Calculations for Working Capital
Working capital represents a business’s ability to pay the current liabilities using its existing assets. This is a crucial measure of the business’s financial health because creditors use it to measure the company’s ability to pay off debts within a 12-month period.
Your working capital represents the difference between the current accents the business has, and the current liabilities owed. The biggest challenge involved with this is figuring out the proper category for the various liabilities and assets on a business’s balance sheet and determining the health of the business regarding its short-term commitments.
The Formula Used for Calculating Working Capital
Today, your business’s working capital is determined by using the current ratio, which is the business’s current assets divided by the current liabilities. Any ratio over one means that the current assets of your business exceed the current liabilities, and usually, the higher the ratio is, the better.
Will Working Capital Ever Change?
While the working capital will not expire, the figure may change as time passes. This is because the current liabilities and the current assets are going to be based on a rolling period of 12-months. The precise figure for working capital may change each day, based on the nature of the debt the company has. What was formally considered a long-term liability, as a 10-year loan, it’s now a current liability in the ninth year, when a repayment deadline is under a year away. Also, what was once considered a long-term asset, like equipment or real estate, has suddenly become a current asset when there’s a buyer lined up and reach to go.
Also, working capital, such as current assets, are not subject to depreciation like fixed, long-term assets. There are some working capital assets, such as accounts receivable and inventory that can lose value or even be something you write off; however, the way that is recorded won’t follow the typical deprecation rules. Working capital in the form of current assets is only expensed immediately as a one-time cost to match the revenue that is generated during the period.
Understanding working capital is essential as it can help ensure your business is able to continue growing and thriving. Being informed is the best way to ensure that you have the funds needed to grow your business and that you fully understand the concept of working capital and how it can be beneficial for your business both now and in the future.
