What is working capital 3

Working capital

Working capital, in German Working capital is a simple key figure that is used by companies in American accounting to measure and display changes in liquidity. Another name is Net working capitalthat the German term Net working capital corresponds to.

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Calculation of working capital

A company's working capital is calculated as the difference between current assets and current liabilities:

Current assets - current liabilities = working capital

A company's current assets include accounts receivable from customers and the company's inventories. Short term liabilities are primarily claims from suppliers for goods delivered, wages and salaries as well as claims from the tax office. For example, if a company has current assets of 100,000 euros and has to service short-term liabilities of 50,000 euros, this results in:

100,000 euros - 50,000 euros = 59,000 euros = working capital / working capital

The ratio of a company's current assets to current liabilities is called Working capital ratio or in German as Liquidity coefficient designated. In the example, the liquidity coefficient is 2: 1.

The changes in working capital are made for easier evaluation in a so-called Movement balance shown. In this movement balance, the increase in current assets and the decrease in the items of short-term liabilities are shown on the left. The opposite changes are entered on the right-hand side, i.e. the decrease in current assets and the increase in short-term liabilities for the respective period. An increase, i.e. an improvement in liquidity in the company, or a decrease, i.e. a deterioration in liquidity, can be read from the balance on both sides.

What is the significance of positive or negative working capital?

In contrast to other assets of a company, current assets can be quickly converted into cash. If the current assets are higher than the short-term liabilities, this results in a positive net working capital. This means that the company's net working capital is sufficient to service its short-term liabilities so that supplier invoices and wages and salaries can be paid. So that's that Working capital a direct measure of a company's solvency. A negative result of the calculation would mean that the current liabilities exceed the value of the current assets. The company may run into financial difficulties.

What options do companies have to increase working capital?

Companies can take various measures to increase working capital to ensure liquidity. This includes, for example, if enforceable, a Shortening the payment terms for customers. Another option is to finance the working capital with a bank loan. However, a bank loan means higher financing costs. Especially when a high level of working capital has to be financed with outside capital.

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