Understanding Working Capital

Working capital is a critical measure of the financial health of a company. It is a measure of a company’s current assets minus its current liabilities. The resulting positive or negative value reflects the company’s short-term financial position – or its ability to pay short-term bills.

In essence, working capital is the difference between a company’s total current assets and its total current liabilities, and it is a useful tool for measuring a company’s liquidity and its ability to survive over the near term. Companies need to invest in working capital to survive day-to-day operations, and investors, creditors, and lenders use it as a way to gauge a company’s overall financial stability.

Why is Working Capital Important?

Working capital provides a snapshot of a company’s efficiency and short-term financial health, and it plays a key role in helping a company meet its obligations as they come due. A company that has a lower working capital than its peers may run into a situation where it is unable to pay its bills or make new investments, potentially leading to bankruptcy. In contrast, companies with high working capital will have a strong financial position and the ability to make new investments.

Integral to the Financial Picture

Working capital has the potential to be the single most important factor in a company’s short-term financial health and long-term sustainability. It is important to look at working capital in comparison to sales and assets, in order to get an idea of the company’s efficiency. Furthermore, as a company’s working capital is heavily impacted by its ability to collect due receivables, a company’s accounts receivable process should also be considered in order to make sure the company is able to collect due receivables in a timely manner.

Working capital plays a key role in helping companies survive day-to-day operations, investors, creditors, and lenders use it as a way to gauge a company’s overall financial stability. For a company to remain financially viable, it needs to actively manage its balance sheet and revisit its working capital needs on a regular basis.