Understanding Types of Working Capital – A Guide for Your Business

March 26, 2025

22 min read

Working Capital is an essential requirement of business in today’s scenario. It is very tough for businesses to grow and flourish without enough liquidity which is needed to meet their daily expenses. Businesses can only function well if they have enough operational liquidity in hand. Shortage of operational funds results in a shortage of raw materials and other resources which might hamper the success of any business. On the contrary, surplus funds for operations might result in a higher cost of production for the business.

Therefore, it is necessary to have neither surplus nor less but optimum liquidity to successfully run a business. In other words, working liquidity should be almost exactly the actual amount required for running a business.

Furthermore, one should evaluate beforehand the returns on the funds that are invested in the form of liquidity in the business. The return thus gained should not be less than the return earned by the business in other avenues.

Most of the time, businesses do not succeed not because of insufficient profits but because of lack of sufficient funds necessary to run its daily operations. Hence, management of operational capital plays a crucial role in the success or failure of a business. That is because operational liquidity immensely influences the profitability and liquidity of the business. So the first step for starting a business should be rightly ascertaining the actual liquidity required and also the various avenues of financing such a working liquidity. This step is essential to ensure that the operational cash in hand is sufficient enough to meet the obligations of the business in the short term. Therefore, one should properly understand the meaning of working cash and its importance in business and also the factors that influence the working liquidity of a specific business.

What is Working Liquidity?

Working liquidity may be defined as the money needed for financing current assets by a particular firm. It symbolises the necessary funds available to the business to finance day-to-day operations, i.e. regular business activities, efficiently and effectively. It assists in calculating the operating liquidity of the specific company, i.e., how efficient the company is in covering the short-term debt with the help of short-term assets.

Components of Working liquidity

Working liquidity management involves keeping a close eye on several key elements that are crucial for a company’s day-to-day operations. Let’s break down these components to understand them better:

Cash and Cash Equivalents: This is the lifeblood of any business. It includes money in bank accounts and on hand. Companies need to carefully track their cash flow, predict future needs, and maintain enough balance to cover expenses. Good cash management helps avoid sudden shortfalls and keeps operations running smoothly.
Receivables: These are the amounts customers owe to the company for goods or services already provided. Managing receivables involves setting smart credit policies, keeping track of who owes what, and finding ways to collect payments efficiently. The goal is to turn these into actual cash as quickly as possible.
Account Payables: This represents money the company owes to its suppliers and vendors. Balancing timely payments with preserving cash flow is key. Smart management of payables can help build good relationships with suppliers while also optimizing the company’s financial position.
Inventory: This includes all the products a company has ready to sell, whether in a warehouse or on store shelves. Effective inventory management means having enough stock to meet customer demands without tying up too much money in unsold goods. It is about finding the right balance to avoid both stockouts and excess inventory.

Working Capital Formula

The term ‘working capital’ refers to the financial amount required by an enterprise to carry out regular business operations like rent of the premises where business is run, salaries of employees, raw materials, electric bill and other expenses that are necessary for the running of a business. This type of capital is not used for making investments or purchasing long-term assets. Instead, it is used to cover expenses related to short-term operations of the specific business. Typically, working cash amount is calculated on the basis of current liabilities and current assets in the form of a ratio called working liquidity ratio that is current assets divided by current liabilities. Thus, it is seen that every business needs liquidity and the amount of capital can vary depending on the type of business.

So, it can be seen that working liquidity can also be called a calculator for measuring liquidity position of a business, its efficiency in operation, and soundness of finance in the short-term.

So the operational liquidity can be understood through the following equation:

Operational Capital is equal to the Current Assets minus the Current Liabilities

Now, let us understand what is the meaning of current assets and current liabilities of a business so as to understand the above mentioned equation.

