Working Capital
How is it calculated?
Working Capital = Current Assets - Current Liabilities
Goal of the Ratio
The goal of this figure is to measure the difference between a borrower’s Current Assets and Current Liabilities. Working Capital is a measure of Liquidity for a business, but beyond that, Working Capital is the initial safety blanket for a business to shield it from Ups and Downs in the business cycle.
When is it used?
Working Capital is relevant in all situations, and you should be paying attention to changes in Working Capital over time and identifying the underlying causes of these changes.
Rules of Thumb
Higher is better - More Working Capital means a borrower is better able to meet short term payment obligations as well as weather the UPS and Downs in a business cycle.
Please note all ratios should be viewed in relation to industry norms to determine overall adequacy.
What changes in the ratio could mean:
Some example reasons why Working Capital can change:
- Profits/Losses
- Distributions/Contributions
- Purchase/Sale of LT Assets
- Taking out or paying down LT Debt
Other Relevant Terms
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