Also known as ‘net current assets’, working capital is the total of a firm’s current, or short term, balance sheet assets minus all current liabilities (often shown as ‘creditors: amounts falling due within one year’). So, with stock of £2m, debtors of £2.5m, short term investments of £1.5m, cash of £1m and short-term creditors of £3m, working capital is £4m (2 + 2.5 + 1.5 + 1 – 3).
Most businesses need working capital in order to trade and expand. Too much, however, can indicate inefficiencies, perhaps arising from overly generous credit terms given to customers, carrying too much stock or a lack of control over suppliers (poor ‘supply-chain management’). Indeed many of the smaller, fastest growing companies that eventually go bust do because they have focused on sales growth at the expense of proper working capital management.