In this post we will investigate its importance and what formula you should use in order to make the right decisions according to your business. Let's go!
What is the Working Capital and what is it for?
Working capital, also known as current capital, is the difference between a company's current assets, such as cash, accounts receivable (unpaid invoices from customers), and inventories of raw materials and finished goods, and its current liabilities, such as accounts payable.
In simple terms, working capital refers to the money needed to fund day-to-day business operations.
It can also be used to pay short-term debt and cover operational expenses.
It is the lifeline of any business, helping an organization bulk sms turkey run smoothly and carry out its day-to-day operations, such as making payroll and paying off creditors.
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Formula: Working Capital = Current Assets – Current Liabilities
You will probably wonder what Current Assets and Current Liabilities mean, here is an explanation:
Current assets
These are assets that can be converted into cash in a short period of time.
Cash, including foreign currency
Investments, except those that cannot be easily liquidated
Expenses paid in advance
Accounts receivable
Inventory
Current liabilities
Amounts that must be paid to creditors in the short term, say within a year.
An example: Pepito Company has 100,000 euros in cash, 500,000 euros in accounts receivable, 1,000,000 euros in inventory and 200,000 euros in accounts payable.
Its calculation would be:
100,000 euros in cash + 500,000 euros in accounts receivable + 1,000,000 euros in inventory - 200,000 euros in accounts payable = 1,400,000 euros in working capital.
Important: The working capital ratio (current assets/current liabilities) indicates whether a company has enough short-term assets to cover its short-term debt.
Anything below 1 indicates working capital, which will be negative. Whereas anything above 2 means the company is not investing in excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.
