What is Working Capital

Working capital is the net of current assets minus current liabilities. That is working capital is equal to the value of raw materials, work‐in‐progress, finished goods inventories and accounts receivable less accounts payable. The aim of working capital management is to achieve balance between having sufficient working capital to ensure that the business is liquid but not too much that the level of working capital reduced profitability. Working capital management is essential for the long‐term success of a business. No business can survive if it cannot meet its day‐to‐day obligations. A business must therefore have clear policies for the management of each component of working capital.

Short‐term financing: Short‐term financing is cheaper than long‐term finance because lenders would demand a greater compensation for having their money tied up for long periods. Short‐term finance is more flexible than long‐term finance because the amount of finance needed will fluctuate over the operating cycle. A business will only pay interest on the amount of overdraft (short‐term) utilized whereas with long‐term the business will pay fixed interest even though the loan is not fully utilized.  an overdraft is simple to arrange and is normally unsecured against the company’s assets. It does not need any of the formalities that go with setting up long‐term finance.

Sources of short term Financing

• Factoring of accounts receivable: The debts of the company are effectively sold to a factor.
• Invoice Discounting: selected invoices are used as security against which the company may borrow funds.
• Trade Credit: The delay of payment to suppliers on credit terms, no interest funding
• Overdrafts from bank: Short‐term borrowings from a financial institution
• Bank Loans: Loans between one and three years
• Bills of Exchange: An agreement to pay a certain amount at a certain date in the future