Working capital refers to the amount which the company requires with the purpose of financing the day to day operation and example of which includes the working capital of $100,000 with a manufacturer which is calculated by subtracting current liabilities of $200,000 from the current assets of $300,000.
Top Examples of Working Capital
Working Capital refers to the Funds available with the Company to meet its day to day Business operations. It is an indicator of the Short Term Financial Strength of the Company and signifies the capability to meet the Current LiabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc.read more and Debt Obligations due within one year. The following working capital example provides an outline of the most common sources of working capital.
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For eg:
Source: Working Capital Examples (wallstreetmojo.com)
- Spontaneous: It refers to the Funds which are easily available in market
- Sundry Creditors
- Bills Payable
- Trade creditTrade CreditThe term "trade credit" refers to credit provided by a supplier to a buyer of goods or services. This makes it is possible to buy goods or services from a supplier on credit rather than paying cash up front.read more
- Notes PayableNotes PayableNotes Payable is a promissory note that records the borrower's written promise to the lender for paying up a certain amount, with interest, by a specified date. read more
- Short Term WC :
- Bills Discounting
- Cash Credit
- Bank OD
- Commercial PaperCommercial PaperCommercial Paper is a money market instrument that is used to obtain short-term funding and is often issued by investment-grade banks and corporations in the form of a promissory note.read more
- Inter Corporate Loans and Advances
Each example of the Working Capital below states the topic, the relevant reasons, and additional comments as needed.
Calculation Examples of Working Capital
Example #1
Suppose ABC Limited has Current Assets $ 5,00,000 and Current Liabilities of $ 300,000. Fixed Assets are $ 1,00,000. Long Term DebtTerm DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company's balance sheet as the non-current liability.read more is $1,00,000, and Short Term Debt included in the Current Liability above is $25,000. Calculate the Working Capital of the Company and analyze the same.
Solution:
Here,
- Gross Working Capital/Current Assets of the Company: $5,00,000
- Permanent Working Capital/Fixed Assets of the Company: $1,00,000
- Current Liabilities: $300,000
- Long Term Debt: $100,000
- Short Term Debt: $25,000
Calculation of Net Working Capital is as follows –
- NWC = Current AssetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more – Current Liabilities
- = $5,00,000 – $3,00,000
- = $2,00,000
Temporary WC will be –
- Temporary WC = NWC – PWC
- = $2,00,000 – $1,00,000
- = $1,00,000
Analysis:
In the above example of working capital, ABC Limited has a Strong Working Capital to meet its Short Term as well as Long Term Financial needs. However, the Current Ratio of the CompanyCurrent Ratio Of The CompanyThe current ratio is a liquidity ratio that measures how efficiently a company can repay it' short-term loans within a year. Current ratio = current assets/current liabilities read more is slightly below the industry average of 2, which the Company needs to improve in the future. Further Temporary WC of ABC Ltd is also positive, which is a good sign.
Example #2
Suppose ABC Limited has Current Assets of $10,00,000 and Current Liabilities of $15,00,000. Calculate the WC of the Company.
Solution:
In this case, the Gross Working CapitalGross Working CapitalGross working capital refers to the total current assets of the company that can be converted into cash within a year, such as accounts receivables, inventory of raw material, WIP inventory, finished goods inventory, cash, and bank balance, marketable securities such as T-bills, commercial paper and short term investments.read more will be $10,00,000. However, the NWC of the Company would be (-$5,00,000 ) since the Current Liabilities are more than the Current Assets of the Company. ABC Limited is suffering from Liquidity Crisis due to the negative Working Capital of the Company, which will hinder the Business Operations in the long term.
Such a high negative WC is a negative sign as far as the Credit Rating Agencies are concerned, which would force them to downgrade the Rating by one notch if the situation does not improve in the Future.
Example #3
XYZ Limited has Current Assets of $2,00,000 and Current Liabilities of $ $90,000. Accounts receivable of$ 75,000 included in current Assets are declared as Bad Debts and shall be written offWritten OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more to the Profit & Loss Account next year.
Solution:
In this case, although the Net Working Capital is positive, i.e., $110,000 on paper, in reality, this would not be the true picture since $75,000 is considered as Bad & Doubtful of Recovery. In true sense, the Net Working Capital will have to be adjusted with the Accounts Receivable portionAccounts Receivable PortionAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more to work out the Revised Net Working Capital of XYZ Limited as this will impact the Strategic Decision making of the top management.
Example #4
PQR Limited has Current Assets of $2,00,000 and Current Liabilities of $ $90,000. Inventory of$ 1,50,000 included in current Assets have become Obsolete since the Goods are lying in Inventory for more than 6 months. The Market Value of the same would be $50,000.
Solution:
In this case, the Net Working CapitalNet Working CapitalThe Net Working Capital (NWC) is the difference between the total current assets and total current liabilities. A positive net working capital indicates that a company has a large number of assets, while a negative one indicates that the company has a large number of liabilities.read more of PQR Limited as per the Balance Sheet view would be $110,000 which is a positive for the Company, however since the Market Value of Inventories as provided in the Example above has been declined to $ 50,000, this should be considered the Actual Recovery price of Inventory.
Hence the Revised Net Working Capital would be ($2,00,000 – $1,50,000 + $50,000 ) – $90,000 = $1,00,000. The management of the Company would have to sell the Inventory as early as possible in order to maintain the Liquidity.
Conclusion
Hence, it forms a major component for analyzing the Financial position of the Company and compare it with peers. A Strong Working Capital Cycle gives the Company the Cushion to perform the Business operations of the CompanyBusiness Operations Of The CompanyBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.read more smoothly. A negative working capitalA Negative Working CapitalNegative Working Capital refers to a scenario when a company has more current liabilities than current assets. It implies that the available short-term assets are not enough to pay off the short-term debts. read more puts the Company in tremendous Stress since the Company is not in the position to pay off its Day to Day obligations due to Liquidity issues.
- Further, it is also not advisable to lock a huge amount of Funds in the Working Capital Cycle since there is a cost attached to it. For example, a high Inventory will be a negative sign for the Company since there is a chance of the Inventory becoming obsolete. So on paper, the WC of the Company may look Good in the Short Term; however, it may have a significant impact if the Inventory is not Sold and becomes obsolete.
- Hence the Company should strategically plan the Cash FlowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more and the minimum Working Capital required to run the Business operations smoothly so that there is no high amount locked in the Current Assets or any liability is understated as this may increase/decrease the WC.
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