Working capital definition can be understood in easy terms as the total amount of money the company has in order to run the day-to-day transaction of the business. The working capital of a business is measured by deducting the current liabilities of the business from its current assets. The resultant figure, can give a fair idea about the liquidity status of the company. A positive working capital is definitely favorable, while a negative working capital can be a serious cause of concern.The best thing for a business to do is to ensure that the inventory of the business does not stay idle. Thus, working capital definition is highly important to understand and to positively implement.
Working capital definition – Understanding it better
Working capital definition is one of the easiest business terms. In the simplest terms, working capital is the money that the company needs in order to keep the business running. Working capital is needed in order to make daily payments to creditors and to pay off bills of the business. It is like the cash-on-hand that a business has in order to carry on with the day to day operations. Lack of working capital can be a point of concern as at this point, the business mechanics need to be re-looked at. If a business does not have money to run the daily operations of the business, there is a serious problem at the level of planning or execution or both.
Working capital definition – What’s the formula
As mentioned earlier, working capital is one of the easiest businesses terms to follow. The working capital definition can be best understood with the help of this formula:
Working capital = Current assets – Current liabilities
If the current assets of the business are higher than the current liabilities, one gets a positive working capital. If the current assets are not as much as the current liabilities, the business suffers from negative working capital.
Working capital definition – Why is it important
It is important to understand the working capital definition for a business in order to gauge its operational abilities. Working capital is the measure of a company’s working efficiency. If there is a great amount of money to be collected from debtors or if there is a huge sum that still needs to come from the customers, there are higher chances of the business suffering from a negative working capital. In such a situation, the creditors cannot be put off due to lack of payments from the debtors. As a result, the mechanics of the business should be a run in a way that the creditors and the debtors have a clean account. This will also ensure that the business is run in a smooth and a calculated manner.
Working capital definition – Underestimating it – When businesses underestimate the importance of working capital, chances of operational problems arise and increase manifold. Running out of cash can be the gravest mistake for a business. Getting back on track may then become not only difficult, but also highly time consuming.