It is essential that you know that the working capital of a company completely assesses the companies ability to pay all of the current liabilities with the current assets. It also gives us an indication of the short-term financial health of the subject and the capacity to clear all of the debts within one single year, which will be 12 months with operational efficiency.
The working capital represents the proper differences between the current assets of the company and the current liabilities. It is essential that you know these basics. The challenge presented self when you are trying to determine the proper category of a huge array of assets and liabilities, and when you mix it in with corporate balance sheets. You will also have to decipher the entire health of the company when it comes to meeting the short-term commitments as well.
Let us talk about some key takeaways of what we have just learnt.
The working capital is the proper amount of finances that is available to the company that the company can use for its day to day activities. This much should be imprinted into your mind. It also measures the liquidity of the company and the operational efficiency, which in turn signifies the financial health of the company. If you want to calculate working capital, you should compare the assets of the company to the current liabilities with the help of current ratios.
Now, let us talk about the components of working capital.
Let us start with current assets. This is what the company currently owns. This can include intangible assets and tangible assets, as well. Tangible assets mean the assets which you can see and touch. Intangible assets are the opposite, which means you cannot see or touch these assets, but they exist in a virtual form. Any asset can easily be turned into cash within one single year or one single business cycle. Some examples of current assets would be savings accounts and checking accounts. It would be best if you also considered the highly liquid marketable securities like bonds, mutual funds, stocks and more. We should also consider money market accounts and cash equivalents, inventory accounts receivable and some short-term prepaid expenses.
Now, let us talk about current liabilities. In a very similar fashion, the current liabilities are all of the debts and the expenses that the company expects to pay within one single year or one single business cycle. This would typically include some normal cost of running the business like utilities, supplies, rent and more. It also includes that on payments. Accrued liabilities, accrued income taxes and accounts payable are also included in current liabilities.
Calculating working capital is very simple. Current liabilities minus current assets is the formula.