Working Capital Definition & Application Wiki

Working Capital Definition & Application Wiki

Last Updated by WikiWealth

Short Definition

Short term capital used to operate the business. An investment in working capital is the net change in working capital. Investments are needed to sustain growth in a business, but an increase in investments lowers available cash to investors and thus lowers the value of the business.

Working capital (also known as net working capital) is a financial metric which represents the amount of day-by-day operating liquidity available to a business. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. It is calculated as current assets minus current liabilities. A company can be endowed with assets and profitability, but short of liquidity, if these assets cannot readily be converted into cash.

Decreasing working capital investments indicate an increase in business efficiency and an increase in value.

Why Does WikiWealth Modify the Working Capital Formula?

There are a number of different ways to calculate working capital, because each firm may have a sightly different way of doing business. The formula we use is more accurate then the broadest measurements of working capital.

The most typical way to measure working capital is current assets minus current liabilities. However, WikiWealth uses a modification of that formula to produce a more accurate measurement. We subtract cash under the assumption that you need some cash for emergencies, but firms certainly don't use every last dollar for everyday business needs. Some cash may be restricted from use, and various other reasons may increase the need for cash. We add back short-term debt, because it works like a businesses' credit card.

Think of how you use cash in your bank account and your credit cards. If you make short-term purchases using a credit card, then you pay it off eventually with your cash balance. You can also use cash to make purchases, but you may not necessarily run your balance to zero every month or week. Companies work the same way, but they rely on debt (read: business credit cards) to a greater extent.

Long Definition

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