The main categories in which Capital required for a business can be classified are given below:
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(i) Fixed capital
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(ii) Working capital
Every business needs funds for two purposes for its establishment and to carry out its day-to-day operations. Long term funds are required to create production facilities through purchase of fixed assets such as plant and machinery, land, building, furniture etc.
Investments in these assets represent that part of firm’s capital which is blocked on a permanent or fixed basis and is called fixed capital. Funds are also needed for short-term purposes for the purchase of raw materials, payment of wages and other day-to-day expenses, etc. these funds are known as working capital.
Working capital, in general practice, refers to the excess of current assets over current liabilities.
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Management of working capital is therefore concerned with the problems that arise in attempting to manage the current assets, the current liabilities and the inter-relationship that exists between them.
The basic goal of working capital management is to manage the current assets and liabilities of a firm in such a way that a satisfactory level of working capital is maintained i.e. it is neither inadequate nor excessive. Working capital management is three dimensional in nature:
(i) Dimension I is concerned with the formulation of policies with regard to profitability, risk and liquidity.
(ii) Dimension II is concerned with the decisions about the composition and level of current assets.
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(iii) Dimension III is concerned with the decisions about the composition and level of current liabilities.