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Business Financials – What is Working Capital and how to calculate it
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Published on Friday, 18 November 2016 19:50
A common financial ratio is Working Capital which is an indicator of Financial Health. Working Capital is calculated as taking current assets (CA) minus current liabilities (CL) at a specific date. You can obtain the CA and CL amounts are on your company's balance sheet. As an example, if your company's balance sheet has current assets of $150,000 and current liabilities of $120,000 then your company's working capital is $30,000.
Working Capital – Current Assets – Current Liabilities
But beware – even with a decent amount of working capital, a company can still have a period of cash shortage if its current assets are not turning to cash. As an example, a company with most of its current assets locked up in inventory. Or if a company has a large accounts receivables (debtors) that are not being collected, the working capital amount isn't much help when you can't meet the payroll run! (So keep a regular debtor-monitor and reminder process going weekly!).
Other financial ratios sometimes use the working capital CA & CL components. They include the current ratio, quick ratio, accounts receivable turnover ratio, and inventory turnover ratio.
Good management keeps watch on current assets (receivables and inventory) to keep the cash coming into the bank.
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