Working Capital: Know about its Formula, Definition and Calculation

Working capital is the company’s money available for everyday operation.  Also, it’s used for measuring the capital of the company’s liquidity, overall health as well as efficiency. Well, it includes the cash, account payable, account receivable, inventory, other short-term accounts etc. There are different types of working capital, which are based on the operation cycle view or the balance sheet.  Working capital also indicates the company’s liquidity levels for managing their day to day expenses.

How to Calculate and what’s the Formula?

For calculating the working capital, there is a formula which can be used.

Working capital = current asset – current liabilities

Well, the positive working capital indicates that the company is capable of paying the short-term liabilities if the situation arises to pay it immediately. Whereas the negative numbers say that the company is not able to pay it.

Because of this, the analysts are sensitive when it comes to working capital. If the company’s working capital decreases, they suggest the companies are turning overleveraged and struggling in maintain the sales or growth. Including, paying bills quickly and receivable collections are way too slow. 

In such a situation, it’s important to improve the capital of the company, which can be possible but doing certain cautions. Such as the current ratio, the quick ratio, calculating the inventory turnover ratio, days payable and the receivable ratio.

What to know about the working capital ratio?

Working-Capital-Formula

Well, it’s a ratio which helps in comparing the current asset of the company to the current liabilities. Its different from the traditional formula of working capital, which is current asset subtracted with current liabilities.  

The formula of the working capital ratio is.

Working capital ratio = current assets/ current liabilities

Or

Working capital ratio = (cash + short-term investments + inventory + accounts receivables) / (short-term notes + accounts payables)

Also, the working capital ratio indicates what asset for short term does the company have for clearing the short-term debt. If the ratio is lower than 1, then it indicates working capital is negative. However, for the positive and sufficient working capital, the ratio should be between 1.2 and 2.0. Well if the ratio exceeds then 2, it shows that the company have too many assets. In that case, its how’s that company missed lots of opportunities where they should invest the asset on time.

What is the Working Capital Cycle?

The working capital cycle is also known as WCC, and it refers to the time period that is used for converting the asset and net current liabilities into the cash by the company. This also indicates that the company is efficient when it comes to positions in effectivity managing liquidity in the short term. It is calculated in days. It also means if the cycle is shorter, the company will take lesser time to get the money back, which is blocked. If it’s longer, then the company will get stuck without getting the return in its operation cycle.

Author: Naveen E

This is E.Naveen Kumar full time Content Writer, SEO, Digital marketing Expert, founder of financesrule.com. Really enjoying playing cricket at free times. Being a Btech Graduation from Computer Science stream Selected full-time blogging as my Profession.

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