Sep 26, 2021 FINANCE 101

Working capital, the capital that companies use to fund their day-to-day operations, is critical to understanding operating cash-flows. While you might think of ­finance as associated only with debt and equity, ­finance is deeply embedded in the daily operations of a business.

Working Capital = Current Assets – Current Liabilities

While working capital is a general term for the difference between current assets and current liabilities, it usually emphasizes three important components: accounts receivable, inventory, and accounts payable.

Accounts receivable: Accounts receivable are amounts that customers, typically other businesses, owe a company. The dollar amount can be reframed as a receivables collection period, which shows the average number of days it takes for customers to pay the company.

Inventory: The goods, and the associated inputs, held by a company prior to sale all count toward inventory. Based on inventory, you can generate a days inventory, which shows the average number of days that the company holds inputs and goods.

Accounts payable: The amounts a company owes to suppliers are accounts payable. Based on that, you can generate a days payable, which indicates the average number of days the company takes to pay suppliers.

A slightly narrower way to de­ne working capital is:

Working capital = accounts receivable + inventories − accounts payable

One simple way to think about the consequences of working capital is to note that the daily operations of a company result in an amount that needs to be fi­nanced, like any other asset. If the amount of working capital is lowered, that lowers the ­financing needs of a corporation. So, the way you manage working capital has deep fi­nancial consequences

By thanhnambui

I am a bank employee specializing in trade finance- a field that is not directly linked to my university major in Financial Investment. However, with a passion for economics and finance, I determined to pursue a higher education degree and successfully achieved a Master in Economics of Banking and Finance from CFVG in 2019. During that study time, I encountered many difficulties in consolidating background knowledge studied at university, which made me realize the necessity of building foundation for effective learning outcomes. Therefore, my friend and I decided to create Econfin-Invest to record basic knowledge of economics, banking, finance, and investment fields. The articles I write are carefully selected and collected from a wide range of different reliable sources such as textbooks, economic and financial reports and relevant journals. Most importantly, these articles are not A to Z lectures of subjects related to the aforementioned fields, yet simply articles I consider to be accessible to all interested readers as well as being essential to apply in everyday practices. Thank you for reading and supporting!

One thought on “FIN101 #14 WORKING CAPITAL”
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