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Understanding working capital will help you understand the financial health of your business. Working capital is always changing, like cash flow. Due to this, you will need to be able to calculate your business’ working capital and review your balance sheet to find this number. In this post, we will discuss how you can correctly take charge of your business finances.
The Definition of Working Capital
Working capital is the amount of capital that your business has uncommitted to paying off short-term liabilities. It is the literal amount of capital you have to work with.
Working capital is valuable to your business and you should try to have as much of it as much as you possibly can. With more capital, you will have more assets that you can use, save, or sell.
The working capital formula is as follows:
Current Assets – Current Liabilities
Both current assets and current liabilities can be found on your company’s balance sheet. Every time your business changes its assets or liabilities, your working capital will be altered in response.
Current assets represent the total amount your business owns in terms of cash and other liquid assets. These include things that will be converted into cash within the next 12 months. Examples of current assets include cash, accounts receivable, inventory, and commercial paper.
Current liabilities are the amount you need to pay to your creditors within the next 12 months. Examples of current liabilities include operating expenses, taxes, and accounts payable.
If your business increases currents assets or decreases existing liabilities, then your total amount of working capital will increase. If your business decreases current assets or increases current liabilities, then your total level of capital will decrease.
The Usefulness of Working Capital
Many business owners believe that capital is one of the most useful figures that can be extracted from a balance sheet. Understanding working capital can help you determine if you should apply for a business loan and how to adjust your level of capital in response to the changes in your business cycle.
Capital is derived from current asset and current liabilities; this formula is more useful for making short-term decisions. t’s incredibly helpful to businesses that need to make choices they regarding their business’s finances.
The Bottom Line
Hopefully, you now have a better understanding of what capital is and what it means for your business. you should now be able to understand how to calculate positive working capital utilizing your balance sheet.
