DEFINITION: The phrase “working capital,” sometimes also known as “net working capital” (NWC), refers to the difference between a company’s current assets and its short-term liabilities.
Current assets encompass things like the cash a company has in the bank, its accounts receivable (unpaid customer bills), its inventories of raw materials and finished products, and other assets that are expected to be liquidated (turned into cash) within a period of one year or less.
Short-term liabilities encompass accounts payable (unpaid supplier statements), wages, taxes payable, and the portion of long-term debt owed to banks or other companies that falls due within a year.
Working capital serves as a widely utilized metric for assessing the near-term well-being of an organization.
ETYMOLOGY: The phrase “working capital”is attested from around the turn of the twentieth century.
The English present participle “working,” from the verb “to work,” derives, via Middle English werken or worken, from Old English wyrcan, meaning “to bring about,” “to effect,” “to fashion,” “to forge,” or “to create.”
The English noun “capital” derives, via Middle English capitale, from either Italian or French capitale, meaning “chief” or “principal.” Capitale ultimately derives from the Latin adjective capitālis, capitāle, meaning “relating to the head,” which, in turn, is from the noun caput, capitis, meaning “head.”
USAGE: Assessments of working capital are calculated from the assets and liabilities recorded on a company’s balance sheet.
By focusing on its imminent debts—and counterbalancing them with its most readily available assets—a company can gain a deeper insight into its liquidity status for its immediate future.
As well as a metric of a company’s short-term financial health, working capital is also a measure of its operational efficiency. If a company has substantial positive NWC, then it could have the potential to invest in expansion and grow the company.
On the other hand, if a company’s NWC is negative—that is, if current assets are smaller than its short-term liabilities—then it may have trouble growing or paying back creditors, or even be at risk of bankruptcy.
The amount of working capital a company possesses generally depends upon its industry.
Certain sectors characterized by lengthier production cycles might necessitate a greater amount of working capital to offset their limited capacity for rapid inventory turnover, which hinders quick cash generation.
Conversely, retail enterprises that serve thousands of customers on a daily basis may be able to expedite the generation of short-term funds, thus reducing their need for working capital.
To compute working capital, deduct a company’s current liabilities from its current assets.
Working Capital = Current Assets – Short-Term Liabilities
Working capital is often stated as a dollar figure. For example, say a company has $10,000 in current assets and $4,000 in short-term liabilities.
The company is therefore said to have:
$10,000 – $4,000 = $6,000
of working capital.
This means the company has $6,000 at its immediate disposal if it needs to raise money for some reason.
Note that in the case of publicly traded firms, these data may typically be found in publicly disclosed financial statements.
However, in the case of privately held companies, the relevant financial information might not be immediately accessible.
It’s important to recognize that negative working capital is not inherently bad. Its impact may be either positive or negative, depending upon the particular business and whether and how fast the company is growing.
On the other hand, a persistent state of negative working capital may potentially lead to unfortunate consequences.