What is working capital?

working capital

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When we talk about the concept of working capital, an important and vital aspect of the business world appears before us, as it plays with the strings of success and failure. It is like the blood running through the arteries of companies, as it gives them life and strength to move forward or drags them into the dark abyss, and it is worth noting that understanding it means understanding the essence of financial success. It includes assets that can be converted into cash in a short time and that are used to finance the daily operations of the company, such as inventory, debt, and cash in circulation. As they say, “Money attracts money.” This capital can be the pivotal element that separates successful companies from those that fail. Unable to continue achieving its goals, follow this article with us, in which we will discover this world, learn about its importance, and learn about its fundamental impact on companies and economies.

Definition of working capital

It is a term that refers to a company’s assets that can be converted into cash relatively quickly. It consists of assets that trade frequently in the business cycle and are used to support the company’s daily operations, such as purchasing raw materials and paying salaries, in addition to paying off outstanding debts.

One of the main components of working capital is the company’s ability to manage cash flows and assets efficiently. When a company has sufficient working capital, it can meet its outstanding obligations easily and without disrupting its daily operations; on the contrary, if it is insufficient, the company may face difficulties in repaying debts and financing operational activity. Which negatively affects the sustainability of its operations.

The benefit of knowing working capital

Knowing the working capital in your company has valuable and vital benefits, and these benefits can be summarized as follows:

Providing a satisfactory answer to the question of financial stability

This capital is an important indicator of a company’s financial stability and soundness. It provides detailed information about its ability to meet its current obligations and manage liquidity in the company. It is worth noting that by knowing the size of working capital and how it changes over time, the company’s management can evaluate its financial stability and take the necessary measures if necessary.

Providing indicators about assets and liabilities

It also provides company decision-makers with important indicators about the status of assets and liabilities; it helps them evaluate their ability to finance current activities and meet future obligations; and it is worth noting that by understanding the relationship between assets that can be converted into liquidity and outstanding obligations, decision-makers can make the right decisions and move in the right direction.

Avoid over-reliance on loans and financing.

By understanding the amount of sufficient capital in the company, decision-makers can avoid over-reliance on loans and external financing. This gives them the ability to manage their operations and expansion plans using the resources available within the company instead of depleting them from external sources and incurring additional costs. Thus, financial balance can be achieved and greater financial flexibility can be maintained.

However, we must note that a large amount of working capital is not always a good sign in all cases, as it can simply mean that there are large amounts of inventory that have not yet been sold, that the additional income is not being used enough, or that the benefits of low-cost loans.

Components of working capital

Working capital is an important concept in management accounting, as it reflects the company’s ability to finance its operational activity and maintain its sustainability. Remember that there are several main points that the accountant must take into account when calculating the value of this capital, which can be summarized as follows:

Know the company’s current assets.

First, the accountant must know the company’s current assets, which include cash, accounts receivable, inventory, and any other assets expected to be sold or converted into cash within a period of less than a year.

It is worth noting that this information can be obtained through the company’s balance sheet and annual and monthly accounts reports.

Current liabilities account

The accountant must calculate the company’s current liabilities, including accounts payable, salaries, and taxes due, as well as any other debts due during the year, and remember that these liabilities must be recorded in the company’s balance sheet and accounts reports.

Pay attention to the assets that should be deleted.

Finally, the accountant must be aware of any assets that should be removed from the current assets account. For example, if the company’s supplier does not expect to hold inventory during the year, the value of inventory must be excluded from the list of current assets.

How to preserve capital

Preserving capital is a vital aspect of managing money and financial resources. Here are some key points to help preserve capital in an effective manner:

Determine the maximum loss.

The investor must determine the maximum loss that he can bear in each deal or investment. This requires studying financial assets, analyzing potential risks, and determining the level that the investor will not exceed in order to preserve capital.

Saving and smart investing

You should give priority to saving a portion of your income and allocating it to savings. You can achieve this by setting a personal budget plan and refraining from excessive spending. In addition, you should use the saved money to invest in smart and diverse ways, such as stocks, bonds, and real estate, while making careful analyses of potential assets and diversifying your investment portfolio.

Building human capital

Investing in people by providing nutrition, healthcare, education, jobs, and skills development is an effective way to build human capital. Trained and skilled people can be more productive and able to achieve financial success in the future.

Diversification

Diversification is important in maintaining working capital. By distributing investments across a variety of assets and markets, potential risks can be reduced, achieving better portfolio stability.

Review and evaluate performance.

The investor must review and evaluate the performance of his investments on a regular basis, which includes reviewing the financial return, continuous evaluation of financial assets, and ensuring that they are still consistent with the investment objectives and the acceptable level of risk.

Continuous learning

The investor must be aware of economic and financial developments and trends. By continuing to learn and develop financial knowledge, the investor can make better, smarter decisions regarding capital management.

You must remember that capital preservation is an ongoing process that requires constant interaction and adaptation to economic and financial changes. So you must be prepared to adjust strategies and make appropriate decisions when necessary.

How to calculate working capital

Working capital is calculated in a simple way using the following equation:

Working capital = current assets minus current liabilities.

Current assets include assets that are expected to be converted into cash within a period that usually does not exceed one year, such as cash, short-term receivables, and inventory. As for current liabilities, they include debts and obligations that must be paid within a period that usually does not exceed one year, such as outstanding debts. to suppliers and also short-term debts.

A practical example of capital

Suppose there is a parcel delivery company, “Waslak,” that has 87.1 billion Saudi riyals of current assets, while its current liabilities amount to 38.75 billion Saudi riyals. In this case, we can calculate the working capital of the company as follows:

  • Capital = current assets minus current liabilities.
  • Working capital = 87.1 billion minus 38.75 billion.
  • Capital = 48.35 billion Saudi riyals.

Therefore, after liquidating all current assets and paying all current liabilities, Waslak will have approximately 48.35 billion Saudi riyals in working capital. It is worth noting that this amount represents the resources available to the company to finance its commercial activity and meet its obligations in the future.

Conclusion

In the midst of business and economic development, working capital remains the real engine that drives success and prosperity, and the driving force that enables companies and institutions to achieve sustainable growth and achieve their goals, and when managed effectively and intelligently; This reflects positively on financial liquidity and achieving profits, and remember that the ability to improve capital management is the crucial key to success in the rapidly changing business world, as distinguished institutions become the ones that know how to improve the capital cycle, whether by reducing the period between payments and collecting… debts, or improving inventory and supply management; In this way, companies are prepared to adapt to future challenges and developments that they may face.

 

Managing working capital effectively means making the most of available resources and achieving financial sustainability in the long term. So try Qoyod now, which offers all its customers electronic invoice systems as well as point-of-sale systems, warehouses, customers, etc., which makes it the best accounting program.

 

After knowing what working capital is and its types, try Qoyod now for free for 14 days. To achieve your future success, It is an affordable accounting program.

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