working capital formula
Working capital : is a key measure of a company’s financial health and liquidity. It represents the company’s ability to meet its short-term obligations using its current assets.
Here’s the essential formula to calculate working capital:
Working Capital = Current Assets – Current Liabilities
Key points to remember:
- Current assets : are those that can be converted into cash within a year, such as cash, inventory, accounts receivable, and marketable securities.
- Current liabilities : are obligations due within a year, such as accounts payable, short-term debt, and accrued expenses.
A positive working capital indicates that a company has enough current assets to cover its current liabilities, which is generally a good sign.
A negative working capital, on the other hand, suggests potential financial difficulties and may raise concerns about the company’s ability to meet its obligations.
Working capital can be improved by increasing current assets, decreasing current liabilities, or both.
Working capital has a disadvantage as a liquidity measure in that, it is an absolute $ measure of liquidity (aggregate liquidity measure), so it is the least important liquidity measure because it does not facilitate comparisons.