Why Firms require Working Capital ?

Working capital refers to the amount of funds available to meet the day to day activities of a business enterprise. It is considered as the life blood of a business & is essential for the survival of the business.

The more working capital a company has available, the more stable it is. Hence, it is a good measure of the short and medium-term financial health of a company.

CALCULATION OF WORKING CAPITAL

The working capital can be calculated by subtracting the current liabilities from the current assets of a company. The net working capital shows how much money is readily available to meet current expenses. It is calculated as –

Working Capital = Current Assets – Current Liabilities

IMPORTANCE / NEED OF WORKING CAPITAL

Working capital plays a very important role to ensure the effective and efficient conduct of day to day operations of a business enterprise. Lack of adequate working capital not only impacts the profitability but may also lead to the liquidation of assets and eventually to bankruptcy.

The following points highlight the need of working capital for a firm –

  • GOODWILL :- A firm with adequate working capital can fulfill its financial obligations on time which will enhance its reputation.
  • DISCOURAGE INVESTORS :- Lack of adequate working capital can make it difficult for a business, especially a small business, to attract investors. If a company possess sufficient working capital it shows the investors and creditors that it has the capacity to repay their loans.
  • EASY AVAILABILTY OF LOANS :– Adequate amount of working capital improves the credit worthiness of the firm & it becomes easier for the business to obtain loans at favourable terms & conditions from the lenders.
  • MEETING UNFORESEEN CONTINGENCIES :– A business enterprise can easily overcome its unforeseen contingencies like business depression, financial crisis due to huge losses etc. if it has ample working capital availability.
  • TIMELY PAYMENT OF EXPENSES :– A firm needs adequate working capital to make the timely payment of current expenses including payroll, materials, operating costs of business, salary & wages to the employees etc.

 

Thus, in simple words a company’s working capital is the money that is used to finance its daily operations & serves as an important measure of a company’s ability to pay off short-term expenses or debts

Accounting & Finance for Banking

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Accounting and Finance for Banking Module A Pdf

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Accounting and finance for bankers all ePDFs are available in our an app. Get them all at https://iibf.info/app

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