Working capital is normally defined - very broadly - as the excess of current assets (excluding cash) over current liabilities.
It represents the day to day capital requirement to continue the operations of the organisation.
Ignoring any cash or overdraft balances for now, in very simple terms, a measure of working capital can be calculated as:
ADD: Accounts receivable
LESS: (Accounts payable)
= Working capital
This working capital requirement has to be financed in some way, or usually a combination of different ways.
For example by borrowings, shareholders' funds, external parties including supply chain finance, factoring, securitisation, or a combination of these.
Working capital can be negative, for example in food retailing.
Alternative definitions of working capital may include any short-term cash or overdraft balances of the organisation.
This inclusion (or exclusion) of cash and overdrafts may depend on:
- Whether the cash or overdraft is considered to be an operating item or part of financing
- The purposes for which the working capital figure is being calculated and used.
Other issues of definition and inclusion / exclusion arise in respect of supply chain finance/prepayments, revenue recognition accounting rules and their application in different sectors.
Here as elsewhere, it is always best to be as clear and consistent as possible - and explicit - about the detailed definition being used.
- Accounts payable
- Accounts receivable
- Cash flow statement
- Current assets
- Current liabilities
- Fixed assets
- Free cash flow
- Liquidity management
- Management efficiency ratio
- Over trading
- Reporting on Payment Practices and Performance Regulations
- Shareholders’ funds
- Supply chain finance
- Trade creditors
- Working capital management