Current assetscurrent liabilitiescurrent ratioquick ratio

Working capital: What is it? Is it important to know?

Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining the proper category for the vast array of assets and liabilities on a firms’ balance sheet
and deciphering the overall health of a firm in meeting its short-term commitments.

Current Assets:

Are assets that a firm expects to turn into cash within one year, or one business cycle, whichever is less. More obvious categories include cash, cash and cash equivalents, accounts receivables, inventory, and other shorter-term prepaid expenses. Other examples include current assets of discontinued operations and interest payable.

Current Liabilities:

Are liabilities that a firm expects to pay within a year, or one business cycle, whichever is less. Examples include accounts payables, accrued liabilities, and accrued income taxes. Other current liabilities include dividends payable, capital leases due within a year, and long-term debt that is now due within the year.

Significance:

A healthy business will have ample capacity to pay off its current liabilities with current assets.

The ratios which are used to gauge working capital significance are :

1) Current ratio: Current ratio is current assets divided by current liabilities and provides insight into working capital health at a firm. A ratio above 1 means current assets exceed liabilities.
The higher the ratio, the better.

2) Quick ratio: A more stringent ratio is the quick ratio, which measures the proportion of short-term liquidity as compared to current liabilities. The difference between this and the current ratio is in the numerator, where the asset side includes cash, marketable securities, and receivables. The key item it backs out is inventory, which can be more difficult to turn into cash on a shorter-term basis

The higher the ratio, the better.












Leave a Reply

Your email address will not be published. Required fields are marked *