Working capital - What is it and how to calculate it?

Working capital or working capital represents the resources available to the company to meet its short-term payment obligations. 

What is the Working Capital Fund?

Working capital or working capital can be defined as the company's capacity in terms of resources to pay its debts in the short term.

Within the Balance Sheet or Statement of Financial Position, to calculate the working capital, it is necessary to focus on Current Assets and Current Liabilities, and to make calculations ranging from simple to increasingly complex estimates.

What is the Working Capital Fund used for?

The working capital is used for decision making, depending on the needs of the users of the information. 

• In the treasury area, the working capital is useful to organize the cash flow. In this last tool, it is essential to achieve an adequate estimate of the maximum terms that the company has to generate cash income or its equivalent, which must be used to meet the payment of obligations and other short-term debts, for example: payment of salaries, suppliers, taxes and fees for services, among others.

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• In the marketing area, working capital is useful for defining customer financing policies. For example: if an interest-free installment sales promotion is carried out, it is necessary to consider the impact that this decision may have on the company's income flow, with its corresponding effect on the calculation of working capital.

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• In the purchasing area, the working capital is useful for negotiating the financing that the supplier of inputs for the company can provide. For example: if the supplier offers a generous commercial discount for cash payment and the company accepts it without further ado, it is possible that, in the cash flow, the company does not have the necessary cash to meet the required payment.

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• In senior management, the calculation of working capital may be necessary when making business decisions that impact the company's finances in the short term.

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• The governing body needs to know the working capital to know if it can distribute profits in the short term without affecting the normal operation of the company.

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• Some third parties, such as suppliers, may need to know the company's working capital in order to rely on the provision of purchase financing.

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Related content

• Financial audit of a company
• Economic and financial management of a company

How to calculate it: Working Capital Formula

There are formulas of varying complexity for the calculation of working capital, depending on technical needs. 

Simple calculation of working capital

The Current Assets and Current Liabilities of the Balance Sheet are compared globally, without considering specific items.

Working Capital = Current Assets - Current Liabilities

Positive Working Capital: Current Assets > Current Liabilities

Fondo de Maniobra negativo: Activo Corriente < Pasivo Corriente

Simple calculation of the working capital in addition to the liquidity gap.

In addition to the traditional working capital formula, represented by the difference between Current Assets and Current Liabilities, there is another complementary formula that analyzes the time required to stabilize the working capital related to the company's main activity, and is called the Financial Gap or speed ratio in the cash cycle.

Calculation of the Working Capital by the Analytical Method

The working capital calculated by the analytical method allows the composition of the relevant elements of Current Assets and Current Liabilities to be adequately considered in the calculation.

Zero working capital:

Positive working capital:

Negative working capital:

Interpretation of working capital

The working capital may show a positive or negative result, or even a neutral balance.

Positive working capital

This result implies that the resources to meet short-term obligations are sufficient to pay short-term debts, and there are even excess resources. Maintaining a positive working capital, but leaving a large margin of idle resources, is not necessarily good for the company, because cash is not properly invested.

Negative working capital

This result implies that the resources to meet short-term obligations are insufficient to pay short-term debts, i.e., there are clear problems of current liquidity. 

If the working capital result is zero, it means that the company does not have surplus resources, but neither does it have any debts that cannot be paid in the short term. At a financial level, a zero working capital is ultimately a negative working capital, since there are no surpluses and, in the event of unforeseen events, the zero working capital can become negative.

How to improve the Working Capital of Companies?

There are a number of methods to improve working capital. Some can be achieved through business decisions and others depend on our third parties, with whom we must negotiate.

1 - Accelerate the Collections Cycle: to reduce the financial gap and keep the working capital balanced, it is better to have short collection cycles.

2 - Balance the Payment Cycle according to the Collection Cycle: if the collection cycles are long, the payment cycle cannot be short, because it generates liquidity problems; on the other hand, if the collection cycles are fast, but the payment cycles are too long, idle resources may be generated, unless they are adequately invested.

3 - Refinance Short-Term Debts to Long-Term: in this case, it is necessary to evaluate refinancing costs, and opt for medium-term debts at fixed rates, in order to reduce the impact of short-term debts on working capital, but without generating financial damage to the company.

4 - Efficiently manage the inventory: to avoid overstocking or stock-outs, but at the same time, achieving a balanced inventory cycle and reducing the financial gap.

5 - Look for financial alternatives: it is not always necessary to finance with suppliers, it is possible to buy from suppliers, but to finance with bank credits, with funds for SMEs, with subsidies for entrepreneurs, and even with tax moratoriums.

6 - Control dividend withdrawals: investors need to collect their dividends, which is the return on their investment in the company. However, massive withdrawals of cash or cash equivalents in a single month, for example, can cause serious drawbacks in the working capital.

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