What is Working Capital?


Working Capital

Also known as working assets, it is part of the total capital which is currently employed in a company’s day-to-day operations. Cash or liquid assets vital to run a company’s daily operations are collectively known as Working Capital. It is computed as the difference between current assets and current liabilities.

Evaluation is done to find out if a business has enough current assets to cover all its short-term liabilities. Monitoring helps in efficient management of a company’s operations and maintenance of its short-term financial health.

Formula to calculate working capital

The volume and composition of working capital vary among different sectors, size, and types of organizations. For example – a manufacturing unit typically sells on credit basis and hence generates plentiful short-term receivables.

On the other hand, a business which runs solely on cash (example – jewellery) may have very few receivables. Another example may be that of a business which only accepts custom orders (example – made to order clothing) may not have a lot of inventory pile-up.

Related Topic – Current Ratio


How to Calculate Working Capital

The excess of current assets over current liabilities is known as a company’s working capital, it is calculated as follows:

Working Capital = Current Assets – Current Liabilities

Examples of current assets – Debtors, Cash, Bank, Inventory, Prepaid Expenses, etc.

Examples of current liabilities – Creditors, Overdraft, Outstanding Expenses, etc.

 

Low Working Capital

In case of inadequacy of working assets, current assets are less than current liabilities, which means the company has to pay more money than it will receive in short-term.

Current Assets < Current Liabilities

A poor working capital condition is the first indication of financial problems for a business and shows that it is struggling to keep up with its daily operations.

 

Excess Working Capital 

In cases where current assets are considerably higher as compared to current liabilities, it is said to be an excess of WC.

Current Assets > Current Liabilities

Surplus WC may indicate inefficiency in the way the business operations as it symbolises that current assets are sitting idle and need to be put to better use.

 

Example of Working Capital

Calculate working assets for the business, with help of the below extract from a balance sheet.

Liabilities Amt Assets Amt
..
Current Liabilities Current Assets
Sundry creditors 75,000 Bank 1,00,000
Bills payable 25,000 Cash 50,000
Bank overdraft 75,000 Debtors 1,50,000
..

Current Assets = 1,00,000 + 50,000 + 1,50,000

Current Liabilities = 75,000 + 25,000 + 75,000

Applying the formula = Current Assets – Current Liabilities

= 3,00,000 – 1,75,000

= 1,25,000

>Read Accounting Process



 

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