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For a successful business, you need adequate working capital. Working capital is one of those types of loans that is called as the lifeline of any business because it is crucial for its smooth functioning and daily operations. While earning profits is important, effective working capital management is indispensable to keep the organization going. An essential step of managing the working capital effectively is, having an understanding of the types of working capital. Typically, there are two kinds of working capital - gross working capital and net working capital. While managing your business, you must know the difference between the two.
Here is a brief guide on gross and net working capital and the difference between the two.
What Is Gross Working Capital?
The capital invested in the current assets of a company is called gross working capital. The total amount of short-term funds that a company has and uses for its daily operations can be called gross working capital. In short, the total current assets of a company is its gross working capital. To clarify, current assets means the assets that can be converted in cash within a year, for example, inventory, trade receivables, cash and cash equivalents, current investments, marketable securities, etc.
Gross working capital is calculated as:
Gross working capital = total current assets
What Is Net Working Capital?
Net working capital is the difference between the current assets and current liabilities of a company. Depending on the value of your current liabilities and assets, it can have a positive or negative balance.
Current liabilities are short-term liabilities like short-term borrowings, outstanding expenses, accounts payable, etc. If the company’s investment is higher in current assets and has minimum liabilities, the net working capital would be positive. Similarly, if the company has a higher amount of current liabilities, it will have a negative working capital balance.
Negative working capital could indicate that the business is in a risky position and its borrowings are greater.
Net working capital is calculated by subtracting the value of current assets from the current liabilities.
Net working capital = current assets - current liabilities.
The success of a business significantly depends on the management of net working capital, as the businessmen should ensure that there is a right balance in the current assets and liabilities of the firm.
What Is the Difference Between Gross Working Capital and Net Working Capital?
Gross working capital
Net working capital
It is the sum total of the current assets.
It is the difference between current assets and current liabilities.
The balance of gross working capital is always positive
Net working capital can show positive or negative balance
Does not reflect the true value of the business
It displays the true liquidity position of the company
Understanding the gross and net working capital of the business is crucial to managing the working capital effectively. Ensure that you gather adequate knowledge about these types of working capital finance for effective working capital management.
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