Working Capital

This chapter presents an overview of working capital: how a company manages its current assets and current liabilities. Working capital decisions are the day-to-day decisions all companies must make to keep their operations running. While they may not seem as critical as stock issues and capital budgeting, the reality is that poor short-term management is a leading reason why businesses fail. Understanding these concepts is essential for everyone in an organization.

Importance of Working Capital

Working capital (WC) is a measurement of a company’s operating liquidity.



Learning Objectives

  • Discuss why working capital is important to businesses

Key Takeaways

Key Points

  • WC is important for large companies’ ability to borrow, increase their share price, pay expenses and short-term debts.
  • WC is important for small companies that cannot access financial markets to borrow, and for start-ups that need to survive until they break even.
  • WC cannot guarantee whether a company is financially sound, but it gives some insight.

Key Terms

  • operating liquidity: The ability of a company or individual to quickly convert assets to cash for the purpose of paying operating expenses.
  • working capital: A financial metric that is a measure of current assets of a business that exceeds its liabilities and can be applied to its operation.
Working capital (WC) is an important metric for all businesses, regardless of their size. WC is a signal of a company’s operating liquidity. Having enough WC means that the company should be able to pay for all of its short-term expenses and liabilities.


Cash: Liquidity is a measurement of a company’s ability to quickly turn assets into cash.

Large companies pay attention to WC for the same reason as small ones do: WC is a measure of liquidity, and thus is a measure of their future credit-worthiness. Companies who want to borrow by issuing bonds or purchasing commercial paper (a market of large, short-term loans for big companies) will find it more expensive if they do not have enough WC. If they are a public company, their stock price may fall if the market doesn’t believe they have adequate WC.

For small businesses and start-ups, unable to access financial markets for borrowing, WC has more dire implications. WC can also be described as the amount of money that a small business or start-up needs to stay in operation. Start-ups need to pay attention to their WC because it is the amount of money they need to keep the business running until they break-even (start earning a net profit).

On one hand, WC is important to because it is a measure of a company’s ability to pay off short-term expenses or debts. On the other hand, too much working capital means that some assets are not being invested for the long-term, so they are not being put to good use in helping the company grow as much as possible.

WC is only one measure of a company’s operating liquidity. It is not the only measure, and it is certainly not a guarantee of a company’s ability to pay. A company may have positive WC, but not enough cash to pay an expense tomorrow. Similarly, a company may have negative WC, but may be able to adjust some of their debt into long-term debt in order to reduce their current liabilities.

WC is an important metric, but is not the whole story of a company’s financial health.