Working Capital
✅ Definition:
Working capital is the difference between a company’s current assets and current liabilities. It is a measure of a company’s short-term financial health, liquidity, and ability to cover day-to-day operations.
🔹 Formula:
Working Capital = Current Assets – Current Liabilities
📊 Components:
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Current Assets:
Assets expected to be converted into cash within one year. Examples:-
Cash
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Accounts receivable (money owed by customers)
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Inventory
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Short-term investments
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Current Liabilities:
Obligations due within one year. Examples:-
Accounts payable (money owed to suppliers)
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Short-term debt
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Taxes payable
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Salaries and wages
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🧮 Example Calculation:
| Item | Amount |
|---|---|
| Current Assets | $500,000 |
| Current Liabilities | $350,000 |
| Working Capital | $150,000 |
This means the company has $150,000 in net resources to fund its operations in the short term.
✅ Why Working Capital Matters
🔹 Positive Working Capital:
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Indicates that the company can pay off short-term obligations.
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Suggests operational efficiency.
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Enables growth and investment.
🔹 Negative Working Capital:
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Indicates potential liquidity issues.
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May lead to difficulty paying bills or wages.
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Can signal financial instability, especially if persistent.
⚖️ Types of Working Capital
| Type | Description |
|---|---|
| Gross Working Capital | Total current assets (before subtracting liabilities) |
| Net Working Capital | Current assets minus current liabilities (main focus) |
| Permanent Working Capital | Minimum level always needed to run business |
| Temporary Working Capital | Additional capital needed during peak seasons or expansion |
🔍 Key Factors Affecting Working Capital:
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Sales volume and turnover rate
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Inventory management efficiency
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Credit terms with customers and suppliers
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Seasonal business cycles
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Economic conditions
🧠 Conclusion:
Working capital is a vital indicator of a company’s short-term financial performance and operational liquidity. Managing it well ensures that the company can continue running smoothly, meet obligations, and take advantage of new opportunities.