Looking for a way to check how liquid a company is? Have a look at its working capital…

Julie Brownlee, Fsp Invest, 12 Jan. 2015

Tags: working capital, what is working capital, company liquidity, how to calculate working capital, investing,

Some companies did better than others coping with the financial crisis and its knock on effects.

With the South African economy still struggling to get on track, it pays to be cautious when investing in companies. You don’t want to invest just before a company goes bust or encounters severe financial hardship.

So how can you check this?

One way is to have a look at a company’s working capital.

Here’s how to do it and what to watch out for…

What is working capital?

If you’re looking for a way to measure a company’s ability to pay its way, you can look at its working capital. This looks at how liquid a company is.

Working capital is the money that a company needs to carry on with its day-to-day business.

To calculate a company’s working capital, you can use the following equation:

Working capital = Value of current assets – value of current liabilities

Current assets are assets that a company can turn into cash within one year. This includes finished goods, cash and raw materials.

Current liabilities include outstanding supplier invoices, tax and repayments on money borrowed.

How to use working capital to check a company’s liquidity

If you calculate working capital and you find that its current assets are larger than its current liabilities, this means the company has positive working capital.

This is a good sign, but you still need to be cautious. It doesn’t mean that a company can always pay its liabilities when they’re due.

If a company struggles to turn its assets into cash before it can pay its bills, it can still become insolvent.

You’ll also find that some companies operate with a negative working capital. This includes supermarkets.

But with supermarkets and companies like this, they can easily turn their stock into cash before they need to pay their suppliers.

So there you have it, how to check how liquid a company is with working capital.

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