Gross working capital refers to total current assets and these are those assets that can be converted to cash within an accounting year e.g. stock receivables, cash short-term securities and so on. Net working capital refers to current assets less current liabilities. Current liabilities are those claims of outsiders which are expected to mature for payment within an accounting year e.g. bank overdraft, payables, short term loans, accruals etc.
Management of working capital refers to management of cash, receivables, inventory and current liabilities. The management of current assets is similar to that of fixed assets in the sense that in both cases, the firm analyses their effect on risk and return of currents fixed assets, however, differs in 3 important ways
- In management of fixed assets, time is very important, the compounding and discounting effects play a major role in capital budgeting are a minor role in current assets.
- The large holding of current assets, especially cash strengthens a firms liquidity position, however, it reduces profitability
- Levels of fixed as well as current assets depend on expected sales but it is only current assets which can be adjusted with sales in the short term.
Working capital might therefore refer to the management of both current assets and current liabilities involve 2 major decisions.
1. Target levels of each category (optional current assets).
2. How these assets will be financial