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Understanding Gross Working Capital

Gross working capital refers to a firm's investment in current assets, which can be converted to cash within a year. This includes cash, debtors, marketables, and stock. The gross working capital concept focuses on optimal investment in current assets and financing those assets. Investment should be adequate but not excessive to avoid threats to profitability or solvency. Net working capital is the difference between current assets and current liabilities, indicating liquidity and the extent long-term funding can finance working capital needs. Permanent working capital is the minimum level of current assets like raw materials, work-in-process, and cash required to operate normally. It remains in the business and grows with firm size.

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7 views2 pages

Understanding Gross Working Capital

Gross working capital refers to a firm's investment in current assets, which can be converted to cash within a year. This includes cash, debtors, marketables, and stock. The gross working capital concept focuses on optimal investment in current assets and financing those assets. Investment should be adequate but not excessive to avoid threats to profitability or solvency. Net working capital is the difference between current assets and current liabilities, indicating liquidity and the extent long-term funding can finance working capital needs. Permanent working capital is the minimum level of current assets like raw materials, work-in-process, and cash required to operate normally. It remains in the business and grows with firm size.

Uploaded by

Ashish Agarwal
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© All Rights Reserved
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ON THE BASIS OF CONCEPT

1. GROSS WORKING CAPITAL

Gross working capital refers to the firm investment in current assets. Current assets are assets,
which can be converted into cash within an accounting year. The main components of current
assets are cash, debtors, marketable securities and stock.

The gross working capital concept focuses attention on two aspects of current assets
management-

 Optimum investment in current assets.


 Financing of current assets

The considerations of level of investments in current assets should be to avoid two-danger point:
excessive and inadequate in current assets. Investment in current assets should be just adequate,
not more not less to the need of business firm. Excessive investment in current assets should be
avoided as its impairs firm’s profitability. On the other hand inadequate amount of working
capital can threaten solvency of the [Link] aspect of gross working capital points to the
need of arranging funds to finance current assets. Whenever a need for working capital arises,
financing arrangement should be made quickly. Similarly arising shall be invested in short-term
securities.

2. NET WORKING CAPITAL


Net working capital refers to the difference between current assets and current liabilities. Net
working capital can be positive or negative. Net working capital is a qualitative concept. It
indicates the liquidity position of the firm and suggests the extent to which working capital needs
may be financed by permanent source of funds such as shares, debentures and long term debts
etc. it covers the question of judicial mix of long and short term funds for financing current
assets. In order to protect their interests, short-term creditors like a company to maintain a
positive NWC. Conventionally the ratio of CA and CL is 2:1. A negative NWC means a negative
liquidity, which may prove to be harmful to company’s reputation. It poses a threat on the
company solvency and makes it unsafe and unsound.

Net working capital= CA - CL

ON THE BASIS OF TIME-


On the basis of time, we may be classified as-

 Permanent working capital


 Temporary or variables working capital

I. PERMANENT WORKING CAPITAL


Permanent or fixed working capital is the minimum amount, which is required to ensure
effective utilization of fixed facilities and for maintaining the circulation of current assets. There
is always a minimum level of current assets, which is currently required by the enterprise to
carry out normal business operations. Every firm has to maintain a minimum level of raw
material, work in process, finished goods and cash balance. This minimum level of current assets
is called permanent or fixed working capital as this part of capital is permanently blocked in
current assets.

Characteristics of permanent working capital


 Amount of permanent working capital remains in the business in one form or the other.
The suppliers of such WC should not accept its returns during the lifetime of the firm.
 It grows with the size of the firm.
 Permanent WC is permanently needed for the business.

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