Working Capital is the capital of a business which is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities. It may be defined as the funds required within a business for supporting day to day business activities. It represents a company’s ability to pay its current liabilities with its current assets. It is the amount of available capital that a company can readily use for day-to-day operations. Working capital is derived from several company operations such as debt and inventory management, supplier payments, and collection of revenues. It is a measure of a company’s short-term liquidity and is important for performing financial analysis, financial modeling, and managing cash flow.
If a company has substantial positive working capital, then it should have the potential to invest and grow. It is obtained by subtracting the current liabilities from the current assets. This ratio indicates whether the company possesses sufficient assets to cover its short-term debt. If a company’s current assets do not exceed its current liabilities, then it may have trouble growing or paying back creditors, or even go bankrupt. A company’s working capital reflects a host of company activities, including cash, inventory, accounts receivable, accounts payable, and the portion of debt due within one year.
Working capital may increase in the case of a new proposal. These increases working capital increase cash outflow. It is an important measure of financial health since creditors can measure a company’s ability to pay off its debts within a year. Working Capital indicates the liquidity levels of companies for managing day-to-day expenses and covers inventory, cash, accounts payable, accounts receivable, and short-term debt that is due. Some times working capital may decrease and these decrease working capital increase cash inflow. In broader terms, working capital is also a gauge of a company’s financial health.
In other words, reduction refers to the returning investing, It should be cleared as follows:
Increase in working capital = cash outflow(-)
Decrease in working capital = cash inflow (+)
To calculate working capital, you first need to determine a company’s current assets and current liabilities.
Current assets include a company’s liquid cash as well as other assets that can be converted to cash within one year or less. Some examples of current assets include money in checking accounts, inventory, supplies, equipment, and temporary investments.
Formula: Working Capital = Current Assets – Current Liabilities.
If you have current assets of $1 million and current liabilities of $500,000, your working capital ratio is 2:1. That would generally be considered a healthy ratio, but in some industries or kinds of businesses, a ratio as low as 1.2:1 may be adequate.