Activity Ratio: Working Capital

Working capital is the difference between a company's current assets and current liabilities.

It measures a company's short-term financial health and ability to cover day-to-day operations.

A positive working capital means a company has enough assets to meet its short-term liabilities.

Alternatively, a negative working capital indicates potential liquidity problems, as the company may struggle to pay off immediate obligations.

Consider Freshly, a small grocery store with an inventory worth fifty thousand dollars as current assets.

Its current liabilities include "Payments due to vendors" of twenty thousand dollars in accounts payable and loan payments of fifteen thousand dollars due within the next few months.

In this case, to calculate Freshly's working capital, its current liabilities will be deducted from its current assets, amounting to fifteen thousand dollars.

This positive working capital indicates that the business is financially stable in the short term, with enough resources to pay its current liabilities and continue operations without external funding.

Proper management of working capital is crucial for ensuring smooth business operations.