What Is Trade Working Capital?
Understanding Trade Working Capital
Working capital, the amount of money available to fund a company’s day-to-day operations, is one of the first things that investors choose to analyze when weighing deciding if a stock is worth buying. By simply subtracting current liabilities—all debts due within the next 12 months—from current assets—resources that are expected to be converted to cash within a year—on the balance sheet one can immediately learn how much money would remain if a company used all of its liquid possessions to pay off all the money it owes to its creditors.
- Trade working capital is the difference between current assets and current liabilities directly associated with everyday business operations.
- It defines working capital, which takes into account all current assets and liabilities, more narrowly to determine if a company has enough cash on hand to manage its short-term commitments.
- Usually, trade working capital is calculated by adding together inventories and accounts receivable (AR) and then subtracting accounts payable (AP).
If a company generates positive working capital, meaning it has enough easily accessible funds to meet its short-term obligations, it has greater scope to invest in new assets that produce extra revenues and profit (and return money to shareholders). Alternatively, if current liabilities exceed current assets, there’s a risk that the company might be forced to turn to a bank or financial markets to raise additional capital (or face defaulting on its bills and going bankrupt).
Trade Working Capital vs. Working Capital
When investors examine current assets and liabilities to determine if a company has enough cash on hand to manage its short-term commitments, they occasionally elect to refine their search criteria. Investors may decide to omit some resources and obligations from the equation because they are deemed to be less representative of a company’s short-term liquidity than others.
Working capital takes into account all current assets, including cash, marketable securities, accounts receivable (AR), prepaid expenses and inventories, as well as all current liabilities, including accounts payable (AP), taxes payable, interest payable and accrued expenses. Trade working capital, meanwhile, differs by only considering current assets and liabilities that are related to daily operations.
Trade working capital is a narrower definition of working capital and, as a result, can be viewed as a more stringent measure of a company's short-term liquidity.
Calculating Trade Working Capital
Usually, trade working capital is calculated by taking the number for inventories—the collection of unsold products waiting to be sold—adding the AR, or trade receivables—the balance of money due to a company for goods or services delivered or used but not yet paid for by customers—and then subtracting the AP, or trade payables—the amount a company owes its vendors for inventory-related goods, such as business supplies or materials. Together, these items are viewed as the key drivers of a company’s working capital.
Example of Trade Working Capital
If a company has $10,000 in AR, or trades receivables, associated with everyday operations, $2,000 in inventories and $5,000 in AP, or trades payable, associated with everyday operations, then its trade working capital is:
$10,000 + $2,000 - $5,000 = $7,000.
Determining what is an acceptable amount of trade working capital depends on the type of company. For instance, it might be less of a cause for concern if certain very large companies display negative trade working capital because they are generally better equipped to generate additional funds swiftly, either by moving money around, through the acquisition of long-term debt or by leveraging their strong brand recognition and selling power.
It’s also worth pointing out that an extremely high trade working capital could be a red flag. In some cases, this may indicate that a company is not investing its excess cash optimally, or is neglecting growth opportunities in favor of maximum liquidity. By not putting its capital to good use, the company can be accused of doing its shareholders a disservice.