Working capital is the difference between the company’s acquired current assets and current liabilities. Another term for Working Capital is Net Working Capital or NWC, this is the measurement of the company’s liquidity status, this also determines the operational efficiency and the short-term financial health of the company can also be detected by this tool.
In this content, we are going to discuss ‘What is Working Capital?’ where students will get a clear understanding on the concept of Working Capital, how working capital impacts a company and way to calculate it will be consisted in our discussion.
What is Working Capital?
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Working Capital, meaning in accounting language, is a method which is used to indicate the financial position of a firm or a business organization. Though this tool is only used for a short time basis, it proves to be a great analyser if you want to know about the liquidity or financial condition of the business in a short span of time. This is a scale to measure the overall performance and efficiency of the business entity.
If you want to calculate the working capital of a specific firm or any organisation you only need to subtract the current liabilities from the total current assets present in the business. The ratio which comes out as an answer suggests whether the particular organization has enough assets with it which will in turn help in the payment of the short-term debts.
In simpler and direct terms, we can say that working capital is nothing but an indicator of the liquidity levels in an organization which will suggest if the business is capable of taking care of the day-to-day expenditure and cash, accounts payable, inventory, accounts receivable, and at the same time the due short-term debt.
This working capital is acquired from many operations of the company like the inventory and debt management, the revenue collection, and paying to the supplier.
Working Capital Example
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Working capital refers to the amount required for the purpose of financing the daily operation. Like - Working capital of Rs.100,000 with the business owner is being calculated by subtracting the current liabilities of Rs. 200,000 from the current assets which are Rs. 300,000.
Working Capital Example:
Cash and cash equivalents. To note, Cash equivalents are highly-liquid assets, it includes money-market funds and treasury bills.
Funds in checking or in the savings bank account.
Marketable securities also come under working capital like stocks, mutual fund shares, and some types of bonds.
The Relation between The Components of Working Capital
The relation is depicted in the formula itself:
Current Assets - Current Liabilities = Working Capital |
The working capital can be negative for a company whose current assets are less than its current liabilities. Now let us know about the types of Working Capital in the following section.
Types of Working Capital
The types of Working Capital are as follows:
Positive Working Capital: A company that has more current assets than its current liabilities, has positive working capital. This type of company has enough working capital which acts as an assurance of fully covering the short-term liabilities as and when they become due in the following twelve months. Having a positive working capital signifies a company's financial strength.
Zero Working Capital: When a company has exactly the same amount of current assets and an equal amount of current liabilities, then there is the situation of zero working capital in place. This situation will exist if the company is totally funded by its current liabilities. Having a zero-working capital, potentially increases the chance of investment, while it also signifies financial risks.
Inside Negative Working Capital: The negative working capital is very much closely related to the factor of the current ratio which is being calculated as - current assets divided by its current liabilities. If a current ratio comes to be less than 1, then the current liabilities exceed the current assets and thus the working capital turns negative.
Did You Know?
Working Capital helps in making the long-term strategy as well, not only the short-term strategy.
Working capital helps in monitoring the cash regularly.
Working capital is used as a benchmark against other competitors.
By calculating the working capital, one can also encourage the customers to pay on time.
Working Capital is to be used in a full-fledged manner in a business, not only in downtimes.
Businesses might not talk about working capital every day, but this accounting method is a key to the company’s success. Working capital affects many vital aspects of the business, from paying the vendors to keeping the electricity going, working capital funds important facets in day-to-day business activity.
