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Working capital is a fundamental accounting concept essential to running a business. Essentially, working capital is a company’s current assets minus its current liabilities. Current assets are typically those that are highly liquid, such as cash or inventory. Current liabilities are those debts or accounts payable that are due to creditors within one year. Working capital is the money used to purchase inventory and sustain operating activities.
Available working capital can measure the success of a company by how it manages its cash flows. Working capital can also help measure how well debt instruments are being implemented and used to leverage the business into a position of increased financial strength. If your company has positive working capital it may be in good shape to continue operations without immediate financing. A positive cash flow might indicate operations are being financed well by the sale of inventory, and your business may use the surplus working capital to pay-down liabilities to limit debt. If working capital is negative, your business may have to incur more immediate debt to sustain its operating activities. While this can be tricky, there are some funding alternatives that can increase your working capital without compromising your operations, and when used strategically, an influx of working capital can turn a negative cash flow into a positive.
To ask, “What is the definition of working capital?” and to understand how the answer applies to your organization, you need a solid grasp on the business model your company uses to generate revenues and sustain its activities. Look at your profit and loss statements and your debt-to-income ratio. Look into your accounts to see what your business has borrowed, and what debt remains outstanding. Know exactly where the money is coming in, where it is going out, and how much is tied-up in unmoving inventory. When you understand the definition of working capital and how the formula of assets minus liabilities applies to your business, you can start to look more aggressively to the future and plan for growth more accurately.
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