- Working capital
- Working Capital Ratio
Working capital is the amount of money that a company has tied up in funding its day to day operations.
A company has to tie up money to fund its stocks, credit sales and other current assets, but this is offset by its ability to fund this from current liabilities liabilities such as purchases on credit. If a company buys on credit it does not have to tie up (as much) money in its stocks. In some businesses (such as grocery retail) working capital can even be negative. A business that buys on credit and sells for cash is being partly funded by its suppliers.
The most common definitions of working capital are:
- current assets - current liabilities
- stocks + trade debtors - trade creditors
The advantage of the second definition is that it focuses on the most important parts of working capital from the point of view of judging the efficiency of a business's operations. It avoids some short term liabilities (such as overdrafts) which reflect the financing of the business rather than the capital requirements of its operations.
It is worth looking at trends in working capital, and in particular the reasons for increases or decreases. For example, if working capital is growing faster than sales it could mean that the company is offering over generous credit terms to get sales, or that it is over-stocking. These are just two of many possibilities. Either of these would also slow the conversion of profits into cashflow.
Working capital, particularly when defined as current assets minus current liabilities, is closely related to key measures of financial stability such as the current assets ratio and the quick assets ratio .