Working capital is a company’s current assets that are used to finance its current liabilities. It includes accounts receivable, accounts payable, inventory, and cash.

Formula for Working Capital:

Working Capital = Current Assets - Current Liabilities

Components of Working Capital:

• Current Assets: Assets that can be easily converted into cash within a short period, such as accounts receivable, accounts payable, and inventory.
• Current Liabilities: Liabilities that are payable within a short period, such as accounts payable, short-term loans, and current portion of long-term debt.

Importance of Working Capital:

• Cash Flow: Working capital provides the necessary cash flow to cover current liabilities and operations.
• Liquidity: Working capital measures the company’s ability to meet its current obligations and debt obligations.
• Profitability: Adequate working capital levels can improve profitability by allowing the company to operate efficiently and reduce carrying costs.
• Solvency: Working capital can contribute to the company’s solvency, as it reduces the need for external financing.

Examples:

• A company with accounts receivable of $10,000, accounts payable of $5,000, and inventory of $20,000 has a working capital of $25,000.
• A company with current assets of $50,000 and current liabilities of $20,000 has a working capital of $30,000.

Key Considerations:

• Working capital is a flexible measure, and its composition can vary depending on industry, size, and growth of the company.
• It is important to maintain an optimal working capital balance to ensure liquidity and profitability.
• Companies should consider factors such as industry benchmarks, company size, and growth projections when managing working capital.