Current Assets

Current Assets are those assets of the enterprise that can be easily cashed within twelve months or normal operating cycle of time of the business, whichever is greater. Generally these assets include:

Inventory : It is the amount of product that the company holds in stock which is ready to be sold, as and when the orders come. Inventory is a great measure of the liquidity of the company.
Cash and cash equivalents : This is pretty self explanatory, cash and cash reserves are the most important part of assets, it highlights the liquidity position of the company i.e. how easily the company can pay off the short term liabilities.
Prepaid Expenses : Expenses are a non avoidable part of the capital management, efficient expenses cycles means efficient use of the capital expenditure. Prepaid expenses highlight the current or future expenses already being paid for in the past.
Accounts Receivable : For a business, accounts receivable forms one of the biggest part of the current assets, it means the current bills for which the product or services have been delivered but the company is yet to realize the monetary compensation from its customers.
Marketable Securities : These are financial assets, which can be readily traded in the financial markets for a cash consideration. These are highly liquid in nature and form a big chunk of current assets for the companies which have operations centred around markets and securities.
Current Liabilities : Current liabilities form an essential part of the balance sheet of a company, highlighting the total short term liabilities in the company.
Other Liquid Assets : Other liquid assets is a broad classification, and can include various marketable assets or securities that can readily be sold for a cash consideration. It can include assets like precious metals, art work, etc.

Current Liabilities

Current Liabilities are defined as the obligations of the enterprise which are due within a year or one operating cycle, whichever is greater. These liabilities are paid by using either the current assets of the enterprise or by creating new current liabilities.

Current Liabilities include:

Notes payable : Notes payable are a loan contract between a borrower and the lender, it is a critical liability, these are included under the current liabilities header because of the nature of the liabilities, which needs to be paid in short term
Accounts Payable : Accounts payable is a major constituent of the current liabilities, as it highlights the bills that are to be paid to the vendors for products or services that the company has already availed.
Accrued Liabilities : Accrued liabilities highlight the expenses that the company has incurred but not yet paid for, or recorded in the financial statements.
Current Portion of Long Term Debt : As the name suggests long term term debt means liabilities that are to be paid over a long repayment tenure, the current portion of long term debt indicates the amount liable to be paid in the short term as a part of the overall long term debt.
Unearned Revenues : Unearned revenues essentially means the expected revenue for the products/services the company is yet to deliver. It indicates the order book of the company, and how much revenue the company is expected to make if they’re able to deliver the goods and services as per their order book.

Working liquidity Loans Benefits

There are lots of advantages of working cash loans and they are as follows:

Lack of any restriction on how to use loan funds
Easy availability of the operational cash loan coupled with quick drawdown or disbursement
Loans do not need any collateral and these are extended on the business credentials
An affordable rate of interest and quite short tenure of loan as short as maybe 12 months

An enterprise can apply for business loans under various categories of working caplital loans depending on the needs of their business

Additional Read: Working Capital – What is Working Capital, Meaning & Formula

Temporary Working cash

Capital that is needed by the enterprise for some specific period of a year is termed as temporary operational liquidity. For instance, this type of operational capital might be the need of the hour during festive season due to the increased immediate demands of the business. This type of requirement is thus called temporary and so it changes depending on changes in the operations of the business and situations in the market. In short, this type of loan is taken for a short period temporarily to meet immediate demands and is paid back as soon as the cash starts coming in hand.

Permanent Working Cash

Capital that is needed to make liability payments even before the enterprise is able to change invoices or assets into cash is called the permanent operational capital. This type of loan is needed by the business for a long and sometimes very long period of time. It also depends on the operating cycle. This type of loan is also known as hardcore operations capital or fixed operations capital, which is a requirement for the smooth functioning of any business.

