Working capital or operating capital is the amount of resources that make up and finance the operating activity of a company; net working capital, on the other hand, is given by the difference between current assets and liabilities. Working capital is used to finance the company's ordinary activity (commercial transactions) and its level depends on the type of activity and its management policy. The working capital can be managed following a restrictive policy that tries to limit it as much as possible or a more relaxed policy that does not provide for particular limitations or by following a middle ground.

The level of working capital in a company is not stable, but is subject to fluctuations of various kinds, which can be seasonal or cyclical. Nevertheless, each company tries to maintain an adequate and stable level of working capital over time. Working capital therefore has two components within it: a durable component linked to the technical constraints of the production process and the economic constraints of the competitive system, and a floating component, due to temporary expansion of turnover (e.g. seasonal peaks).

The working capital management process is shown in the previous sections; here instead the various types and funding policies are presented. The set of short-term loans, i.e. working capital, can be financed in various ways: 

• following a medium risk method, which provides for the synchronization between the maturities of the loans and the sources, financing the durable component of the working capital from durable sources and the floating component from current sources;
• adopting a more aggressive and riskier policy, financing only part of the durable component with durable sources and all the remaining part with current sources;
• adopting a more conservative and less risky policy, also covering part of the seasonal fluctuations with long-term financial means.

 

 In this context, it is good to remember that short-term loans have, compared to long-term debts, strengths such as: faster access times, greater flexibility and generally a cheaper interest rate; however by being short-lived they often need to be renewed or renegotiated.

 Source: Dolenc, P. & Stubelj, I. 2011. Poslovne finance s praktičnimi primeri. Ljubljana.

To finance working capital and cover short-term needs, a company can resort to: 

• short-term payables to staff,
• short-term trade payables,
• short-term bank loans.

 

Short-term trade payables and payables to staff arise during the ordinary course of business of the company, for example, when the company does not pay the due salaries, or when a supplier allows it to defer the payment or when the company makes use of an extension of payment of taxes. The company is generally freer to manage these debts, especially those towards suppliers, depending on the state of its liquidity, but it must always follow some rules, for example regarding the payment of wages and taxes.

Trade payables usually have special payment terms, and sometimes the company can take advantage of a discount if it makes the payment within a certain term. It is up to it to decide whether it will pay for the goods or the service within the term yy and will thus be able to enjoy the xx% discount, or whether it will opt for the deferred payment within zz days without discount. The decision depends on the amount of the discount, expressed on an annual basis and compared to the interest rate of the loan or the interest rate of current corporate investments. For more information see the example.

The working capital can also be financed with short-term bank loans. There are various types: among others we mention the loan with a fixed maturity, the credit lines (a loan that can be repaid or used according to the needs of the company similarly to the current account overdraft for natural persons), and revolving loans (with fixed expiration, renewable without particular bureaucratic burdens and practices). The convenience of a bank loan must not be defined only on the basis of the contractual interest rate, but must also be considered its overall cost, as the items of expenditure that make up the final cost of the loan are manifold. For more detailed information on the calculation of the actual cost of a loan, see the section "How much does the debt cost and what should you pay attention to? What is the effective interest rate?".

Practical example.