Overview
Working Capital is usually defined as current assets minus current liabilities. In accounting parlance, current assets are cash or assets that will be converted to cash within a year, and current liabilities are the portion of a firm's liabilities that are due within a year. (or current operating cycle)
As a general rule, the primary reason for holding current assets like cash, is to be able to pay current liabilities as they come due, or to be able to pay for additional investments that are deemed necessary. In other words, a firm needs cash to pay its bills, so it will want to hold a buffer of cash or assets easily converted into cash in order to meet those obligations.
Factors Affecting Working Capital Needs
- Business Cycle: An expanding economy typically causes company's to need more working capital, as they often try to capitalize on the economic growth through increasing sales.
- Product Seasonality - products that have a dependency on the season may also mean that a company's working capital needs are then tied to the season.
- Operating Cycle - the amount of time that is required to produce a new unit of a firms product and then to sell the product affects the need for working capital. When the cycle is long, working capital gets tied up in inventory and my not be able to be converted to more liquid assets quickly.
Management
- Liquidity Risk: refers to the amount of assets that the company has that represent liquid (able to be turned into cash quickly) assets that can be used to pay upcoming liabilities.
- Inventory Management: a key concern of working capital management is the management of inventory. Companies must balance the need to have quick access to inventory against the need to have liquidity to meet their obligations.
- Operating Cycle Mapping
- Working Capital Finance - ways to manage working capital through financial means.