In the economic sphere, the indicator characterizing the size of funds that are not dependent on current liabilities is working capital. In other words, it makes up a share of the finances of a company that are not used to pay off external or internal debts for a certain period of time.
General concept
Working capital came from the English term Net Working Capital (NWC). But in Russia, its other name is more popular - its 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 number of current assets and current liabilities. Its dimensions determine the liquidity of the company. If the 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 a flip side to the coin. In the case of too high working capital, doubts arise about the correctness of the economic policy pursued by the company's management.
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. Work features, terms of inventory turnover, the amount of short-term debt, conditions for attracting loans, loans, etc. also matter. Practice shows that both excess working capital and a shortage of working capital can negatively affect.
To calculate how much labor capital should have, there is a simple formula. Short-term liabilities must be taken away from current assets, and as a result we will get the desired value. You can use another, no less true way. We add long-term liabilities to our current assets and subtract non-current assets from the received amount.
How to manage working capital
The complexity of managing an NWC is to keep working capital at an optimal value. What does optimal mean? This refers to a value that would allow the company to perform all functions and non-stop engaging in core business.
At the same time, you should not overestimate the indicator, as this may result in the withdrawal of a significant part of the funds from the turnover. Management of working capital goes in parallel with the right financial management, which includes several points:
- Determination of the total need for working capital.
- Indicates the level of investment in this indicator.
- Identification of funding sources.
- Analysis of the impact of working capital on income and on increasing the value of the enterprise.
Based on the foregoing, managers who are involved in the management of working capital, in principle, work to maintain the liquidity of the company.
Reasons for lower working capital
Often there are times when the organization's current assets are almost equal to the amount of short-term debt. This can lead to the company declaring bankruptcy. This requires clear work by leading managers whose task is to monitor the indicator. If there is such a tendency that working capital is gradually declining, this indicates the irrational use of funds.
The reasons for the decline can be very different, among which is a drop in sales volumes, which, in turn, provokes a decrease in accounts receivable. In this case, the balance of current assets will decrease, and behind them - the value of working capital.
What does working capital mean?
Often a large company or corporation has many investors who are interested in its fruitful work. Thanks to the indicators of working capital, they can see the real picture of the effectiveness or inefficiency of the company's operations.
For example, if accounts receivable are collected at a slow pace, this leads to an increase in working capital and inefficient operations. Irrational investment of funds may also negatively affect, due to which the indicator of working capital will increase. The described indicator should be considered for several periods of time in order to compare and do the analysis.
