Primary navigation:

QFINANCE Quick Links
QFINANCE Topics
QFINANCE Reference
Add the QFINANCE search widget to your website

Home > Cash Flow Management Calculations > Working Capital

Cash Flow Management Calculations

Working Capital

Working capital is concrete proof of the business axiom “It takes money to make money.”


What It Measures

The funds that are readily available to operate a business. Working capital comprises the total net current assets of a business, which are its inventory, debtors, and cash—minus its creditors.

Back to top

Why It Is Important

Obviously, it is vital for a company to have sufficient working capital to meet all of its requirements. The faster a business expands, the greater will be its working capital needs.

If current assets do not exceed current liabilities, a company may well run into trouble paying creditors who want their money quickly. Indeed, the leading cause of business failure is not lack of profitability, but rather lack of working capital, which helps to explain why some experts advise: “Use someone else’s money every chance you get, and don’t let anyone else use yours.”

Back to top

How It Works in Practice

Working capital is also called net current assets or current capital, and is expressed as:

Working capital = Current assets – Current liabilities

Current assets are cash and assets that can be converted to cash within one year or a normal operating cycle; current liabilities are monies owed that are due within one year.

If a company’s current assets total $300,000 and its current liabilities total $160,000, its working capital is:

300,000 – 160,000 = $140,000

The working capital cycle describes capital (usually cash) as it moves through a company: It first flows from a company to pay for supplies, materials, finished goods inventory, and wages to workers who produce goods and services. It then flows into a company as goods and services are sold and as new investment equity and loans are received. Each stage of this cycle consumes time. The more time the stages consume, the greater the demands on working capital.

Back to top

Tricks of the Trade

  • Good management of working capital includes actions like collecting receivables faster and moving inventory more quickly; generating more cash increases working capital.

  • While it can be tempting to use cash to pay for fixed assets like computers or vehicles, doing so reduces the amount of cash available for working capital.

  • If working capital is tight, consider other ways of financing capital investment, such as loans, fresh equity, or leasing.

  • Early warning signs of insufficient working capital include pressure on existing cash; exceptional cash-generating activities such as offering high discounts for early payment; increasing lines of credit; partial payments to suppliers and creditors; a preoccupation with surviving rather than managing; frequent short-term emergency requests to the bank, for example, to help pay wages, pending receipt of a check.

  • Several ratios measure how effectively and efficiently working capital is being used. These ratios are explained separately.

Back to top

Further reading on Working Capital

Websites:

Back to top

Share this page

  • Facebook
  • Twitter
  • LinkedIn
  • Bookmark and Share