Working Capital Calculator

What is working capital?

In accounting and audit, working capital also called as “net working capital” is the figure that results from subtracting the current liabilities of a company from its current assets. For example if at the end of August 2015 a company's balance sheet presents total current assets of $200,000 and total current liabilities of $150,000 then its working capital would be $50,000.
The optimal level of the working capital varies from one company to another since it depends on the area it operates in, its contractual relationship with its suppliers and customers and on many other factors that should also be taken into account, such as the ones described below:

- The structure and allocation of its assets, especially which are the types of the current assets and the extent at which they can be transformed into cash. The higher the proportion of cash or near cash/liquid current assets the better. For instance if most of a company’s current assets are cash & cash equivalents or investments easy to convert to cash, then a smaller amount of working capital may be considered sufficient, while in case the current assets consist in their majority of inventory that are less liquid, then it will most probably require a larger working capital to be considered stable from financial point of view.

- The way the customers pay on sales and the term they agreed to payout. For example retailers or online ecommerce companies receive payments from their clients either in cash, respectively via bank transfers which both take place almost instantly when the purchase takes place. The larger the term allowed for clients to pay their purchases, the worst from the working capital perspective analysis and the reverse.

- The terms negotiated to pay its suppliers. The larger the term to pay its bills the better, since it allows the company to run its business under favorable conditions.

- An existing line of credit the company may have at its disposition. At the end of a business cycle/month there might happen for a company to register either zero or even negative working capital, but that not necessarily mean it will face default, especially if it has an approved line of credit that may be used to finance on a short run its business.

Understanding the changes of the working capital available

Generally speaking there are few financing options a business has at its disposition to increase its working capital whenever required and that may include:

- Financing from its profit by reinvesting or keeping part of it for running the business, thus by increasing profits a company may increase its working capital.

- For companies listed on the stock market selling shares is a way to fund their activity.

- Borrowing money through loans, lines of credit or any similar options.

- Selling certain assets (that are not used at all or used inappropriately within the business) may help a company fund its working capital. Especially converting unnecessary assets may prove a positive move for a company, thus this aspect is often analyzed since it may help the company get resources without borrowing.

Taking into account all of the above, there are few aspects that may impact the value of the working capital that is available at a certain moment and its fluctuation over time:

- Any change in the term the clients are allowed to pay. If they are requested to pay quicker than in the past that may lead to a higher working capital (considering all the other variables unchanged). The opposite happens in case the clients are allowed to pay their purchases within a larger time period. Usually companies tend to have a flexible approach on this matter if they consider they have sufficient working capital, however this may be a risky strategy since whenever it may be the case imposing new payment terms for clients may lead to serious problems for the business as it is a process that takes time to be implemented and since it may also lead to some customers dissatisfaction.

- Any fluctuation in the discount rates offered by suppliers for ordering larger quantities at once may have an impact on the inventory planning and on the working capital available of a company.

- Any changes in the term a company is allowed to payout its current liabilities.

- Any change in the collection policy the company applies, that aims to improve its rate and time of collecting its receivables.

- Any improvement or deficiency in the inventory planning may impact directly the working capital value.

- Seasonality may contribute to the fluctuation of the working capital and this may be analyzed appropriately by the managers coordinating especially the production and sales areas.

How to calculate working capital and how to interpret its level?

Working capital as absolute value

The standard formula used to calculate the working capital as absolute value is by subtracting from the current assets figure the amount of the current liabilities. Further on the value that result is usually used to determine several liquidity ratios.

A negative value indicates the company does not have enough short term assets to cover its short term liabilities.

A value equal to zero shows the company’s current assets equal its current liabilities, while any positive value is interpreted as a positive signal that the company has the ability to meet its short term payments.

The higher the absolute value is the stable a company is considered to be, but please note that a significantly positive working capital may indicate that the company being analyzed is not using its resources appropriately to generate new revenue and profits.

This working capital calculator performs this calculation as:

Working capital = Current assets - Current liabilities

Example: A corporation has $200,000 of cash, $300,000 of receivables, $400,000 of inventory and $300,000 of accounts payable. This means that its working capital would be:

Current assets = $200,000 Cash + $300,000 Receivables + $400,000 Inventory = $900,000

Current liabilities = $300,000 Payables

Working capital = $900,000 - $300,000 = $600,000

Working capital ratio

The working capital ratio is calculated as the proportion of Current Assets against the Current Liabilities and demonstrates whether an entity has sufficient short term internal resources to meet its current payments. Thus any value below 1 shows the value of the current liabilities exceed the one of the current assets, while in most cases a ratio between 1.2 and 2.0 is interpreted as optimal.

This WC calculator finds the working capital ratio by using this equation:

Working capital ratio = Current assets / Current liabilities.

Example:

Assuming a company has total current assets of $100,000 and total short term debts of $80,000. In this case its WC ratio would be:

Working capital ratio = $100,000 / $80,000 = 1.25 (or 125%).