How is working capital defined?

Working capital is defined as the difference between current assets and current liabilities. This metric is crucial for assessing a company's short-term financial health and operational efficiency. Current assets are assets that are expected to be converted into cash or used up within a year, such as cash, accounts receivable, and inventory. Current liabilities, on the other hand, are obligations that the company expects to settle within the same timeframe, such as accounts payable and short-term debt.

By calculating working capital, businesses can understand their ability to cover short-term obligations with their short-term assets. A positive working capital indicates that a company can easily pay off its current liabilities with its current assets, which is a sign of financial stability and operational efficiency. Conversely, a negative working capital can point to potential liquidity problems, where the company may struggle to meet its obligations.

Understanding this definition helps in analyzing the overall financial position of a company and assessing its capacity to manage day-to-day operations effectively.