Working capital is a key metric that shows how much liquidity a company has tied up in day-to-day operations. It is calculated as the difference between current assets and current liabilities:
Working capital = Current assets - Short-term liabilities
What does working capital consist of?
- Current assets: typically inventory, trade receivables and cash.
- Short-term debt: Trade payables, accrued expenses and other liabilities due within one year.
Positive and negative working capital
A positive working capital means the company has sufficient short-term assets to cover its short-term liabilities. This provides flexibility and security in day-to-day operations.
A negative working capital means that short-term liabilities exceed current assets. This can create liquidity issues and, in the worst case, threaten the company’s survival if it can’t pay its bills on time.
Importance for the business
Working capital is an important measure of the company’s liquidity and operational robustness. Investors and banks often look at working capital to assess whether a company has its short-term finances under control. At the same time, it is a tool for management to control how much capital is tied up in, for example, inventory and receivables.
Example
A company has:
- Current assets of DKK 2m
- Current liabilities of DKK 1.5m
Working capital = 2.000.000 - 1.500.000 = DKK 500.000
The company therefore has DKK 500,000 in available working capital to finance its operations and unforeseen expenses.