What is working capital?

Working capital is a financial metric that displays a company’s short-term liquidity and the ability to meet its day-to-day operational expenses.

It reflects the cash available after accounting for current liabilities from a company’s current assets.

Working capital can be either positive or negative:

• Positive working capital indicates the company has sufficient current assets to cover its current liabilities. This suggests a healthy financial position and the ability to meet short-term obligations.
• Negative working capital suggests the company’s current liabilities exceed its current assets. This indicates difficulty meeting short-term obligations or reliance on external financing. However, it can also be a strategic choice in some industries.

Frequently asked questions

What are some factors that can affect working capital?

The following factors affect working capital:

• Rapid sales growth can strain working capital as a company needs to invest more in inventory and receivables to meet customer demand
• Inefficient inventory management practices, like holding excess stock, can tie up cash and reduce working capital
• Longer credit terms offered to customers can lead to higher accounts receivable, impacting working capital

How can companies improve their working capital?

Companies can improve their working capital by doing the following:

• Implementing strategies to optimize inventory levels can free up cash flow
• Encouraging faster payments from customers through early payment discounts or stricter credit policies
• Negotiating better payment terms with suppliers can extend the time frame for settling accounts payable, improving short-term liquidity