CONCEPTS OF WORKING CAPITAL
There are two concepts of Working Capital - Net working capital and Gross Working capital.
1. Gross Working Capital
Gross Working capital relates to the firm's investment in current assets (Short Term Securities, Cash, Debtors, Bills Receivable and Inventory). Current assets are those assets which can be converted into cash within a year. This idea focuses on - how to optimize investment in current assets and how should they be financed? In this instance, both excessive and inadequate investment in current assets should be avoided.
2. Net Working Capital
Net Working capital relates to the variation between current assets and current liabilities. It may be negative or positive. This idea is a qualitative concept. It shows the liquidity position of the firm and suggests the extent to which working capital needs may be financed by permanent sources of capital. Current assets should be sufficiently in excess of current liabilities to constitute a margin for maturing obligations within the ordinary operating cycle of a business. This idea also covers the question of judicious mix of short-term and long-term funds for financing current assets.
The two concepts of Working Capital are not exclusive rather they have equal significance from management's view point.