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Working capital

Sidst opdateret 16. august 2023

What does it mean?

Working capital refers to the difference between a company’s current assets and its current liabilities. It represents the funds available to a company for its day-to-day operations and is a measure of its short-term financial health and liquidity.

How to calculate working capital?

In mathematical terms, the concept is calculated with the following formula:

Working capital = Current Assets - Current Liabilities

  • Current assets are the assets that are expected to be converted into cash or used up within a year or the normal operation cycle of the business. Examples include cash, accounts receivable (money owed by customers), inventory (goods for sale), and short-term investments.
  • Current liabilities, on the other hand, are obligations that the company is expected to settle within a year or the normal operating cycle. Examples include accounts payable (money owed to suppliers), short-term loans, and other short-term debts.

What are the main states of working capital?

  • Positive working capital: This means that a company’s current assets exceed its current liabilities. It indicates that the company has sufficient resources to cover its short-term obligations.
  • Negative working capital: If a company’s current liabilities exceed its current assets, it has negative working capital. This situation can indicate financial stress, potential liquidity issues, and difficulty meeting short-term obligations.

Why is working capital important?

  • Operational continuity: Positive working capital ensures that a company has enough resources to cover its short-term obligations and continue its day-to-day operations.
  • Liquidity: It indicates a company’s ability to meet its short-term financial obligations and manage unexpected expenses without resorting to emergency measures.
  • Growth: Adequate working capital can support business expansion, allowing a company to invest in new projects, purchase additional inventory, and hire more staff.
  • Creditworthiness: Lenders and suppliers often evaluate a company’s working capital to assess its financial stability and creditworthiness.