Gross and Net Working Capital

Gross capital for operations, in actuality, is the company’s assets in total. Such assets are generally the ones which can be easily converted to cash in a year. These assets generally include:

Cash : Cash is the gold equivalent in the scheme of working liquidity, as it helps the company meet its short term and long term obligations. It is essential for smooth functioning of the operations and ample cash reserves indicate healthy working liquidity management of the company.
Receivable accounts : Receivable accounts means the money consideration that the company is yet to receive in exchange for delivery of goods or services that the company has already performed. It is essential for a company to maintain receivable accounts in moderation, as high receivables may indicate difficulty in realizing the money, or longer cash conversion cycles, and low receivable accounts indicate little product float in the market.
Short-term investments : Short term investments are crucial for any business. These investments could be directed towards enhancing operational efficiency or can be focused on making more money. Irrespective of the nature, short term investments solidify the company’s position to fulfill its capacity to fulfill its short term liabilities.
Marketable securities such as stocks : Marketable securities are great for making the company’s cash position more efficient. A company sitting on a good amount of marketable securities while having enough cash to fulfill its short term liabilities indicate efficient treasury management of the company.

The most preferred way of expressing the positive working liquidity is to define the ratio of the current assets to the current liabilities. Such a net operational capital in the business is actually the difference between the current liabilities and gross operational capital.

Negative Working Capital

A deficit or shortfall is called negative operational capital. This reflects that there is an excess of the current liabilities as compared to the current assets. Negative operations liquidity increases if the current liabilities are exceeding the current assets. In simple terms, there is greater short-term debt as compared to short-term assets. In such a case of the working liquidity, it may be better as the company with some negative operational capital funds would see a growth in its sales by borrowing more from the suppliers effectively and its customers. In the case of better management, the negative operations capital might be a better way for funding the business growth through sales with someone else’s monetary funds.

Reserve Working liquidity

The reserve working liquidity is another type of fund which the business needs to maintain above and over the working liquidity as required. Businesses need to use such types of funds in case of an emergency for some unexpected market opportunities or situations. So, the reserve working liquidity actually refers to a short-term financial need that is required by the businesses to cope up with uncertainties or meet any unexpected changes.

Regular Working cash equivalent

Such type of working cash is generally the minimum capital which is required by business for running the daily operations. A business needs to maintain some kind of appropriate level of this regular working liquidity for operating with stability. This is the permanent operations capital that is generally required for the general course of the business for ensuring a better flow of the working cash cycle.

So regular working liquidity can be defined as the least amount of money which is required by a certain business for carrying out the day to day operations of the business. One can consider paying the monthly payment of wages and salaries and maintaining some overhead expenditure for raw materials processing as required by the businesses. It is very essential for business to have a flow of regular operations capital.

Seasonal Operations Capital

Such working liquidity generally refers to the higher amount of the working liquidity which is required by a business during its peak season in a particular year. Such businesses which somehow deal in the manufacturing or production of the products or if they provide some services which have some kind of seasonal demands are required in maintaining the seasonal operations capital. This can be understood as a kind of reserve capital which is to adapt for the seasonal fluctuations or sudden change in the market of the business.

Seasonal working liquidity can be considered as the temporary increase in the working liquidity. It is not permanent. This is only applicable when businesses have some kind of impact on the seasons, such as a manufacturer of umbrellas and raincoats for them the monsoon is the relevant season. Generally, the operations capital need will increase in the season for the higher demand and the sales in the monsoon period and then it will go down when the collection from debtors is greater than the sales. Let’s move to the last one.

Special Working Liquidity

This depends on the various types of operations capital necessary, the company can choose to get additional finance as its working liquidity loan for maximizing such a business’s efficiency. This operations capital is generally based on the urgent financial needs of the businesses. The extra working liquidity might also be needed by such a business for undertaking unforeseen circumstances or exceptional operations. Such capital which is required in crucial circumstances is known as the special operational liquidity. There are funds that are required to finance marketing campaigns, or unforeseen events such as floods, accidental fires, etc. So, a special working cash loan is required due to the rise in the working liquidity temporarily due to the occurrence of a special event that didn’t take place generally. There is absolutely no chance to predict such a condition as such events take place rarely. For example in the Covid-19 scenario, there was a spike in the production of certain types of medicine, surgical masks and PPE kits. So, a pharmaceutical company manufacturing these would require special operations capital for increasing the production of the medicines in the company. Also, such a scenario could not be predicted. Such short-term and special loans might help the company to boost its sales.

