Working Capital
Working capital refers to the amount of assets available for use towards the acquisition of additional assets. It is used to gauge a company’s financial health, and whether it can operate at an efficient manner. The working capital can be computed by using this formula: Working Capital = Current Assets – Current Liabilities.
To ascertain the value of current assets, liquidity must also be considered. A liquid asset typically can be sold quickly without losing much of its value. If it cannot be converted to cash in an effective manner, then it loses its value as capital as the money cannot be spent.
Currents assets are derived from accounts receivable and inventory. Account receivable refers to the amount owed to a company from customers. This is the money obtained from providing a particular good or service to that customer. Inventory, on the other hand, refers to the goods in their possession. Current liabilities are derived from account payable. This refers to the money a company owes to the supplier of a good or service. These are the costs incurred for running the business. An example of this would be an electric bill or a water bill.
Based on the formula, a higher working capital is obtained from an increase in the current assets or a decrease in the current liabilities. For current assets to increase, this means that the company is able to generate a good amount of money from the services and goods rendered to their customers. A decrease in current liabilities typically means that the cost of running the business is reduced, which leads to an increase in the overall profitability of the company.
A company operating with positive working capital means that they are able to meet the payment requirements of their current liabilities. This is an indicator of the company’s current standing. If the working capital is negative, it means that they are unable to pay off current liabilities. This causes the company to incur some debt.
It is important to maintain a positive working capital. Paying off loans is important so as to avoid getting into deeper levels of debt. If the working capital is negative for a long period of time, it is a sign that there are problems within the company. Changes must be made such that a positive working capital can be achieved. It is an indicator of the company’s efficiency and is used to determine whether a substantial loan can be approved.