# 5. Liquid ratio, Working capital is the most important to find out liquidity ratio

## What is working capital-

• The capital used in the company for day to day operations is called working capital.
• This capital, also known as net working capital (NWC), is the difference between current assets and current liabilities

Working capital = Current assets – Current liabilities

• This capital is measures a company’s liquidity, operational efficiency, and its short-term financial health.

If you do not know about the current assets, inventory, account receivable, and current liabilities, then you can read the post containing part 1 of the liquidity ratio, whose link we have given, please read now

Both current assets and current liabilities for any company can be found on it’s balance sheet Which you can get by following the instruction given below.

First of all, you have to go to the https://www.moneycotrol.com website, after that you will have to search by entering the name of the company and you will have to click on the option of financial data upwards. you will get an option of a balance sheet as soon as you click. On which you can find current assets and current liability by clicking.

We take an example of BHEL (Bharat Heavy Electricals Ltd.) date- 29/07/2020

• Current assets = 32,711.18
• Current liabilities = 22,676.84

When we plug the relevant data into the above formula, we get the working capital of the BHEL company.

Working capital = 32711.18 – 22676.84 = 10034.34

Now let us talk a little bit about the cycle of this capital so that you can understand it further.

### Working capital operating cycle

There are a lot of processes in the working capital operation cycle, about which we know a little.

#### 1. Cash

A company must keep some cash in reserve for short term which the company uses to run its day to day operations like room rent, wages, purchasing raw materials, etc.

#### 2. Raw material / Inventory

To make a company product, the first process is to buy raw material with the help of reserve cash ie it is the first step of the production process which takes about 30 days.

#### 3. Work in progress

When the company buys the raw material and makes it suitable for machining, then the second phase of the production process starts, which is known as Work in Progress, in which we make the product according to the customer and make it worth selling. And in all of these, we believe that it may take about 10 days or even more.

#### 4. Finishing goods

After making the product worth selling, the product is sent to the company’s warehouse from where the retail store owner takes it to sell the product. It is not possible that as soon as the product is ready, it will be sold immediately. It takes time, so we keep in mind that the product will have to be kept in the company’s warehouse for about 20 days

#### 5. Account receivable

There is no need that all retail stores owner pay the immediately, Some pay it immediately, but most retail stores owner own the company’s products on credit and we keep in mind that these owner almost Pay to the company in 30 days

The money that comes to the company later by the retail store owner, we keep it in the category of the account receivable.

#### 6. Cash

The company is paid by the retail store owner only after all the products are sold.

Now we add the time taken to complete the whole process

To buy Raw material (30 days) + Working process (10 days) + Finished goods (20 days) + Account receivable (30 days) = 90days

The cost incurred to complete the working capital process = Room rent, wages, purchasing raw materials, Long term loan installment, short term loan, Light bill, etc.

Note– So we saw that the working capital operating cycle took about 90 days to complete, there is no need that in all companies the working capital operating cycle takes only 90 days to complete, it can be even more and less Might

From the beginning of the working capital operating cycle until the end, the money put by the company is called working capital.

### Inventory

Materials from raw material to finished goods of the working capital operating cycle is called inventory and the cost involved is called inventory cost. It has 3 types

1. Raw materials
2. Working process (production process)
3. Finished goods

The working capital operating cycle is also known as cash to cash cycle because it starts from cash and finishes on cash.
The company which earns more profit in less working capital gets ranked in the category of good company

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In the next post we will talk about the cash ratio

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