Importance of Working liquidity Management

In today’s business landscape, especially in India, operations capital management has become more critical than ever. Recent trends show that many Indian manufacturing companies are facing challenges with their cash flow from operations. This is happening because customers take longer to pay (increasing receivables), while at the same time, companies are having to pay their bills faster.

The situation is even tougher for small and medium-sized businesses. They are finding it harder to get short-term credit from their suppliers, which puts extra pressure on their cash reserves. On top of this, global supply chain issues have forced many companies to keep more inventory on hand, further tying up their funds.

Without proper working liquidity management, businesses can quickly find themselves in trouble. They might struggle to pay bills, miss growth opportunities, or even face the risk of closing down. That is why it is so important for companies to understand different types of working liquidity and make sure they always have enough to keep things running smoothly.

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Advantages and Limitations of Working cash

Advantages

Having a healthy amount of working liquidity brings several benefits to a business:

Liquidity: Good operations capital means a company can easily pay its bills and handle day-to-day expenses. This financial cushion helps businesses operate smoothly without constantly worrying about running out of cash.
Operational Efficiency: When a business has enough operations capital, it can pay suppliers and employees on time. This reliability helps build strong relationships and keeps operations running without hiccups or delays.
Flexibility: Extra operations capital gives businesses the ability to jump on new opportunities or deal with unexpected costs. It is like having a financial safety net that allows for quick decisions and adaptability in a changing market.
Creditworthiness: A healthy operations capital position makes a business look good to banks and other lenders. It shows that the company is financially stable. This can lead to better loan terms and easier access to credit when needed.
Cost Management: With sufficient working liquidity, businesses can avoid the need for expensive short-term loans. This helps keep overall costs and improves profitability in the long run.

Limitations

While working liquidity is crucial, it is important to be aware of its potential drawbacks:

Idle Assets: Having too much working liquidity can mean that money is sitting idle instead of being put to good use. This excess can represent a missed opportunity for growth or investment.
Opportunity Cost: Funds tied up in working liquidity might be better used for long-term investments or expansion projects that could yield higher returns.
Seasonal Variations: Many businesses, especially in India, face seasonal ups and downs. This can make it challenging to maintain the right level of operation capital throughout the year.
Dependency on External Factors: Economic changes, market shifts, or even policy changes can suddenly affect a company’s working liquidity needs. This makes it difficult to plan accurately.

Types of Working liquidity Management Ratios

To keep track of how well a company is managing its working cash , there are three main ratios to look at:

Working liquidity ratio: This is calculated by dividing current assets by current liabilities. It gives a quick snapshot of a company’s financial health. A ratio between 1.2 and 2.0 is generally considered good. It showcases that the company has enough short-term assets to cover its short-term debts. If it is below 1.0, it might signal trouble, while above 2.0 could mean the company is not using its assets efficiently.
Collection Ratio: This ratio helps understand how quickly a company is turning its credit sales into cash. It is calculated by looking at how long, on average, it takes customers to pay their bills. A low number is usually better, as it means the company is collecting payments faster and can use the cash sooner.
Inventory Turnover Ratio: This shows how quickly a company is selling and replacing its inventory. It is found by dividing the cost of goods sold by the average inventory value. A high ratio might mean the company is selling products quickly but could risk running out of stock. A low ratio could indicate that inventory is moving slowly, potentially tying up too much cash in unsold goods.

What Happens if a Company Has Low Working liquidity?

When a company finds itself with low operations capital, it is not always a sign of trouble. In fact, it can sometimes indicate efficient financial management. Low working liquidity means the company has fewer current assets compared to its current liabilities. This situation might arise if the business has invested heavily in growth opportunities or long-term assets.

However, consistently low or negative operational capital can be risky. It might mean the company is struggling to pay its short-term debts or running its operations efficiently. In extreme cases, prolonged negative operations capital could even lead to bankruptcy.

In the Indian context, many small and medium enterprises (SMEs) often operate with tight working liquidity. While this can show efficiency, it can also leave them vulnerable to market fluctuations or unexpected expenses. It is a balancing act that requires careful management and planning.

