Businesses need working capital to cover day-to-day operational costs such as equipment and salaries. The amount of working capital a business has is the result of several things including inventory management, debt management, revenue collection, and payments to vendors. Many small business owners may need a loan to establish cash flow for their working capital. A company accrues unpaid salaries on its balance sheet as part of accounts payable, which is a current liability account. Thus, unpaid salaries are included in the calculation of the company's working capital. However, a company would not record paid salaries as current liabilities, so they would not affect the calculation of working capital.

Key Takeaways:

  • The extent of a company's working capital is the result of inventory management, debt management, revenue collection, and payments to vendors.
  • Many small business owners may need a loan to establish cash flow for their working capital and to cover expenses and salaries.
  • A company accrues unpaid salaries on its balance sheet as part of accounts payable; thus, unpaid salaries are included in the calculation of the company's working capital.
  • Paid salaries have been paid, are no longer a debt, and are not included as current liabilities, so they would not affect the calculation of working capital.

Understanding Working Capital and Salaries

Many small businesses seek loans to provide working capital. Businesses need cash to pay bills and to cover workers' salaries. Workers' salaries must be covered if a business is to continue operations; thus, there must be sufficient working capital to cover salaries and the inevitable expenses such as equipment that breaks down or delays in incoming cash flow from clients and accounts receivables. In short, a well-run firm manages its short-term debt and current and future operational expenses through its management of working capital.

Unpaid Salaries

Unpaid salaries represent a company's arrears to its workers for a specific period. A company typically expenses unpaid salaries immediately through a debit entry to its income statement. Since the company has not yet paid those salaries, it has a liability to its workers and must accrue them by recording an equivalent credit entry to its accrued salaries account, which is shown as a current liability account on the company's balance sheet. Since current liabilities are part of the working capital calculation, unpaid salaries reduce the company's working capital.

Unpaid salaries typically arise as a result of the timing between closing the company's books and when the actual payroll payment to its workers goes out of the cash account.

Paid Salaries

Once an unpaid salary is cleared through a payment to the workers, accountants record a credit entry to the cash and cash equivalents account and a debit entry to the accrued salaries account. If a company has paid all salaries, it does not owe money to its workers, and its balance sheet does not contain a current liability account. Therefore, salaries do not affect the working capital of a company that has paid all its wages.