Working Capital Formula

Working Capital Formula (Table of Contents)

• Working Capital Formula
• Working Capital Calculator
• Working Capital Formula in Excel (With Excel Template)

Working Capital Formula

The excess of current assets over current liability is known as working capital. Liabilities and assets which are short-term in nature are required in day to day business activities. When a business managers short-term liability from short-term assets, the procedure is known as a working capital cycle.

Here’s the Working Capital Formula –

From working capital, we can get away with an idea regarding the scenery of the business or, in other words, how effectively the particular business is going. So, it is a reflection of the short-term liquidity of the particular company and the degree of operational efficiency can we measure on the basis of a higher current asset over current liabilities.

Constituents of Current Assets

• Current investments
• Cash
• Inventories
•  Trade receivables
• Bank balance
•  Short term loans and advances
•  Other current assets

Constituents of Current Liabilities

• Short-term borrowings
• Trade payables
• Other current liabilities
• Short-term provisions.

Example of Working capital Formula

The Balance Sheet of Tata Steel is presented as follows:

The Working Capital of Tata steel at that point in time would be

• Working Capital= Current Assets – Current Liabilities
• Working Capital = INR (34643.91 – 25607.34)
• Working Capital = INR 9036.57

Explanation of Working Capital Formula

• A working capital formula is extensively used in a business to meet short-term financial obligations or short-term liabilities.
• Positive net working capital is resultant when a company has enough current assets over its current dues. On the other hand, if the company is unable to produce positive working capital, then the company has to take its excess liabilities such as higher short-term borrowings, higher accounts payable, etc.
• Another striking formula of each analyst inspect is the operating working capital which is accounts receivable class inventory minus accounts payable.
• Thus, in spite of looking at each and every current asset, one may have a look at the accounts receivable and inventory value along with the accounts payable. Thus, the financial health of the particular company can be fairly understood when it shows a positive value.
• Having a positive working capital, it indicates a healthy sign of short-term financial health of the particular business as it has enough liquid assets after repairing its short-term bills, and internally the financial health of the particular company would help to grow its business and its assets.
• Without additional working capital, a company has to borrow additional funds from a bank loan or from a financial institution then it will hinder the working capital as the current borrowings will come under current liabilities, and hence the net working capital will reduce.
• So, in other words, it can be integrated that a business is not strong enough to meet its short-term liabilities from its short-term assets. Thus, there is always a requirement of short-term borrowings from a third party and which can be interpreted as a negative sign for the business. Short-term borrowings would lead to higher interest costs, and it will affect profitability and margin. So, in most of the business which is capital intensive in nature does have negative working capital or very low working capital and the profitability and the margin is very low compared to assets light businesses.
• Negative working capital suggests that the assets of the particular business are not effectively used, and it may lead to a liquidity crisis.
• If a company has used fixed assets such as Land properties buildings long-term investments, but there is a cash crunch because of higher short-term liabilities, then also the company will face a liquidity crisis, and hence it will force to take short-term borrowings.
• A late payment to creditors will result in higher accounts payable, and delay in the entire process will result in lower working capital, and ultimately it will hinder the corporate credit rating of the particular business.

Significance and Use of Working Capital Formula

Working capital is extensively used in analyzing different companies within the same sector.

An FMCG business would have relatively Lee higher working capital compared to a steel manufacturing business because of steel manufacturing request plants and machinery, which are relatively costly than the manufacturing plants of FMCG. So, in spite of having higher assets, the business would require borrowing from banks and other financial institutions, and hence it will create higher interest costs.

Show the margin of steel plants business is generally lesser compared to an FMCG company.

From working capital, one can have a fair idea about the current assets and the current liabilities of a particular business.

If a business is generating enough cash flows, then a part of that cash flow will be invested in current investments, which are short-term in nature, and long-term investments, which is for long-term investing purposes.

Short-term investments can be utilized when there is a requirement for additional liquidity within the business due to a spike in current liabilities.

Cash and Bank balances generally don’t contain any interest receipt due to short-term in nature. Trade receivables generally happen to be a certain portion of the Revenue. So higher trade receivable suggests there is a chance of bed date in future if the business scenario is not favored for the company. On the other hand, trade payables r generally credit given by the supplier.

Working Capital Calculator

You can use the following Working Capital Calculator

Working Capital Formula in Excel (With Excel Template)

Here we will do the same example of the Working Capital formula in Excel. It is very easy and simple. You need to provide the two inputs i.e. Current Assets and Current Liabilities

You can easily calculate the Working Capital using the Formula in the template provided.

We need to calculate Working Capital using Formula, i.e. Working Capital= Current Assets – Current Liabilities.

Conclusion:

A working capital formula determines the financial health of the business, and it suggests how the profitability can be increased in the future through the current ratio, which we get by dividing current assets by current liabilities. The ideal ratio should be 2 is to 1 in the case of manufacturing companies. However, a capital-intensive company will have a different ratio, and in the case of negative working capital, the ratio might reverse in most cases. The day-to-day operations can be determined by the Working capital formula, i.e. the excess of Current Assets over Current Liabilities.

Recommended Articles

This has been a guide to a Working Capital formula. Here we discuss its uses along with practical examples. We also provide you with Working Capital Calculator with a downloadable excel template. You may also look at the following articles to learn more –

1. Guide to Working Capital Projections
2. Private equity vs Venture capital – Comparison
3. Guide to Gross Profit Margin Formula
4. Guide to Working Capital Example