Working capital - What is working capital?
Working capital refers to the total value of a company’s assets after subtracting the current liabilities, providing an idea of the cash available for operating
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A business can quickly calculate the working capital by subtracting the current liabilities from the assets. This amount outlines how much a business generally has for day-to-day costs of operations. It also provides useful information about the financial state and trends of a business.
How working capital is used
Measuring working capital regularly over time can give a business a good idea of how much cash they have available and any increases or decreases.
Ideally, a company’s assets should be greater than their liabilities, giving them a reasonable amount of working capital with which to operate. New businesses will likely not see this immediately, but will work towards establishing greater working capital.
When the liabilities outweigh the assets in a more established business, this can lead to decreased or even negative working capital, making it difficult for the business to cover operating costs and to make payments to creditors.
The worst-case scenario of decreases in working capital over time is eventual insolvency. It can also indicate other problems with a business, for example if a company is not receiving payments from customers, this can lead to a diminishing working capital and warrants a reevaluation of how the company conducts business.
The working capital ratio
The ratio is determined by following the equation:
Current assets / current liabilities
This will provide the business with a numerical figure to help determine the financial health of their business in terms of working capital. A company should typically aim for a ratio between 1.2 and 2. A ratio under 1 indicates a business with negative working capital. A ratio over 2 likely indicates an over-investment in assets.
Working capital and online accounting software
The first step to calculating and tracking working capital is proper management of a business’s income and expenses. Particularly useful is accounting & invoicing software that makes it easy to register expenses and track depreciation.
Instant financial reports provide a quick overview of assets and liabilities at any given time, making it fast and simple to determine working capital and track the amounts over time.