The amount of money a company must have to meet its various needs is its gross working capital. A company’s current assets are those assets that can be converted into cash within an accounting year. This includes cash and bank balances as well as short-term investments, commercial paper, and marketable securities. Gross working capital is an important factor in gauging a company’s financial strength and liquidity. It denotes a company’s ability to repay short-term liabilities such as debentures, overdrafts, and trade creditors. Gross working capital also aids in estimating the market value of a company during a takeover because it reflects the value of the company’s inventory. However, gross working capital alone cannot measure a company’s liquidity because it does not account for the company’s current liabilities such as accounts payable or any outstanding loans.
Did you know? Fixed assets are not included in working capital because you cannot convert them to cash easily.
Calculation of Gross working capital:
Gross working capital = The total value of the current assets of the company
Current assets include cash and cash equivalents, current investments, short-term loans & advances, inventory, trade receivables, and other current assets. Current liabilities include trade payables, short-term borrowings, short-term provisions, and other current liabilities.
Net Working capital = Total current assets – Total current liabilities
When a business has a surplus of current assets over current liabilities, it is said to have a positive working capital. It indicates that the company has enough funds for its operations. Negative working capital implies that the company’s current liabilities are more than its current assets. This may sound alarm bells of financial distress for the company because it may be unable to repay its creditors.
To assess the company’s financial health, business owners also calculate the working capital ratio:
Current Assets / current liabilities = Working capital Ratio
Also read: What Is Gross Salary? Know How To Calculate Gross Salary Or CTC
Example of Gross working capital:
Below is an example of the balance sheet and Gross working capital calculation of ABC Pvt Ltd:
Name of the company: ABC Pvt. Ltd.
Gross working capital is best defined as the sum of a company’s current assets. These assets represent the short-term financial resources of the company, which can be converted into cash within a time span of a year or less than a year. It includes inventory, cash and cash equivalents, debtors, marketable securities, and prepaid expenses.
Gross working capital = Trade receivables (debtors) + inventory + marketable securities + cash and cash equivalent + prepaid expenses. However, it does not take into account the current liabilities.
Balance sheet dated – 31st March 2019
Difference between Gross working capital and Net Working Capital:
To better understand the concepts of gross working capital and net working capital, let’s look at the fundamental differences between them:
|
Parameters |
Gross working capital |
Net Working Capital |
|
Definition |
Gross working capital is the total value of a company’s all current assets. |
Net Working Capital is the difference between the value of a company’s all current assets and all current liabilities. |
|
Concept |
It is the value of current assets hence is a quantitative concept. |
The value networking capital denotes the financial position of the company hence it is a qualitative concept. |
|
Indicator |
It indicates the amount of money available to fund current assets. |
It demonstrates a company’s ability to pay off existing liabilities and operating costs. |
|
The financial health of the company |
A company’s liquidity cannot be measured by gross working capital as it considers only assets that can be converted into cash within a year |
The true picture of a company’s operating liquidity is provided by net working capital, which takes into account the company’s financial obligations. |
|
Formula |
Gross Working Capital = Cash accounts receivables Marketable Securities short term investments Inventory Other Current Assets Or, Gross Working Capital = Receivables + Cash and Marketable Securities + Inventory + Short Term Investments + Other Current Assets |
Net Working Capital = Total value of current assets – total value of current liabilities |
|
Suitability |
This metric is more appropriate for companies. |
This metric is more appropriate for sole proprietorship and partnership firms. |
Significance of Gross working capital:
Gross Working Capital is important to businesses for the following reasons:
· The assessment of gross working capital provides an insight into the expected cash flow available to a business.
· It helps in determining the financial standing and ability of a company to repay the liabilities on time.
· It helps to calculate the company’s working capital ratio, which is a more accurate indicator of the company’s financial standing.
· Gross working capital enables investors and shareholders to make well-informed decisions about making investments in a company.
Also read: Real-Time Gross Settlement (RTGS)- Definition & Importance
Conclusion:
This article gives you a complete understanding of how Gross working capital is used to measure a firm’s available cash flow within an organisational setup. You can download the Legaltree App to avail of more details.