Let’s dissect the terms working and capital!
First is the more obvious. Why is it working? It is because it is “currently” being used (within a year). A good example of a current asset is inventory which is obviously used up within a year or at least to be used up in the future. This also churns out more operating cash in turn.
Second is the capital. So is this the current money or cash? NO. So what is it then? Let’s get to the more often heard of capital, which is A-L=E, i.e, Assets minus the liabilities. Thus the working capital Is simply CA-CL=CE, or current equity, if I may coin such a term. So the working capital is nothing but a ‘current equity’ of sorts!
What do we mean by saying someone works really well? It means that he not only does the job well (quality) but also does it in time (quantity) as more time is available to complete many such similar tasks. Let’s understand working capital from this context.
Take a manufacturing plant like that of a car. What’s interesting to note is that the rate at which the Finished goods are manufactured has a direct bearing on the working capital. How? Imagine a car being manufactured with every value addition made being a significant one (quality—resulting in a higher value of the asset), and also if the time consumed is less (quantity) to do the series of value addition, the value chain is gonna have current assets worth much more for a given liability!
No wonder it’s called the working capital. It indicates how well it works (the value addition), and how fast it works (the time factor) to ensure it remains well within the 1 year mark to deem it ‘current’.
So I would leave this blog with a food for thought for which I look forward to interesting responses. Considering the above interpretation, so is working capital a requirement (which we so often quote as) or is it an offshoot of efficient operations?
Author Bio :
Kumar Simha is an NIT Graduate with an MBA, Finance from HULT, Boston, USA, Kumar has more than 8 years of experience across Financial services, Business management and Training.