Working capital is the key factor in carrying out the business operations of a financial entity. It is the lifeline of a business or a company. Working capital is calculated as the accounting theory current assets, minus current liabilities. Changes can be brought about in the working capital either with an increase or decrease in these two items. Working capital loan is intended directly for the workings of the business.
What are current assets?
The items of current assets are cash and cash equivalents. Cash equivalents mean those that can be easily converted into cash. Stock of inventory, bills receivable, and notes receivable are items of assets that are used up in less than a year’s time. When there is an increase or decrease in the current assets the working capital changes. Accounting transactions that result the changes in only either of the two assets, would have no effect on the working capital figure. For example an increase in cash and a decrease in bills receivable will effect no change on the working capital of a company, because here, one asset has been converted into another and the total assets figure does not change.
What are current liabilities?
The current liabilities are categorized as items, accounts payable, trade credit, short term loans and credit lines. Like current assets, these are to be paid off within short spans, of a year or less. These are financial obligations to outsiders. Changes in working capital result when there is an increase or decrease in any of these items. A decrease in current liabilities can be made only by paying off those liabilities. One current liability cannot be converted into another, as could be done with assets, except where a refinancing option is sought. The refinancing loans or credit lines can pay off bills payable, and reduce the balance of that item. At the same time refinancing loan comes up as an item of current liability.
Banks, lenders and investors are interested in working capital to make an assessment of the company. When there are large uncollectable items, it will bring down the working capital. Negative working capital can result when goods are sold on account, and balances are outstanding on these and you’re short on cash. A working capital loan can compensate for negative working capital.
Change in working capital means a change in the current assets or current liabilities of a business. These are items entered in the books of accounts of a company.