Working Capital
Also known as working assets, it is part of the total capital which is currently employed in a company’s day-to-day operations. Cash or liquid assets vital to run a company’s daily operations are collectively known as Working Capital. It is computed as the difference between current assets and current liabilities.
Evaluation is done to find out if a business has enough current assets to cover all its short-term liabilities. Monitoring helps with efficient management of a company’s operations and maintenance of its short-term financial health.
The volume and composition of working capital vary among different sectors, size, and types of organizations. For example – a manufacturing unit typically sells on credit basis and hence generates plentiful short-term receivables.
On the other hand, a business which runs solely on cash (example – jewellery) may have very few receivables. Another example may be that of a business which only accepts custom orders (example – made to order clothing) may not have a lot of inventory pile-up.
Related Topic – Current Ratio
How to Calculate Working Capital
The excess of current assets over current liabilities is known as a company’s working capital, it is calculated as follows:
| WC = Current Assets – Current Liabilities |
Examples of current assets – Debtors, Cash, Bank, Inventory, Prepaid Expenses, etc.
Examples of current liabilities – Creditors, Overdraft, Outstanding Expenses, etc.
Low Working Capital
In the case of inadequacy of working assets, current assets are less than current liabilities, which means the company has to pay more money than it will receive in short-term.
| Current Assets < Current Liabilities |
A poor working capital condition is the first indication of financial problems for a business and shows that it is struggling to keep up with its daily operations.
Excess Working Capital
In cases where current assets are considerably higher as compared to current liabilities, it is said to be an excess of WC.
| Current Assets > Current Liabilities |
Surplus WC may indicate inefficiency in the way the business operations as it symbolises that current assets are sitting idle and need to be put to better use.
Example
Calculate working assets for the business, with the help of the below extract from a balance sheet.
| Liabilities | Amt | Assets | Amt |
| .. | |||
| Current Liabilities | Current Assets | ||
| Sundry creditors | 75,000 | Bank | 1,00,000 |
| Bills payable | 25,000 | Cash | 50,000 |
| Bank overdraft | 75,000 | Debtors | 1,50,000 |
| .. |
Current Assets = 1,00,000 + 50,000 + 1,50,000
Current Liabilities = 75,000 + 25,000 + 75,000
Applying the formula = Current Assets – Current Liabilities
= 3,00,000 – 1,75,000
= 1,25,000
Short Quiz for Self-Evaluation
>Related Long Quiz for Practice Quiz 33 – Working Capital
>Read Accounting Process