Working capital or net working capital is a difference between Current Assets and Current Liabilities of the business. This index depicts current financial health of the business, i.e. indicates whether the business has enough current assets to cover its current liabilities.
The calculation formula is as follows:
Working Capital = Current Assets – Current Liabilities
In case the index is negative, this would mean that the business does not have sufficient current assets to cover its current liabilities, when they are due. This might lead to liquidity issues. Therefore the reasons behind should be clarified and known.
This index should be analysed from period to period and across industry comparing with competitors.
Also important to note that high working capital is not a very good sign, as it indicates the business might have excess cash, which is not being utilized efficiently.
While using this calculation formula, current assets are those which do include cash and other current assets which can be turned into cash within one year. These do include inventory, accounts receivable, prepaid expenses.
Current liabilities are those which are due within period shorter than one year. Usually they do include accounts payable, salaries payable, accrued liabilities.
Working capital index is closely related to Current Ratio, i.e. where Current Assets are divided by Current Liabilities. In case the ratio is higher than 1, current assets are higher than current liabilities.