Working capital happens to be one of the most important essentials that a company should have. Let me start by telling you what exactly working capital is. Working capital basically assesses the companies ability to pay all of its current liabilities with the help of its current assets, and it gives us an indication of the financial health of the company. It also gives a clear indication of the operational efficiency of the company. In other words, working capital is basically the difference between the current assets and current liabilities of a company.
Working capital does not expire. The funds do not expire; the working capital figure does indeed change over time. That is because, the current liabilities and the current assets of the company are based on a yearly period. It would help if you always kept that in mind.
Keep in mind that inventory can expire and it can get obsolete in time. It can get obsolete, and it is certainly a real issue when it comes to operations. When that ends up happening, the market for the inventory prices are lower than initial numbers. In order to reflect the current market conditions and also make use of the lower cost and a market method, a company will have to mark the inventory town, and that would result in a loss of value in the working capital. Any changes to the working capital can be a significant problem, and it can be damaging.
Meanwhile, we should keep in mind that some accounts receivable me actually become uncollectible at some point, and they have to be completely written off, and that would represent another loss of value in the working capital. I am sure you are seeing a pattern which would create a problem. As these losses in current assets reduce the working capital much below the desired level, it will definitely end up delaying the long-term funds or assets to replenish the shortfall of the current assets, and this will end up being a costly way to finance any additional working capital which is required.
You should also know that working capital should always be assessed periodically, over time in order to ensure that no devaluation occurs and also that there or enough funds left over to fund some operations which are day to day. Some operations are continuous, and they require a decent working capital to happen all the time.
A healthy business that is working in a lucrative manner will have ample capacity to pay off all its current liabilities with the help of its current assets. The ratio of above one, means that the company’s assets can actually be converted into cash at a much faster rate.