There is need for every investor to calculate the investment working capital of their business. Having established that fact, let us break things down such that even a newbie can get an idea of what an investment working capital is all about, and how to calculate it as well.
Note that this is just to give you an idea of what investment working capital entails, and as such, this is not a full comprehensive training on the topic. It is more like a summary.
WHAT IS AN INVESTMENT WORKING CAPITAL?
An investment working capital is the difference between the current assets and current liabilities of a company.
Current assets are all the investments expected to be turned into cash in about a year’s time from the start of the business cycle. It include
- Cash equivalence
- Account receivables
- Short term prepaid expenses
- Assets held for sale
A very notable feature of assets of all kind is that they are highly liquid in nature. This makes it possible to be converted to cash on demand
Current liabilities are any business deal that is expected to be paid for within about a year. They are the exact opposite of current assets. They include
- Accrued income taxes
- Capital annual leases
- Dividends payable
- Accrued income
- Accounts payable
- Liabilities for held for sale
Now that we have an idea of what an investment working capital is all about, let us answer this very important question; what is the essence of it all? “How can a firm benefit from investment working capital calculations?”
The answer to that question is simple to be able to tell if a business is healthy or not. A company with shinny glasses and luxurious finishes is not a pointer to how healthy it is.
This calculation is one of the ways to know if a business is really doing well or not. For instance, a healthy company will have ample capacity to pay off the value of its current liabilities with current assets, without having to rely on the working capital.
HOW TO CALCULATE WORKING CAPITAL FROM A BALANC SHEET
The balance sheet of any firm displays a whole lot of information, basically about the activities of that firm, in a way that their investors can clearly see. From all such information, the working capital of that company can be calculated. All that would be needed are the value of the current assets and that of the current liabilities.
CURRENT ASSETS – CURRENT LIABILITIES = WORKING CAPITAL
This calculation can show the possibility for a financial difficulty in the future, depending on its results.
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.