WORKING CAPITAL

• Amount of capital used to meet day to day expenses
• Example of expenses:
• Purchase of inventories
• Pay to trade payables
• Wages

HOW TO CALCULATE WORKING CAPITAL

• Current assets - current liabilities

WHAT HAPPENS IN CASE WORKING CAPITAL NOT SUFFICIENT

• Customer goodwill is lost
• Insufficient cash to pay for daily expenses, such as rent, utility bills
• Firm can’t pay promptly to trade payables; unable to benefit from cash discounts

WORST CASE SCENARIO

HOWEVER

Is negative working capital = insolvency ?

THE ANSWER IS nO

• Can mortgage and raise level of current assets
• Can sell some of equipment

HOW CAN WORKING CAPITAL INCREASE?

• Profit from business operations
• Sale of non current assets
• Additional fund by owner
• Long term borrowing

FACTORS CAUSING A DECREASE IN WORKING CAPITAL

• Loss from business operations
• Purchase of non current asset
• Withdrawal by owner
• Payment of dividend to shareholders

CONFLICT BETWEEN PROFITABILITY AND LIQUIDITY

• Large working capital May appear to be good sign of liquidity yes, but,
• Excess working capital = idle resources, hence low investments = low profit in long run
• High liquidity must not equal to low profit in the Long run
• ( read on disadvantage of excessive working capital)

BUSINESS STRENGTH

VERY IMPORTANT

USERS OF RATIOS

Untitled Slide

• Owner- assess performance (trend analysis)
• Managers ( performance in department)
• Trade payables ( to assess credit worthiness of the business, solvency and liquidity)
• Banks and financial institutions ( ability to pay interest on any possible loan)
• Potential investors
• Tax authorities (if paying right amount of tax)
• Competitors ( compare performance and find new strategies if needed)

WORKING CAPITAL