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What is Working Capital?
Here's a simple explanation...
Working capital -- aka Net Working Capital -- is the difference between a company's current assets (expected to be used/consumed/converted into cash <1 year) and current liabilities (debts that are expected to be paid off in <1 year).
💡Why is working capital important?
Working Capital is a quick way to assess a company's liquidity, which is its ability to meet its short-term obligations.
It serves as an indicator of a company's financial health.
If working capital is positive, it indicates that a company has sufficient resources to cover its short-term financial needs.
If working capital is negative, it indicates that a company may face financial difficulties.
There are three ways to calculate working capital:
1️⃣ THE SIMPLE METHOD
Current Assets - Current Liabilities
This is the most common method and easiest to calculate.
2️⃣ THE NARROW METHOD
(Current Assets - Cash) - (Current Liabilities - Debt)
This method excludes cash & debt, which can be useful for comparing companies with different capital structures.
3️⃣ THE SPECIFIC METHOD:
Accounts Receivable + Inventory - Accounts Payable:
This method focuses on the cash conversion cycle of a business, which is the time it takes to convert inventory into cash.
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