- October 13, 2020
- Posted by: saenicsa
- Category: Accounting, Business plans, Consulting
When times are good, the income statement is the go-to report for management, but when times are lean, the Balance Sheet is what will keep your company from going bankrupt.
An important metric that you can utilize to have a better understanding of your liquidity is the working capital metric, below we talk about what exactly this is.
What is Working Capital?
We can define working capital is a financial metric that is calculated by obtaining the difference between the total of current assets subtracted the total of current liabilities.
Not everyone calculates and defines working the same, for example, other calculate working capital by adding cash, trade receivables and inventory together and then subtracting trade payables.
Why is Working Capital Important?
Working capital is simply another metric or base that can be used to better understand a company’s liquidity.
Therefore, this metric can help us in having a simple and clearer picture as to how well the company is being managed in terms of receivables turnover and inventory supplies, as well as accounts payable obligations and operating cash.
If for any reason working capital is deficient or negative this is an important sign that should indicate to you that something is wrong with the company and due to the nature of the metric you can better fixate the source of the problem so as to promptly correct it and recover lost capital.
Although there are certain conditions that, if given a negative amount of working capital will not necessarily mean that a company is bankrupt, but it is recommendable to always have and maintain a positive working capital amount.
How can I Better Manage Working Capital?
To better manage working capital it is important so as to be aware of exactly what factors into it.
For example, when we talk about current assets remember that essentially, we are looking at cash, bank accounts and inventory, while on the other side of the Balance Sheet for current liabilities its accounts payables.
Therefore, the factors that will come into play that will have the greatest effects on working capital and how much is either available or not will be based on: inventory at hand, credit policies with customers, purchasing from vendors and accounts payables.
So, to improve working capital, it will be important to really manage these sections of your Balance Sheet as much as possible and if necessary change or adapt as needed so as to not only have positive cash flow, but more importantly have sufficient capital available so as to not require costly financing or need to liquidate assets.