Working Capital

Working capital, also known as net working capital or NWC, is a financial metric and it represents operating liquidity existing for a business. Along with fixed assets like plant and equipment, working capital is considered to be a part of operating capital. It is computed as current assets minus current liabilities. If current assets are less as compared to current liabilities, the entity has a working capital deficiency. Working capital deficiency is also called a working capital deficit.

Working Capital = Current Assets - Current Liabilities

A company can be having assets and profitability but may be short of liquidity if its assets are not in a position to be readily converted into cash. Positive working capital is needed to ensure that a firm is able to carry on its operations and that it has adequate funds to satisfy both - the maturing short-term debt as well as upcoming operational expenses. Management of working capital involves managing inventories, managing accounts receivable & payable and cash.

Calculation

Working Capital Ratio [Current ratio] = Current Assets/Current Liabilities

This ration indicates whether a firm has adequate short-term assets for covering its immediate liabilities. Anything below 1 reflects a negative W/C (working capital). While anything above 2 indicates that the company is not investing its excess assets. There exists a general belief that a ratio between 1.2 and 2.0 is sufficient.

Current assets and current liabilities comprise of three accounts that are of special importance. These accounts indicate the areas of the business where managers have a direct impact:

• accounts receivable (current asset)

• inventory (current assets), and

• accounts payable (current liability)

The current portion of debt (that is payable within 12 months) is critical, since it represents a short-term claim on current assets and is often secured by long term assets. General types of short-term debt are lines of credit and bank loans.

An increase in working capital points out that the business has either increased current assets (that is received cash, or other current assets) or has decreased current liabilities, for instance has paid off short-term creditors.