Business Finance 101 – What is Working capital – and how it can be used

Business Finance 101 – What is Working capital – and how it can be used
What is Working capital – and how it can be used

Working capital is defined as 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. For example, if your company’s balance sheet has current assets of $150,000 and current liabilities of $120,000 then your company’s working capital is $30,000.

Working Capital = Current Assets – Current Liabilities
Normally we want cash and assets that can be turned into cash within 12 months, such as Inventory, debtors who owe the company etc (ie “Current” means within 12 months) to be GREATER than Current (12 months) Liabilities.

But 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 if a company has 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, and inventory turnover ratio.

Good management means keeping watch on current assets (receivables and inventory) to keep the cash coming into the bank.

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