Working capital is a measure of liquidity of a business. It equals current assets minus current liabilities.
|Working Capital = Current Assets − Current Liabilities|
Current assets are assets that are expected to be realized in a year or within one operating cycle.
Current liabilities are obligations that are required to be paid within a year or within one operating cycle.
If current assets of a business at the point in time are more than its current liabilities the working capital is positive, and this tells that the company is not expected to suffer from liquidity crunch in near future. However, if current assets are less than current liabilities the working capital is negative, and this communicates that the business may not be able to pay off its current liabilities when due.
- Company A has current assets of USD 5 million and current liabilities of USD 3 million. Its working capital is USD 2 million (USD 5 million minus USD 3 million).
- Company B has current ratio of 1.5 and its current liabilities are USD 80 million. Since current ratio is equal to current assets minus current liabilities we can calculate current assets by multiplying current ratio with current liabilities (USD 80 million*1.5=USD 120 million). Current liabilities are USD 80 million hence working capital is USD 120 million minus USD 80 million which equals USD 40 million.