Explain the Importance of Working Capital

Importance of working capital

Every company needs working capital to meet its short-term expenses. It keeps the business moving. Without it, the business will stop, and the company will become sick.

Explained below is the importance of working capital.

Image credits © Prof. Mudit Katyani.

1. Continuity in Business Operations: Working capital keeps the business operations moving. It is needed to purchase raw materials, to pay the workers and staff and also to pay the recurring expenses like electricity and power bills, rent, etc.
2. Dividend Payment: Working capital is needed to pay a dividend to the shareholders. The payment of dividend takes place on a yearly or half-yearly basis.
3. Repayment of Long-Term Loans: Working capital is also used to repay long-term loans and debentures. It will be impossible to repay debentures, long-term loans and other long-term liabilities without it.
4. Increases Creditworthiness: A company that pays its creditors well on time has a positive reputation in the credit market. Such a goodwill helps a company to get raw materials on credit. It can also get loans and advances from the banks. The dealers are also willing to give money to the such a company. Hence, working capital increases company's creditworthiness.
5. Boosts Efficiency and Productivity: The company that faces no working capital problems provides better working conditions and welfare facilities to its workers. It also can maintain its machines in good conditions. It can afford to spend money for training and development of its workers. All such steps boost the efficiency and productivity of the company.
6. Helps to Fight Competition: Working capital helps the company to fight its competitors. It can be used to advertise and to do sales promotion. The company can also afford to give longer credit terms to the customers.
7. Helps to Withstand Seasonal Fluctuations: Working capital is required throughout the year. But the sales may be seasonal in nature. If the sales are down, the money inflow is less. Therefore, liquid cash is required, to pay wages to workers and to meet other expenses. So, it helps the company to withstand seasonal fluctuations.
8. Increases Goodwill: The company that meets the needs of its working capital without any difficulty earns a good reputation in the labour and capital markets. It is so, since, the company pays wages and salaries to the employees and the suppliers of raw materials, etc., in time. Thus, it also helps to increase the goodwill of the company.

The related article on this topic:

1. Importance of fixed capital.