What is working capital and why is it important?

What is working capital and why is it important?

• A. Working capital = Current assets − Current liabilities; indicates short-term liquidity and operating efficiency.
• B. Working capital = Total assets − Total liabilities.
• C. Working capital = Net income.
• D. Working capital = Cash plus fixed assets.

Answer: (A)

Working capital is a measure of a company’s ability to pay its short-term obligations with its short-term assets. It’s calculated as current assets minus current liabilities. This matters because it shows the liquidity available to cover day-to-day operating needs like inventory purchases, payroll, and supplier payments. A positive number means there’s a cushion to fund operations in the near term, while a negative number suggests potential cash-flow concerns. The idea is tied to the operating cycle: you want enough assets that can be converted to cash relatively quickly to meet bills as they come due. This concept is not about profitability or long-term solvency; it’s about whether the business can keep operating smoothly in the near future. Other options don’t fit because they describe different things: total assets minus total liabilities equals owners’ equity, not working capital; net income is profit over a period; cash plus fixed assets includes noncurrent assets and doesn’t reflect short-term obligations.

Working capital is a measure of a company’s ability to pay its short-term obligations with its short-term assets. It’s calculated as current assets minus current liabilities. This matters because it shows the liquidity available to cover day-to-day operating needs like inventory purchases, payroll, and supplier payments. A positive number means there’s a cushion to fund operations in the near term, while a negative number suggests potential cash-flow concerns.

The idea is tied to the operating cycle: you want enough assets that can be converted to cash relatively quickly to meet bills as they come due. This concept is not about profitability or long-term solvency; it’s about whether the business can keep operating smoothly in the near future.

Other options don’t fit because they describe different things: total assets minus total liabilities equals owners’ equity, not working capital; net income is profit over a period; cash plus fixed assets includes noncurrent assets and doesn’t reflect short-term obligations.