Balance sheets show the financial position of a business by listing its assets, liability, and the equity of the proprietors.
A business’s balance sheet consists of several elements, including its gross working capital, which is utilised to determine its market value.
Gross working capital represents a company’s total present assets, including liquid funds, inventory, investments, and securities that can be transferred into cash within a year.
How gross working capital is calculated?
Here is a brief idea of how the gross working capital is calculated –
Let’s assume that an organisation holds the inventory of Rs.10,000, liquid cash of Rs.30,000, the amount due from debtors Rs.15,000, receivable bills of Rs. 10,000, an investment of Rs.15,000. Then the total working capital (or current asset) will be of Rs.80,000.
Deducting that organisation’s total liabilities from that amount will show the net working capital. This value changes every time when an organisation receives due payments, or make payments towards its suppliers. This progression is also known as the working capital cycle.
Importance of understanding working capital calculation
It is necessary for every organisation to understand how to calculate gross working capital as well as net working capital, as it helps recognise the financial shape of that organisation.
Studying working capital level helps recognise whether an organisation requires an external financial backing to continue its everyday operations or not.
Moreover, an accurate calculation of the balance sheet helps determine the best ways to utilise available funds.
An organisation can identify the necessary fields where it should invest to improve its production while lowering its costs, without compromising on the quality of any finished products.
Mistakes to avoid while managing working capital
Managing working capital can be challenging, especially for small and medium scale businesses that operate on limited working capital.
Adequate working capital helps businesses stay agile, which is why it is necessary to understand and avoid some of the common mistakes that may damage a businesses’ net working capital.
Let’s take a look at some of the factors that every company should avoid:
- Utilising complete working capital
Utilising funds labelled under net working capital unnecessarily can lead to severe financial distress, especially if the outcome does not return positive revenue by time the used funds become a necessity.
It is necessary for every organisation to set aside a portion of their funds to pay for overhead expenses.
To meet any expenses beyond the basic operations of a business, individuals can always look to avail a business loan to collect necessary monetary backing in such situations.
These credits are offered by various financial institutions, including NBFCs like Bajaj Finserv. Easy-to-meet eligibility criteria, substantial loan amounts, and an affordable interest rate allow organisations to meet all their liabilities without worrying about repayment.
They also provide pre-approved offers, which further simplify the application process for such credits making it easier for borrowers. Such offers are provided on both secured and unsecured credit, including business loans, personal loans, home loans, etc.
Maintaining excessive inventories
Companies often face severe financial pressure by holding on to excessive inventory. Inventory, including both raw materials and finished goods, requires a dedicated storage facility, and can potentially incur large losses if not cleared in time.
Companies, especially the ones dealing with manufacturing, should maintain inventory according to projected customer demands. In most cases, organisations face cycles of steep and short market demand. They should prepare for higher market demands by setting aside some funds.
Businesses should also learn about sources of working capital financing to ensure they have access to funds when necessary.
There are several options to finance small businesses; including working capital financing, business loans, SME and MSME loans, etc. These can provide the necessary monetary support whenever required.
Maintaining a healthy working capital helps an organisation support its operations, as well as recognise sections of its operations that require additional attention.
It also improves the company’s creditworthiness, as lenders will be likely to extend monetary support to companies that have more assets.
Understanding what is gross working capital and how it is required to understand organisational operations is vital.