The term working capital or net working capital (NWC) refers to the funds available to a business for all purposes. Subtracting the current liabilities from the current assets provides the NWC. Financial institutions and investors use this figure as a short-term health measurement of the business.
Working Capital vs. Fixed Capital
Capital overall breaks down into two categories – working and fixed capital. Fixed capital refers to the funds a business invests in long-term asset purchases. It uses these perpetual assets in the production of its products. Any durable, tangible assets required for manufacturing of the company’s products that it utilizes over the long-term qualify as fixed capital. Examples of these include plants, vehicles, buildings, machinery, and other equipment.
Working capital refers to the available funds a business can use in the near term. It includes items that the business could liquefy in one year or less and still cover its debts. Working capital lets the business meet its short-term business operation needs. Eight types of working capital exist.
What are the types of working capital?
Working capital sounds simple at first, but big business categorizes it depending on its uses. Its eight types include:
- Gross Working Capital,
- Net Working Capital,
- Permanent Working Capital,
- Regular Working Capital,
- Reserve Margin Working Capital,
- Seasonal Variable Working Capital,
- Special Variable Working Capital,
- Variable Working Capital.
Let’s look at the specific uses of each type of working capital.
Gross Working Capital
The term gross working capital refers to the aggregate funds invested in a company’s current assets. This includes its cash, accounts receivables, securities, inventory, and short-term investments.
Net Working Capital
The term net working capital refers to all funds arising from the business’s current assets exceeding its liabilities. A healthy net working capital signals a liquid company with efficient operations.
Permanent Working Capital
Permanent working capital remains with the current assets so the firm can manage its day-to-day activities. This earns it the name of fixed working capital.
Regular Working Capital
The term regular working capital refers to the minimum capital needed for day-to-day operations. This includes money set aside for paying salaries and wages and overhead.
Reserve Margin Working Capital
When we discuss reserve margin working capital, we mean the capital set aside for emergency expenses. This doesn’t refer to money set aside for day-to-day expenses. This reserve capital offers the business funds to handle a strike or natural hazard.
Variable Working Capital
The term variable working capital refers to the funds temporarily invested in the company. Also called fluctuating working capital, it varies according to business size and because of changes in assets.
Seasonal Variable Working Capital
The term seasonal variable working capital refers to the peak of the year’s working capital needs fund. This type of seasonal upswing requires a larger amount of day-to-day operations funding. This typically occurs in retail and manufacturing businesses most frequently.
Special Variable Working Capital
The term special variable working capital refers to a supplementary working capital fund that addresses unique situations that require immediate, short-term funding, such as an oil spill that requires a marketing campaign for reputation repair.
When Liabilities Exceed Assets
These eight types of working capital all fall under a single line item as sub-items in annual and monthly budgets. Buy, what if your business assets don’t exceed your liabilities? A business in the red needs working capital, too. That’s how you move it into the black.
Sometimes, customers don’t pay quickly. At these points, your business may need funding. Other times, your business does own enough assets to remain in the black, but you need an infusion of funds to grow your business. At these points, bootstrapping might not work because you may have resorted to that to begin the business. In those cases, you can obtain funding by various means, including accounts receivable advances, venture capital, angel investors, and other funding options.
Does working capital include payroll?
The formula to calculate working capital does include payroll, under the category of debts. You owe the employees their salaries and hourly wages for their service to the company and work produced. It also appears in the set-aside category in regular working capital.
How do you calculate working capital in Excel?
To calculate working capital for your company, use the following formula:
Working Capital = Current Assets – Current Liabilities
The following items qualify as current assets – cash, accounts receivable, unpaid invoices, raw materials inventories, and finished goods inventory.
The following items qualify as current liabilities – as accounts payable and debts.
Calculating the various types of working capital uses a different approach. For instance, to determine the amount needed for regular working capital, you calculate the amount required for day-to-day operations. Similarly, you set the reserve margin working capital by the amount needed to address specific emergencies. Calculate these by budgeting for various scenarios in your risk analysis plan or business continuity plan.
Once you calculate each amount, you can create a line-item budget with a set aside for each of the eight categories. If you approach a financial institution about working capital solutions or funding new projects that go beyond your available funding, it will request the financial reports and budgets that reflect all of this data.
Learn More Now!
You can obtain funding or financing from financial institutions like iKahn Capital to grow your business. Today’s business environment offers a plethora of ways to fund your business now, such as accounts payable advances and venture capital. Learn more now about your funding options from iKahn Capital; contact us today.