What is ‘Working Capital’?
Working capital is an important measure for analyzing short-term financial health and efficiency.
Formula: Working Capital Assets – Current Liabilities
Going by INVESTOPEDIA , Working Capital ratio which is ratio of current assets to current liabilities makes clear if the company had adequate amount of short term assets so as to cover short term debt.
Working Capital ratio < 1 means negative working capital
Working Capital ratio > 1 means company is not investing surplus assets.
The ideal ratio number is between 1.2 and 2.0
For a company with current assets way less than current liabilities, then the company may find it difficult to pay back its creditors in short term, means it may go bankrupt in short time. A company with declining sales volume can fall in such a scenario.
Working capital indicates
- Company’s underlying operational efficiency
- A company not working efficiently will have an increase in working capital – in case money a company has can’t be paid back to fulfill its obligations. So working capital from one period to another should always be analyzed to analyze company’s operations.
- A high working capital ratio isn’t always a good thing, it could indicate that they have too much inventory or they are not investing their excess cash.