Working capital is the capital that a business has available to use for its day-to-day operations, and can include resources such as cash, short-term loan facilities, and inventory. It is sometimes referred to as “circulating capital” or “operating liquidity”. Working capital often serves as a measure of the short-term financial health of a business; sufficient working capital gives a business the flexibility to respond to changes in the marketplace, pay short-term liabilities, and to remain solvent.
What Is Working Capital?
The term ‘working capital’ is often used in corporate financial management to refer to the capital that is available to finance day-to-day operations. It is often used to measure a business’s ability to cover liabilities in the short-term, and includes both fixed and circulating assets that are exchanged in such transactions. These resources include cash, short-term loans, and supply inventory. Working capital can be calculated by subtracting total liabilities from total assets.
Working capital is often used to analyze a company’s liquidity, which measures its ability to pay liabilities due in the short-term. A positive working capital means that the company is able to pay its short-term debt obligations. A negative working capital can indicate that the company is unable to cover liabilities, and so may need to seek external financing to address liquidity issues.
Key Features and Considerations
When looking at working capital, financial managers should consider the following:
– The ability to cover short-term liabilities: The goal of working capital is to ensure that a business has access to the resources necessary to meet its short-term debt obligations.
– Cash flow and liquidity: The working capital figure can help to establish the level of liquidity available and therefore the relative solvency of the company.
– The ability to react to changes in the marketplace: Working capital can also be used to assess a company’s capacity to react to changes in the marketplace. Companies with more available working capital are better positioned to take advantage of opportunities.
– Inventory levels: Working capital is also a key measure of inventory levels, taking into account the amount of inventory a business needs to cover its ongoing operations.
Real-World Example
Recently, a company we know had experienced a decrease in working capital due to slight drops in profitability and an increase in short-term debt. To address this problem, the financialmanager recommended that the company reduce its inventory levels, explore leasing options to reduce the amount of equipment it owns outright, and undertake a cost-saving program to cut expenses across departments. This strategy, put in place over the next 12 months, successfully restored the company’s working capital.
Conclusion
Working capital is an important measure of liquidity and solvency in corporate financial management. It can be calculated by subtracting total liabilities from total assets, and can give a business the flexibility to pay short-term liabilities, respond to changes in the marketplace, and to remain solvent. By taking proactive steps such as reducing inventory levels and cost-saving programs, companies can restore working capital and ensure financial stability.
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