Working Capital – Understanding, Importance, Optimal Utilization & Funding Options (Including Promoter’s Margin)
1. Introduction
Working capital is the lifeblood of every business. Whether a company is in manufacturing, trading, or services, its ability to run daily operations smoothly depends on adequate working capital. A business may be profitable on paper, but without sufficient liquidity, even large companies can face stress, delays, or in extreme cases, insolvency. This article explains what working capital is, why it matters, how companies should optimize its utilization, and the various sources—both internal and external—for funding it, including promoter’s contribution.
2. What is Working Capital?
Working capital represents the capital required to meet short-term operational needs.
a. Gross Working Capital
Total current assets of the business such as:
- Inventory (Raw Material, WIP, Finished Goods)
- Receivables
- Cash & Bank
- Short-term loans & advances
b. Net Working Capital
Net Working Capital = Current Assets – Current Liabilities
This reflects the liquid cushion available after meeting current obligations.
c. Working Capital Cycle (Operating Cycle)
The time taken to convert cash → inventory → receivables → back to cash. Shorter the cycle, better is the liquidity position.
3. Importance of Working Capital for a Company
a. Ensures Smooth Business Operations
Adequate working capital ensures uninterrupted procurement of raw materials, timely salary payments, utility expenses, logistic charges, etc.
b. Enhances Creditworthiness
Banks, vendors, and stakeholders assess a company’s working capital position to determine its financial health.
c. Supports Revenue Growth
Higher sales often require higher inventory and receivables. Strong working capital enables scale-up without financial strain.
d. Protects Against Business Shocks
Companies with a strong liquidity buffer withstand market slowdowns, supply chain disruptions, or customer payment delays.
e. Helps in Availing Bank Finance
Banks evaluate the working capital cycle to fix drawing power, limits, interest costs, and promoter’s margin requirements.
4. How to Optimally Utilise Working Capital?
Optimal utilisation does not mean increasing or decreasing working capital blindly—it means balancing liquidity and efficiency.
a. Inventory Management
- Adopt JIT, ABC analysis, EOQ models
- Avoid overstocking
- Optimise raw material and finished goods storage
b. Receivable Control
- Implement strict credit policies
- Offer early payment incentives
- Periodic reconciliation with customers
- Use digital invoicing and e-payments to reduce delays
c. Payables Management
- Negotiate better credit periods
- Utilise supplier financing options
- Avoid early payments unless beneficial
d. Cash Flow Monitoring
- Prepare monthly/weekly cash flow statements
- Track variances between projected and actual flows
- Improve billing and collection cycles
e. Use of Technology
- ERP, inventory software, AI-based forecasting tools
- Automated reconciliations and payment tracking
f. Cost Controls
- Reduce non-essential expenses
- Optimise logistics and procurement
- Avoid idle labour & idle capacity
Efficient working capital utilisation reduces borrowing requirements and interest costs, directly improving profitability.
5. Sources of Working Capital Funding
Working capital can be financed through internal as well as external sources.
A. Internal Sources
1. Profits retained in the business
2. Depreciation and non-cash expenses
3. Better collections & shorter receivable cycles
4. Inventory turnover improvement
5. Payable extensions (within ethical and contractual limits)
Internal sources reduce reliance on bank finance.
B. External Sources
1. Bank Finance ! Financial Institutions
Common banking facilities include:
- Cash Credit (CC) Limits
- Overdraft (OD)
- Working Capital Demand Loans (WCDL)
- Short-term loans
- Packing Credit for exporters
- Bill Discounting ! Invoice Financing
- Letter of Credit (LC) ! Bank Guarantees
Banks determine the limit based on the company’s working capital cycle and financial statements.
2. Trade Credit
Suppliers offer credit periods of 30–120 days, reducing the requirement for external funding.
3. Factoring & Invoice Discounting
- Receivables sold to NBFC/banks for immediate liquidity.
- Useful for businesses with long credit cycles.
4. Commercial Paper (CP)
Short-term corporate debt instrument for large, highly rated companies.
6. Inter-Corporate Deposits (ICD)
Short-term borrowing from other corporates.
6. External Commercial Borrowings (ECB)
For eligible companies, used mainly for larger working capital needs under RBI guidelines.
6. Promoter’s Margin in Working Capital Funding
Banks require promoters to bring in a portion of working capital from their own funds. This is known as margin money.
Purpose of Promoter’s Margin
- Indicates commitment of the promoters
- Ensures risk-sharing between bank and company
- Prevents over-dependence on debt
How Banks Calculate Margin?
Example:
If the working capital requirement is ₹10 crore and the bank finances 75%, then promoter’s
margin = ₹2.5 crore.
Sources of Promoter’s Margin
- Capital infusion by promoters
- Internal accruals
- Subordinated unsecured loans (sometimes treated as quasi-equity)
- Retained earnings
Margin money strengthens the liquidity base and builds trust with lenders.
7. Working Capital Best Practices for Companies
- Maintain healthy current ratio (bank norms often 1.25:1)
- Keep stock records updated and reconciled
- Conduct periodic ageing analysis of receivables and payables
- Prepare quarterly projected financials
- Avoid diversion of working capital to long-term assets
- Establish a Working Capital Management Committee for large organisations
8. Conclusion
Working capital is not just a finance function—it is a strategic pillar of business sustainability. Proper understanding and monitoring can significantly improve operational efficiency and profitability. Companies that manage working capital optimally reduce dependence on borrowing, improve credit ratings, and create strong foundations for growth.
Author Bio
Excellent article, Ankit. You have explained the concept of working capital—its importance, utilisation, and funding options—in a very clear and practical manner. The structured breakdown make it easy for readers to understand . Very informative and well-written!”