What is working capital and why is it so important?

Working capital is the money a company needs to run its day-to-day operations.It is the difference between a company’s current assets (such as inventory, accounts receivable and cash) and current liabilities (such as accounts payable, taxes and loans). Working capital indicates how liquid a company is, or how well it can meet its short-term payment obligations.

Working capital is important for a company’s continuity and growth. A positive working capital means that a company brings in more money than it spends, and thus has sufficient financial room to invest, innovate and anticipate changes in the market. A negative working capital means that a company spends more money than it takes in, and thus relies on external financing or cutbacks to survive.

How do you calculate working capital?

There are several ways to calculate working capital.The most commonly used formula is:

Working capital = Current assets – Current liabilities

This formula is also called net working capital or net working capital. It indicates how much money a company has left over after paying its current liabilities. Another way to calculate working capital is:

Working capital = Fixed assets + Current assets – Equity – Long-term debt

This formula is also called induced net working capital. It indicates how much money a company needs to finance its fixed and current assets using equity and long-term debt.

How do you improve working capital?

A company can improve its working capital by increasing its current assets or reducing its current liabilities. The most effective way to accomplish this is to speed up accounts receivable management, or in other words to collect outstanding customer invoices faster. If the various reminders and call actions follow each other tightly, the customer will become aware of her outstanding debts more quickly and thus will start paying more quickly.

A good balance between working capital and returns

Having adequate working capital is essential to a company’s financial health. But having too much working capital can also be detrimental. In fact, holding too much money in current assets can come at the expense of return on invested capital. A company must therefore strike the right balance between working capital and returns, and align its working capital management with its strategic goals and market conditions.