Working Capital is a common measure of the health of your business operations. Knowing how to manage working capital is a crucial aspect of financial procedures. Working capital refers to the funds required to operate your firm on a daily, weekly, and monthly basis. It is the money used to pay your suppliers for materials, as well as the money needed to pay for the items and services (such as inventory and payroll) that you have utilized while waiting for your customers to pay you.
What is Working Capital?
The Working Capital Procedure describes methods to properly manage the working capital invested to operate the business in areas such as Accounts Receivable, Accounts Payable, and Inventory.
It is the Amount of capital needed to run the business. It is the difference between a company’s current assets (cash accounts, accounts receivable or unpaid invoices from customers, plus raw materials inventory, work-in-process inventory, and finished goods inventory) and a company’s current liabilities (accounts payable and short term loans).
How is Working Capital Calculated?
working capital is calculated as:
Current Assets – Current Liabilities
or
(Cash + Accounts Receivable + Inventory) – Accounts Payable
Positive or Negative Working Capital
If you have more current assets than current liabilities then you are in a positive working capital position, which is not necessarily good. This means you may not be using your assets as efficiently as you could. You either have too much cash not working for you, too much inventory, or you have lent too much to your customers in accounts receivables.
Negative working capital means your current liabilities (expenses) may be out of balance with your current assets position. In this case, you need to generate more cash, restructure, or stop spending so much until your cash position improves. But, if a firm is expanding, this may be the best working capital position to be in since it actually “makes” money for the company.