Working Capital:

Working capital (WC) is a financial metric which represents operating liquidity available to a business, organization, or other entity, including governmental entity. Net working capital is ascertained by deducting current liabilities from current assets. It is also called Net current assets or current capital.

Working Capital = Current Assets

Net Working Capital = Current Assets − Current Liabilities

When a company has more current liabilities than current assets, it has negative working capital. When current assets outweigh current liabilities, a company has positive working capital. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses.

Working capital management involves managing inventories, accounts receivable and payable and cash. Working capital is essential for efficient functioning of a company. Higher the working capital in a company, the lesser strain on the company. A negative working capital for a prolonged period may lead to bankruptcy. Poor working capital will lead to financial pressure on a company, increased borrowing, and late payments to creditor - all of which result in a lower credit rating. A lower credit rating would lead to banks charge a higher interest rate, which can cost the company a lot of money over time.

A company that has high inventory turns and works on a cash basis (e.g. grocery store) needs very less working capital. These businesses raise money quickly and plough back into inventory to increase sales. Working capital gives an idea about the company’s operational efficiency to the investors. If a company does not operate in the most efficient manner then there will be increase in the working capital. Comparing the working capital of a company from one period to another may give a signal to the company about the underlying problems.

Questions:

• What is working capital?
• Why is it essential for a company’s effective functioning?