Working Capital

Definition Of Working Capital:

Working capital is a financial term that measures the amount of operating cash accessible to a business, organization, or other body, including government bodies. Working capital, like fixed assets like plant and equipment, is considered part of operational capital. Current assets are equal to gross working capital. Current assets less current liabilities equals working capital. A working capital deficiency, also known as a working capital deficit or Negative Working Capital, occurs when current assets are fewer than current obligations.


Even though a company is well-capitalized and profitable, it may lack liquidity if its assets are difficult to convert into cash. Positive working capital is essential to ensure that a business can continue to operate and that it has enough cash on hand to pay down short-term debt and cover upcoming operational costs. Inventory management, accounts receivable and payable, and cash management are all part of working capital management.


Formula:

Working Capital Ratio Analyst Interview




Interpretation:

In order to decrease net working capital and maximize free cash flow, a positive working capital cycle balances incoming and outgoing payments. A company's working capital cycle is 30 days if it pays its suppliers in 30 days but takes 60 days to recover receivables. This 30-day cycle is typically funded with a bank operating line, and the interest on this financing is a carrying cost that lowers the company's profitability. Growing a firm requires cash, and the most cost-effective method to grow is to free up cash by shortening the working capital cycle. Sophisticated purchasers extensively examine a target's working capital cycle since it gives them an indication of management's ability to manage the balance sheet and generate free cash flows.




Funders, as a whole, prefer to see a positive working capital since it indicates that current assets are sufficient to meet current liabilities. When working capital is negative, however, businesses risk being unable to satisfy current obligations with current assets. While a corporation can potentially show negative working capital on regularly reported balance sheets indefinitely (since working capital can really be positive between reporting periods), working capital must generally be non-negative for the business to be sustainable.


The following are some of the reasons why a company's working capital may be negative or low over time without suggesting financial distress:


Where do we find the information for this ratio

Current Assets: Balance Sheet

Current Liabilities: Balance Sheet

Pros and Cons-

Pros-

  • Helps in Running Business Smoothly

  • Goodwill of the company

  • Helps in Bargaining


Cons-

  • No return on Capital

  • Chances of Overspending