Variance of Current Assets and Current Liabilities is termed as Working Capital. This means that whatever the business position is during the fiscal year and after deducting what it owes which is payable is the same period; the rest is treated as Working Capital. As the name indicates, the rest of the capital after asset and liabilities, working capital is that capital which is available for business to play into the market either by investing or securing it for future or other long term liabilities.
Working capital management is the key element for the financial manager in order to maintain the value of the business so that it may not get to the disaster level. These managers have to keep a close eye upon the working capital be at the safe level. Higher the working capital, the business would be more safe. However, the working capital should not be more than double of its liabilities; rather this is more hurting for the business because this indicates that management is saving more as compared of doing business or investing in order to generate more profit for business. Thus, maintaining a balance in the working capital is the utmost requirement for a sustainable business.
Working capital loan is the loan which is required by the business to meet daily and routine expenditures. Normally a business moves for working capital loans due to following major reasons.
- Business is unable to meet its daily expenses which means that the business is soon going to be windup as it cannot even fulfil its short term obligations which is the most dangerous position of any kind of business.
- Business is either in process of Restructuring, which states that major expenses are going to cut like human resource. Till the time the restructuring of the organization is done and meeting the short term obligations, working capital loan is required to be taken.
- Business has less liquid assets due to which business is unable to meet the short term liabilities which normally require enough of the liquid asset. However, this state of business is less risky as the business can generate liquidity within some time.
- Business is focusing to invest the liquid assets into long term investment can also be another reason for going for working capital loan. This decision is not recommended as doing long term investment from the available liquid assets requires business to have lower profitability as the major portion of profit would be utilized for the payment of interest on the loan. Thus, a bird in hand is better than two in the bush and investment be only made from surplus undistributed profits.
- Business is involved in doing operation during off season activities, for example, for manufacturing business of Leather Company, their season is in winter which is only for 3 to 4 months. In extreme summer season, the company may have not liquid assets to pay its current obligation or before the start of winter season, however, the business will generate enough liquid assets once the business is started.
- Start up business require the working capital loans so that they can focus on getting and doing business by simply paying the interest rate obligations and after sometime generate their own profits to fulfil other obligations from their own money.
- Last but not least, working capital loans are required by any business when it gets a bigger order from one of its reputed client or from government where payment is assured to be received. Now for completion of that order, management decides to purchase the raw material etc by obtaining working capital loan from any financial institution for about 3 to 6 months. Once the payment is received from the client, the loan would also be paid back.
Getting working capital loan is easy for the business as compared to long term loans because the payback period is less and the interest rate is higher as of long term loans. In addition, financial institution feels safe while giving short term loans to the business so that urgent cash is generated.
Apart from going to the financial institutions, it is wise to get loan from lenders or suppliers so that the terms and condition of payback would be somehow acceptable by the business.
In addition, getting inventory from the suppliers is another way of generating own working capital. This is the best and safest way to meet the short term obligations as in this way; the company would not only be doing business but also paying out its obligations. Thus the pressure of these payable over the management is much lesser as compared to loan.