What is working capital?

Working capital is defined as the difference between current assets and current liabilities. This measure is crucial for understanding a company's short-term financial health and operational efficiency. Current assets refer to assets that are expected to be converted into cash or used up within one year, such as cash, accounts receivable, and inventory. Current liabilities, on the other hand, are obligations that the company needs to settle within one year, such as accounts payable and short-term debt.

By calculating working capital, a business can assess its ability to pay off its short-term liabilities with its short-term assets. A positive working capital indicates that a company has sufficient assets to cover its current liabilities, suggesting good financial health and liquidity. Conversely, a negative working capital could signal potential financial trouble, as it implies that current liabilities exceed current assets.

This understanding of working capital is vital for managing small business finances, as it helps in making informed decisions regarding day-to-day operations, cash flow management, and overall financial strategy. Recognizing the distinction between current and long-term assets and liabilities also underlines how working capital is specifically focused on short-term financial positioning, making it a critical metric for businesses that require liquidity to sustain daily operations.