working capital

Domestic credit to private sector in 2005

Working capital (also known as net working capital) is a financial metric which represents the amount of day-by-day operating liquidity available to a business. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. It is calculated as current assets minus current liabilities. A company can be endowed with assets and profitability, but short of liquidity, if these assets cannot readily be converted into cash.

Current assets and current liabilities include three accounts which are of special importance. These accounts represent the areas of the business where managers have the most direct impact:

• accounts receivable (current asset)
• inventory (current assets), and
• accounts payable (current liability)

In a situation where a company carries more cash than the mininum amount needed to maintain operations, the excess portion is usually excluded from working capital.

In addition, the current (payable within 12 months) portion of debt is critical, because it represents a short-term claim to current assets. Common types of short-term debt are bank loans and lines of credit.

A positive change in working capital indicates that the business has either increased current assets (that is received cash, or other current assets) or has decreased current liabilities, for example has paid off some short-term creditors.

Implications on M&A: The common commercial definition of working capital for the purpose of a working capital adjustment in an M&A transaction (ie for a working capital adjustment mechanism in a sale and purchase agreement) is equal to:

Current Assets - Current Liabilities excluding deferred tax assets/liabilities, excess cash, surplus assets and/or deposit balances.

Cash balance items often attract a one-for-one purchase price adjustment.

See also

• Working capital management

External links

• Investopedia: Working Capital
• Accounts Receivable as Collateral
• Finding capital for international trade

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