Working capital depicts a company’s capacity to pay. It pays its current liabilities using its existing assets. It is an essential factor to understand the company’s financial health.
A creditor can easily understand the company’s capacity to clear off the debts by monitoring its yearly resources.
Working capital exhibits the contrast between a company’s current liabilities and current asset. It can be hard to determine the actual category for the plethora of asset and liabilities a company has from its balance sheet.
Also, it can be challenging to interpret the financial health of a firm to satisfy its short-term obligations.
So, to understand the working capital, you must know its components accurately.
1- Current Assets:
A current asset is an asset that a company holds at present. These assets can be both tangible and intangible because only such assets can be turned into cash within one business cycle or one year, whichever comes first.
The apparent categories of current assets include savings and checking accounts. It can also consist of liquid marketable collaterals like bonds, mutual funds, stocks and EFTs. The other current asset categories are accounts receivable, inventory, cash and cash equivalent and other short-term prepaid expenses.
However, you must note that current assets do not compromise of illiquid or long-term investments like collectables, real estate or hedge funds.
2- Current Liabilities:
When we talk about current liabilities, they include every debt and expenses the company has to pay out with a business cycle or business year, whichever that is less.
The current liabilities comprise of all the reasonable costs that are used for maintaining the business. The list includes supplies, utilities, materials, rents along with principal or interest payments on loans. The other categories included here is the accumulated income tax and liabilities.
Even the capital leases, dividends that are payable within a year and in due long-term debts are considered as current liabilities.
How to calculate the working capital?
The calculation of working capital is done using a current ratio that is the current asset divided with current liabilities.
Current Ratio= Current Asset/Current Liabilities
Suppose the outcome of this ratio is more than one. In that case, your current assets outweigh the liabilities. This is good, because the higher ratio exhibits your capability of clearing the debts. Such ratios are termed as positive working capital.
A company that has a ratio of less than one is considered unsafe by many creditors and investors. This is because such companies directly exhibit their incompetence in covering the debts. A ratio under one is termed as negative working capital.
The other type of inflexible ratio type is the quick ratio. It evaluates a fraction of short-term liquidity as to current liability.
Can working capital change?
Yes, working capitals do change. Although they never expire. This is because a company’s current asset and the liability is both based on the rotating 12-month period.
You can even expect the precise working capital number to change on a daily basis. And this totally depends on the nature of your company’s overall debt.
Even your long-term liability will be changed into a current liability if the approaching date is less than a year. Similar to this, if you have a buyer lined up for your long-term asset, then it will suddenly become a current asset.
If you have working capital as a current asset, then it won’t be depreciated like the long-term, fixed asset.
Bottom line
If you want that your working capital to operate without hindrance, then you must evaluate the working capital periodically over time. This is because, without proper money, the operation may stop and cause devaluation.
We hope this blog post was able to offer you the most information related to working capital in an easy way. If raising working capital is a challenge due to a lot of unpaid invoices, then new age agencies like Kredx can come up with a viable solution.
They help arrange for finance using invoice discounting on the unpaid invoices you have. So convert the barrier into an opportunity and raise adequate cash for your working capital needs.
