Circulating Capital

Circulating Capital refers to that portion of finance that a company constantly consumes and restores to fund its core business operations. It generally reflects the current assets of the firm and comprises cash, finished goods inventory, raw materials, inventory-in-progress, short-term investment, and accounts receivable.

The primary objective of maintaining the revolving capital is to ensure that the business has sufficient money to fund its regular activities so that there is no interruption in the production of goods and services. However, the requirement for such an investment depends upon various factors, including the type of industry, company size, scale of production, seasonality, and lifecycle stage.

• The amount of funds utilized and restored for executing core business activities efficiently is the circulating capital.
• It finances current assets such as cash, cash equivalents, raw materials, inventory-in-progress, finished stocks, accounts receivable, and short-term investments.
• A company considers various factors for determining the amount designated to this capital, including the business type, size, industry, production scale, lifecycle stage, and seasonality.
• The company funds the long-term assets with fixed capital, and the business sustains regular business operations on a daily basis with the amount of working capital.

Circulating capital acts like blood for keeping the business alive by facilitating its everyday operational needs and maintaining the flow of core business activities. Moreover, when the business has sufficient revolving capital, it can avoid any emergency restocking or production halt due to a resource shortage. It even improves supplier relationships by ensuring timely payments to them.

The type of business often determines such fund requirements, whether capital-intensive or labor-intensive, production capacity, the business's lifecycle stage, seasonality, and financial management. People often use it as a synonym for working capital. However, there is an acceptable difference between the two forms of funding. The firm deducts the amount of current liabilities from its current assets to determine its working capital.

Analysts often use it to gauge the financial health of a business by assessing its operational competency. Further, investors often compare the capital of a company with that of another firm in the same industry before investing in it. Thus, if a company has enormous inventory and a poor inventory conversion rate, then it may indicate the firm's incompetence in converting its stock into sales.

On the other hand, significant cash in hand may signify that the business needs proper financial planning and optimal resource use to take advantage of new investment opportunities. Moreover, in dynamic markets, excessive circulating capital might lead to losses if a business fails to adapt and invest strategically in response to market shifts. Therefore, maintaining a balanced revolving capital is crucial for any organization.

The circulating capital formula represents the current assets of the organization. Thus, businesses can calculate this capital as follows:

Circulating Capital = Cash + Accounts Receivable + Raw Materials + Inventory In Process + Finished Goods Inventory + Operating Expenses

Below are some examples to explain circulating capital:

Example #1

Let us say a US bakery pledges to deliver orders on schedule. The bakery uses organic flavoring agents and extracts, which it imports from Madagascar. As a result, it needs to keep a sufficient inventory to ensure that this raw material is always in stock since its replenishment takes around 20 days. Therefore, the bakery keeps a circulating capital of $5,000 quarterly to maintain the relevant raw materials.

Example #2

Given below is the list of current assets of ABC Ltd. Let us determine this capital requirement if its operational expenses amount to $1,500 in a given period:

Solution:

Circulating Capital = Cash + Accounts Receivable + Raw Materials + Inventory In Process + Finished Goods Inventory + Operating Expenses

= $22,900 + $1,500 = $24,400

Thus, the needs of ABC Ltd. are $24,400 in the given period.

This capital differs from both fixed capital and working capital in nature, tenure, and liquidity. Some of the differences are as follows:

This article has been a guide to what is Circulating Capital. We explain it with its examples, how to calculate it, and comparison with fixed and working capital. You may also find some useful articles here –

• Cash Conversion Cycle
• Cash Flow Management
• Inventory Conversion Period