What is Working Capital and Why is it Important?

Managing a business isn’t just about big goals and long-term success. It’s also about making sure your daily operations run smoothly—paying salaries on time, buying raw materials, paying utility bills, and keeping your supply chain moving. That’s where working capital becomes important.

So, what is working capital and why is it important?

In simple terms, working capital is the money available to cover your short-term expenses. If your business doesn’t have enough working capital, even small issues—like delayed payments from clients or seasonal dips in sales—can lead to serious disruptions. On the other hand, having positive working capital gives you flexibility, improves your cash flow, and builds trust with suppliers and lenders.

This blog explains everything about working capital, including its meaning, types, examples, and how it affects your business. We’ll also cover what is a working capital loan, how it helps in a crisis, and what options are available through banks or equipment financing companies like My Mudra.

What is Working Capital? 

Working capital, also known as Net Working Capital (NWC), is a basic but essential financial formula that shows whether your business has enough short-term assets (like cash, inventory, and receivables) to cover its short-term liabilities (like unpaid bills, salaries, and taxes).

Working Capital Formula:

Working Capital = Current Assets – Current Liabilities

Let’s break it down:

• Current Assets are the things you own that can be quickly converted into cash (like cash in hand, money in the bank, inventory, and pending payments from customers).
• Current Liabilities are the payments your business must make soon (like rent, supplier bills, employee wages, EMIs, and taxes).

Example of Working Capital:

Imagine your business has the following:

• Current Assets = ₹2,00,000
• Current Liabilities = ₹80,000

Your working capital = ₹2,00,000 – ₹80,000 = ₹1,20,000

This means your business has ₹1,20,000 available to use for day-to-day activities like purchasing stock, paying bills, or managing sudden expenses. If this number was negative, it would suggest that your liabilities are more than your assets—a warning sign for your business health.

Types of Working Capital 

The working capital in financial management can be of the following types: 

1. Positive Working Capital

If the working capital is in positive value, then it belongs to this category. Positive working capital means the presence of enough cash and assets to meet short-term expenses and debts. 

2. Negative Working Capital

If the working capital value is negative, then it belongs to this category. The negative working capital can be interpreted as there is not enough capital to meet the short-term obligations. 

The businesses won’t be able to meet basic payment requirements and face challenges in raising funds to ensure business growth. It may also lead towards a business’s financial failure and lead to shut down. 

3. Net Working Capital

The net working capital is the same as working capital. It is the difference between current assets and liabilities. It indicates the company’s ability to fulfil short-term debts. 

4. Gross Working Capital 

It is the total current assets of the company as listed in the balance sheet. The components of gross working capital involve accounts receivable, cash and inventory. 

5. Short Term Working Capital 

It means that the working capital is capable of covering the immediate expenses of the company. It can fund the day-to-day operational needs, and the short term working capital example includes inventory and payroll. 

6. Long Term Working Capital 

The long term working capital is the availability of funds that can help fund the strategic investments and business endeavours. It is necessary to help predict the long-term growth of the business. 

Importance of Working Capital

Still wondering why working capital is important? The significance of working capital lies in its functionality. It is used by businesses to meet the expenses on a day-to-day basis. It includes funding the regular payments, buying materials for inventory and handling unexpected costs. Further, considerations on enhancing long-term working capital are also essential. 

Having mentioned that, there also lies the significance of working capital management. The management here involves monitoring and tracking the inventory and accounts transactions. It also encompasses strategic planning to lower the cost of capital, maintaining the working capital cycle and increasing the ROI on current assets. It helps streamline the business operations and enhances their capability to earn profits. 

Limitations of Working Capital 

Here are certain aspects that need thorough consideration before opting for the working loan to ensure maximum utilisation of the same. These are: 

• Working capital changes every day, and hence, the information may be different by the time the reports are ready 
• Working capital does not offer clear insights into the nature of assets 
• Inaccurate insights can lead to missing business growth opportunities 
• Assets can lose value suddenly 
• Missing debts can lead to discrepancies in the insights offered by the reports. 

What is Working Capital Loan?

Having understood the importance of working capital, what would a company do in a scenario of its negative value? To meet the day-to-day expenses, the companies can opt for a working capital loan. The option is well-suited for companies facing poor sales at certain times or during specific festivals or seasons of the year. The expenses to be covered with a working capital loan include raw material purchases, utility bills, inventory management and monthly payments. 

This loan is appropriate for small and medium enterprises, startups, established businesses, sole proprietors and self-employed individuals. The loan tenure generally ranges from 6 to 60 months but varies across the banks and as per the cash flow and loan amount. The interest rate can be fixed or floating.

Types of Working Capital Loans 

There are three main types of working capital loans: fund-based, non-fund-based, and customisable options.

1. Fund-based Working Capital Loans 

The fund-based working capital loans are of the following types: 

• Working Capital Loan Unsecured: A working capital loan unsecured does not require keeping collateral to obtain the funds. The loan depends on multiple factors, including eligibility criteria, credit score, repayment history and others. 
• Working Capital Loan Secured: It involves taking a loan on assets as collateral. It accompanies lower interest rates. 
• Working Capital Loan Overdraft: This facility allows borrowing from a fixed line of credit. It involves paying interest on the used amount and duration. 
• Working Capital Term Loan: The working capital term loan is a fixed amount of loan provided for a specific period to help with short-term operational expenses. 
• Working Capital Demand Loan: These are appropriate to meet the urgent financial needs of the business. The working capital demand loans are cost-effective owing to lower interest rates and a structured repayment plan. 

2. Non-Fund-Based Working Capital Loans 

Alternatively, the non-fund-based options are as follows: 

• Letter of Credit (LC): Here, the bank promises to pay the amount if the company cannot, thus building trust and preventing hindrances in functions. It involves paying a specific amount of money to the seller if certain conditions are met. 
• Bank Guarantee: The Bank guarantees to pay the supplier or vendor if the company fails to pay. A bank guarantee is an assurance from the bank for coverage of potential losses in case the borrower defaults. It is well-suited for national and global deals or contracts.
• Capex LC for Capital Goods: It is a specific type of Letter of Credit that is useful for purchasing capital goods. Hence, this option is for buying long-term assets such as equipment or machinery or to build new plants, projects, and technology. 

3. Customizable Working Capital Loans 

The banks also offer customised options to businesses. These working loans are flexible and adjustable as per the specific bank's needs. 

• ITR-Based Loans: Here, the working capital loans are provided on the basis of ITR. 
• Bank Statement-Based Loans: These loans are easily offered based on the company’s bank records. These are suited for all business types. 
• Turnover-Based Loans: Here, the loan is provided based on the business’s turnover. 

Conclusion 

Working capital is a measure of the operational efficiency and financial resilience of the business. It is the difference between the current assets and the current liabilities of the company. While healthy and positive working capital is necessary for business growth, it can become negative as well. Early handling of such situations is needed to ensure the sustainable running of the business. 

Thus comes the option of a working capital loan to meet the seasonal or festive blues of the business. With different types of working capital loans available, find the most appropriate one for your business-specific needs. Connect with us now to learn in detail or explore the working capital loan at My Mudra.