How to Calculate Working Capital Through Your Balance Sheet
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Working capital is something that is constantly changing. Due of this, to calculate your current amount of working capital, you’ll need to review your balance sheet.
The Definition of Working Capital
Working capital is the amount of capital your business has that is uncommitted to paying off short-term liabilities. In other words, working capital is, quite literally, the amount of capital you have to work with.
As you probably know, working capital is inherently valuable to your business. Of course, your business should strive to have as much working capital as possible. With more working capital, your organization will have a greater supply of assets that you can either use, save, or sell.
Calculating Working Capital
Considering its widespread usefulness, the formula for working capital might seem surprisingly simple.
Working Capital = Current Assets – Current Liabilities
Both current assets and liabilities can be found directly on your company’s balance sheet. Contrary to your income statement, your balance sheet is a “snapshot” in time, and the numbers are constantly changing. Every time your business changes its amount of currents 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 (things that will be converted into cash within the next 12 months). Examples of current assets include cash, accounts receivable, inventory, and commercial paper.
The term current liabilities is the amount you currently need to pay to your creditors within the next 12 months. Examples of current liabilities include operating expenses, taxes, and accounts payable.
Your business’ current amount of working capital can be changed in multiple ways. 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 working capital will decrease.
The Usefulness of Working Capital
Many business owners believe that working capital is one of the most useful (and simple) figures that can be extracted from a balance sheet. Understanding the meaning of working capital can help your company make important decisions such as:
- How to adjust your level of capital use in response to changes in the business cycle (this is especially useful for seasonal retailers).
- If you should apply for a loan.
- Understand the potential risks and rewards of making any operational changes.
Why Working Capital Matters
There are numerous formulas that you can extract from your business’ balance sheet or income statement. Yet, despite the continuous development of new formulas, working capital is something that has maintained its usefulness.
Because working capital is derived from current assets and liabilities, it is much more useful for short-term decision-making than using your total assets and liabilities Working capital is incredibly helpful to businesses that need to make choices they regarding their business’s finances.
Though working capital obviously shouldn’t be the only financial metric your business reviews, it’s still beneficial to seemingly every type of business. Hopefully, now you understand how to calculate working capital utilizing a balance sheet!
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