What is Working Capital?
Working Capital means the net liquid funds maintained by an organisation to manage the business’s day-to-day running expenses, whether in the form of cash, bank deposits, or in any other way. In other words, working capital is current assets less current liabilities.
Working Capital formula
Working capital = Current assets – Current liabilities
Current assets are usually convertible into cash and cash equivalent within twelve months. Examples are accounts receivable- unpaid customer invoices, raw materials and finished goods inventories, prepayments.
Current liabilities are short term liabilities due within twelve months. Examples are accounts payable- unpaid supplier bills, VAT payable, employees salaries, rent payable.
The working capital formula measures short-term liquidity and helps financial analysis, financial modelling, and cash flow management.
Working capital (positive vs negative)
Positive working capital
● Working Capital is positive when current assets are greater than current liabilities.
● It can be a good indicator of a company’s short-term financial health because it has sufficient liquid assets to pay off short-term bills and internally finance business growth.
● Too much working capital indicates that there are either excessive inventories or surplus cash that remains uninvested.
Negative working capital
● Working Capital is positive when current liabilities are greater than the current assets.
● It indicates that assets are not used efficiently, and a company may be facing a liquidity issue.
● Even if a company has heavily invested in fixed assets, it will face financial and operational difficulties if it cannot pay its current liabilities on time.