What Is Working Capital?
There are a number of different metrics a business owner can use to evaluate his or her company’s financial health. One of the most important of these measurements is known as working capital. Like cash flow, working capital is a value that is constantly changing. Because of this, a business owner will need to study his or her balance sheet in order to calculate the business’ current amount of working capital.
Working capital may be defined as the amount of capital that a company has, which is not reserved for paying back short-term liabilities. This means that working capital is essentially the amount of capital that a business owner has to use. Working capital is valuable to a business, and a company should endeavor to have as much working capital as it can achieve. With more capital available to use, a company will have access to a greater amount of assets that it can choose to use, save, or sell. Please contact our San Diego business dispute attorney if your company is missing working capital and suspects foul play.
How To Calculate Working Capital
The formula for calculating working capital is actually very simple:
Working Capital = Current Assets – Current Liabilities
The above values, current assets and liabilities, may both be found on the company’s balance sheet. Unlike a company’s income statement, a business’ balance sheet is a picture of a specific moment in time. This means that the numbers on the balance sheet are always changing. Whenever a business changes its amount of liabilities or current assets, the company’s working capital will change as a result.
Currents assets reflect the total amount that a business owns when it comes to cash and liquid assets. This also includes items that will be turned into cash within the next year. Examples of current assets might be accounts receivable, cash, inventory, and commercial paper.
Current liabilities may be defined as the amount a business needs to pay back his or her creditors with a year’s time. Examples of current liabilities might be operating expenses, accounts payable, and taxes.
A business’ current amount of capital can be altered in a number of ways. If a business increases it current assets or reduces its current liabilities, then the total amount of working capital will grow. If a business reduces its current assets or increases its current liabilities, then its total amount of capital will decrease.
There are many formulas that a business owner can take away from his or her company’s income statement or balance sheet. Still, even with the creation of new formulas, capital remains one of the most useful measurements.
Since capital is derived from both liabilities and current assets, the formula is more useful for making decisions for the short-term. It is very useful for companies that must make important decisions regarding their financing.
How Is Working Capital Useful to a Business?
A lot of entrepreneurs think that working capital is one of the most beneficial numbers that can be taken from a balance sheet. By understanding the significance of working capital, a business owner can help his or her company decide on important matters including:
- How to adjust the level of capital use to respond to changes in the business cycle (as can happen with seasonal retailers)
- If a business owner should apply for a business loan
- Understand the possible risks and rewards associated with changing elements of the company’s operations
Conclusion
While capital should not be the only financial measurement that a business owner keeps track of, it is still very helpful for almost every kind of business.
