One of the most important factors in a business is capital. In the business world, the amount of money used for daily operations is also called working capital. Working capital management is essential for running a business to ensure its financial health.
Good working capital management can help a company avoid a liquidity crisis, a situation where the company is unable to meet its needs and obligations. Conversely, unmonitored working capital can lead to financial problems.
Working capital can be obtained from various sources, including personal funds, bank loans, business credit, investments, and others. The obtained working capital must be managed properly to ensure smooth business operations and support long-term growth.
So, what is meant by working capital in more depth? To learn more, check out the following information. Let's take a look!
What is Working Capital?
Working capital is the amount of funds a company uses to finance daily operational activities, such as purchasing raw materials, paying employee salaries, and other short-term expenses.
In a business, working capital ensures the company has sufficient liquidity to operate efficiently without facing financial difficulties. The working capital amount can be calculated using the formula current assets minus current liabilities.
Adequate working capital indicates that a company regularly monitors its financial condition. This level of attention will prevent the company from experiencing financial problems that could potentially disrupt its stability.
Furthermore, companies must always strive to maintain an optimal balance between current assets and current liabilities to ensure financial efficiency and increase profitability.
Functions of Working Capital
In a business, working capital plays a crucial role in maintaining company stability. Here are some of the functions of working capital in a business.
1. Maintaining Company Stability
The primary function of working capital is to maintain company stability. In a business, working capital is allocated to cover operational needs, employee salaries, and other short-term expenses.
Adequate working capital can minimize the possibility of a company experiencing financial problems. To ensure this, proper working capital management is necessary to maintain company stability.
2. Supporting Smooth Daily Operations
As previously mentioned, the primary function of working capital is to support smooth daily operations. Sufficient working capital will make it easier for the relevant team to cover various operational costs, from electricity, communications, transportation, and so on.
With sufficient capital, a company can continue operating without having to wait for income from clients.
3. Increase Business Flexibility
The function of working capital also includes increasing business flexibility. With adequate working capital, a company can easily seize every opportunity that presents itself. For example, taking advantage of opportunities to stock raw materials, add employees, expand markets, and so on.
Furthermore, good working capital management also allows a company to adapt to current market conditions.
4. Increase Profitability
With efficient capital management, a company can optimize the use of existing resources and minimize raw material shortages. Efficient working capital management can prevent avoidable work errors.
5. Increase Investor Confidence
Companies with sufficient working capital tend to be more trusted by investors, banks, and suppliers. This trust is crucial for the company's sustainability in the coming years. Stakeholder trust will facilitate a company's business development.
For example, trust from investors makes it easier for a company to generate business profits. Meanwhile, trust from banks makes it easier for a company to obtain capital loans.
Types of Working Capital
1. Permanent Working Capital
Permanent or fixed working capital is the amount of funds a company needs to carry out its long-term operational activities.
Typically, this capital is used to finance current assets that are needed continuously, such as raw material inventory and relatively stable accounts receivable.
Permanent working capital is then classified into two categories:
• Primary working capital: The minimum capital a company must have to maintain operational stability
• Normal working capital: Working capital required to expand the scope or capacity of a business
2. Variable Working Capital
Temporary or variable working capital is the amount of funds a company needs to meet short-term operational needs that are temporary or seasonal in nature.
For example, when a company requires additional funds due to increased seasonal demand or a large project that requires more capital temporarily. This temporary working capital is dynamic and can change according to needs.
Variable working capital is classified into two categories:
• Seasonal working capital: Working capital whose amount fluctuates according to seasonal fluctuations
• Cyclical working capital: Working capital whose amount is affected by fluctuations in the market
• Emergency working capital: Working capital whose amount is affected by sudden conditions
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