Assessing Your Working Capital

The formula for working capital is simply:

Also known as liquid assets, current assets include cash, inventory, and accounts receivable, and any assets that are expected to be turned into cash within one year. Current liabilities are the debts that a business expects to pay within one year.

Suppose a company's current assets amount to $700,000 and its current liabilities are $380,000 in total. Working capital is therefore:

The working capital cycle tracks the movement of capital (typically cash, in which case it's also known as the cash cycle) through a business. First, it flows out of the business to fund supplies, equipment, materials, and inventory—and to pay staff. Then it flows back in, as the company sells its goods and services, and receives new sources of funding from equity and loans. Each of these processes takes time, and the longer they take, the heavier the strain on a company's working capital.

• Companies can boost their working capital by collecting receivables promptly, moving inventory faster, and generating more cash.
• Paying cash for fixed assets like equipment or machinery means there'll be less available for working capital.
• Capital investment can be funded through loans, leases or equity rather than drawing on working capital.
• A company having trouble managing its working capital effectively is constantly diverted by cash emergencies. Possible indications of trouble include: attractive discounts to customers who pay promptly or in advance; additional loans; part or late payment of bills; last-minute visits to the bank for short-term advances—perhaps to pay staff or in lieu of expected income.
• A number of key financial ratios draw on working capital, and are useful to investors wanting to assess the effectiveness and efficiency of its use.