Concept of Working Capital

Concept of Working Capital: Gross and Net Working Capital

There are two concepts or senses used for working capital.

These are:

1. Gross Working Capital

2. Net working Capital

1. Gross Working Capital:

The concept of gross working capital refers to the total value of current assets. In other words, gross working capital is the total amount available for financing of current assets. However, it does not reveal the true financial position of an enterprise. How? A borrowing will increase current assets and, thus, will increase gross working capital but, at the same time, it will increase current liabilities also.

As a result, the net working capital will remain the same. This concept is usually supported by the business community as it raises their assets (current) and is in their advantage to borrow the funds from external sources such as banks and the financial institutions.

In this sense, the working capital is a financial concept. As per this concept:

Gross Working Capital = Total Current Assets

2. Net Working Capital:

The net working capital is an accounting concept which represents the excess of current assets over current liabilities. Current assets consist of items such as cash, bank balance, stock, debtors, bills receivables, etc. and current liabilities include items such as bills payables, creditors, etc. Excess of current assets over current liabilities, thus, indicates the liquid position of an enterprise.

The ratio of 2:1 between current assets and current liabilities is considered as optimum or sound. What this ratio implies is that the firm/ enterprise have sufficient liquidity to meet operating expenses and current liabilities. It is important to mention that net working capital will not increase with every increase in gross working capital. Importantly, net working capital will increase only when there is increase in current assets without corresponding increase in current liabilities.

Thus, in the form of a simple formula:

Net Working Capital = Current Assets-Current Liabilities

Amit Kumar
Amit Kumarhttp:////hmhelp.in
Hii! Welcome to My digital home, I am Amit – an almost no-code generalist, helping businesses with their online presence using WordPress and other tools and simplifying some of their operations with ideas and automation. A psychology and philosophy geek by interest and a graduate in Hospitality Management. I founded hmhelp during college, which got me into WordPress. I am a highly motivated and results-oriented professional with a proven track record of success in the hospitality industry. I’m also a Digital Marketing Enthusiast with significant academic and practical experience managing digital content across multiple platforms. Skilled at SEO optimization, developing digital content for social media platforms, I offer extensive knowledge of multiple software programs, strong attention to detail, and extraordinary communication skills. If you are interested in talking about any of the topics I have mentioned on my website, you are in the right place. You can contact me or learn more about what I do. You can also connect with me on social networks.

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