Working Capital

What it means

Working capital is the money a business needs to run its day-to-day operations: buying raw material and stock, paying salaries and bills, and waiting for customers to pay. It is calculated as current assets minus current liabilities. Positive working capital means the business can meet its short-term obligations; a shortage means it may struggle to pay suppliers or staff on time even if it is profitable.

How it works

• Current assets: stock, trade receivables (debtors), cash and bank balance, short-term advances and deposits.

• Current liabilities: trade payables (creditors), statutory dues like GST and TDS payable, short-term loans and expenses payable.

• Working capital cycle: days of stock + days of debtors - days of creditors. A longer cycle means more money locked in the business.

• Bank funding: banks fund working capital through cash credit or overdraft limits. The amount you can draw (drawing power) is usually based on stock and debtors, less creditors, minus a margin of around 20% to 25%.

• Banks review the limit each year using stock statements, audited accounts and CMA data.

Example

A Surat textile trader has this position at year end:

1. Current assets: stock ₹25,00,000 + debtors ₹30,00,000 + cash and bank ₹5,00,000 = ₹60,00,000.

2. Current liabilities: creditors ₹20,00,000 + GST and other dues ₹5,00,000 = ₹25,00,000.

3. Working capital = ₹60,00,000 - ₹25,00,000 = ₹35,00,000.

4. Current ratio = ₹60,00,000 / ₹25,00,000 = 2.4.

5. Drawing power for the bank: (stock ₹25,00,000 + debtors ₹30,00,000 - creditors ₹20,00,000) = ₹35,00,000, less 25% margin of ₹8,75,000 = ₹26,25,000.

If the trader cuts the debtor period from 90 to 60 days on annual sales of ₹1,20,00,000, debtors fall by about ₹1,20,00,000 x 30 / 365 = ₹9,86,000, releasing that much cash.

Key points to remember

• Profit is not cash. Fast-growing businesses often run short of working capital.

• Collect from customers faster and negotiate longer credit from suppliers to shorten the cycle.

• Submit stock statements to the bank on time. Delays can freeze your cash credit limit.

• Do not use the cash credit limit to buy fixed assets. Use a term loan instead.

• MSME suppliers must be paid within 45 days, so factor this into payables planning.