Classification of Working Capital

1. On the Basis of Concept:

Working capital can be categorized based on the accounting concept into two types:

• Gross Working Capital:
  • Definition: This is the total capital invested in the current assets of an enterprise.
  • Examples of Current Assets :
    • Cash in hand and bank balances.
    • Bills receivable.
    • Short-term loans and advances.
    • Prepaid expenses.
    • Accrued incomes.
• Net Working Capital:
  • Calculation: Net Working Capital = Current Assets - Current Liabilities.
  • Positive vs. Negative Working Capital:
    • Positive: When current assets exceed current liabilities.
    • Negative: When current liabilities are more than current assets.
  • Examples of Current Liabilities:
    • Bills payable.
    • Sundries debtors.
    • Accrued expenses.
    • Bank overdraft.
    • Provision for taxation.

2. On the Basis of Time:

Working capital is also classified based on its usage over time:

• Permanent or Fixed Working Capital:

  • Definition: This is the minimum amount required to ensure effective utilization of fixed facilities and maintain the circulation of current assets.
  • Importance: It ensures that the company has enough resources to continue its operations without interruption.

• Regular Working Capital:

  • Purpose: This capital is necessary to ensure the continuous circulation of current assets from cash to inventories, then to receivables, and back to cash.
  • Cycle Management: It is crucial in managing the operational cycle of converting cash into goods and back into cash.

• Reserve Working Capital:

  • Definition: This is the additional amount over the regular working capital.
  • Purpose: It serves as a cushion for contingencies such as strikes, price rises, depressions, etc.
  • Significance: It provides financial stability during unforeseen financial requirements.

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