How is working capital defined and measured?
Working capital is the amount of current assets minus the amount of current liabilities as of specific date. These amounts are obtained from your company’s balance sheet. For example, if your company’s balance sheet reports current assets of $450,000 and current liabilities of $320,000 then your company’s working capital is $130,000.
Even with a significant amount of working capital, a company can experience a cash shortage if its current assets are not turning to cash. For example, if a company has most of its current assets in the form of inventory, that inventory needs to be sold. Similarly, if a company has a large amount of receivables that are not being collected, the working capital amount isn’t much consolation when you can’t meet Friday’s payroll.
There are several financial ratios that pertain to working capital. They include the current ratio, quick ratio, accounts receivable turnover ratio, days sales in accounts receivable, inventory turnover ratio, and days sales in inventory.
Monitor your current assets daily to keep the cash coming into your checking account. If you do the right things each day, your financial ratios have a better chance of being respectable at the end of the month.
Learn more about Financial Ratios.
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