In this article we will provide the information related to Working Capital Gap and net capital gaps. These are essential financial concepts for businesses to manage effectively.
These terms refer to the difference between a company’s current assets and current liabilities (excluding bank borrowings) and the difference between a company’s long-term sources and long-term uses of funds.
WORKING CAPITAL GAP
The working capital gap represents the difference between a company’s total current assets and total current liabilities, excluding bank borrowings.
It is a critical metric for businesses, as it helps determine the amount of working capital available to fund day-to-day operations.
The formula for calculating the working capital gap is as follows:
Working Capital Gap = Current Assets – Current Liabilities (excluding bank borrowings)
Example:
Suppose a company has current assets of Rs. 100 and current liabilities of Rs. 80, with bank borrowings of Rs. 20.
To calculate the working capital gap, we need to find the current liabilities excluding bank borrowings, which amounts to Rs. 60. Using the formula, the working capital gap would be Rs. 100 – Rs. 60 = Rs. 40.
NET CAPITAL GAP
The net capital gap is a broader financial concept that considers the difference between a company’s long-term sources and long-term uses of funds.
It assesses the balance between the funds available for long-term investments and the funds allocated for long-term assets. The formula for calculating the net capital gap is as follows:
Net Capital Gap = Long-term Sources – Long-term Uses
Example:
Suppose a company’s total liabilities amount to Rs. 100 lakh, with Rs. 40 lakh as current liabilities and Rs. 60 lakh as long-term liabilities (including owner’s equity). The total available sources for various asset acquisitions would be Rs. 100 lakhs.
If the company allocates Rs. 50 lakhs for acquiring current assets and Rs. 50 lakhs for acquiring fixed assets, miscellaneous and non-current assets, and intangible assets, then it has effectively used Rs. 50 lakhs from its long-term liability (source) of Rs. 60 lakhs for long-term uses (Rs. 50 lakhs).
This leaves Rs. 10 lakhs (Rs. 60 lakhs – Rs. 50 lakhs) from long-term liability (source) available for short-term uses.
To find the working capital gap, we can calculate the difference between current assets (Rs. 50 lakhs) and current liabilities (Rs. 40 lakhs), which equals Rs. 10 lakhs.
This result aligns with the net capital gap calculated as Rs. 60 lakhs (long-term sources) – Rs. 50 lakhs (long-term uses) = Rs. 10 lakhs.
The balance sheet diagram below illustrates the structure of long-term sources (LTS), short-term sources (STS), long-term uses (LTU), and short-term uses (STU), all contributing to the net working capital.
 CL = Current Liabilities
 TL = Term Liabilities
 NW = Net Worth
 CA = Current Assets
 FA = Fixed Assets
 M&NCA = Miscellaneous and Noncurrent Assets
 ITA = Intangible Assets
In a balanced balance sheet, the total of assets equals the total of liabilities.
In the example provided earlier, the total on both sides of the balance sheet adds up to Rs. 100.
LONG TERM SOURCES AND USES
Long term sources (LTS) of funds may include retained profits, share capital, the issue of debentures, long term investments, the sale of fixed assets, and sale proceeds of long term investments, among others.
These sources provide the company with funds for long term investment and expansion.
Long term uses (LTU) of funds include expenses such as the purchase of fixed assets, repayment of long term loans, redemption of debentures and bonds, and covering losses from business operations.
CONCLUSION
Understanding the working capital gap and net capital gap is crucial for businesses’ financial health. These concepts help companies assess their financial standing and their ability to cover both short term and long term financial needs.
By managing these gaps effectively, businesses can ensure their stability and growth in a competitive market.