A company’s potential to withstand any unexpected crisis or downturn can be measured through two major metrics: cash flow and working capital. These two metrics denote distinct aspects of the company’s financial health. While cash flow indicates how much fund the company consumes or generates in a specific period, working capital refers to the difference between company’s current assets and current liabilities. Current assets include cash and several other assets that can easily be liquidated into cash in a year and current liabilities include accounts payable, payroll and accrued expenses.
A company that maintains a positive working capital most likely has higher potential to withstand various financial challenges and has the flexibility to invest towards growth after mitigating the short-term obligations.
Working capital is computed by deducting current liabilities from current assets as mentioned on the balance sheet of a company.
- Positive working capital indicates a company has the potential to pay its bills as well as invest to spur the business growth.
- Working capital management concentrates on ensuring the business can meet the daily operating expenditures while using its financial resources in the most efficient and productive way.
Importance of Working capital
Working capital is utilized for fund operations as well as to mitigate various short-term obligations. If a business has adequate working capital, it can continue paying its suppliers and employees and mitigate other crucial obligations. These obligations may include loan repayments, rent payment and others, even in occasions when your company faces cash flow challenges.
Thus, for a healthy financial health, a company adopts goals, which may be twofold: have a comprehensible view about how much cash is in hand at any specific time and work with the company to maintain an adequate working capital to meet liabilities along with some scope for contingencies and growth.
How can you compute working capital?
A Working capital equation deducts current liabilities from current assets. A positive number indicates you have adequate cash to meet your debts and short-term expenses, while a negative number indicates you are struggling to make the ends meet.
Working capital formula
Working capital = current assets – current liabilities
Negative vs positive working capital
A company having positive working capital means it has adequate cash, liquid assets, and account receivables to cover its various short-term obligations like short term debt and accounts payable. On the contrary, having a negative working capital indicates the company does not have sufficient working assets to meet its short-term obligations.
A company with negative working capital might face trouble paying creditors and suppliers and difficulty in raising funds for business growth. If this situation continues, the business can avail loans like a working capital loan to meet such obligations with ease.
Working capital refers to the money a business can instantly tap into to mitigate their daily financial obligations like rent, salaries, and office overheads. In case of lower or no working capital, businesses can route for working capital finance options.