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Gross Working Capital vs. Net Working Capital
There are mainly two types of working capital–gross working capital and net working capital. Although many people tend to use the two alternatively, there are some stark differences between the concepts of working capital. Therefore, it is important to know the differences so that no confusion arises while considering the two concepts of working capital.
Following are the differences between Gross Working Capital and Net Working Capital −
Investment in current assets vs. liabilities to be paid
Gross working capital is the investment of a company in its current assets. Current assets are the items that can be converted to cash within a year or so. Therefore, gross working capital refers to cash, short-term securities, bills receivable, debtors, and stock.
Net working capital is the difference between the company’s current assets and current liabilities. Current liabilities are items that need to be paid by the company within a year. The most common current liabilities include accounts payable (creditors), bills payable, and outstanding expenses.
Net working capital can be both positive and negative. When current assets are more than current liabilities, net working capital will be positive while it will be negative when current liabilities are more than current assets.
Quantitative vs. Qualitative
There is a basic difference between gross working capital and net working capital in terms of their nature. Gross working capital is quantitative in nature while net working capital is qualitative in nature. It is obvious from the definitions that gross working capital deals with quantitative items while net working capital is just the differences between two items at a certain point of operation of the company.
Wealth in Hands vs. Wealth to Meet Liabilities
There is a notable difference between net and gross working capital in terms of their meanings. Gross working capital means the wealth a company has in its hands to finance the current assets. On the other hand, net working capital means whether a company will be able to meet the current liabilities and operating expenses. If net working capital is positive, the company will be able to meet the liabilities with its assets but if it is negative, the company won’t be able to do so.
Difference in Uses
Net and gross working capital measurements not only differ in terms of their meaning but also are used in different scenarios. Gross working capital is used in financial management, whereas net working capital is used in accounting. Therefore, although they deal with similar variables, their uses are different to a large extent.
Difference in Users
As is apparent from the meaning and use of the two concepts, net and gross working capital are suitable for two different users. Gross working capital is usually applicable to companies, whereas net working capital is suitable for partnership companies and sole traders.
Outcome in Financial Positioning
It is the nature of net working capital that when it is calculated, the financial position of the company for which it is calculated is revealed. The situation in the case of gross working capital is different. In the case of gross working capital, on its application, the financial position of the company is not revealed.
Increment and reduction
The increment of the net and gross working capital depends on two different factors. An increment of net working capital is observed when there is an increment in retained profits and sales in assets, whereas gross working capital increases with the borrowings of a company.
Although net working capital and gross working capital seems to be quite similar, however there are many differences between the two. Therefore, one should not use one of them for the other. They are different parameters used to judge different factors in accounting and finance. As a point of precaution, net and gross working capital should not be used alternatively because it may result in huge mistakes in the outcome if done so.
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- What is a Working Capital Cycle?
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- Explain percentage of sales method in estimation of working capital.
- How does Working Capital affect the Cash Flow from Operations?
- What are short term financial requirements or working capital requirement in finance?
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