The calculation for working capital includes any prepaid expenses that are due within one year since such prepaid expenses are categorized as current assets.
Working capital is the difference between current assets and current liabilities. Current assets are assets that are reasonably expected to be converted into cash within one year. Current liabilities are a company's obligations due within one year. Working capital helps a company understand the strength of its ability to meet its short-term obligations. It also helps investors assess how efficiently the company is using its resources. This information assists management in making good investment decisions and provides a better understanding of how to manage the business. It also helps investors gauge how effectively management is running the company.
Prepaid expenses are costs that have already been addressed but have yet to occur. Since the prepaid expense is used when the actual expense occurs in the future, it is classified as an asset the company holds on its balance sheet. If the prepaid expense is expected to occur within the next year, it is classified as a current asset. An example of a prepaid expense is a company paying for a full year of insurance premiums in a lump sum at the beginning of the year. Even though the payment has already been made for 12 months, only the current month's premium is a current expense. The sum of the remaining 11 premiums is bucketed into a prepaid insurance account that is classified as a current asset on the balance sheet.