Working capital is a measurement of an entity’s current assets, after subtracting its liabilities. Sometimes referred to as operating capital, it is a valuation of the amount of liquidity a business or organization has for the running and building of the business. Generally speaking, companies with higher amounts of working capital are better positioned for success. They have the liquid assets needed to expand their business operations as desired.
Sometimes, a company will have a large amount of assets, but have very little with which to build the business and improve processes. Even a profitable company may have this problem. This can occur when a company has assets that are not easy to convert into cash.
This measurement can be expressed as a positive or negative number. When a company has more debts than current assets, it has negative working capital. When current assets outweigh debts, it becomes positive.
Changes in working capital will impact a business’ cash flow. When it increases, the effect on cash flow is negative. This is often caused by the liquidation of inventory or the drawing of money from accounts that are due to be paid by the business. On the other hand, a decrease translates into less money to settle short-term debts.
Working capital is among the many important things that contribute to the success of a business. Without it, a business may cease to function properly or at all. Not only does a lack of capital render a company unable to build and grow, but it may also leave a company with too little cash to pay its short-term obligations. Simply put, a company with a very low amount of working capital may be at risk of running out of money.
When a company has too little working capital, it can face financial difficulties and may even be forced toward bankruptcy. This is true of both very small companies and billion-dollar organizations. A company with this problem may pay creditors late or even skip payments. It may borrow money in an attempt to remain afloat. If late payments have affected the company’s credit rating, it may have difficulty obtaining a loan at an affordable interest rate.
In some types of businesses, it isn’t as much of a problem to have a lower amount of working capital. Companies that are operated on as cash basis, have fast inventory turnovers, and can generate cash quickly don’t necessarily need as much.
