What Is Working Capital?

Working capital, often shortened to WC or called net working capital or working capital ration, is a measurement of a company's efficiency and ability to pay for short term obligations. In most financial settings, working capital is the best measurement of an entity's short term strength and the success of a business in managing its assets. 

In the following, you'll learn more about how working capital is calculated and what strategies companies use to manage their working capital. 

Calculating a company's working capital is quite easy. Working capital is equal to the company's current assets minus its current liabilities. A current asset is something that can be converted to cash or used to pay off a liability within one year, and includes items such as cash, short term investments, inventory, accounts receivable and prepaid liabilities. 

The definition of current liabilities is a little less straightforward, but it includes all liabilities that need to be settled in cash within one year as well. Current liabilities are also sometimes defined in reference to current assets, as any obligations which will need to be settled by those current assets. 

If a company has fewer current assets than current liabilities, that company is said to have a working capital deficiency or working capital deficit. Some companies may be profitable in terms of being asset rich but have very little liquidity, as their assets are not convertible directly into cash. 

In instances like these, a company may benefit from improving its working capital management, because companies in this position are often unable to deal with short term debt, expansion or unexpected operating expenses. 

In order to improve on situations like the one described above, companies often call upon experts to help them with their working capital management. Such professionals help companies make sure that they can continue to operate successfully, keeping up the necessary cash flow to pay off short term debts and operating expenses. 

Companies often work to improve on their working capital if they're considering being acquired by another company or are contemplating an IPO. When improving on working capital, the cash conversion cycle is a vital metric.  

Cash conversion cycle or CCC measures the amount of time it takes from putting out cash for making a product to getting payment from a customer for that product. CCC is a good measure of how efficiently a company is using its money and time, and is important in that tying up money for less time lets you invest that capital in other places. 

Thus, having a shorter CCC can very quickly help out with working capital. Some of the techniques used by working capital managers include cash management, which figures out how much a company needs for its day to day operations and attempts to reduce holding costs, and inventory management, which tries to identify how much inventory a brand needs to produce without interruption and reduce the amount spent on raw materials, and thus increase its cash flow. 

Working capital management also includes the improvement of short term financing and the improvement of a brand's management of its debt and obligations.

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