Working capital, or net working capital, is a metric used to evaluate a company’s operational efficiency and short-term financial health. It is calculated by subtracting a company’s liabilities, such as accounts payable, from a company’s current assets, like so:
Current Assets – Current Liabilities = Working Capital
Current assets can include cash and customers’ unpaid bills, as well as inventories of raw materials and finished goods. Current liabilities include any debts that must be paid off by the end of the year.
Essentially, working capital is used to see if a company has enough short-term assets to cover its short-term debt. If a company has negative working capital, it may need to sell off an asset, take out a bond, or even go bankrupt to cover that debt.
Working capital can also be expressed as a ratio of current assets divided by current liabilities. In this case, a desirable working capital ratio is generally between 1.2 and 2.0. A ratio lower than 1 indicates negative working capital, while a ration higher than 2 may indicate that a company is not using its assets effectively.
Recent Comments