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Working capital is the amount by which the value of a company’s current assets exceeds its current liabilities. Also called net working capital. Sometimes the term “working capital” is used as synonym for “current assets” but more frequently as “net working capital”, i.e. the amount of current assets that is in excess of current liabilities.
If you’re running a business, you must have a working capital. Working capital is the measure of cash or liquid assets essential for its day-to-day operation. By calculating your working capital, you can find out the value of your current assets and if you are able to meet your financial obligations. It is simply the current assets in excess of current liabilities.
Calculate your working capital using this formula:
Current Assets – Current Liabilities = Working Capital.
If a company’s current assets do not exceed its current liabilities, then it may run into trouble paying back creditors in the short term. The worst-case scenario is bankruptcy. A declining working capital ratio over a longer time period could also be a red flag that warrants further analysis. For example, it could be that the company’s sales volumes are decreasing and, as a result, its accounts receivables number continues to get smaller and smaller.
Working capital also gives investors an idea of the company’s underlying operational efficiency. Money that is tied up in inventory or money that customers still owe to the company cannot be used to pay off any of the company’s obligations. So, if a company is not operating in the most efficient manner (slow collection), it will show up as an increase in the working capital. This can be seen by comparing the working capital from one period to another; slow collection may signal an underlying problem in the company’s operations.
Things to Remember :
1. If the ratio is less than one then they have negative working capital.
2. A high working capital ratio isn’t always a good thing, it could indicate that they have too much inventory or they are not investing their excess cash.
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