Working Capital

AAA

DEFINITION of 'Working Capital'

A measure of both a company's efficiency and its short-term financial health. The working capital is calculated as: 

Working Capital

The working capital ratio (Current Assets/Current Liabilities) indicates whether a company has enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C (working capital). While anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.Also known as "net working capital".

INVESTOPEDIA EXPLAINS 'Working Capital'

If a company's current assets do not exceed its current liabilities, then it may run into trouble paying back creditors in the short term. The worst-case scenario is bankruptcy. A declining working capital ratio over a longer time period could also be a red flag that warrants further analysis. For example, it could be that the company's sales volumes are decreasing and, as a result, its accounts receivables number continues to get smaller and smaller.Working capital also gives investors an idea of the company's underlying operational efficiency. Money that is tied up in inventory or money that customers still owe to the company cannot be used to pay off any of the company's obligations. So, if a company is not operating in the most efficient manner (slow collection), it will show up as an increase in the working capital. This can be seen by comparing the working capital from one period to another; slow collection may signal an underlying problem in the company's operations. 

Things to Remember
  • If the ratio is less than one then they have negative working capital.
  • A high working capital ratio isn't always a good thing, it could indicate that they have too much inventory or they are not investing their excess cash.

Ready to take your knowledge of Working Capital to the next level? Read -- The Working Capital Position and Evaluating A Company's Capital Structure.

VIDEO

Loading the player...
RELATED TERMS
  1. Capital Growth

    The increase in value of an asset or investment over time. It ...
  2. Return On Capital Employed (ROCE)

    A financial ratio that measures a company's profitability and ...
  3. Gross Working Capital

    The sum of all of a company's current assets (assets that are ...
  4. Capital Project

    A long-term investment made in order to build upon, add or improve ...
  5. Total Asset-To-Capital Ratio - ...

    A leverage covenant placed on Canadian Institutions regulated ...
  6. Return on Average Capital Employed ...

    A financial ratio that shows profitability compared to investments ...
RELATED FAQS
  1. What are the pros and cons of using the fixed charge coverage ratio?

    One main advantage of using the fixed-charge coverage ratio is it provides a good, fundamental assessment for lenders or ... Read Full Answer >>
  2. How is investing in a corporate bond different from buying shares of the company's ...

    Examples of just in time, or JIT, inventory processes are found in automobile manufacturing, drop shipping retailers, fast ... Read Full Answer >>
  3. What are the different sources of business risk?

    A certain risk level is inherent in running a business. A company cannot completely eliminate risk, but it can control or ... Read Full Answer >>
  4. How can an investor determine the efficiency of a company's working capital management?

    There are a number of tools that determine how efficiently a company is managing its working capital, principally by looking ... Read Full Answer >>
  5. What does a low working capital ratio show about a company's working capital management?

    The working capital ratio is commonly used to assess a company's financial performance. Low working capital ratio values, ... Read Full Answer >>
  6. How does working capital management affect corporate earnings?

    A company that does not manage working capital effectively is less profitable and could potentially face financial insolvency. ... Read Full Answer >>
  7. What ratios are most commonly used to judge working capital management?

    The most commonly considered working capital ratios include the working capital ratio, the working capital turnover ratio, ... Read Full Answer >>
  8. What is the most important "C" in the Five Cs of Credit?

    Financial institutions attempt to mitigate the risk of lending to unworthy borrowers by performing a credit analysis on individuals ... Read Full Answer >>
  9. What sorts of factors decrease cash flow from operating activities?

    The operations section of the cash flow statement reconciles net income and cash flows by adding back noncash expenses and ... Read Full Answer >>
  10. How can an investor use the Z-Score to compare investment options?

    The Altman Z-score is a test that an investor uses to gauge the likelihood of a company going bankrupt. The Altman Z-score ... Read Full Answer >>
  11. What sorts of factors increase cash flow from operating activities?

    Cash flow from operating activities is calculated by adding net income, total non-cash expenses and net change in working ... Read Full Answer >>
  12. What are some examples of cash flow from operating activities?

    Cash flows from operating activities is a section of the cash flow statement that explains the sources and uses of cash from ... Read Full Answer >>
  13. How do you calculate net current assets in Excel?

    The value of net current assets, or working capital, helps to gauge a company's short-term financial health. If you are working ... Read Full Answer >>
  14. What is a common number for days payable outstanding? (DPO)?

    Probably the most common number for days payable outstanding (DPO) is 30, with the vast majority of standard days used by ... Read Full Answer >>
  15. What is the difference between the current ratio and the acid test ratio?