How to Increase Your Working liquidity?

Boosting working liquidity involves strategies to either increase current assets or decrease current liabilities. Here are some practical approaches:

Speed Up Collections: Encourage customers to pay faster. This might involve offering small discounts for early payments or implementing stricter credit policies. For Indian businesses, especially in the B2B sector, improving collection efficiency can significantly impact operations capital.
Optimize Inventory: Keep only what you need. Excess inventory ties up cash that could be used elsewhere. Use inventory management systems to maintain just enough stock to meet demand without overstocking.
Negotiate with Suppliers: Try to arrange longer payment terms with your suppliers. This allows you to hold onto your cash longer. Many Indian businesses build strong relationships with suppliers to negotiate favorable terms.
Explore Financing Options: Consider short-term loans or credit lines to cover temporary cash flow gaps. In India, there are various options available, including working liquidity loans from banks and non-banking financial companies (NBFCs).

Conclusion

Effective working cash management is essential for businesses, especially in India’s dynamic market. It requires balancing enough funds to operate smoothly while avoiding excess that could stifle growth. For small businesses and MSMEs, managing operations capital is often a challenge, and this is where institutions like Lendingkart help. We offer tailored loans that provide financial flexibility to handle seasonal changes, seize growth opportunities, and manage market complexities. With quick, accessible financing options, Lendingkart enables small businesses to maintain healthy working liquidity levels. It aids in driving growth and stability in India’s entrepreneurial landscape.

Additional Read: How to Calculate the Working Capital Requirement for Your Business

Frequently Ask Questions

What Happens If The Company Has Low Working liquidity?

If a company has low working liquidity, it may face liquidity challenges. Operations capital consists of both permanent and temporary components. Permanent operations capital is the minimum required for day-to-day operations, while temporary working liquidity fluctuates with business cycles. Effective working liquidity management is crucial to maintaining financial stability. Companies may consider measures like optimizing inventory, managing accounts receivable, or seeking external financing wherever possible to address low operational capital issues.

What is the difference between gross and net working liquidity?

The key difference between gross and net operational capital lies in how they account for types of working liquidity. Gross working liquidity includes all current assets without considering current liabilities, providing a broader view of a company’s liquidity. On the other hand, net working liquidity deducts current liabilities from current assets, emphasizing the company’s short-term financial health. Understanding these types of operations capital is essential for effective operational capital management.

What is the sole purpose of using working liquidity?

The sole purpose of operations capital is to ensure a company’s day-to-day operations run smoothly. It consists of two main types: permanent working liquidity, necessary for ongoing needs, and temporary operations capital, used for short-term fluctuations. Effective working liquidity management is crucial, as it ensures a balance between these two types, wherever possible, to meet financial obligations and capitalize on opportunities for growth.

Is collateral required for a working working liquidity loan?

No, collateral is not required for a working liquidity loan. As these loans are targeted towards helping companies fulfill their short term obligations, and from the companies standpoint it may not be efficient to produce collateral. Also, since the loans are short term, lenders’ risk is low which allows them to disburse loans without collateral.

What collateral would be acceptable for the loan facility?

The preferred collateral option would be industrial, residential, commercial or such properties. As these properties have credible and increasing market value, making them a safe collateral option.

Which companies are eligible?

The eligible individuals are manufacturers, wholesalers and retailers.

Are traders eligible for this loan?

Traders engaged in any kind of exports or imports are eligible for the loan.

Is a sole proprietorship firm available for this loan?

Yes, sole proprietorship firms are available for this loan.

Is a partnership firm available for this loan?

Yes, partnership firm available for this loan.

Can limited companies apply for loans?

Yes, private limited companies or public limited companies apply for loans.

What is the interest rate for this loan facility?

The interest rate for the loan facility depends on various parameters.

On what factors does interest rate depend?

The factors on which interest depends on are:

tenure of loan
business profile
financial records
past track record
loan amount required

What is the validity of the working finance limit?

The validity of the working finance limit is valid for one year.