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Liquidity And Working Capital

Working capital is the amount of money a firm has available, to pay its bills each day. Working capital does not include money used to buy fixed assets (machinery and equipment). Money used to buy fixed assets is called capital expenditure.

Working capital diagram
This diagram explains how to calculate the working capital for a business

What is Working Capital Used For?

Working capital is used to pay for things like:

  1. Stock
  2. Materials
  3. Wages/Salaries
  4. Telephone Bills
  5. Heating Bills
  6. Water Bills
  7. Business Rates
  8. Broadband
  9. Rent Payments

Why Is Liquidity Important

Businesses need to ensure that they have enough money or liquidity to pay for their daily bills. If a business does not have sufficient liquidity it may face eviction, utilities being cut off, no stock and loss of reputation or worse still closure. Businesses can be making a profit but still be forced to close if they do not have enough money to cover their daily activities and bills.

How Do You Calculate Working Capital?

Working capital is the difference between the money your business has and the amount of money it has to pay.

Working Capital = Current Assets - Current Liabilities

When people are analysing the financial strength of a firm they may review working capital ratios to assess how much working capital is available for every dollar/pound of liabilities (bills). Remember what a "healthy" working capital ratio is will vary by industry.

Working capital ratios are called the Current Ratio and the Acid Test Ratio. Our article about Liquidity Ratios explains how to calculate the working capital ratio for a company.

How Does Knowing The Working Capital Help?

Once a business knows what its working capital is, it can plan how to deal with it. If a business does not have enough money to cover its bills (ie a working capital deficit) it may apply for a loan to cover the deficit especially if it feels that it will generate enough money to cover the loan repayment. However if a business knows that it is unlikely to cover the deficit in the future it may decide to stop trading.

Working Capital/Liquidity Ratios | Cashflow Analysis


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