Few people know, but there are at least four terms to differentiate the types of working capital . Also known as current assets, its basic definition of being cash in hand and the amount that is “turning over” is not enough to represent the variations and details.
It is almost impossible to manage a company without studying finance. If you already have a business and are not familiar with these concepts, that’s okay. There is still time to get started. You just need to learn more, and knowing the types of working capital is a good place to start.
Below, you will learn about four types of working capital and what defines them. You will also learn about the impact they have on a business’s routine. Finally, discover the ideal tool for coordinating the company’s cash flow and financial transactions.
Have a good read!
What are the types of working capital and how are they defined?
Before we start explaining the types of working capital, we need to know if you already understand the basic concept. That is, if you already know what it is, how to calculate it, and if you are familiar with its relationship with self-financing.
The term working capital can be used in four different circumstances , with variations in meaning and context. For this reason, the name gains a complement depending on the situation. These types refer to distinct values or conditions of each amount in circulation:
Net working capital
This term refers to the amount resulting when current liabilities are subtracted from current assets . Answering this way is simple, but the entrepreneur needs to know what the terms assets, liabilities and current mean.
Assets are the goods and rights that make up a company’s balance sheet. Current assets refer to the liquidity of the values. Therefore, current assets are those that can be converted into money in the short term, such as cash and inventory.
Real estate, automobiles, equipment and other medium and low liquidity assets are known as fixed assets. Because they have low conversion rates, these amounts are not normally considered in net working capital.
Current liabilities are not assets. On the contrary, they are debts or payment obligations. What makes them “current” is that they are due within one year.
Examples include supplier invoices, employee payroll, taxes, electricity bills and loans.
Negative working capital
Negative working capital refers to when current assets are not sufficient to pay creditors . When your company finds itself in this situation, it is necessary to be on alert.
Of course, in the short term this may be an eventuality, but if this continues for a long time, there may be a liquidity crisis. The consequence is losses that, if not covered, turn into a snowball effect that, the bigger it is, the more likely it is to lead the company to bankruptcy.
However, our goal is not to scare entrepreneurs. We want to help businesses achieve success through research, strategies and tools. So, we have a suggestion to avoid negative working capital: adopt strategic cost management.
Own working capital
This is another term referring to a state of working capital. When the company manages to accumulate enough capital to cover all its bills without having to borrow or invest from outside, it is not “positive”, it is “its own”.
If this is your situation, celebrate! It means that the business is financially healthy and can sustain itself with the resources it collects. However, it is important to know that there is an operation that maintains regular financial control, making it easier to achieve your own working capital.
This operation is called cash flow . When done regularly, it keeps track of the amounts the company has, those it is about to pay, and those it is yet to receive. With control and predictability, the entrepreneur makes better decisions to achieve its own working capital.
Working capital associated with investments
The investment operation in a company is necessary for expansion . When a part of the circulating financial resources are allocated to pay the costs of an investment operation, we give it the name of working capital associated with investments.
Knowing this part of the account is important for monitoring the company’s financial health and understanding the real state of affairs. Even if working capital decreases from one month to the next, if the cause is investment, it is a sign that the business may be evolving.
However, don’t put the company’s money anywhere before calculating the payback . This is the financial indicator that represents the return time on an investment that the business makes.
The impact of working capital on companies’ routine
Calculating a company’s working capital is important for understanding and controlling cash flow . This is the only way to keep your accounts and business financially healthy. And we’re not just talking about growth, because anyone with negative working capital can end up going bankrupt.
Of course, many businesses, especially at the beginning, may have difficulty maintaining a high working capital with their own resources. For this reason, there are several institutions, including government institutions , that offer loans with personalized conditions for small and medium-sized companies.
Credit can be a blessing or not . When an entrepreneur knows what he is doing and uses intelligent management, he can use this money to increase his revenue, pay off his loan and make a profit. Without planning, debt accumulates and fines arise, leading to losses and bankruptcy.
Optimize the management of your working capital
Working capital encompasses several values that are always in flux . Keeping an eye on all of them at the same time makes the entrepreneur become like a fly, with eyes all over the place, or a chameleon, with each eye moving in a different direction.
At least that’s how it is for those who don’t know about smart tools that centralize, integrate and facilitate the reading of all this data. In this case, we’re talking about integrated management platforms, which offer this and everything else.
With an online ERP, you can manage all of your company’s money from one place. And by that, we also mean forecasting, settling and collecting accounts payable and receivable, reconciling bank accounts and taxes, and accessing all of your business’s financial health data.