Working capital is the amount of a company’s current assets minus the number of its current liabilities. The formula for working capital is Current Assets – Current Liabilities. Apart from the investment in fixed assets every business organization needs to invest in current assets.
The working capital ratio (Current Assets/Current Liabilities) indicates whether a company has enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C (working capital). While anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient. Also known as “net working capital”.
Sales – There is a direct link between the working capital and the scale of operations. In other words, more working capital is required in case of big organizations while less working capital is needed in case of small organizations.
Technology and production policy – If a company is using labor-intensive technique of production then more working capital is required because company needs to maintain enough cash flow for making payments to labor whereas if company is using machine-intensive technique of production then less working capital is required because investment in machinery is fixed capital requirement and there will be less operative expenses.
Inflation – Inflation means a rise in prices. In such a situation more capital is required than before in order to maintain the previous scale of production and Sales. Therefore, with the increasing rate of inflation, there is a corresponding increase in the working capital.