What is working capital?
Have you ever wondered what the dictionary definition is of working capital?
The capital of a business that is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities.
Investopedia defines it as:
A measure of both a company’s efficiency and its short-term financial health.
Working capital is calculated as:
Working Capital = Current Assets – Current Liabilities
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 negative W/C (working capital). While anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.
It is imperative that all businesses manage their working capital as efficiently as possible. By doing this, you maintain the flexibility needed to increase working capital if a sudden uptick in market demands occurs or to fund day to day operations in times when markets or the economy slows.
There are many steps you can take to improve working capital including:
- Negotiating more favourable terms for your accounts
- Stretching or extending terms on your accounts payable
- Postponing of principal payments on a debt.
Working capital is a key ratio which all businesses need to pay close attention to but essentially it comes down to living within your means.
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