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Working capital refers to the amount of capital used by a company to perform its daily operations. It is simply the difference between current assets and current liabilities of a company.
It can be used to measure:
a) the short term financial health and
b) efficiency of a company to meet its short term liabilities.
The amount of negative or very less working capital indicates that the company is not able to pay its current liabilities within given time period. On the contrary, it indicates that the company has either generated a large number of credit sale or it has invested a big amount of capital in its current assets, that also is not good for company.
Formula for calculating working capital:
The given formula can be used for this purpose:
Application of the formula:
Suppose, XYZ Ltd has following figures in its balance sheet:
Total current assets of the company = 1,27,000
Total current liabilities of the company = 1,07,000
By using the given figures and formula, working capital for XYZ Ltd is:
= 1,27,000 – 1,07,000 = 20,000.