Working capital represents the company’s ability to pay its current liabilities through its current assets. Working capital is an important indicator of financial health, as the lenders can measure the company’s ability to repay its debts in the short term and less than one year.
Working capital represents the difference between current assets and current liabilities. This problem can be determining the correct category for a wide range of assets and liabilities on the balance sheet of the companies and breakdown the overall health of the company in achieving its short-term obligations.
Components Of Working Capital
Current assets represent assets that a firm expects to turn into cash within one year or one operating cycle, whichever is less. The more obvious category includes cash, cash and cash equivalents, accounts receivable, inventory and other short-term deferrals. Other examples include current assets of discontinued operations and interest payable.
Similarly, current liabilities are obligations that a firm expects to pay during the year or one operating cycle, whichever is less. Examples include accounts payable, accrued liabilities and accrued income tax. Other current liabilities include liabilities for the payment of dividends, financial leasing, during the year, and long-term debt, which is now in the course of the year.
How To Calculate Working Capital
Working capital is calculated by current ratio. The current ratio of current assets to current liabilities. A ratio above 1 means that current assets exceed liabilities, and the higher the ratio, the better.
Example Working Capital: Coca-Cola
The Coca-Cola company (Ko) had current assets in the financial year ending 31 December 2017 inclusive is estimated at $36.54 billion. Current assets included cash and cash equivalents, short-term investments, securities, receivables, inventory, prepaid Expenses and assets held for sale.
Coca-Cola current liabilities for the fiscal year ended December 2017 in the amount of $27.19 billion. In short-term liabilities include accounts payable, accrued expenses, loans and notes payable current liabilities long-term debt, accrued income tax and liabilities held for sale.
Using the provided information about KO above, the current ratio of the company is:
÷ 36.54 billion to $27.19 billion U.S. dollars = 1.34
What Is Working Capital
- A healthy business will have a sufficient capacity to repay its current liabilities with current assets. A higher ratio of 1 or higher means that the company’s assets can be converted into cash faster. As a result, it is more likely that the company can repay its short-term liabilities and debt.
- A higher ratio also means that the company can easily Finance its day-to-day operations. The more the working capital of the company means that she may not have to borrow to Fund its business growth.
- A company with a ratio less than 1 is risky for investors and lenders because it shows that the company may be unable to cover your duty if necessary. A current ratio less than 1 is known as negative working capital. Learn more about the different types of working capital please read can working capital be negative?
We can see from the chart below that Coco-Cola working capital as shown on the current ratio, has improved steadily over the last few years.
A more stringent ratio, the quick ratio, showing the share of short-term liquidity compared to current liabilities. The difference between this and the current liquidity in the numerator, where the assets include cash, marketable securities and accounts receivable. The quick ratio excludes inventory, which can be turned into cash on short-term basis.
The formula for calculating working capital is straightforward, but lends great insight into the short-term financial health of the company. The quick ratio is an even better indicator of short-term liquidity, and this may be important for suppliers and lenders to understand as well as investors, to assess how the company can handle short-term obligations.