Working capital is money available to a company for day-to-day operations. It is a measure of both a company's efficiency and its short-term financial health. Working capital is defined as the difference between current assets and current liabilities. The working capital is calculated as:
Working capital = current assets - current liabilities
Working capital is essential for your company to meet its continuous operational needs.
The
availability of working capital influences your company's ability to
meet its trade and short-term debt obligations, as well as to remain
financially viable. If your current assets do not exceed your current
liabilities, you run the risk of being unable to pay short term
creditors in a timely fashion.
Businesses
that are seasonal or cyclical often require more working capital to
stay afloat during the off season. Although your company may make more
than enough to pay all its obligations yearly, you must ensure you have
enough working capital at any one time to meet your short term
obligations. For example, a company may do significantly more business
over the holidays, resulting in large payoffs at the end of the year.
However, the company must have enough working capital to buy inventory
and cover payroll during the off season as well, when revenues are
lower.
