• Calculate working capital

 

Working capital is a measure of a company’s liquidity, operational efficiency, and its short-term financial health. If a company has substantial positive working capital, then it should have the potential to invest and grow. If a company’s current assets do not exceed its current liabilities, then it may have trouble growing or paying back creditors, or even go bankrupt.

Working capital is the difference between a company’s current assets, such as cash, accounts receivable (customers’ unpaid bills) and inventories of raw materials and finished goods, and its current liabilities, such as accounts payable. Working capital reflects the company’s liquidity and refers to the difference between operating current assets and operating current liabilities. In many cases, these calculations are the same and are derived from company cash plus accounts receivable plus inventories, less accounts payable, and less accrued expenses.

The calculation for working capital is as follows:

[latex]\text{current assets} - \text{current liabilities} = \text{working capital}[/latex]

For example, Jonick Company has $911,000 in current assets and $364,000 in current liabilities, so working capital is $547,000. In other words, on December 31, 2019, at the close of business, there was a healthy amount of working capital. In fact, just at a glance, there was enough cash in the bank on December 31, 2019, to pay all of the current liabilities.

It’s important to note that even with a large amount of working capital, some of that is not actually liquid; for instance, salaries and accounts payable may need to be paid off in less than a month, but inventory may take longer than that to liquidate, and prepaid insurance, although considered a current asset, is not actually available to pay current bills (as you may recall, it is an expense that has been paid in advance, which is theoretically the exact opposite of an account payable – an expense not yet paid.)