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What Is Working Capital?
Working capital is defined as the difference between current assets and current liabilities. Current assets are the most liquid of your assets, meaning they are cash or can be quickly converted to cash. Current liabilities are any obligations due within one year. Working capital measures what is leftover once you subtract your current liabilities from your current assets, and can be a positive or negative amount. The working capital is available to pay your company's current debts, and represents the cushion or margin of protection you can give your short-term creditors.
Positive Working capital is essential for your company to meet its continuous operational needs. The availability of working capital influences your company's ability to meet its trade and short-term debt obligations, as well as to remain financially viable. If your current assets do not exceed your current liabilities, you run the risk of being unable to pay short term creditors in a timely fashion.
Businesses that are seasonal or cyclical often require more working capital to stay afloat during the off season. Although your company may make more than enough to pay all its obligations yearly, you must ensure you have enough working capital at any one time to meet your short term obligations. For example, a company may do significantly more business over the holidays, resulting in large payoffs at the end of the year. However, the company must have enough working capital to buy inventory and cover payroll during the off season as well, when revenues are lower.