What is the Connection Between Working Capital and Assets?

Working capital and assets are financial items or figures relating to a company’s accounting process. Accounting is the process by which companies keep score of their operations through the recording, reporting, and analyzing of financial transactions. Working capital is a measure of a company’s ability to run efficient operations through the use of current assets and current liabilities. The formula also helps business stakeholders determine a company’s short-term financial health. Investors can use this formula to review whether a company has the ability to remain viable in the near future and avoid using debt for running operations.

The relationship between working capital and assets is seen immediately when looking at the working capital formula, which is current assets minus current liabilities. Current assets are items a company will use in within the next 12 months or accounting period, whichever is longer. These items will include cash and cash equivalents, short-term marketable securities, notes receivable, inventory, and accounts receivable, among other items. These assets represent the items that fluctuate frequently through the course of a business’s lifetime.

Working capital uses current assets because these items are typically seen as the easiest to transfer into cash if necessary. Companies in dire financial situations can cash out marketable securities, sell or return inventory and force collections on accounts receivable customers or factor them to earn some capital. Working capital and assets can also provide an indicator to help business owners and managers track negative working capital trends prior to cashing out current assets to raise capital. An uptick in the company’s current liabilities can also indicate issues between the company’s working capital and assets.

A rise in current liabilities — the second-half of the working capital formula — can result from companies using trade credit or short-term debt to pay for expenses rather than purchasing assets for generating higher sales revenue. Additionally, significant or continual decreases in a company’s current assets can result in cash flow issues and potentially lead to bankruptcy. Business owners and managers typically try to avoid debt so they do not wind up in this situation.

Working capital and assets can also provide information for measuring a company’s operations performance. While working capital can represent a large, positive number, it may be the result of increasing accounts receivable balances. Companies who fail to collect these outstanding balances will be forgoing the cash necessary to run the organization. This creates a strong working capital figure on paper that is not really representative of the company’s cash position without further analysis.