Working Capital

What is Working Capital?

A fairly straightforward but nonetheless important metric, Working Capital is the monetary value of the difference between a company’s current assets and current liabilities. It’s intended to show if a company can cover any short-term expenses and debts, and generally serves as a proxy for financial health and operational efficiency.

A company’s ‘current assets’ are primarily composed of but not limited to cash, property, and inventory. Meanwhile, a company’s ‘current liabilities’ include wages, rent, utilities, and taxes. Leftover cash – the Working Capital – can be used to cover expenses including inventory purchase, short-term debt, and other operating expenses.

Working Capital is an important KPI for your finance team to monitor.

Why is Working Capital important?

Working Capital is an important KPI because it tracks your business health at the most basic level – how much cash do you immediately have on hand?

With this in mind, Working Capital is a surefire way to understand financial solvency. Having sufficient Working Capital, especially if your business is subject to seasonal fluctuations, is one of the best ways to ensure it remains solvent in the short-term while setting it up for future growth.

While it’s generally a good thing to have sufficient Working Capital, this KPI does have its downsides. For example, if a company has most of its holdings as accounts receivable, its financial model is reliant upon customers actually paying for what they’ve bought, regardless of whether the company’s Working Capital appears sufficient.

Furthermore, Working Capital might not always provide an accurate picture of your company’s finances, as assets can appreciate or depreciate even within a year.

Calculating Working Capital

How to increase Working Capital

Having sufficient Working Capital is ultimately dependent on the wise use of resources during the fiscal year. However, if you do need to increase your Working Capital, there are some steps you can take:

• Restructuring debt: You can take out long-term debt to immediately add to your cash pool. You can also refinance short-term debt as long-term debt, so that it’s not due within the year.
• Optimize processes: Eliminate any redundancies in your inventory management or your end of the supply chain to save costs.
• Sell liquid assets: With a market readily available for such assets, this is an easy way to obtain cash if needed.

Other KPIs similar to Working Capital include:

• Operating Cash Flow
• Gross Profit Margin
• Inventory Turnover