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Working Capital
Written by Kenny Foo   
Monday, 09 March 2009 15:23

Investment Formula Description

Working capital or net working capital is an investment formula to measure operating liquidity available to a company.

 Working capital or net working capital refers to assets that can turn into cash in short term after deducting short-term debts and liabilities. Hence, fixed assets such as plants and equipments is not included in working capital or net working capital. If a company's current assets are less than current liabilities, this company has a working capital deficiency or working capital deficit. Positive working capital means that the company is able to pay off all the current liabilities in short term. Negative working capital means that company has difficulties to pay off all the current liabilities in short terms and it might caused bankruptcy too. Over a period of time, a continuous decline on working capital or net working capital is bad sign and it might caused by decline in revenue and sales.

Very similar to current ratio, net working capital can gives some ideas to investors on the corporations' operational efficiency. An increase in working capital might not always a good sign. If the trade receivables ( the money that  the customer owe to corporations) is increasing enormously, it means that the corporations might not efficient enough to collect money from the customers ( slow collection ). If this scenario continues for long period and it shows significant increase on trade receivables, the corporations will not able to collect money from its customers to pay of its current liabilities.

 

Investment Formula

Working Capital or Net working capital = Current Assets - Current Liabilities

 

Investment Formula Examples

Corporation A has $50,000 current assets and $40,000 current liabilities at the end of this financial period. The working capital calculation for corporation A is as following.

Working Capital or Net working capital = Current Assets - Current Liabilities = 50,000  - 40,000 = $10,000

Corporation A has $ 10,000 working capital at the end of this financial period, which also means corporation A will have remaining $10,000 after pay off all the short term debts in short period.

 

At the end of next financial period, Corporation A current assets remain unchanged but the current liabilities increase to $60,000. The working capital calculation is as following.

Working Capital or Net working capital = Current Assets - Current Liabilities = 50,000  - 60,000 = - $10,000

Corporation A has negative working capital now, which means it will short of $10,000 if it need to pay off all the short term debts now. In this case, corporation A has working capital deficiency or working capital deficit.



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Last Updated ( Tuesday, 10 March 2009 10:38 )
 

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