The working capital ratio is commonly used to assess a company's financial performance. Low working capital ratio values, near 1 or lower, can indicate serious financial problems with a company.
Working capital is the money that a company uses to fund its daytoday production. Working capital is used to purchase raw materials that the company uses to manufacture its goods. These goods are sold, and the revenue that is returned from sales goes back into the company’s cash flow.
The working capital ratio is the metric that measures a company's efficiency and the health of its shortterm finances. The formula to determine working capital uses a company's current assets and then subtracts its current liabilities. The working capital ratio acts as an indicator that reveals whether the company has enough shortterm assets to pay off its shortterm debt.
If a company's working capital ratio value is below 1, it indicates negative cash flow and that the company’s current assets are less than its liabilities; the company cannot cover its debts with its current working capital. In this situation, a company is likely to have difficulty paying back its creditors. If a company continues to have a low working capital, or if it continues to decline over a longer period of time, it is a definite warning sign of serious financial trouble. The cause of the decrease in working capital could be a result of several different factors, such as decreasing sales revenues, mismanagement of inventory or problems with accounts receivables.
An excessively high working capital is not necessarily a good thing either, since it can indicate that the company is allowing excess cash flow to sit idle rather than effectively reinvesting it in company growth. Most analysts consider the ideal working capital ratio to fall between 1.2 and 2. As with other performance metrics, it is important to compare a company's ratio to those of similar companies within its industry.

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