Top Examples of Working Capital

Working Capital refers to the Funds available to the company to meet its day-to-day business operations. It is an indicator of the Short Term Financial Strength of the Company and signifies the capability to meet the Current LiabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They’re usually salaries payable, expense payable, short term loans etc.read more and Debt Obligations due within one year. The following working capital example outlines the most common sources of working capital.

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  • Spontaneous: It refers to the Funds which are easily available in marketSundry CreditorsBills PayableTrade creditTrade CreditThe term “trade credit” refers to credit provided by a supplier to a buyer of goods or services. This makes it is possible to buy goods or services from a supplier on credit rather than paying cash up front.read moreNotes PayableNotes PayableNotes Payable is a promissory note that records the borrower’s written promise to the lender for paying up a certain amount, with interest, by a specified date. read moreShort Term WC : Bills DiscountingCash CreditBank ODCommercial PaperCommercial PaperCommercial Paper is a money market instrument that is used to obtain short-term funding and is often issued by investment-grade banks and corporations in the form of a promissory note.read moreInter Corporate Loans and Advances

Each example of the Working Capital below states the topic, the relevant reasons, and additional comments as needed.

  • Sundry CreditorsBills PayableTrade creditTrade CreditThe term “trade credit” refers to credit provided by a supplier to a buyer of goods or services. This makes it is possible to buy goods or services from a supplier on credit rather than paying cash up front.read moreNotes PayableNotes PayableNotes Payable is a promissory note that records the borrower’s written promise to the lender for paying up a certain amount, with interest, by a specified date. read more

  • Bills DiscountingCash CreditBank ODCommercial PaperCommercial PaperCommercial Paper is a money market instrument that is used to obtain short-term funding and is often issued by investment-grade banks and corporations in the form of a promissory note.read moreInter Corporate Loans and Advances

Calculation Examples of Working Capital

Example #1

Suppose ABC Limited has Current Assets of $ 5,00,000 and Current Liabilities of $ 300,000. Fixed Assets are $ 1,00,000. Long Term DebtLong Term DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company’s balance sheet as the non-current liability.read more is $1,00,000, and Short Term Debt included in the Current Liability above is $25,000. Calculate the Working Capital of the Company and analyze the same.

Solution:

Here,

  • Gross Working Capital/Current Assets of the Company: $5,00,000Permanent Working Capital/Fixed Assets of the Company: $1,00,000Current Liabilities: $300,000Long Term Debt: $100,000Short Term Debt: $25,000

Calculation of Net Working Capital is as follows –

  • NWC = Current AssetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more – Current Liabilities= $5,00,000 – $3,00,000= $2,00,000

Temporary WC will be –

  • Temporary WC = NWC – PWC= $2,00,000 – $1,00,000= $1,00,000

Analysis:

In the above example of working capital, ABC Limited has a Strong Working Capital to meet its Short Term and Long Term Financial needs. However, the Current Ratio of the CompanyCurrent Ratio Of The CompanyThe current ratio is a liquidity ratio that measures how efficiently a company can repay it’ short-term loans within a year. Current ratio = current assets/current liabilities read more is slightly below the industry average of 2, which the company needs to improve in the future. Further Temporary WC of ABC Ltd is also positive, which is a good sign.

Example #2

Suppose ABC Limited has Current Assets of $10,00,000 and Current Liabilities of $15,00,000. Next, calculate the WC of the Company.

Solution:

In this case, the Gross Working CapitalGross Working CapitalGross working capital refers to the total current assets of the company that can be converted into cash within a year, such as accounts receivables, inventory of raw material, WIP inventory, finished goods inventory, cash, and bank balance, marketable securities such as T-bills, commercial paper and short term investments.read more will be $10,00,000. However, the NWC of the Company would be (-$5,00,000 ) since the Current Liabilities are more than the Current Assets of the Company. ABC Limited is suffering from Liquidity Crisis due to the negative Working Capital of the Company, which will hinder Business Operations in the long term.

Such a high negative WC is a negative sign as far as the Credit Rating Agencies are concerned, forcing them to downgrade the rating by one notch if the situation does not improve.

Example #3

XYZ Limited has Current Assets of $2,00,000 and Current Liabilities of $ $90,000. Accordingly, accounts receivable of$ 75,000 included in current Assets are declared as Bad Debts and shall be written offWritten OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more to the Profit & Loss Account next year.

Although the Net Working Capital is positive, i.e., $110,000 on paper, in reality, this would not be the true picture since $75,000 is considered as Bad & Doubtful of Recovery. Therefore, in the true sense, the Net Working Capital will have to be adjusted with the Accounts Receivable portionAccounts Receivable PortionAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more to work out the Revised Net Working Capital of XYZ Limited. This will impact the Strategic Decision making of the top management.

Example #4

PQR Limited has Current Assets of $2,00,000 and Current Liabilities of $ $90,000. Inventory of$ 1,50,000 included in current Assets has become Obsolete since the Goods have been lying in Inventory for more than six months. The Market Value of the same would be $50,000.

In this case, the Net Working CapitalNet Working CapitalThe Net Working Capital (NWC) is the difference between the total current assets and total current liabilities. A positive net working capital indicates that a company has a large number of assets, while a negative one indicates that the company has a large number of liabilities.read more of PQR Limited, as per the Balance Sheet view, would be $110,000, which is a positive for the company; however, since the Market Value of Inventories as provided in the example above has been declined to $ 50,000, this should be considered the Actual Recovery price of Inventory.

Hence the Revised Net Working Capital would be ($2,00,000 – $1,50,000 + $50,000 ) – $90,000 = $1,00,000. The management of the Company would have to sell the Inventory as early as possible in order to maintain the Liquidity.

Conclusion

Hence, it forms a major component for analyzing the company’s financial position and comparing it with peers. A Strong Working Capital Cycle gives the Company the Cushion to perform the Company’s Business operationsCompany’s Business OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company’s goals like profit generation.read more smoothly. Conversely, a negative working capitalA Negative 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 puts the company under tremendous Stress since the company is not in the position to pay off its Day to Day obligations due to Liquidity issues.

  • Further, it is also not advisable to lock a huge amount of Funds in the Working Capital Cycle since there is a cost attached. For example, a high Inventory will be a negative sign for the company since there is a chance of the Inventory becoming obsolete. So on paper, the WC of the Company may look Good in the Short Term; however, it may have a significant impact if the Inventory is not Sold and becomes obsolete.Hence the company should strategically plan the Cash FlowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more and the minimum Working Capital required to run the business operations smoothly. There is no high amount locked in the Current Assets, or any liability is understated as this may increase/decrease the WC.

This has been a guide to Working Capital Examples. Here we discuss its meaning and the various examples of working capital to understand it better. You can learn more about accounting from the following articles –

  • Top Components of Working CapitalCalculate Working Capital Turnover RatioChange in Net Working Capital FormulaFixed Capital vs. Working Capital