What is Working Capital? A measure of both - a company's efficiency and its short-term financial health.

The working capital ratio is calculated as: Working Capital = Current Assets Current Liabilities By a positive working capital it means that the company is able to pay off its short-term liabilities. By a negative working capital it means that a company currently is unable to meet its short-term liabilities with its current assets (cash accounts receivable and inventory!. The "orking #apital is also known as $net working capital$ or the $working capital ratio$. %f a company's current assets do not e&ceed its current liabilities then it may run into trouble paying back creditors in the short term. The worst-case scenario is bankruptcy. A declining working capital ratio over a longer time period could also be a red flag that warrants further analysis. 'or e&ample it could be that the company's sales volumes are decreasing and as a result its accounts receivables number continues to get smaller and smaller. "orking capital also gives investors an idea of the company's underlying operational efficiency. (oney that is tied up in inventory or money that customers still owe to the company cannot be used to pay off any of the company's obligations. )o if a company is not operating in the most efficient manner (slow collection! it will show up as an increase in the working capital. This can be seen by comparing the working capital from one period to another* slow collection may signal an underlying problem in the company's operations. There are two concepts of "orking #apital: +! ,ross working capital which refers to gross current assets. -! .et working capital which refers to difference between current assets and current liabilities.

The most important aspect of working capital is that : A business which is in financial trouble needs "orking #apital 'inance to pull it out of this situation thus %t is in a great need of "orking #apital 'inance. But a business which is doing so well and e&panding further is in greater need of "orking #apital 'inance since it has to produce more and more products to keep the momentum going. )o in both the conditions "orking #apital 'inance planning becomes imperative for any enterprise.

Advantages of "orking #apital : +! %t brings instant finance for the business. -! %t protects the business against any unforeseen future challenges. /! The "orking capital finance gives strength fle&ibility and stability to the business. 0! "ith ade1uate working capital finance other available funds can be utili2ed in other productive activities thus enabling the enterprise to reali2e its full potential. 3! "orking capital finance can be e&tremely useful when a business is e&periencing financial troubles it can provide instant finance and pull it out of trouble situations.

Negative Working Capital Can Be a

oo! Thing for "igh Turn Businesses

#ompanies that have high inventory turns and do business on a cash basis (such as a grocery store! need very little working capital. These types of businesses raise money every time they open their doors then turn around and plow that money back into inventory to increase sales. )ince cash is generated so 1uickly managements can simply stockpile the proceeds from their daily sales for a short period of time if a financial crisis arises. )ince cash can be raised so 1uickly there is no need to have a large amount of working capital available. A company that makes heavy machinery is a completely different story. Because these types of businesses are selling e&pensive items on a long-term payment basis they can't raise cash as 1uickly. )ince the inventory on their balance sheet is normally ordered months in advance it can rarely be sold fast enough to raise money for short-term financial crises (by the time it is sold it may be too late!. %t's easy to see why companies such as this must keep enough working capital on hand to get through any unforeseen difficulties.