What is Working Capital?

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Working Capital (aka “Net Working Capital”) helps provide a snapshot of a company’s near-term financial health – It’s the value that remains after subtracting a company’s current liabilities from its current assets.

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🤔 Understanding working capital

Working capital offers a quick way of showing whether or not a company can pay for its current liabilities, or debts. It’s similar to your own personal monthly budget, that makes it clear if you have enough money to pay your bills or not. Working capital can sometimes be an indication of whether a company has the resources it needs to grow and expand. The way the company manages its working capital, – for example, how consistently it has a positive or negative working capital - can sometimes help signal how well (or not) a company is poised for growth.


If we look at Fitbit’s working capital for the period ending Dec. 31, 2018, we can see it had positive working capital of about $592 million. That means the company had more current assets than current liabilities. (Negative working capital would mean the company has more liabilities than assets).

Its current assets were $1.3B, and their current liabilities were $779.7M. To find the working capital, we subtract the current liabilities from current assets. So $1,311,811,000 minus $719,383,000 leaves $592,428,000, positive working capital.

(Source: Fitbit, Inc. 2018 Balance Sheet via NASDAQ.)


Working capital is kind of like a candid photo...

It captures a moment but doesn’t tell the whole story of a company. For example, a newspaper photo of a car being repossessed doesn’t tell you why the car was repossessed, or how difficult it will be to get that car back later.

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How do you calculate working capital?

The working capital formula is pretty straightforward:

Current assets - Current liabilities = Working capital

While the company’s financial statements include all assets and liabilities, working capital only uses current assets and liabilities. Fortunately, balance sheets show current assets and current liabilities broken out in separate sections for easy reference.

Current assets can be turned into cash within a year of the balance sheet date. Current liabilities are due to be paid within a year of the date of the balance sheet. Specific items included in the list of current assets or current liabilities are fairly consistent, but can vary between companies. Those items also change from year to year as loans and other term-based debts become due.

What are the four main components of working capital?

The four main parts of working capital: 1. Cash 2. Receivables 3. Inventory 4. Accounts Payable

In other words, how much money is coming in, and how much money is going out soon. Cash, receivables, and inventory make up the short-term, or current, assets that are expected or can be converted to cash within a year. However, some companies carry inventory that is long-term and omitted from the current asset number.

Accounts payable belong in the current liability component of the working capital equation. They include items a company expects to have to pay out within a year, which may specifically vary by the company or industry. A common accounts payable item is employee wages.

These are the main components of working capital, but not an exhaustive list. Sometimes the current asset or current liability categories vary, particularly between industries. Current assets include investments easily and quickly converted to cash such as money markets or ETFs. In some cases, current liabilities may also include Items such as dividends due or payments on long-term debt. Regardless of the items included, they are typically listed by category in companies’ balance sheet.

Why does working capital matter?

Working capital can help an investor see how capable a company is of paying current debts, and whether the company has money available to spend on growth or expansion in the short-term. Like all financial benchmarks that rely on a limited set of information, it doesn’t give a complete picture of a company’s financial health, and is never a guarantee of how a company will perform.

Kind of like a doctor taking a patient’s blood pressure, even if that number looks good, the patient’s health may pose other concerns. Because of this, there are separate calculations and ideas built off of the working capital formula that can help offer more insight into a company’s liquidity, or how much cash a company can raise in a short amount of time.

What is the working capital ratio?

A company’s working capital ratio compares working capital to its debts. In other words, the working capital ratio helps indicate how well (or not) a company can cover its debt, or how comfortable its margin of working capital really is.

The working capital ratio is calculated by dividing current assets by current liabilities. For example, a company with a working capital ratio of 1 would have an equal amount of current liabilities and current assets. In theory, this means the company can pay its bills, but wouldn’t have any capital left over for emergencies. A company with a working capital ratio of 2 would have twice the current assets as their current liabilities. This means that it should be able to pay some or all of its current debts and still have funds left over.

Working capital and the working capital ratio are short term calculations. They do not guarantee that a company will continue to be able to cover its debts in the long term. It’s kind of like paying bills for the month and having money left over. Just because you have money left doesn’t mean you’ll still have enough to pay next month’s bills if a significant expense arises.

What is working capital management?

Working capital management is monitoring and adjusting working capital to keep amounts in line with a company’s strategy. Every company will have different plans and different comfort levels with working capital totals. A common way to manage working capital is to keep extra cash as an insurance policy of sorts. Keeping this extra money can help protect against fluctuating current assets or current liabilities.

This is sort of like how you might have a savings account for emergencies or occasional large purchases, and a checking account for the expenses you make regularly. Additional expenses for a company might be a long-term loan when a lump sum final payment comes due. Current assets might also fall short if sales don’t end up meeting projections. Keeping a cash reserve helps to protect against downturns.

Another primary method of working capital management is to attempt to encourage quick asset turnaround while delaying making payments on current liabilities.

What is the working capital cycle?

The working capital cycle allows a company to visualize the amount of time needed to convert working capital into cash and any gaps between receiving assets and paying liabilities. Although current assets and current liabilities are generally considered assets and liabilities that can be converted within one year, most do not take that long. Many may only take 15, 30, 60, or 90 days to come due or be paid to the company.

The formula for finding the working capital cycle is: inventory days + receivable days - payable days

Inventory days means the number of days it takes for inventory to sell. Receivable days refers to the time needed to receive the money from those sales. Payable days represents the current liabilities side of the equation and shows the number of days until paying for inventory. For example, a company sells inventory every 60 days, receives the funds every 30 days after the sale, and pays for inventory every 15 days. The working capital cycle is 45: 60 + 30 -15 = 45

Sometimes, the working capital cycle can reveal that a company needs to supplement cash flow through loans or other methods. This need for supplemental cash arises when the working capital cycle is longer than the time it takes for the current liabilities to come due. Let's look at an example. Say a company has a working capital cycle of 45 days, but they have to pay suppliers every 15 days. This company will need extra funds to pay bills three times more often than they receive money from assets.

What is the working capital requirement?

The working capital requirement goes hand-in-hand with the working capital cycle. The working capital requirement is the amount needed to fund the company during the working capital cycle. It’s the amount necessary to cover business activity in the time gap between paying suppliers and receiving funds. The formula for calculating the working capital requirement is inventory plus accounts receivable minus accounts payable.

The working capital requirement will vary between industries because of different working capital cycles. For example, a car company might have a higher working capital requirement than a grocery store because cars take longer to sell than meat or vegetables.

The working capital requirement often increases for new and quickly growing companies. This happens as quick sales increases require more inventory. Strong working capital management can help reduce issues by planning and taking out short term loans when needed. Without planning, a company can experience a lack of funds to pay suppliers as they spend on inventory before receiving money from sales. In other words, even a rapidly growing company can suffer cash flow problems because of working capital needs.

How do changes in working capital affect a company's cash flow?

Cash is one component of working capital – It’s a key current asset. Cash flow, the amount of cash moving in and out of a business (much like a tide ebbing and flowing, affects a company’s working capital, but the working capital can also affect cash flow. There are also times when cash flow changes do not affect working capital.

Changes to the current liabilities such as large purchases can reduce the cash flow into a company. Sometimes companies make large purchases with cash instead of financing, for example, when opting to buy a large piece of factory equipment or a new transport truck. Those situations can reduce the amount of cash that’s available for a period of time.

Working capital can increase alongside cash flow if the company sells a long-term fixed asset that isn’t considered a current asset, for example, if a company sells a building. Cash flow can decrease without affecting working capital as well. This happens when the company purchases another current asset with cash, such as inventory or foreign currency.

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