A formula that assesses a corporation’s short-term liquidity; measured by subtracting the company’s current liabilities from its current assets. Also referred to as “net working capital.”
Working capital is an important tool, as it is used to determine corporate efficiency and financial health in the short-term. If a corporation’s working capital is strong, it is likely in a position to expand its operations, invest or grow in other ways. Conversely, if a corporation’s working capital is weak, this reality may serve as a flag that its operations may be in distress. In this scenario, changes may need to be made in order to reduce the company’s risk of insolvency.
For the purposes of assessing working capital, “current” liabilities are those due within a period of 12 months and “current” assets are those that either are immediately available or will become available within a period of 12 months.
Executive One: “I just spoke with the accounting team and our-short term liquidity is in great shape. Apparently, our working capital is strong enough that the accountants have no problem with us researching some expansion opportunities.”
Executive Two: “Woo hoo! Let’s open some hot dog stands and invest in one of those ice cream places where the ice cream gets frozen flat and then rolled into those little rosette-looking things.”
Executive One: “We’re an auto parts manufacturing company.”
Executive Two: “You JUST SAID that we should look into expanding…”