent (fixed) working capital, the minimum level of current assets the firm must always keep to run without interruption, or temporary (variable) working capital, the extra current assets needed to meet seasonal or fluctuating demand.
Its importance lies in the fact that adequate working capital keeps the firm liquid so it can pay wages and suppliers on time, maintains an uninterrupted flow of production, allows the firm to grant credit to customers and to earn cash discounts from suppliers, and protects it against sudden shocks. Too little working capital threatens solvency, while too much ties up funds that earn nothing, so the aim is a sound balance.