What is working capital? It is effectively a calculation of the short term asset / liability position of a business to see whether it can meet its meets its short term obligations. And the great thing about this calculation is that it is also a measure of how efficient your business operations are.
So lets look at working capital and some key things you should focus on:
When looking at this balance sheet, the working capital calculation is as follows: cash + current assets – current liabilities = ($24,997). This means that there is a working capital deficit which is a significant problem for this company as they do not have enough funds to pay out their liabilities.
Issue No. 1: Always ensure your working capital is positive to avoid short term financial hardship
Looking at numbers from the same demo company below, we can see that the working capital ratio (also seen below as current assets to liabilities) is 0.4 x. This highlights Issue No. 1 above that there are not enough assets to cover the businesses liabilities.
When observing some of the other financial indicators of this business, we can see an increase in debtor days (meaning how long it takes to receive the cash for a sale) and creditor days are increasing (meaning it is taking longer to pay suppliers). This highlights that the financial systems within the business may not be working as effectively as they should be.
Issue No. 2: Your numbers can say a lot about the efficiency of your operations so watch them carefully.