Working Capital Definition | Meaning | Example and Importance

0
19
determinants of working capital
Download PDF

Working Capital Definition

Working Capital Definition – “A measure of a company’s day-to-day liquidity. It equals the difference between a company’s current assets and its current liabilities”.

In simple words, it is the money for carrying out the day to day operations of the company. The working capital ratio measures the short term financial performance of the firm. In addition to this, it also measures the efficiency of a firm and hence is one of the type of efficiency ratios. Efficiency in the sense that how efficiently the enterprise is using its current assets to meet out the short term debts that is current liabilities.

Working Capital Formula

W/C = Current Assets – Current Liabilities

Current assets are short term assets which are readily convertible into cash within the period of 1 year. Current Liabilities are those debts are company has to pay within the duration of 1 year.

Working Capital Example

Balance Sheet of XYZ Pvt Ltd as on 31st March 2017

 Cash and cash equivalents 60,000 Accounts Payable 30,000
 Marketable securities 5,000Accrued expenses20,000
 Debtors15,000Overdraft25,000
Prepaid expenses3,000Outstanding rent5,000
Inventory/ Stock17,000Bills payable5,000
 Total Current Assets1,00,000 Total Current Liabilities 85,000

Working capital = 1,00,000 – 85,000

= 15,000

Net Working Capital/ Working Capital Ratio  = Current Assets/ Current Liabilities

= 1,00,000/85,000

= 1.17

Importance of Working Capital

Without knowing the importance of working capital, it is quite difficult to understand Working capital definition. The logic behind W/C is very simple. If current assets exceeds current liabilities, it means that company can repay their short term debts. Continuation of situation ultimately leads to insolvency.

If the ratio is less than 1, it means company has negative working capital. At the same time ratio more than 2 or 2 means that company is not utilizing their assets to the optimal level.

Thirdly, it also provides a clear picture of the company’s operational efficiency. So, it is very important for the company to operate in the most efficient manner to tackle with the working capital related problems.

LEAVE A REPLY

Please enter your comment!
Please enter your name here