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Working Capital

Management
What is 'Working Capital Management'

Working capital management refers to a company's managerial accounting strategy designed


to monitor and utilize the two components of working capital, current assets and current
liabilities,, to ensure the most financially efficient operation of the company. The primary
liabilities
purpose of working capital management is to make sure the company always maintains
sufficient cash flow to meet its short-term operating costs and short-term debt obligations.

VIDEO
BREAKING DOWN 'Working Capital Management'

Working capital management commonly involves monitoring cash flow, assets and liabilities
through ratio analysis of key elements of operating expenses, including the working capital
ratio, collection ratio and the inventory turnover ratio. Efficient working capital management
helps with a company's smooth financial operation, and can also help to improve the
company's earnings and profitability. Management of working capital includes inventory
management and management of accounts receivables and accounts payables.

Elements of Working Capital Management

The working capital ratio, calculated as current assets divided by current liabilities, is
considered a key indicator of a company's fundamental financial health since it indicates the
company's ability to successfully meet all of its short-term financial obligations. Although
numbers vary by industry, a working capital ratio below 1.0 is generally indicative of a
company having trouble meeting short-term obligations, usually due to insufficient cash flow.
Working capital ratios of 1.2 to 2.0 are considered desirable, but a ratio higher than 2.0 may
indicate a company is not making the most effective use of its assets to increase revenues.
The collection ratio, also known as the average collection period ratio, is a principal measure of
how efficiently a company manages its accounts receivables. The collection ratio is calculated
as the number of days in an accounting period, such as one month, multiplied by the average
amount of outstanding accounts receivables, with that total then divided by the total amount

of net credit sales during the accounting period. The collection ratio calculation provides the
average number of days it takes a company to receive payment, in other words, to convert
sales into cash. The lower a company's collection ratio, the more efficient its cash flow.
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Reference

The final element of working capital management is inventory management. To operate with
Simulator
maximum efficiency and maintain a comfortably
high level of workingNewsletters
capital, a company has
to carefully balance sufficient inventory on hand to meet customers' needs while avoiding
Advisor capital
Insightsfor a long period of time before it is
unnecessary inventory that ties up working
converted into cash. Companies typically measure how efficiently that balance is maintained
by monitoring the inventory turnover ratio. The inventory turnover ratio, calculated as
revenues divided by inventory cost, reveals how rapidly a company's inventory is being sold
and replenished. A relatively low ratio compared to industry peers indicates inventory levels
are excessively high, while a relatively high ratio indicates the efficiency of inventory ordering
can be improved.

Working Capital
Video Definition
Working Capital

Working
capital
is a measureCAPITAL
of both a company's efficiency and its short-term financial health.
health.
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: WORKING
Working capital is calculated as:
Working Capital Management

Topics

Reference

Working Capital = Current Assets - Current Liabilities


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The working
capital ratio (Current Assets/Current Liabilities) indicates whether a company has
Working
Capital

enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C
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Insights
(working capital). While anything over
2 means
that the company is not investing excess assets.
Working Capital Turnover
Most believe that a ratio between 1.2 and 2.0 is sufficient. Also known as "net working capital".

BREAKING
DOWN 'Working Capital'
Days
Working Capital

If a company's current assets do not exceed its current liabilities,


liabilities, then it may run into trouble
paying back creditors in the short term. The worst-case scenario is bankruptcy
bankruptcy.. A declining
Activity
Ratios
working
capital ratio over a longer time period could also be a red flag that warrants further
analysis. For example, it could be that the company's sales volumes are decreasing and, as a
result, itsRatio
accounts receivables number continues to get smaller and smaller.Working capital
Efficiency
also gives investors an idea of the company's underlying operational efficiency.
efficiency. Money that is
tied up in inventory or money that customers still owe to the company cannot be used to pay
Current
off anyRatio
of the company's obligations. So, if a company is not operating in the most efficient
manner (slow collection), it will show up as an increase in the working capital. This can be seen
by comparing the working capital from one period to another; slow collection may signal an
Days Sales Of Inventory - DSI
underlying problem in the company's operations.
Short
Term
Things
to Remember

If the ratio is less than one then they have negative working capital.
A high working capital ratio isn't always a good thing, it could indicate that they have too
much inventory or they are not investing their excess cash

Gross Working Capital

Ready to take your knowledge of Working Capital to the next level? Read -- The Working Capital
Position and Evaluating A Company's Capital Structure.
Structure.

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Working
Capital
Turnover

Working Capital Management

Working Capital

Video Definition

Working Capital Turnover


Explaining Working Capital Turnover

Days Working Capital

Activity Ratios

Efficiency Ratio

Current Ratio

Days Sales Of Inventory - DSI

Short Term

Working capital turnover is a measurement comparing the depletion of working capital used to

Gross
Capital
fund Working
operations
and purchase inventory, which is then converted into sales revenue for the

company. The working capital turnover ratio is used to analyze the relationship between the
money that funds operations and the sales generated from these operations. For example, a
company with current assets of $10 million and current liabilities of $9 million has $1 million in
working capital, which may be used in fundamental analysis.
analysis.

BREAKING DOWN 'Working Capital Turnover'

The working capital turnover ratio measures how well a company is utilizing its working capital
for supporting a given level of sales. Because working capital is current assets minus current
liabilities, a high turnover ratio shows that management is being very efficient in using a
companys short-term assets and liabilities for supporting sales. In contrast, a low ratio shows
a business is investing in too many accounts receivable (AR) and inventory assets for

supporting its sales. This may lead to an excessive amount of bad debts and obsolete
inventory.
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