Working capital

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Working capital is a valuation metric that is calculated as current assets minus current liabilities. Working capital is also known as operating capital. A most important value, it represents the amount of day-by-day operating liquidity available to a business. A company can be endowed with assets and profitability, but short of liquidity if these assets cannot readily be converted into cash. See Working capital management, under Corporate Finance.

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 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.

Any change in the working capital has an effect on the cash flow into or away from the business. A positive change in working capital means that the business has pumped in cash for inventory, to pay off creditors (accounts payable) etc. Hence, an increase in working capital has a negative effect on cash flow. However, a negative change in working capital will mean lower funds to pay off short term liabilities (current liabilities) which will have bad repercussions to the future of the company. So, working capital is the most sensitive part of a business.