What is Working Capital?
Working capital represents the variance between a company's current assets and current liabilities. This metric assesses a business's ability to meet its short-term financial responsibilities, navigate cash flow dynamics, and optimize resource utilization. Current assets include items convertible to cash within a year, including cash, accounts receivable, inventory, and short-term securities. On the other hand, current liabilities comprise obligations due within a year, such as accounts payable, taxes, salaries, and interest.
Working Capital Explained
Working capital shows how much liquid cash a company has to meet its short-term obligations and fund its operations. Working capital also reflects a company's efficiency and financial stability. A high positive working capital means a company can invest in growth and expansion. A low or negative working capital means a company may struggle to pay its debts or grow its business. It may even face bankruptcy.
Different industries have different working capital needs. Some industries, such as manufacturing, have long production cycles and need more working capital to keep their inventory and cash flow steady. Other industries, such as retail, have fast turnover and can generate cash quickly from their customers. They need less working capital to run their business.
Working Capital Formula = Current Assets – Current Liabilities
How to Balance Working Capital and Cash Flow Management
Working capital is essential for a company to pay its short-term bills and run its business smoothly. It involves managing cash and inventory well.
However, having too much working capital, more than the industry norm, is not good for a company. It indicates that the company is not investing its cash wisely or holding too much inventory that is not sold.