Working capital

Working capital is an accounting magnitude referring to those economic resources that a company has within its assets to meet payment commitments in the short term and related to its economic activity.

Working capital

In a simple accounting scheme, the concept of working capital focuses on the capital resources that a given company can count on in the short term to operate. That is, those capitals commonly used in the daily economic activity that the firm carries out.

These resources owned by the company are cash, the portfolio of financial products and other investments made by the company.

For this reason, working capital is usually identified with the concept of current assets on the balance sheet. In turn, it is common for the concept of working capital to be identified with that of liquidity of an organization.

We must remember that companies usually must meet short-term requirements for inputs or raw materials, payment to workers, replacement of assets, among others. Otherwise, they cannot continue to operate.

To comply with the above, liquid resources are needed, that is, they can be quickly transformed into (or are) cash.

That is why when we talk about working capital, debts that are close to maturing are usually discounted. In this way, the net working capital would be calculated as the current assets minus the current liabilities of the company.

Main characteristics of working capital

The resources used by a particular company to meet the commitments of its productive work make up the working capital.

In this way, every society has different accounting accounts intended to favor or enable the supply of inputs to start its activity, enabling the normal operation of a company.

The purchase of raw materials or the payment of wages at this point require the ability to pay instantaneously by means of money or other similar monetary instruments for short-term payment.

Calculation of working capital

As we saw above, to calculate the working capital in the most objective way, the current assets must be subtracted from the current liabilities of the firm. This is known as net working capital.

It should be noted that current assets are those comprised of cash (in the cash and bank account) and those values ​​that can be easily transformed into money. We refer to accounts receivable from customers (with terms of less than one year) and inventories, for example.

Likewise, current liabilities comprise all the obligations that must be met in the short term. For example, we have debts with suppliers that must be paid in thirty days.

Example of working capital

To better understand the concept of working capital, we can use an example. Let’s imagine that a company presents the following accounts (all measured in euros):

  • Cash / Banks: 4,000
  • Stock: 5,000
  • Short-term accounts receivable: 6,000
  • Machinery and equipment: 10,000
  • Land: 25,000
  • Short-term accounts payable: 10,000
  • Long-term accounts payable: 16,000
  • Assets: 24,000

So, to estimate net working capital, we first calculate current assets that would comprise cash / banks, inventory, and short-term accounts receivable, adding:

4,000 + 5,000 + 6,000 = 15,000 euros

Likewise, current liabilities would comprise only short-term accounts payable (10,000 euros), so the net working capital would be:

15,000-10,000 = 5,000 euros

Importance of working capital

It is important to note that a company can have a high equity capital and not have a similar working capital at the same time. The opposite would also happen. This non-dependence will have to do with the composition or structure of the company’s assets and liabilities.

For example, a company may have a large amount of real estate within its equity, but it cannot face several short-term payments because it does not have constant monetary returns. This is common in times of crisis or lack of liquidity.

Then, it can be deduced that this magnitude (working capital) is especially important in companies with a commercial nature and in need of having (due to their usual activity) short-term means of payment for the constant entry and exit of inputs and outputs.