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Business Financials – What is Working Capital – Calculate and use the working capital formula
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Published on Thursday, 24 November 2022 21:19
Working capital is the difference between current assets (CA) and current liabilities (CL) at a specific date.
The CA and CL amounts are found on your company's balance sheet.
Working Capital = Current Assets – Current Liabilities
For example, if your company's balance sheet has current assets of $50,000 and current liabilities of $30,000 then your company's working capital is $20,000. It’s a bit like the breathing space available for emergencies.
For a healthy business, ideally, we want Current Assets to be GREATER than Current Liabilities.
Current Assets can be turned into cash within 12 months, such as: cash, Inventory, debtors who owe the company etc.
Current Liabilities are paid within 12 months, credit cards, small loans, super, PAYG staff and company taxes etc.
NOTE - even with a significant 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 a company with a large accounts receivables that are not being collected, but even still, this large working capital situation isn't much immediate help when you can't meet the payroll run!
There are also other financial ratios use the working capital components such as the current ratio, quick ratio, accounts receivable turnover ratio, inventory turnover ratio and many others.
Good management means keeping watch on key current assets (receivables and inventory) to keep turnover (sales) and the actual cash coming into the bank!
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