Thursday, 3 August 2017

Investopedia/Ryan C. Fuhrmann: How do you calculate working capital?


How do you calculate working capital? By Ryan C. Fuhrmann, CFA | Updated April 9, 2017 — 9:21 PM EDT

Answer:

Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining the proper category for the vast array of assets and liabilities on a firms’ balance sheet and deciphering the overall health of a firm in meeting its short-term commitments.

Current Assets

Current assets represent assets that a firm expects to turn into cash within one year, or one business cycle, whichever is less. More obvious categories include cash, cash and cash equivalents, accounts receivables, inventory, and other shorter-term prepaid expenses. Other examples include current assets of discontinued operations and interest payable. For the fiscal year ended December 31, 2016, the balance sheet of The Coca-Cola Company (KO) showed that the company's total current assets valued at $34.01 billion included cash and cash equivalents, short-term investments, marketable securities, accounts receivable, inventories, prepaid expenses, and assets held for sale.

Current Liabilities

In similar fashion, current liabilities are liabilities that a firm expects to pay within a year, or one business cycle, whichever is less. Examples include accounts payables, accrued liabilities, and accrued income taxes. Other current liabilities include dividends payable, capital leases due within a year, and long-term debt that is now due within the year. The Coca-Cola Company (KO) had current liabilities that comprised of accounts payable, accrued expenses, loans and notes payable, current maturities of long-term debt, accrued income taxes, and liabilities held for sale for the fiscal year ended December 2016. The value of the total current liabilities equaled $26.53 billion.

What Working Capital Means

A healthy business will have ample capacity to pay off its current liabilities with current assets. The current ratio is current assets divided by current liabilities and provides insight into working capital health at a firm. A ratio above 1 means current assets exceed liabilities, and the higher the ratio, the better. Using the information provided about KO above, the company's current ratio is:

$34.01 billion ÷ $26.53 billion = 1.28

A more stringent ratio is the quick ratio, which measures the proportion of short-term liquidity as compared to current liabilities. The difference between this and the current ratio is in the numerator, where the asset side includes cash, marketable securities, and receivables. The key item it excludes is inventory, which can be more difficult to turn into cash on a shorter-term basis.

The Bottom Line

The formula for calculating working capital is straightforward, but lends great insight into the shorter-term health of a firm. The quick ratio is an even better indicator of shorter-term liquidity and can be important for suppliers and lenders to understand as well as for investors to assess how a company can handle short-term obligations.
RELATED FAQS

    What are some examples of current liabilities?
    Examine some common examples of current liabilities a company may owe within a year or less in order to accurately assess ... Read Answer >>
    What are the main differences between the current ratio and the quick ratio?
    Find out how the quick ratio and the current ratio can offer different views on a company's ability to pay off liabilities. Read Answer >>
    How are accounts payable listed on a company's balance sheet?
    Find out how accounts payable is listed on a company's balance sheet, why it is considered a current liability, and how it ... Read Answer >>
    How do I calculate current liabilities in Excel?
    Learn what current liabilities are and examples of a company's current liabilities, and find out how to calculate total current ... Read Answer >>
    Do working capital funds expire?
    Find out how and why a company's working capital can change over time, though the fund does not actually expire, and how ... Read Answer >>
    What does the cash ratio of a company measure, and how does it affect decision making?
    Learn what the cash ratio of a company measures, and understand why its an important liquidity ratio for a company to use ... Read Answer >>

Related Articles

    Investing
    Current Liabilities
    Current Liabilities are company debts due within one year or one operating cycle, whichever is greater. An operating cycle is the time it takes a company to purchase inventory and convert it ...
    Investing
    Reviewing Liabilities On The Balance Sheet
    As an experienced or new analyst, liabilities tell a deep story of how a company finances, plans and accounts for money it will need to pay at a future date.
    Investing
    Liquidity Measurement Ratios
    Learn about the current ratio, quick ratio, cash ratio and cash conversion cycle.
    Investing
    Do Your Investments Have Short-Term Health?
    If a company is strong enough to survive tough times, it is more likely to provide long-term value.
    Investing
    Reading the Balance Sheet
    Learn about the components of the statement of financial position and how they relate to each other.
    Investing
    What is the Cash Ratio?
    The cash ratio is the ratio of a company's total cash and cash equivalents to its current liabilities.
    Investing
    How to Analyze a Company's Financial Position
    Find out how to calculate important ratios and compare them to market value.
    Investing
    Understanding Coca-Cola's Capital Structure (KO)
    Since the crisis of 2008 and the implementation of an accommodative monetary policy by the Fed, Coca-Cola's capital structure has significantly shifted.

RELATED TERMS

    Current Liabilities
    A company's debts or obligations that are due within one year. ...
    Liability
    Liabilities are defined as a company's legal debts or obligations ...
    Total Liabilities
    The aggregate of all debts an individual or company is liable ...
    Long-Term Liabilities
    In accounting, a section of the balance sheet that lists obligations ...
    Other Current Liabilities
    A balance sheet entry used by companies to group together current ...
    Current Assets
    A balance sheet account that represents the value of all assets ...

Trending

    The Trump Economy: News and Analysis
    Who is Anthony Scaramucci?
    Announcing the Top 100 Most Influential Financial Advisors
    Which Income Class Are You?
    Investopedia's Guide to Impact Investing

Hot Definitions

    Total Return Swap
    Value Investing
    Return On Assets - ROA
    Efficient Market Hypothesis - EMH
    Overdraft
    Stop Order

    Work With Investopedia
    About Us Advertise With Us Write For Us Contact Us Careers

© 2017, Investopedia, LLC. Feedback All Rights Reserved Terms Of Use Privacy Policy
Post a Comment