Working capital is a company’s capacity to pay its current liabilities using its current assets. Investors use the figure to evaluate a company’s operational efficiency, short-term financial health, and ability to pay debts within a year. The challenge is usually placing the different liabilities and assets on a balance sheet to understand the company’s current financial health. Read on to understand how to calculate working capital.
Components of Working Capital
The two components of working capital are current assets and current liabilities.
Current assets are the assets the company can quickly turn into cash in one business cycle or a year, whichever term is less. Illiquid or long-term investments like real estate, collectibles, and hedge funds aren’t included here. Current assets include liquid marketable securities like bonds, stocks, exchange-traded funds (ETFs), and mutual funds.
Current liabilities are all the expenses and debts a company is expected to pay in one business cycle or a year, whichever is less. This includes expenses like utilities, rent, interest on debt, supplies, etc. Long-term debt that’s coming due is also under current liability.
How to Calculate Working Capital
As we’ve mentioned, you calculate working capital by deducting current liabilities from current assets. It can also be useful to calculate a metric referred to as the current ratio. The current ratio can give a quick insight into a business’s financial health.
You calculate a company’s current ratio by dividing current assets by current liabilities. If the ratio is above one, current assets are more than liabilities. A higher ratio indicates that the company can pay its short-term liabilities.
Nonetheless, if the current ratio is too high (a significant amount of available current assets), it can mean that a company is underutilizing its assets.
Working Capital Changes
With time, working capital will change. It can even change daily. For instance, something like equipment or real estate, which is considered a long-term asset, can become a current asset if a buyer is available. A 10-year loan, once considered a long-term liability, can become a current liability one year before the repayment deadline.
After calculating your working capital, does your business have enough cash for daily operations? If not, talk to the lenders at Means Commercial Capital today for assistance.