Business management

Working Capital: What It Is and How to Calculate It

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The working capital is a key tool where it tells us if a company is in a good position or not, if it can invest more or not, spend, grow, etc. 

In this post, we will ask about its importance and what formula you should use in order to make the right decisions for your business.

What is the Working Capital and what is it for?

The working capital is the difference between a company's current assets, such as cash, accounts receivable (unpaid invoices from customers) and inventories of raw materials and finished products, and its current liabilities, such as accounts payable. 

In simple terms, working capital refers to the money needed to finance day-to-day business operations. 

It can also be used to pay off short-term debt and cover operating expenses. 

It is the lifeline of any business and helps an organisation to run smoothly and carry out its day-to-day operations, such as payroll payments and payments to creditors. 




Formula: Manoeuvre background = Current assets - Current liabilities.

You are probably wondering what is meant by a current Asset and a current Liability, here is their explanation:

Current assets.

These are the goods that can be converted into cash in a short period of time. 

Some assets may be:

  1. Cash, including foreign exchange
  2. Investments, except those that cannot be easily liquidated
  3. Prepaid expenses
  4. Accounts Receivable
  5. Inventory

Current liabilities.

Amounts to be paid to creditors within a short period of time, say within one year. 

An example: The Pepito Company has 100,000 euros in cash, 500,000 euros in accounts receivable, 1,000,000 euros in inventory and 200,000 euros in accounts payable. 

Your calculation would be: 

100,000 euros cash + 500,000 euros accounts receivable + 1,000,000 euros inventory - 200,000 euros accounts payable = 1,400,000 euros working capital 

Important: The working capital index (current assets/current liabilities) indicates whether a company has sufficient short-term assets to cover its short-term debt. 

Anything below 1 indicates working capital, it will be negative. While anything above 2 means that the company is not investing in excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.

Types of working capital.

There are currently several types of working capital:

  • Permanent margin

This is also known as fixed or durable working capital. It refers to the amount of basic investment among all types of current assets that is required at all times to ensure a minimum level of uninterrupted business operations.

  • Temporary capital

It is also called fluctuating or variable working capital. Temporary changes in investment capital above permanent working capital are known as temporary working capital. This capital, its level of production and its sales, are therefore closely related.

  • Background focused on raw work

It consists of the sum of the company's current assets. It includes assets such as cash, receivables, inventory, marketable products and short-term investments.

  • Negative working capital

Sometimes a business or company has a lower value of its current assets compared to its current liabilities. This type of situation occurs when the company is said to operate with a negative margin.

  • Investment of current assets

This refers to the short-term financial arrangement made by the business units to cope with unexpected changes. This type of capital is used to deal with controllable or uncontrollable risks and to sustain the business.

  • Regular working capital

It focuses on the company's main objective, which is to maintain working capital in normal conditions.

  • Seasonal working capital

This type of capital is based on the fact that the demand for some products increases seasonally and its main cause may be seasonal changes or holidays, etc. For example, the demand for mackintoshes and umbrellas increases during the rainy months.

  • Special margin

Here companies carry out special programmes and campaigns to market and sell their products. Some of the plans they implement include advertising, sales promotion activities, product development, market research, launching new items or expanding the market for goods.

Start calculating your working capital now!

Remember that this capital refers to the current assets that subtract the existing liabilities of your company. You can have both positive and negative capital based on the amount of your current debt. 

When calculating, the assets that can be considered are your income and your company's inventory. The basic point here is to consider cash or anything you can quickly turn into cash. 

As for liabilities, it may include such things as accounts payable, wages or any other debt that must be settled within one year. 

One tool that can help you with all these reports and in your daily work, is a CRM software. 

In addition, it helps you to have all your commercial, administrative and marketing procedures in one place. 

Try it out now! 

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