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Running a growing business comes with its challenges, especially when you need to manage day-to-day expenses while also planning for growth. You need enough cash to pay suppliers, staff, and cover unexpected costs, while also keeping your operations running smoothly. This is where working capital management becomes essential.
It is the difference between your current assets such as cash, receivables, and inventory, and current liabilities like payables, short-term loans, and other obligations due within a year. Managing it well ensures your business can meet daily expenses, avoid delays, and stay financially healthy even when demand fluctuates.
In this article, you will learn about different types of working capital, its key components, important ratios, and practical strategies to help your business stay liquid, profitable, and ready to grow.
Working capital management is the practice of monitoring and controlling a company’s short-term assets and liabilities to ensure it has enough cash to meet daily operational needs.
In simple terms, it means keeping enough liquidity to pay bills, handle unexpected expenses, and maintain smooth operations.
Formula: Working Capital = Current Assets – Current Liabilities
Current assets include cash, accounts receivable, and inventory that can be converted to cash within a year.
Current liabilities include accounts payable, short-term loans, and other obligations due within 12 months.
The main aim of working capital management is to ensure that a business always has enough short-term assets to cover its short-term liabilities without hampering growth. It strikes a balance between liquidity, profitability, and operational efficiency.
Different types of working capital in financial management have a certain set of components. Here is a look at the same:
Let us take a quick look at the types of working capital available:
If you could recall, your business needs capital during some specific times of the year, for example, in the festive season. Such a requirement, which is temporary and fluctuates according to a business’s internal operations as well as the external market conditions, is termed temporary working capital.
Permanent working capital is required to make liability payments even before your assets or invoices are converted into cash. This kind of capital is crucial as it is the minimum working capital required for your business to function uninterrupted.
While forecasting the value of your current assets is often challenging, it is possible to find a level below which a current asset has never gone. The current assets below this level are your permanent working capital. This can be done mainly on the basis of historical trends and experiences.
As the name suggests, gross working capital means the total of all your company’s assets that can be converted to cash within a year. Another way to describe this is the ratio of all your current assets to your current liabilities.
On the contrary, net working capital is your current assets minus your current liabilities. Since this is part of your current assets which are indirectly financed by long-term assets, it is considered relatively more significant for effective working capital management.
If your current liabilities are more than your current assets, it represents negative working capital. There is more short-term debt as compared to short-term assets. This can prove useful for your business as one can fund their growth in sales by effectively borrowing from their suppliers and customers.
Businesses normally require some capital just for things to flow smoothly. The least amount required for the same is known as regular working capital. Whether you have to make monthly salary payments or bear the overhead expenses for processing raw materials, the stability of your operations will depend largely on your regular working capital.
Reserve working capital is the capital over and above your regular working capital. Businesses keep such funds to meet financial requirements that may arise due to unexpected market situations or opportunities.
In case one’s temporary capital increases due to a special and abnormal event, it is referred to as special working capital. This can’t be forecasted as it is needed quite rarely.
For example, in a country where a cricket World Cup tournament is going to be hosted, many businesses might need special working capital due to the sudden rise in business.
Efficient working capital management is not only about identifying challenges but also applying the right solutions to keep liquidity, profitability, and operations balanced. Businesses can adopt the following strategies to improve their working capital:
According to a report, net cash from operations has fallen this year across Indian manufacturing companies. This is because the trade receivables have risen while payments have been delayed in the market.
Moreover, small and mid-sized companies are seeing lower credit through trade payables. Consequently, all of that pressure is being put on cash from operations. Thanks to the supply chain constraints, most businesses have locked in more of their funds in inventories.
Limited availability of cash, poorly managed commercial credit policies, or constrained access to short-term financing can lead to the need for restructuring, asset sales, and even liquidation of a business. Therefore, to protect your company’s existence, you must understand the different types of working capital in financial management and ensure that your business doesn’t fall short of working capital. Always make sure your business possesses appropriate and adequate resources for its daily activities.
| Ratio | Formula | What It Shows |
|---|---|---|
| Working Capital Ratio | Current Assets ÷ Current Liabilities | Financial health and liquidity |
| Collection Ratio | (Days × Avg. Receivables) ÷ Net Credit Sales | Efficiency in receivable collection |
| Inventory Turnover Ratio | COGS ÷ Avg. Inventory | Inventory management efficiency |
There are mainly three crucial ratios in working capital management. Here is a look at them:
It is obtained by dividing current assets by current liabilities. It reflects a company’s financial health. A working capital ratio of less than 1.0 shows that a company’s short-term debts may be causing trouble. On the other hand, working capital ratios of 1.2 to 2.0 are desirable because they reflect that a company’s current assets are greater than its liabilities. Meanwhile, a ratio of more than 2.0 shows that a company is not using its assets properly.
This ratio shows the way a company uses its accounts receivable. The number of days in a given period needs to be multiplied by the average outstanding accounts receivable amount to get this ratio. The product is then divided by the total net credit sales during the given accounting period.
The cost of goods sold (COGS) is divided by the average balance in inventory to calculate the inventory turnover ratio. The average of the beginning and ending balances of inventory is taken to calculate the average balance in inventory. If this ratio is high, it means that the inventory levels are inadequate. Conversely, if the ratio is low, then it shows that the inventory levels are exceedingly high.
In order to run a business well, you should also understand how its working capital works. This shows how long it takes for a company to get cash from its current assets.
Here is a look at how it works:
Working Capital Cycle in Days = Inventory Cycle + Receivable Cycle – Payable Cycle
It is important for a business to keep track of its working capital to make sure it has cash on hand and that day-to-day operations go smoothly, but it can only do so much. It only tells you a small part of how well a business is doing financially and may not always lead to long-term success.
Shiprocket is more than just a courier service. It helps businesses of all sizes manage operations efficiently, save costs, and improve cash flow. By simplifying logistics and providing integrated solutions, Shiprocket enables smarter use of working capital and faster business growth.
How Shiprocket Supports Businesses:
Managing working capital effectively is not just about keeping track of cash or ratios; it’s about giving your business the flexibility and stability to grow. By understanding the different types of working capital and monitoring your assets, liabilities, and cycles, you can make informed decisions, avoid cash crunches, and seize opportunities when they arise.
Smart working capital management helps you balance day-to-day operations with long-term growth, ensures timely payments, and improves profitability. Treat it as a strategic tool: the better you manage it today, the stronger and more resilient your business will be tomorrow.
Cloud-based accounting software, ERP systems, and AI-powered analytics can help monitor cash, receivables, payables, and inventory in real time. Tools like Tally, Zoho Books, or QuickBooks automate reporting and reduce errors in cash flow forecasting.
1. Over-investing in inventory and tying up cash unnecessarily.
2. Ignoring timely receivable collections.
3. Relying too heavily on short-term loans.
4. Failing to forecast cash flow accurately.
Track metrics like working capital ratio, inventory turnover, receivables collection period, and payables period. Monitoring trends over time helps identify bottlenecks and improve efficiency.
Yes. For example:
1. Retail businesses may need more cash for seasonal inventory.
2. Manufacturing may have longer receivable cycles due to bulk orders.
3. Service-based businesses often have lower inventory but need cash for payroll and operational expenses.
Yes. In India, schemes like the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) or working capital loans under priority sector lending can provide access to funds at lower interest rates.
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