Working Capital

From Financial Literacy Wiki

Working Capital is a measure of both a company's efficiency and its short-term financial health. Together with fixed assets such as plant and equipment, working capital is considered a part of operating capital. It is calculated as current assets minus current liabilities.

Working Capital = Current Assets - Current Liabilities

A company can be endowed with assets and profitability but short of liquidity if its assets cannot readily be converted into cash. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. Otherwise, the company might need to declare bankrupt.

A declining working capital ratio over a longer time period could also be a red flag that warrants further analysis. But a rising working capital might not mean it is good for the company too. Investors have to look at what gives rise to the increase in working capital. If it is something to do with non-cash items, then investors have to watch out as this might be another red flag on the company's operational efficiency.

The management of working capital involves managing inventories, accounts receivable and payable and cash.