9.4 Types of working capital

Working capital can be categorized into two main types: gross working capital and net working capital.

1. Gross Working Capital: Gross working capital refers to the total current assets of a company. It represents the overall amount of funds tied up in current assets to support day-to-day operations. Gross working capital includes the following components:a. Current Assets: Current assets are short-term assets that are expected to be converted into cash within one year or within the normal operating cycle of a business. Examples of current assets include cash, cash equivalents, accounts receivable, inventory, and prepaid expenses.

   b. Temporary Investments: Temporary investments, also known as marketable securities, are short-term investments made by companies to earn a return on excess cash. These investments are highly liquid and can be readily converted into cash when needed.

2. Net Working Capital: Net working capital represents the difference between current assets and current liabilities. It indicates the amount of funds available to a company after deducting its short-term obligations. Net working capital provides a more accurate measure of a company’s liquidity position. It is calculated as follows:Net Working Capital = Current Assets – Current Liabilities

   a. Current Liabilities: Current liabilities are the short-term obligations of a company that are expected to be settled within one year or the operating cycle. Examples of current liabilities include accounts payable, short-term loans, accrued expenses, and taxes payable.

Net working capital can be further classified into two categories:

i. Positive Net Working Capital: A positive net working capital indicates that a company has more current assets than current liabilities. This indicates a healthy liquidity position and the ability to meet short-term obligations.

ii. Negative Net Working Capital: A negative net working capital occurs when current liabilities exceed current assets. This situation may raise concerns about a company’s ability to meet its short-term obligations and may indicate liquidity challenges.