Working Capital Definition Formula Examples With Calculations

Working Capital Definition

Formula

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To calculate the working capital or liquid funds of business, below mentioned formula can be used –

Working Capital Formula = Current Assets (Net of Depreciation) – Current Liabilities

Explanation

The following steps should be applied to calculate the working capital of the business:

Step #1 – Bifurcate the value of current and fixed assets from the list of total assets. The same could be preferable to check the financial statements prepared as current assets of the business are specified specifically in the financials.Step #2 – Similarly, check the value of the business’s current liabilities.Step #3 – Check from the value of current assets, whether it includes any value for provision, etc., for instance, provision of depreciation or not.Step #4 – Deduct the value of provision found in step 3 above from the value of current assets found in step 1 above and call it Current Assets (Net).Step #5 – Finally, by subtracting the value of current liabilities from the value of Current assets (Net), we got the value of Working Capital.

Examples

Current Assets –

Accounts Receivables – $40,000Cash – $15,000Inventories – $34,000Marketable Securities – $45,000Prepaid Expenses – $5000

Current Liabilities –

Accounts Payables – $35,000Notes Payables – $15,000Accrued Expenses – $12,000Short term debt – $34,000

Find out the WC of Tithing Inc.

We will first add up the current assets and the current liabilities from the working capital example and then use them to calculate the working capital formula.

The total current assets would be = ($40,000 + $15,000 + $34,000 + $45,000 + $5000) = $139,000.The total current liabilities would be = ($35,000 + $15,000 + $12,000 + $34,000) = $96,000.

Using the formula, we get –

WC = Current Assets – Current LiabilitiesOr, WC = $139,000 – $96,000 = $43,000.

It means that the WC of Tithing Inc. is positive and quite healthy.

Colgate Working Capital Calculation

Below is the Snapshot of Colgate’s 2016 and 2015 balance sheets.

Let us calculate the WC for Colgate

WC (2016)

Current Assets (2016) = 4,338Current Liabilities (2016) = 3,305WC (2016) = 4,338 – 3,305 = $ 1,033 million

WC (2015)

Current Assets (2015) = 4,384Current Liabilities (2015) = 3,534WC (2015) = 4,384 – 3,534 = $850 million

Interpretation of Working Capital

WC depicts so many things about a company.

Suppose a company has a positive WC (meaning the current assets are more than the company’s current liabilities). In that case, the company is in a good position in terms of efficiency, liquidity, and overall financial health.On the other hand, if the company has a negative working capitalNegative Working CapitalNegative Working Capital refers to a scenario when a company has more current liabilities than current assets. It implies that the available short-term assets are not enough to pay off the short-term debts. read more (meaning the current assets are less than the company’s current liabilities), the company is suffering from inefficiency and illiquidityIlliquidityIlliquid refers to an asset that cannot be converted to cash. Such assets suffer a valuation loss when sold in exchange for cash. Bonds, stocks and properties are some examples of illiquid investment.read more.

It’s also important for a company to see how long the inventories sit with the company. If the inventories aren’t moving out for long, the capital will remain tied up.

Importance of Working Capital

#1 – Liquidity Management

#2 – Out of Cash

Inappropriate prepared plans of day-to-day expenses may result in enterprise liquidity issues. They have to postpone or arrange funds from some other sources, which give a bad impression of an enterprise on the party.

#3 – Helps in Decision Making

#4 – Addition to the Value of Business

As the management accordingly manages all day-to-day required funds that help the authorized personnel timely pay for all the outstanding creates a value addition or goodwill enhancement in the market.

#5 – Helps in the situation of Cash Crunches

#6 – Perfect Investments Plans

Correctly managing the funds or working capital, one can choose or plan for their investments accordingly and invest the funds to maximize the return as per their availability.

#7 – Helps in Earning Short Term Profits

Sometimes, the enterprises keep a heavy amount of funds as working capital, which is far over and above the required level of working capital. So by correctly preparing the required capital, those extra funds could be invested for a short period and could create value in the enterprise’s profits.

#8 – Strengthening the Work Culture of the Entity

Timely payment of all day-to-day expenses mainly focused on the employees’ salary creates a good environment and a sort of motivation amongst employees to work harder and strengthens the good working environment.

Working Capital Definition Formula Examples With Calculations