Working capital gap is financed from owner’s contribution and bank borrowings. The owner’s contribution is the Net Working Capital in the Business and is the long term funds available for working capital.
So, what is working capital? The strict definition is current assets minus current liabilities. To an accountant, it tells how much cash is tied up in the Business through receivables and inventories and also how much cash is going to be needed to pay off short term debts in the coming 12 month period.
Why is it important? Well, if a company’s current assets are less than current liabilities, a company has a working capital deficiency, also called a working capital deficit. This means it cannot pay off its short term debts. Its operation liquidity is low and the company is thus in danger of going bust. Positive working capital is needed for a firm to be able to continue its operations, not only by be able to pay off short term debt but also cover unexpected expenses.
With what we know from before we would then get the following (simplified) formula as definition of Working Capital:
accounts receivable + inventory - accounts payable
Working Capital Gap FAQ
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