    The acid-test ratio and the current ratio are two commonly used methods to measure the liquidity and solvency of a company. ... Read Full Answer >>
  16. How do I calculate the acid test ratio on a balance sheet?

    The acid-test ratio, also known as the "quick ratio," is used to highlight the short-term liquidity and solvency of an organization. ... Read Full Answer >>
  17. What is the proper ratio between working capital, current assets and current liabilities?

    There are a number of factors that influence the determination of a good working capital ratio, a primary liquidity ratio ... Read Full Answer >>
  18. What unforeseen circumstances affect what I'll pay in capital gains taxes?

    Under normal circumstances, if you make a profit when you sell your home, the IRS does not tax it if the capital gain was ... Read Full Answer >>
  19. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  20. How do changes in working capital affect a company's cash flow?

    Working capital represents the difference between a firm’s current assets and current liabilities. For well-run firms, managing ... Read Full Answer >>
  21. How do interest rates affect the weighted average cost of capital (WACC) calculation?

    Weighted average cost of capital (WACC) is the average after-tax cost of a company’s various capital sources, including common ... Read Full Answer >>
  22. What is the formula for calculating weighted average cost of capital (WACC)?

    Weighted average cost of capital (WACC) is the average after-tax cost of a company’s various capital sources, including common ... Read Full Answer >>
  23. What's the difference between weighted average cost of capital (WACC) and internal ...

    Weighted average cost of capital (WACC) is the average after-tax cost of a company’s various capital sources, including common ... Read Full Answer >>
  24. What is the difference between return on equity and return on capital?

    Return on equity (ROE) and return on capital (ROC) measure very similar concepts, but with a slight difference in the underlying ... Read Full Answer >>
  25. What are the disadvantages of using net present value as an investment criterion?

    While net present value (NPV) calculations are useful when you are valuing investment opportunities, the process is by no ... Read Full Answer >>
  26. What's the difference between net present value and internal rate of return? How ...

    Both of these measurements are primarily used in capital budgeting, the process by which companies determine whether a new ... Read Full Answer >>
  27. How does the 80% rule for home insurance work, and how do capital improvements affect ...

    The 80% rule refers to the fact that most insurance companies will not fully cover the cost of damage to a house due to the ... Read Full Answer >>
  28. Which is a better measure for capital budgeting, IRR or NPV?

    In capital budgeting, there are a number of different approaches that can be used to evaluate any given project, and each ... Read Full Answer >>
  29. What is fair capital?

    So-called "fair capital," like beauty, is in the eye of the beholder. In financial reporting, there are two kinds of capital: ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    Discounted Cash Flow Analysis

    Find out how analysts determine the fair value of a company with this step-by-step tutorial and learn how to evaluate an investment's attractiveness for yourself.
  2. Insurance

    Working Capital Works

    A company's efficiency, financial strength and cash-flow health show in its management of working capital.
  3. Investing Basics

    Reading The Balance Sheet

    Learn about the components of the statement of financial position and how they relate to each other.
  4. Fundamental Analysis

    Balance Sheet: Analyzing Owners' Equity

    Analyzing owners’ equity is an important analytics tool, but it should be done in the context of other tools such as analyzing the assets and liabilities on the balance sheet.
  5. Personal Finance

    Breaking Down The Balance Sheet

    Knowing what the company's financial statements mean will help you to analyze your investments.
  6. Bonds & Fixed Income

    Evaluating A Company's Capital Structure

    Learn to use the composition of debt and equity to evaluate balance sheet strength.
  7. Investing Basics

    The Working Capital Position

    Learn how to correctly analyze a company's liquidity and beat the average investor.
  8. Investing

    Who are Venture Capitalists?

    Venture capital investment firms can provide the seed money for high-risk, start-up companies. People called venture capitalists run these firms, and make the investment decisions.
  9. Fundamental Analysis

    The Return On Invested Capital (ROIC)

    Return on Invested Capital, or ROIC, is a fundamental method of determining a company's financial performance. It is used to measure how well a company is investing its capital. ROIC is calculated ...
  10. Investing Basics

    The Optimal Use Of Financial Leverage In A Corporate Capital Structure

    The amount of debt and equity that makes up a company's capital structure has many risk and return implications.

You May Also Like

Hot Definitions
  1. Stop-Loss Order

    An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit ...
  2. Covered Call

    An options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset ...
  3. Butterfly Spread

    A neutral option strategy combining bull and bear spreads. Butterfly spreads use four option contracts with the same expiration ...
  4. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
  5. Moving Average - MA

    A widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random ...
  6. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
Trading Center