Working capital is a “measure of a company’s efficiency and its short term financial health” (Ivestopedia, 2008). To calculate a company’s working capital subtract its current liability from its current assets. Current assets include cash, accounts receivable, and inventory on hand. “Working Capital gives investors an idea of a company’s underlying operational efficiency” (Investopedia, 2008). A positive working capital ensures that a company can pay its debts. A negative working capital is a sign that a company is in trouble. It might need short term financing to borrow funds to run its day-to-day operations or might even lead to bankruptcy. A company’s working capital policy would establish the amount of accounts receivable permitted, the amount of acceptable inventory on hand, and the amount of short term financing or internal resources needed for day-to-day operations. A company with a poor working capital policy in relation to A/R might let its A/R (accounts receivable) get too high and the company might be need of a short term loan itself until it collects monies owed. Another example would be companies that experience seasonal highs and lows. These companies need a working capital policy that provides adequate funds for extra raw materials or supplies for the busy season, hoping to make enough money carry them through the lean season (Thompson, Jordan, 2001).
Thompson, R., Jordan, C. W. 'Fundamentals of Corporate Finance', 2nd edition, 2001, 466-499. Retrieved on August 16, 2008 from http://www.unixl.com/dir/business_and_economy/finance/business_financing/short_term_financing/ “Working Capital” Investopedia 2008. Retrieved on August 16, 2008 from http://www.investopedia.com/terms/w/workingcapital.asp