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What is Working Capital ?
Working capital is a valuation
metric. It is calculated as current assets minus current
liabilities. It is known as net current assets or current
capital. It is also known as operating capital because it
represents the daily operating liquidity which is available to a
business.
How is working capital expressed ?
Working capital measures the amount of liquid assets the company
has at its disposal for strengthening its business. In some
cases, the company has assets and profitability but does not
possess liquidity if the assets cannot be readily converted into
cash.
Working capital denotes a number that is positive or negative.
This depends on the debts of the company. Companies which have a
positive mass of working capital are considered to be successful
and have options of expanding and improvement of their business
operations. Whereas companies which have deficit working capital
will have stunted growth.
What does working capital consist of
?
Working capital includes three accounts which represent the
business areas most impacted on. They are accounts receivable or
current asset, inventory or current assets and accounts payable
or current liability.
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Effects
of working capital
A change in working capital is bound to alter the business cash
flows. A positive change in working capital denotes that the
business has paid out cash for purchasing and converting
inventory, paying creditors and other productive business
activities. When working capital increases, the cash flow of the
business is negative. This is due to liquidation of the
inventory or because of withdrawal of money from accounts due to
be paid by the business. However, a negative change in working
capital of a company will result in low funds to pay off current
liabilities and these result in grave business concern for the
company.
Working capital is an important factor that decides the success
of a business. If a company has no working capital, its business
will be hampered and will always be at a risk. It will deter the
growth and expansion of the company. It also leaves the company
with little cash to pay the short-term obligations. |
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With lack of working capital, a
company will face serious financial crisis which may eventually
result in bankruptcy. This is because these companies will start
borrowing money to tide over the financial crunch. They may skip
payments or delay the payment due to creditors. This will
adversely affect the company’s ratings and may also seal its
chance of even obtaining loans at affordable interest rates.
This can affect small holdings and even billion dollar
companies.
However, small companies are able to function with low working
capital due to lack of working capital. This is because small
companies which operate on cash basis, like grocery stores for
instance, have fast turnovers on a daily basis and do not
require much working capital.
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Article Contributed By: Sabina
Zacharias
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