How To Calculate Working Capital

Hi, my name is Grant Hobson. I've been a finance analyst for the last six years. Today, I am going to run you through some financial performance methods, as well as some investment appraisal techniques.

How to calculate working capital: Working capital is made up of two parts, this shows your current assets and your current liabilities. If you are unsure of how to find your current assets and your current liabilities, it's worth just going away and reading up on them and knowing which financial statements they come from, and what components make these up. In terms of working capital, it's a measure of both a company's efficiency and it's short term financial health.

A positive working capital means that your current assets are greater than your current liabilities, which means that you possess more than you owe. That means that you are able to pay off your short term liabilities. A negative working capital means that a company currently is unable to meet its short term liabilities with its cash, and its account receivable in its inventory, which means that the company may face problems in the short term.

The problems would be that you can't pay back your creditors, or even potentially, bankruptcy, if it is quite a severe case. For example, if we look at the calculation, current assets minus current liabilities, if your current assets are made up of cash of £1,000, and accounts receivable of £2,000, then we will say that your current assets equals £3,000. Now, if we look at the current liabilities, your accounts payable is £800 and you have an overdraft of £1,000, then we have current liabilities of £1,800.

So, to get your working capital, take your £3,000 and subtract your current liabilities to give you a working capital of £1,200. So that means that you can meet your short term liabilities. As I say, this is quite a basic summary of your working capital but if you look at what goes into your current assets and liabilities more, you'll get an understanding of what drives the number.

A working capital is beneficial to investors, as it gives them an idea of the company's underlying efficiency in operational terms. So, is there money tied up in inventory? Or is there money that is still owed to a lot of the customers? The investor can gauge whether they can pay off their obligations and that. Similarly, from a management perspective, you may want to alter the level of inventory that you owe.

Or if you've got a lot of cash tied up, then you can put the cash to better use by investing it in either machinery, or into a bank account that generates you a higher return than you are currently seeing.