Definition of Working Capital Example
Working capital is the capital that is required to meet the day-to-day working expenses of the company. It is also an investment in short-term assets. A working capital example is basically the excess between current assets over current liabilities. It is used as a measurement for determining the company’s liquidity and performance. Gross working capital is the investment in current assets while net working capital is the difference between current assets and current liabilities. It can be positive as well as negative
Examples of Working Capital (With Excel Template)
Let’s take an example to understand the calculation of Working Capital in a better manner.
Working Capital Example – #1
Let us look at a simple example that uses the balance sheet of Wells Fargo to calculate working capital
Working Capital is calculated as
Working Capital = Total Current Assets + Total Current Liabilities
- Working Capital = $1,45,000 + $60,000
- Working Capital = $85,000
The total current assets are $1,45,000 while total current assets are $60,000. Subtracting both of these gives us the working capital of $85,000. The company has a good amount of cash after it has paid all of its obligations. This means that the company is in a good financial position
In this example, as we can see the working capital is positive. This means that the company is able to pay off its short-term liabilities immediately. While negative working capital indicates the opposite.
We have here calculated working capital for a period of one year but it is also possible to calculate working capital for a month or a quarter
Working Capital Example – #2
Let us look at an example of Negative working capital. It is mainly possible in the retail sector. Let us look at one example of a major retail giant of the US, Walmart. Let us assume that Walmart buys 200,000 DVD’s and is expected to pay the movie studio in the span of the next 30 days. But it is obvious that Walmart will not wait for 30 days to put those DVDs on its shelf. It will put these DVD’s on the shelf once they receive the delivery.
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Assume that they sold all the DVDs by the 15th of the month. They have sold all the DVD’s and made a considerable amount of profit. They have done all before they paid the studio for the inventory
Now imagine that if Walmart is capable of pulling this off for one product it can do it for all of its products. In this case, it does not need cash on hand to pay for its accounts payable as new cash is constantly generated at various levels to cover for the dues. But an important point to note here is that the timing of the cash flows is a very crucial factor. This helps in maximizing its efficiency
One way to determine if the company is using this strategy is to check inventory with accounts payable. If the amount of accounts payable is high and working capital is high, this might be it.
Working Capital Example – #3
Below is the Balance sheet for a US-based organization. The balance sheet provided is for 2019 and 2018
Total Assets = Total Current Assets + Total non-Current Assets
For 2018
- Total Assets = $9,350 + $22,050
- Total Assets = $31,400
For 2019
- Total Assets = $10,800 + $22,800
- Total Assets = $33,600
Total Liabilities and Equity is calculated as
Total Liabilities and Equity= Total current liabilities + Total Long term liabilities + Common stock + Retained earnings
For 2018
- Total Liabilities and Equity= $7,500 + $6,300+ $10,500 + $7,100
- Total Liabilities and Equity= $31,400
For 2019
- Total Assets = $7,750 + $7,500 + $11000 + $7,350
- Total Assets = $33,600
Let us now calculate working capital for both the years –
Working Capital is calculated as
For 2018 & 2019
- Working Capital 2018 = $9350 – $7500 = $1850
- Working Capital 2019 = $10,800 – $7750 = $3050
Average Value of Working Capital is calculated as
- Average Value of Working Capital = ($3050 + $1850) /2
- Average Value of Working Capital = $2450
The large difference in working capital is mainly due to the significant increase in total current assets. Days in payables and receivables can be calculated using these statements and working capital
Working Capital Example – #4
Examples of real working capital companies are listed below
- Amazon: The main reason Amazon is surviving with this strategy is that customers pay upfront and have no difficulty in raising money
- Dell Computers: This is also a classic case of maintaining minimum inventory and extremely low working capital. Dell computers demand upfront payments from customers. This has not only reduced the working capital but also given an edge against its competitors
- McDonald’s: It is very common for any restaurant business to have negative working capital. McDonald’s business has been running on negative working capital since it more than a decade from 1992 to 2000. It had negative working capital as much as $698.5 million in between this period
Looking at the above examples it can be said that negative working capital is a sign of effective business management
Conclusion
Having positive working capital is a sign of good short term financial health and good liquidity. It means that the company has a sufficient amount of funds to cover for its short-term obligations. If the working capital is increasing it might lead to more borrowing and need to raise more money
On the other hand, negatively working capital may mean that assets are not being used effectively and the organization might be going through a liquidity crisis. However, having negative working capital is not always a bad sign. Huge companies as seen above like Walmart have negative working capital because of the continuous and fast inflow of cash
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