Working capital - an indicator of the company's liquidity

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:43

In the economic sphere, an indicator characterizing the amount of funds that do not depend on current liabilities is working capital. In other words, it is the share of a company's finances that are not used to pay off external or internal debts for a certain period of time.

General concept

Working capital got its name from the English term Net Working Capital (NWC). But in Russia, another name for it is more popular - own working capital. They show how much capital an organization or company has to support its activities financially.

If we briefly analyze the concept of "working capital", then this indicator represents the difference between the amount of current funds and current liabilities. Its size determines the liquidity of the company. If working capital increases, then this indicates an increase in the liquidity of the company, which leads to an increase in its creditworthiness. But there is also the flip side of the coin. If the working capital is too high, there are doubts about the correctness of the economic policy pursued by the managementcompany.

Calculation formula

The optimal cost of working capital (or the amount of working capital) is calculated depending on the individual needs of a particular organization and the scale of its activities. Also, the features of work, the timing of inventory turnover, the amount of short-term debt, the conditions for attracting loans, loans, etc. are important. As practice shows, both excess working capital and a lack of working capital can negatively affect.

To calculate how much working capital should have, there is a simple formula. It is necessary to subtract short-term liabilities from working capital, and as a result we will get the desired value. You can use another, no less sure way. We add long-term liabilities to our own working capital and subtract non-current assets from the amount received.

How to manage working capital

The challenge in managing NWC is to keep working capital at optimal levels at all times. What does optimal mean? This refers to such a value that would allow the company to perform all functions and non-stop to engage in core activities.

At the same time, you should not overestimate the figure too much, as this may result in the withdrawal of a significant part of the funds from circulation. Working capital management goes hand in hand with proper financial management, which includes several points:

1. Determining the total need for working capitalcapital.
2. Designation of the level of investment in this indicator.
3. Identification of funding sources.
4. Analysis of the impact of working capital on income and enterprise value.

Based on all of the above, managers who manage working capital, in principle, work to maintain the liquidity of the firm.

Reasons for lower working capital

It is not uncommon for an organization to have current assets almost equal to short-term debt. This can lead to the company being declared bankrupt. Here, clear work of leading managers is needed, whose task is to monitor the indicator. If there is such a trend that working capital is gradually decreasing, this indicates an irrational use of funds.

The reasons for the decline can be very different, among them - a drop in sales, which, in turn, provokes a decrease in receivables. In this case, the balance of current assets will decrease, and after them - the amount of working capital.

What does working capital say?

Often a large company or corporation has many investors who are interested in its fruitful work. With working capital metrics, they can see the real picture of a company's operating performance or inefficiency.

For example, if receivables are collected at a slow pace, this leads to an increase in working capital and inefficientactivities. The irrational investment of funds can also have a negative impact, due to which the working capital indicator will increase. The described indicator should be considered for several periods of time in order to compare and analyze.

Capital flow

In commercial organizations, there is a movement of capital, labor both within the country and internationally. In particular, the movement of working capital is observed in investment, including foreign investment, for profit. In addition, today firms use interbank export credits. Interestingly, the state authorities reserve the right to control the international movement of capital, even if it belongs to individuals or legal entities.