What is Working Capital?
Working Capital is the measure of operating liquidity of a company. It is calculated as current assets less current liabilities.
Working Capital reflects the company’s overall financial health. Working Capital includes cash, accounts receivable, inventory and any other current assets less all amounts owing within one year. Therefore, it measures if a company has sufficient assets that can be readily liquidated to pay its short-term debts.
If Company ABC has the following balances:
|Accounts Receivable||$10,000||Payroll liabilities||$15,000|
|Inventory||$30,000||Sales taxes payable||$5,000|
|Current Assets||$90,000||Current Liabilities||$50,000|
Working Capital is calculated as Current Assets less Current Liabilities: $90,000-$50,000 = $40,000.
Banks commonly use Working Capital and other ratios (such as current ratio, inventory turnover and accounts receivable turnover) to help determine if a company is a solid investment. If a company has negative Working Capital, it is unable to pay its current debts and may be an indication that the company is over leveraged.
One way to help manage Working Capital is to manage inventory effectively. When inventory sits for a long time in the warehouse before being sold, Working Capital is being tied up.
Another way to help manage Working Capital is to purchase costly fixed assets such as equipment through long-term financing rather than short-term debt so that Working Capital resources remain available for day to day operations.
Dawn Loeffler, BA (Hons), CPA, CA
Manager, Gilmour Group CPA’s
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