Analysing companies: The ins and outs of working capital

Julie Brownlee, Fsp Invest, 04 Aug. 2015

Tags: working capital, what is working capital, using working capital, analysing shares, investing in shares,

When analysing prospective companies to invest in, one important factor to consider is a company’s financial health. You don’t want to invest in a company that isn’t financially fit.

One way to check out the financial health of a company is to look at its working capital.

So what is working capital? And how can you use it when analysing shares to invest in?

Read on to find out…

What is working capital?

Working capital is a way of measuring a company’s short-term financial health. In other words, it looks at a company’s short-term liquidity.

Working capital is the cash and assets a company has on hand for the day-to-day running of its business. To calculate it, you just subtract a company’s current liabilities from its current assets.

Current assets include cash and assets a company can turn into cash within 12 months. Assets like this include raw materials and finished goods.

A company’s current liabilities include outstanding supplier invoices, tax and repayments of any short-term loans.

How to use working capital

Positive working capital
A company has positive working capital if its current assets are greater than its current liabilities.

But a company with positive working capital may not always be able to meet its liabilities when they’re due for payment. If a company can’t turn its assets into cash before it pays its bills, it could become insolvent.

Negative working capital
A company has negative working capital if its current liabilities are greater than its current assets.

But a company with negative working capital isn’t always a bad thing. It depends on the company. For example, supermarkets always run with negative working capital.

This is down to the way companies like this operate and they can easily turn their stock into cash before they need to pay their suppliers.

So there you have it. The ins and outs of working capital.

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