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Introduction to Working Capital
Working Capital
Finance Textbooks Boundless Finance Introduction to Working Capital Working Capital
Finance Textbooks Boundless Finance Introduction to Working Capital
Finance Textbooks Boundless Finance
Finance Textbooks
Finance
Concept Version 5
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Importance of Working Capital

Working capital (WC) is a measurement of a company's operating liquidity.

Learning Objective

  • Discuss why working capital is important to businesses


Key Points

    • WC is important for large companies' ability to borrow, increase their share price, pay expenses and short-term debts.
    • WC is important for small companies that cannot access financial markets to borrow, and for start-ups that need to survive until they break even.
    • WC cannot guarantee whether a company is financially sound, but it gives some insight.

Terms

  • operating liquidity

    The ability of a company or individual to quickly convert assets to cash for the purpose of paying operating expenses.

  • working capital

    A financial metric that is a measure of current assets of a business that exceeds its liabilities and can be applied to its operation.


Full Text

Working capital (WC) is an important metric for all businesses, regardless of their size. WC is a signal of a company's operating liquidity . Having enough WC means that the company should be able to pay for all of its short-term expenses and liabilities.

Cash

Liquidity is a measurement of a company's ability to quickly turn assets into cash.

Large companies pay attention to WC for the same reason as small ones do: WC is a measure of liquidity, and thus is a measure of their future credit-worthiness. Companies who want to borrow by issuing bonds or purchasing commercial paper (a market of large, short-term loans for big companies) will find it more expensive if they do not have enough WC. If they are a public company, their stock price may fall if the market doesn't believe they have adequate WC.

For small businesses and start-ups, unable to access financial markets for borrowing, WC has more dire implications. WC can also be described as the amount of money that a small business or start-up needs to stay in operation. Start-ups need to pay attention to their WC because it is the amount of money they need to keep the business running until they break-even (start earning a net profit).

On one hand, WC is important to because it is a measure of a company's ability to pay off short-term expenses or debts. On the other hand, too much working capital means that some assets are not being invested for the long-term, so they are not being put to good use in helping the company grow as much as possible.

WC is only one measure of a company's operating liquidity. It is not the only measure, and it is certainly not a guarantee of a company's ability to pay. A company may have positive WC, but not enough cash to pay an expense tomorrow. Similarly, a company may have negative WC, but may be able to adjust some of their debt into long-term debt in order to reduce their current liabilities.

WC is an important metric, but is not the whole story of a company's financial health.

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