Working Capital refers to investment in current assets. This is also known as gross concept of working capital. There is another concept of working capital known as net working capital. Net working capital is the difference between current assets and current liabilities.

Working Capital = Current Assets – Current Liabilities

Net working capital is a qualitative concept, which indicates the liquidity position of the firm, and the extent to which working capital needs may be financed by permanent sources of funds. In other words we can say total current assets should be sufficiently in excess of current liabilities to constitute a margin or buffer for obligations maturing within the ordinary operation cycle of a business. A weak liquidity position poses a threat to the solvency of the company and makes it unsafe. Excessive liquidity is also not goods for the business. Therefore it is necessary for the management to take a prompt and timely action to improve the imbalance of the liquidity of the business.

Ordinarily, working capital is classified into two categories:

1. Fixed or Permanent Working Capital; and
2. Fluctuating or Variable Working Capital.

The need for current assets is associated with the operating cycle which, as we know is a continuous process. As such, the need for current assets is felt constantly. The magnitude of investment in current assets however may not always be the same. The need for investment in current assets may increase or decrease over a period of time according to the level of production. Nevertheless, there is always a certain minimum level of current assets, which is essential for the firm to carryon, its business irrespective of the level of operations. This is the irreducible minimum amount necessary for maintaining the circulation of the current assets. This minimum level of investment in current assets is permanently locked up in business and is therefore referred to as permanent or fixed or regular working capital. It is permanent in the same way as investment in the firm's fixed assets is.

Depending upon the changes in production and sales, the need for working capital, over and above the permanent working capital, will fluctuate. The need for working capital may also vary on account of seasonal changes or abnormal or unanticipated conditions. For example, a rise in the price level may lead to an increase in the amount of funds invested in stock of raw materials as well as finished goods. Additional doses of working capital may be required to face cut throat competition in the market or other contingencies like strikes and lockouts. Any special advertising campaigns organized for increasing sales or other promotional activities may have to be financed by additional working capital. The extra working capital needed to support the changing business activities is called the fluctuating (variable, seasonal, temporary or special working capital.

Because of its close relationship with day to day operations of a business, a study of working capital and its management is of major importance to internal, as well as external analysts. It is being increasingly realised that inadequacy or mismanagement of working capital is the leading cause of business failures. We must not lose sight of the fact that management of working capital is an integral part of the overall financial management and, ultimately, of the overall corporate management. Working capital management thus throws a challenge and should be a welcome opportunity for a financial manager who is ready to playa pivotal role in his organisation.

Neglect of management of working capital may result in technical insolvency and even liquidation of a business unit. With receivables and inventories tending to grow and with increasing 'demand for bank credit in the wake of strict regulation of credit in India by the Central Bank, managers need to develop a long-term perspective for managing working capital. Inefficient working capital management may cause either inadequate or excessive working capital, which is dangerous.

 A firm may have to face the following adverse consequences from inadequate working capital:

1. Growth may be stunted. It may become difficult for the firm to undertake profitable projects due to non-availability of funds.
2. Implementation of operating plans may become difficult and consequently the firm's profit goals may not be achieved.
3. Operating inefficiencies may creep in due to difficulties in meeting even day to day commitments.
4. Fixed assets may not be efficiently utilised due to lack of working funds, thus lowering the rate of return on investments in the process.
5. Attractive credit opportunities may have to be lost due to paucity of working capital.
6. The firm loses its reputation when it is not in a position to honour its short-term obligations. As a result, the firm is likely to face tight credit terms.

 On the other hand, excessive working capital may pose the following dangers:

1. Excess of working capital may result in unnecessary accumulation of inventories increasing the chances of inventory mishandling, waste, and theft.
2. It may provide an undue incentive for adopting too liberal a credit policy and slackening of collection of receivables causing a higher incidence of bad debts has an adverse effect on profits.
3. Excessive working capital may make management complacent, leading eventually to managerial inefficiency.
4. It may encourage the tendency to accumulate inventories for making speculative profits, causing a liberal dividend policy, which becomes difficult to maintain when the firm is unable to make speculative profits.

An enlightened management, therefore, should maintain the right amount of working capital, on a continuous basis. Financial and statistical techniques can be helpful in predicting the quantum of working capital needed at different points of time.