Working Capital Key Terms

Terms are key when understanding business working capital

Working capital, the cash a business needs to operate from day-to-day, is a term used by lenders to calculate a business’ ability to survive financial challenges. The success or failure of working capital finance lies in working capital management, which determines how the relationship between short-term assets and short-term liabilities fosters benefits for a company.

Understanding the definition of working capital involves a certain amount of knowledge in the finance world, especially when considering working capital factoring and working capital calculation. The formula to calculate working capital is current assets minus current liabilities equals working capital. Take the time to understand working capital key terms:

1. Get a clear understanding of basic working capital calculation terms.

2. Find a predictor of future working capital needs.

3. Delve into more key terms for working capital comprehension

 

Understand basic working capital calculation terms

The working capital formula is a measure of assets available to overcome financial challenges. The basic formula for working capital is current assets minus current liabilities. Current assets refer to cash or any asset easily turned into cash. Current liabilities include near future expenses or money owed. This formula yields an absolute value for working capital, which does not help predict working capital needed to succeed.
Try: Citizens Bank provides a brief explanation with a working capital calculator. For a comprehensive list of balance sheet ratios with analysis, take a look at the University of Wisconsin Center for Cooperatives site.

Use current ratio results as a predictor of future working capital needs

If you are looking for a predictor of ideal working capital needed to succeed, pay attention to the term current ratio. Current ratio calculations show the ability of a business to pay current liabilities with current assets. The formula for this future-predicting ratio is total current assets divided by total current liabilities.
Try: First Research provides current ratio information plus other terms used when working with working capital. Accountant Site provides a calculator to help you determine the amount of work capital you need for the following year and working definitions.

Wrap up with a few more working capital terms

Finally, a couple of key terms to wrap up small business working capital basics include inventory turnover ratio and cash flow. Inventory turnover ratio reflects the company's ability to turn inventory into cash assets. Cash flow is as simple as it sounds. It is the movement or flow of money into and out of your business.
Try: College-Cram.com provides a description of inventory turnover ratio with a tutorial to work through calculations, and NetMBA.com gives a list of working capital financing ratios explaining inventory turnover ratio too. For an explanation and examples of calculating cash flow ratios, see The Motley Fool.

 

• Know that the premise of the working capital formula rests on the belief that a business will liquidate all assets to pay liabilities and these assets are readily available for liquidation.

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