If a company takes all of its short-term assets (e.g. cash in the bank, receivables invoices, stock, etc) and pays all its short-term liabilities (e.g. suppliers, staff, etc) the remaining balance is their working capital position. If the working capital position is positive, it is more than likely that the company is adequately capitalised and is self sufficient. If however, the working capital position is negative, then the company needs to make up the difference by borrowing money or using some other source of working capital. To calculate the working capital of a business, simply subtract its Current Liabilities from its Current Assets.
Working Capital = Current Assets – Current Liabilities
Knowing the working capital of a business will help to avoid unnecessary financial strain on the company. Companies with insufficient working capital will invariably delay payments to suppliers, fail to pay staff salaries, delay tax payments and may ultimately lead to business failure and/or closure. A useful measurement of the financial health of a business is its working capital ratio. In a financially stable business, the working capital ratio will be above 2.
Working Capital Ratio = Current Assets / Current Liabilities
For example, a company with current assets of 100,000 and current liabilities of 40,000 has working capital of 60,000 and its working capital ratio is 2.5. Working capital ratios below 2 are an indication that there may be a potential financial problem. A company with a working capital ratios below 2 needs to address the issue swiftly by borrowing money or using some other source of working capital.
Finding your Current Assets & Current Liabilities
Go to your accounts system and print your Balance Sheet, or ask your accountant for a recent Balance Sheet. Current Assets is a standard heading on most Balance Sheets. There may be a Current Liabilities heading and if not, there should be a heading: Creditors – amount falling due within one year and this is your Current Liabilities.
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