Working Capital

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#### Example:

Calculate the net working capital of Curzon Florists, when:

• Current asset value = \$5 million
• Current liabilities = 3 million

Working capital = asset value – value of liabilities = \$5 million - \$3 million = \$2 million

Example 2:

Calculate the working capital of Raphaelson Travel, when:

• Current ratio = asset value ÷ liabilities = 1.5
• Current liabilities \$80 million.
• Asset value = current ratio x liabilities = 1.5 x \$80 million = \$120 million
• Working capital = asset value – value of liabilities = \$120 million - \$80 million = \$40 million

#### Working Capital Definition

A company can have assets and be profitable but be unable to convert assets quickly to pay its debts. Working capital measures liquidity, the ease with which assets can be converted into cash. Working capital management involves making choices related to a firm's short-term assets and short-term liabilities. Its goal is to ensure that a business can continue operating and has enough cash flow to pay for maturing short-term debt and future operating expenses. If a business’ current asset value is less than that of its current liabilities, it has a working capital deficiency, also called a working capital deficit.

Working capital is the value of current assets minus the value of current liabilities.

NOTES:

• Current assets are assets expected to be realized in a year or within one operating cycle.
• Current liabilities are obligations that are required to be paid within a year or within one operating cycle.

#### Analysis

Analysts and company managers use working capital values to measure debt risk. That is, if a company’s current asset value is greater than the value of its current liabilities the working capital is positive. This tells managers that the company is not expected to suffer from a liquidity problem in the near future. However, if the current asset value is less than current liabilities, working capital is negative. This alerts managers that the business might not be able to pay off its current liabilities when they come due.