Here is a comprehensive guide to calculating working capital

What is working capital?

If you have a basis in business management or belong to a family that runs a business, you are sure to have heard this compound word being thrown up often between work-related conversations. Have you wondered what it means? In the simplest of terms, the working capital of a business is the measure of its cash reserves that are available to the company as an entity to run its day to day operations.

We say company’s account because for the purpose of accountancy, the owner of the business is removed from his business. Therefore, we are not talking about the net worth of the owner or the money in his account in the personal capacity but we are talking about the money that the company has at its disposal. Thus it is quite clear that the working capital is a separate fund that is created whereby the owner/ owners of the business create a corpus to determine that this much amount shall be either pumped in or shall at all times be in circulation.

Why is it important to have solid information about the working capital of a company?

  1. Firstly, a sound knowledge of the working capital can help the person at the helm of the affairs to manage his business in the best way possible. He will know exactly how much of the funds at the disposal of the company can be allotted for the refurbishing of the premises, stocking of material and also repayment of his suppliers.
  2. Secondly, a businessman is an efficient decision taker when there is clarity on the working capital of his enterprise. The reinvestment factor is important in order to be able to ward off unnecessary competition in the business.
  3. The working capital of a company is the surest way to know the health of the enterprise and also to gauge in approximation how long the company will run. Cash flow is extremely important for a business to meet its financial commitments. No wonder then that the working capital is always regarded as the measure of the company’s progress in the long run.
  4. The working capital is also an effective tool to estimate whether a company is making the best use of the resources at its disposal. The moment the working capital of the company decreases, most f its processes will start to be affected. That is the point when the owners of the company must deliberate into pumping more cash into the company

The formula for calculating the working capital:

Working capital of a company is derived by reducing the current liabilities of the company from the current assets that the company holds.

WC = CA – CL

Where,

WC – Working Capital

CA – Current Assets

CL – Current Liabilities