What Is Working Capital?

Working capital is calculated by subtracting current liabilities from current assets, as listed on the company’s balance sheet . Current assets include cash, accounts receivable and inventory. Current liabilities include accounts payable, taxes, wages and interest owed.

• Working capital is a financial metric calculated as the difference between current assets and current liabilities.
• Positive working capital means the company can pay its bills and invest to spur business growth.
• Working capital management focuses on ensuring the company can meet day-to-day operating expenses while using its financial resources in the most productive and efficient way.

Why Is Working Capital Important?

Working capital is used to fund operations and meet short-term obligations. If a company has enough working capital, it can continue to pay its employees and suppliers and meet other obligations, such as interest payments and taxes, even if it runs into cash flow challenges .

Working capital can also be used to fund business growth without incurring debt. If the company does need to borrow money, demonstrating positive working capital can make it easier to qualify for loans or other forms of credit.

For finance teams, the goal is twofold: Have a clear view of how much cash is on hand at any given time, and work with the business to maintain sufficient working capital to cover liabilities, plus some leeway for growth and contingencies.

Advantages of Working Capital

Working capital can help smooth out fluctuations in revenue . Many businesses experience some seasonality in sales, selling more during some months than others, for example. With adequate working capital, a company can make extra purchases from suppliers to prepare for busy months while meeting its financial obligations during periods where it generates less revenue.

For example, a retailer may generate 70% of its revenue in November and December — but it needs to cover expenses, such as rent and payroll, all year. By analyzing its working capital needs and maintaining an adequate buffer, the retailer can ensure it has enough funds to stock up on supplies before November and hire temps for the busy season while planning how many permanent staff it can support.

Working Capital and the Balance Sheet

Working capital is calculated from current assets and current liabilities reported on a company’s balance sheet. A balance sheet is one of the three primary financial statements that businesses produce; the other two are the income statement and cash flow statement.

The balance sheet is a snapshot of the company’s assets, liabilities and shareholders’ equity at a moment in time, such as the end of a quarter or fiscal year. The balance sheet includes all of a company’s assets and liabilities, both short- and long-term.

The balance sheet lists assets by category in order of liquidity, starting with cash and cash equivalents. It also lists liabilities by category, with current liabilities first followed by long-term liabilities.

Elements Included in Working Capital

The current assets and liabilities used to calculate working capital typically include the following items:

Current assets

include cash and other liquid assets that can be converted into cash within one year of the balance sheet date, including:

• Cash, including money in bank accounts and undeposited checks from customers.
• Marketable securities, such as U.S. Treasury bills and money market funds.
• Short-term investments a company intends to sell within one year.
• Accounts receivable, minus any allowances for accounts that are unlikely to be paid.
• Notes receivable — such as short-term loans to customers or suppliers — maturing within one year.
• Other receivables, such as income tax refunds, cash advances to employees and insurance claims.
• Inventory including raw materials, work in process and finished goods.
• Prepaid expenses , such as insurance premiums.
• Advance payments on future purchases.

Current liabilities

are all liabilities due within a year of the balance sheet date, including:

• Accounts payable.
• Notes payable due within one year.
• Wages payable.
• Taxes payable.
• Interest payable on loans.
• Any loan principal that must be paid within a year.
• Other accrued expenses payable.
• Deferred revenue, such as advance payments from customers for goods or services not yet delivered.