Working capital is the backbone of any company. It should be kept in positive to allow the business to continue as a going concern. Actually, it can be calculated by subtracting the current liabilities from the current assets of the company. The idea behind the calculation of Working capital is that whether the company has sufficient cash and cash equivalents to pay its current liabilities to run its daily operations smoothly.
Formula
Working Capital = Current assets – Current liabilities
By current assets, we mean the assets which are expected to be realized within a period of 12months and on the other hand, current liabilities we mean obligations which are need to be settled within a period of 12 months.
Example
Alpha industry has current assets of $500,000, while current liabilities are $400,000. Calculate Working capital.
Solution
Working Capital = Current assets – Current liabilities = 500,000 – 400,000 = $100,000
Alpha industry has a good working capital cycle. This should be matched with other companies in the same industry to analyze the performance of Alpha Industry. It might possible that other competitors have much better Working capital amount than Alpha. If this is the case, then Alpha need to identify the reason and should try to improve this further.