Working capital is the result of a business's measurable assets that are available for its day-to-day-operation. It is often a good indication of how a company is being managed as the amount of capital that is available provides a glimpse into the financial health of the business.
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It's extremely important for business owners to be able to define working capital so that they can properly measure the impact their efforts are having on their business. Since a company's current capital is a suggestion of how their liabilities are matching up to their assets, most owners want to be able to physically see how well or poorly their business assets are trending.
DefinitionWorking capital is often defined as the difference between a company's current assets and liabilities. It's a common measure of a business's cash flow, productivity, and overall financial health. If the business has sufficient capital, it's a signal that the business is financially healthy and being properly managed. If there isn't enough capital, however, it's a sign that there are operational deficiencies that need to be addressed.
Working Capital FormulaSubtracting a company's current liabilities from its current assets will return the business's current capital.
Current Assets - Current Liabilities = Working Capital
If the result is a positive number, it means the business has sufficient funds. A negative number equates negative working capital meaning the business is in need of more money. While the result of the formula is a good place to start measuring the status of current capital, business owners shouldn't stop there. Having positive capital may appear to be a great sign of financial health, but it's not necessarily a sure sign that the business is being properly managed. To ensure that the business's overall health is well-balanced, owners should take a look at the working capital ratio. This ratio can be determined by dividing the current assets by the current liabilities.
Current Assets / Current Liabilities = Working Capital RatioIf the result returns a number that is less than 1, this will confirm that the business has negative working capital. If the result is more than 2, this will be a sign of excess and suggests that management isn't investing enough assets or is holding onto too much inventory. If the ratio is between 1.2-2.0, then the result demonstrates that there is sufficient capital, or net working capital.